Social Security Primer

Vol. 2, No. 1--Pre-Summit, January 2005

This article comes from the National Committee to Preserve Social Security and Medicare and can be found at www.ncpssm.org.

History of the Social Security Program

Social Security is a lifeline:
In 1935, after bank failures and a stock market crash had wiped out the savings of millions of Americans, the nation turned to Washington to guarantee the elderly a decent income. In those days, only a handful of workers had access to pensions from their employers or through State governmental pension programs. Over half of America's elderly lacked sufficient income to be self-supporting. The Social Security Act was enacted at the urging of President Franklin D. Roosevelt to create a social insurance program that would ensure workers would have a source of income after they retired.

In the decades that have followed, Social Security has become one of the federal government's most popular and essential programs. Despite all our efforts to encourage savings and investment, the private retirement picture has not changed much in recent decades. Even today, barely half of all workers have access to retirement plans at work, and millions reach retirement age without enough private savings to provide an adequate living in retirement. Social Security is still the foundation for most seniors' retirement. Without this critical safety-net program, over half of all older Americans would fall into poverty. More than many other federal programs, Social Security does exactly what it was designed to do--it gives retired people a secure, basic income for as long as they live.

Social Security is flexible:
Over time, Congress has made changes to the Social Security program in order to adjust to changing times. In 1965, for example, the Medicare program was added to provide universal, affordable health care benefits to retirees.

The last major changes to the program came in 1983, when the Social Security program was facing imminent insolvency. At that time, Congress passed a package of changes recommended by the National Commission on Social Security Reform, also known as the Greenspan Commission. Among its major provisions, the amendments accelerated previously scheduled increases in the payroll tax to its current level, began a very slow phase-in of a two-year increase in the retirement age (from age 65 to 67) over a 45 year period of time, covered federal employees for the first time, and enacted a tax on some of the Social Security benefits of higher-income retirees. These changes were intended to prepare Social Security for the anticipated retirements of the baby boom generation and extend the solvency of the Trust Funds for 75 years.

Social Security Benefits

The Social Security system contributes to the well being of Americans by providing a foundation of retirement income that permits seniors to live in dignity, while also providing support to younger family members who may have caregiver responsibilities. In addition to retirement and spousal benefits, workers receive insurance protection that benefits workers and their dependents if the wage earner becomes disabled or dies. In fact, 38 percent of Social Security benefits go to disabled workers, families of retired or disabled workers, and survivors of deceased workers. No other wage-replacement program--public or private--offers the protection Americans receive from the Social Security program.

At the end of 2003, 47 million people were receiving Social Security benefits: 33 million retired workers and their dependents, 7 million survivors of deceased workers, and 8 million disabled workers and their families. During the year, an estimated 154 million people had earnings covered by Social Security and paid payroll taxes.

To qualify for retirement benefits, a typical worker must have earned 40 Social Security credits, which usually requires 10 years of work. Contributions are made through payroll taxes, divided between workers and their employers. Employees pay 6.2 percent of their incomes (up to a ceiling of $87,900 in 2004), with employers contributing another 6.2 percent. Self-employed workers pay 12.4 percent of their income, all subject to the same ceiling.

Social Security benefits are based on the amounts earned during the worker's employment, adjusted to make sure that the benefit keeps up with the overall growth in wages in the economy during the employee's working years. Adjustments are also made to give a higher proportionate benefit to low-income workers. This feature is particularly important to women, who typically earn less than men over their lifetimes. Initial benefits are increased each year through cost of living adjustments (COLAs) to keep up with inflation after retirement.

In 2004, the average monthly retirement benefit for a man is $1,040 and for a woman just under $800. Disabled workers average $860 monthly, while the benefit for a young widow or widower with children averages $1,835 per month. The value of the life insurance provided to survivors through Social Security is over $400,000, and the value of disability protection for a young disabled worker with a spouse and 2 children is over $350,000.

