Should We Privatize Social Security? The Pros and Cons

Privatizing Social Security is controversial—here's what you need to know

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Privatizing Social Security is a hot-button topic that has fallen by the wayside in Washington in recent years, but it's still an issue that comes up when people talk about reforming the system.

What exactly does "privatization" mean? Essentially, it calls for doing away with the notion that the federal government is solely responsible for your retirement payout stream once you opt to claim your benefit. Rather, all, or a portion, of your benefit would be set aside in a separate account controlled by you. This would allow you to make investment decisions that could result in better long-term investment performance and a higher benefit payout than that offered by the federal government.

The trillion-dollar question is: Would it work? Could privatizing Social Security be what saves the program and makes it a better retirement vehicle for retirees? Let's weigh the pros and cons of both sides.

Key Takeaways

  • Generations of Americans have relied on Social Security income to pay for living expenses when they retire, but there's a growing concern that Social Security will run out of money in the future.
  • One proposal is to privative Social Security so people have the freedom to invest some of the Social Security money they are entitled to when they retire, but there are pros and cons.
  • Pros include getting better returns on invested funds and a boost to the economy.
  • Cons include the return on investment still won't be enough for people to live on and the costs to manage privatization would be too high.

Pro: It Could Offer Better Returns

Today, the Social Security trust invests in special-issue bonds. It can invest in public, marketable securities, but as of 2005, it doesn't. This means that the trust invests in itself—all government-issued debt.

As a result, returns tend to significantly underperform the market. Nobody believes that the trust should take on the risk of being in all stocks, but if some portion of a person’s Social Security balance was available for personalized investment, the account holder could choose to take on slightly more risk, according to those in favor of the plan.

Proponents believe that if 401(k) accounts were mandatory for all citizens, more flexibility in how the money is invested creates a higher rate of return. Even a few percentage points higher is a substantial amount of extra income over the years or decades.

Just like most current 401(k)s, citizens could have a list of mutual funds or ETFs to choose from. With the help of a financial professional, citizens could choose a mix of funds that fits their risk profile.

Con: It May Not Boost Retirement Income Much

Opponents of privatization of Social Security argue that the country already has a privatized retirement system that citizens control—it includes the 401(k), IRA, and other tax-advantaged accounts. But with Americans now shockingly behind on retirement savings—48% of Americans 55 years of age and older don't have any retirement savings, according to a 2016 report from the Government Accountability Office—the idea of giving them more control over their retirement money may do very little while risking what they already have.

Although the total investment value of 401(k)s continues to rise, the median value of an account for families was about $60,000 in 2016. If they were to live another 20 years, that’s $3,000 per year before taxes. Add the current average Social Security benefit of approximately $794 per person. That's not exactly a comfortable yearly income.

Pro: It Could Boost the Economy

Proponents argue that by allowing people to invest their Social Security funds in private investments, that could provide a shot in the arm to the American economy and spur growth that could further benefit workers saving for retirement. Social Security is less of an investment program and more of an intergenerational transfer of wealth. By changing it to something more investment-focused, those dollars could be put to work, proponents say.

A potential benefit of Social Security privatization is that it helps boost private savings and therefore increases the pool of capital that can be invested back in the economy.

Con: There Are Better Alternatives

Opponents point out that privatization is not as easy as diverting funds elsewhere. Social Security has liabilities that the current system has to pay, and the earnings that come in from today’s earners help to pay those liabilities. Putting any portion of the trust into private accounts would almost certainly doom the system.

Also, because the Social Security trust invests in the federal government, the administrative costs of the fund are exceedingly low. Recipients aren’t paying the high fees that sometimes come with private, market-based investments. Creating a privatized option means more costs—and the cost is one of the largest sources of lost performance over time.

As an insurance program, its role is to generate safe and stable returns for the life of the person and potentially their families.

Do Americans Support Privatizing Social Security?

The issue hasn't been polled in a while, but in 2005, during the Bush Administration, polls indicated that Americans were fairly divided on privatization. It's hard to say how Americans would feel in the absence of a defined, actionable plan.

What’s clear is that, with 65 million Americans relying on social security, any attempt to make substantive changes to the program should be approached with great caution.