Social Security's Finances

When working Americans pay their Social Security payroll taxes to the United States Treasury, those taxes are credited to the Social Security Trust fund. Most of those taxes are paid out monthly in Social Security benefits. Money left over is credited to the trust fund and invested in U.S. Treasury bonds called "special issue" U.S. securities. These securities earn interest that is also credited to the trust funds. These obligations--or debt--owed to the trust fund by the Treasury are recognized by Congress as part of the national debt. On a regular basis, Congress authorizes that debt, along with all the other debt of the United States, when legislators raise the national debt ceiling.

Total income to the Social Security Trust Fund from payroll taxes in 2003 was $632 billion and benefits paid totaled $471 billion, resulting in a surplus of $161 billion. The Trust Funds were credited with $85 billion in interest from earnings, which represented an effective annual rate of return of 6%. Surpluses over the past two decades built up the assets in the trust funds to over $1.5 trillion by the beginning of 2004. These surpluses will continue for the next decade, increasing the asset amount to almost $3.6 trillion by 2013.

Every year, Social Security's actuaries estimate the program's long-term finances under a variety of economic assumptions for the next 75 years. The Trustees currently project that Social Security's surpluses will end by the year 2018. At that point, first the interest income credited to the trust funds and later the bonds themselves, will have to be made available to cover a portion of the cost of benefits, rather than being used to cover other federal expenditures.

By 2042--almost 40 years from today--the assets saved up in the trust funds are projected to be exhausted, and only incoming payroll tax revenues will be available to pay benefits. This income is expected to be enough to pay over 70% of the promised benefits. While this shortfall poses a challenge, it in no way constitutes a crisis.

The Importance of Social Insurance

Social Security was never intended to be an investment program:
Instead, it is a contributory social insurance program, designed to protect workers and their families from loss of income due to death, disability or retirement.* Social Security is not a needs-based program. Rather, it is a true entitlement program in which people earn the right to participate by working and contributing.

Unlike private retirement plans, Social Security has broader policy goals than merely providing retirement benefits. Social Security was also established to protect our most vulnerable citizens from falling into poverty, raise the standard of living for lower-income workers, and provide financial security to the spouses and dependent children in the event of a worker's disability or death.

Under Social Security all workers contribute to a universal pool of funds from which benefits are paid. Social Security financing is shared equally by employer and employee, is portable from job to job, provides inflation-adjusted benefits, and covers all earnings over a working lifetime up to the taxable wage base. The benefit formula is weighted in favor of workers with lower average lifetime earnings.

What Social Security means for seniors

Social Security is the cornerstone of retirement:
From the program's beginning, it was intended to be a base of protection, supplemented by private pensions and savings, not an individual's sole source of retirement income. Today, nine out of ten people over age 65 receive Social Security benefits. Two out of every three Social Security beneficiaries receive over half of their income from Social Security, and it's the only source of income for nearly one-in-five seniors. Without Social Security, most older Americans would live in poverty.

Unlike virtually any other program, Social Security protects retirees from the ravages of inflation. Seniors are more sensitive to increases in living costs because they are no longer collecting paychecks--they are forced to rely heavily on their savings and Social Security to keep up with their expenses. Social Security has a built-in cost-of-living adjustment (COLA) so that inflation does not erode the value of their benefits over time. While these increases lag behind some expenses like the skyrocketing cost of health care, they do help keep seniors from falling further behind. And unlike private investments, they do it without putting the senior at any financial risk.

Social Security is particularly important to women

Women live longer than men:
Statistics tell us that--on average--women today who reach age 65 outlive men by four years. That is, women can expect to live to age 85, while men are likely to live to age 81. The difference in life expectancy between men and women is even larger for those under age 65. And nearly three out of every four people age 85 or older are women. The evidence of women's longevity is all around us--nursing homes are predominately filled with women.

Women earn smaller paychecks than men:
Women who are employed full-time earn 25% less than men. They are also more likely to have low-wage and part-time jobs than men.

Women have more years out of the workforce than men:
Women are more likely than men to take time completely out of the workforce to raise children or take care of elderly parents. The typical woman is in the workforce for 32 years, compared to 44 years for men. The shorter work history combined with lower wages means that the lifetime earnings for women are lower than for men.

Social Security is the only program that is designed to protect workers with lower lifetime earnings and non-earning years. When determining retirement benefits, more credit is given for the first dollars of a worker's average lifetime earnings than for higher levels of earnings, thus creating a bias in favor of the lower-wage worker. Workers are also hurt less by years with no earnings because benefit amounts are based on a worker's highest 35 years of wages.

Women are less likely to have pensions and other savings:
According to the Institute for Women's Policy Research, only 38% of women today participate in an employer pension plan, compared with 51% of men. Moreover, when a woman does have a pension, it is likely to be smaller than a man's, for precisely the same reasons that their Social Security benefits are likely to be lower than a man's--they have lower lifetime earnings and are more likely to work in jobs that don't offer pensions. In the case of pensions, however, there's no built-in system that improves the benefit relative to earnings for lower wage-earners as there is in Social Security, leaving women without that important protection. Among today's retirees, the average private pension benefit for women is less than half the amount it is for men.

Social Security is more than just a retirement plan

Social Security means life insurance for workers and their families:
One in seven Americans will die before reaching age 67. Many workers do not have life insurance to protect their families from the loss of the earnings of their primary breadwinner. What workers may not realize is that their payroll taxes entitle their families to survivor's benefits, providing life insurance protection worth over $400,000.

Social Security means disability insurance for workers and their families:
Three out of ten of today's 20-year-olds will become disabled before reaching age 67. Yet 75% of the private sector workforce has no long-term disability insurance. Individuals with a prior history of medical problems or who work in industries with a high rate of injury frequently find it prohibitively expensive or impossible to obtain coverage. Many workers don't realize their payroll taxes are also buying them this critical protection. For a young disabled worker with a spouse and two children, the disability insurance value of the benefit they get through Social Security is over $350,000. And, unlike private disability policies and annuities, Social Security benefits are increased annually to keep up with the cost of living. This protection is particularly valuable in times of double-digit inflation such as we experienced in the late 1970's and early 1980's.

The Drive to Privatize Social Security

Despite the 65-plus years of success Social Security has enjoyed, some individuals and organizations, including President Bush and several members of Congress, are promoting the concept of replacing all or part of the current Social Security program with a system of individual retirement accounts. Although these proposals vary, most would divert funds from Social Security into individually-owned accounts, thus transferring investment risks from a pool of all workers to the individual. While individual accounts are often presented as a way to "save" Social Security, diverting money to individual accounts actually worsens Social Security's long-term projected shortfall.

Privatizing Social Security takes money out of the Trust Fund:
What those who promote privatization want to do is take money out of Social Security and have people invest instead in Wall Street. They promote their plans by telling people they will have their own individual investment accounts to save for their retirement. But what they often fail to say is that they finance these investment accounts by taking money out of the current Social Security system.

Because so much of the money workers pay into Social Security is used to pay benefits for current retirees, the disabled, their family members and survivors, money diverted from the trust funds will need to be replaced to keep existing benefits from being reduced. One proposal to divert two percentage points of payroll from Social Security into individual accounts would cost about $1 trillion over the next decade. Complete privatization could cost as much as $9 trillion. If Social Security is privatized, taxes would have to be increased significantly, massive new government debt would be incurred, or guaranteed benefits dramatically scaled back.

To avoid increasing taxes or reducing benefits, some of those promoting privatization are counting on the general Treasury of the United States to make up the difference. Or in other words, they would require every taxpaying American to pay twice to finance this risky experiment--once through their payroll taxes and again through income tax increases to pay off the extra borrowing. The alternative is to pass even more debt along to our children and grandchildren.

In return for paying these transition costs, future retirees would be guaranteed lower base benefits than under current law. The base benefit would be supplemented by the proceeds of the individual accounts, which may or may not be adequate to provide reasonable benefit levels throughout that worker's retirement. Indeed, several studies suggest that even with the proceeds of the individual accounts, many workers will face retirement with fewer assets. In fact, a 1998 study, conducted by noted economist John Mueller and commissioned by the National Committee, concluded that once the transition costs are factored in, nearly everyone alive today would face retirement with fewer benefits under a partially or totally privatized system.

Privatizing Social Security is bad for people in or nearing retirement:
No matter how much privatization promoters may claim that their schemes won't impact current or near retirees, the truth is that diverting payroll taxes from the trust fund places everyone's benefits at risk. Simply said: Social Security will run out of money faster if the program is privatized. Under one plan (by Peter Ferrara), so much money would be taken out of the Trust Fund that it would be empty in 10 or 12 years (by 2015).

Privatization turns Social Security from a guarantee into a gamble:
Privatization places the entire risk of having a decent retirement income on the individual, instead of spreading risk throughout the workforce as Social Security currently does. Even relatively safe investments, such as state or local government bonds, are subject to potentially significant risk for an individual investor. Stock markets can go both up and down, and relying on private accounts means people will have to carefully time their retirement to avoid the bad years. Unfortunately, many people learned this lesson the hard way during the most recent market downturn. From 1999 to 2003, the value of 401(k) accounts owned by people near retirement dropped by an average of 25%. This caused millions to keep working years longer than they had originally planned to make up the difference. Placing Social Security savings into these same Wall Street accounts magnifies the risk many times over.

The report by John Mueller also showed that low-income workers, one-income families, women and minorities--all of whom benefit from Social Security's progressive benefit structure--would stand to lose the most from privatization. Since they would have less to invest than high-earners, even a high rate of return would not enable their savings to accrue at the same rate as that of the higher-income individuals, and they could be devastated by high administrative fees and bad or overly cautious investment decisions. Due to the combination of lower lifetime earnings and longer life expectancies, women would be especially at risk of outliving their private accounts.

No one has a crystal ball into the future:
Even those who time their retirement carefully can't foresee what will happen in the stock market after they've already left the workforce. If the market drops after a worker has retired, he or she could see the value of their assets drop, leaving them with significantly less income than they had planned to live on in retirement. Shifting savings into bonds and other types of more "secure" investments poses its own risks if earnings fall behind the rate of inflation. The biggest variable of all, of course, is how long a person is going to live. Those who guess wrong in a privatized world could easily outlive their assets. And while workers can purchase an annuity to avoid that risk, it will cost money that will reduce their nest eggs. Lifetime annuities are among the most expensive insurance products to buy, precisely because they do guarantee a lifetime income, no matter how long a person lives. Social Security does that already, and at no extra cost to retirees.

Private accounts will cost more to run:
Advocates of privatization assume that a privatized retirement system would be more efficient and cost effective than a government managed program. But in reality, Social Security's administrative costs are very low, at less than one percent of income revenues. In comparison, the Chilean system, which often is cited as a model for privatizing Social Security, has average administrative costs of about 13 percent of worker contributions. In Great Britain, administrative costs consume up to 20 percent of contributions.

Unlike private accounts, Social Security has no hidden fees or extra charges that can deceive workers and divert money needed for their retirement. The newspapers are filled with stories about Wall Street investors playing fast and loose with people's money, even in supposedly "safe" mutual funds. Special deals abound, and practices such as market timing put money in the pockets of speculators at the expense of long-term investors. Placing trillions of dollars more at the mercy of these industry practices, with little ability to effectively monitor how they're treating worker's money, is a disaster waiting to happen.

Our Position
The National Committee to Preserve Social Security and Medicare strongly opposes shifting payroll taxes into private accounts. We believe the Social Security program provides valuable benefits to both retirees and younger workers. The program must meet the challenge presented by the coming retirement of the baby boom generation, but we have met similar challenges in the past without dismantling the program or undermining its guarantees. Social Security gives the American people a secure, basic income that lasts as long as they live. We are pledged to preserve it for all generations.

Department of Policy Research, May, 2004

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