The Hidden Wealth in Social Security II --
$2,300,000 at Age 62 on Retirement

        The original Social Security program was designed 65 years ago in 1937. But it was fatally flawed because it did not adequately anticipate future rates of inflation or life expectancy. In 1937, CPI averaged 1.4% per year over the previous 25 years. Since then, it has averaged 4.0% per year. Life expectancy then was 60 years. Today it is 77. Any remedy to the present retirement system must comprehend and solve the unpleasant unpredictability of both these factors.

        What should be done? Abolishing the present system is the best solution to its problems and transitioning to a new, privatized plan as the old one is phased out. In the new plan, stocks will be safer than Treasury bonds in a pension-fund setting. It will cost remarkably less than the old. Life expectancy will not matter nor will the rate of inflation. Expansion of benefits will be possible. The ratio of the number of workers to retirees will not matter. Each retiree's account will support his or her own retirement per ipse without respect to the presence or absence of other workers. Further, the Treasury will be relieved permanently of an ever growing, ever taxing, ever losing proposition.

        The present hue and cry about Enron and stock dangers to retirement systems are not relevant, nor the recent collapse of NASDAQ, nor presumed other risks, nor quarterly, annual, 3-, 5-, and 10-year performance reports, as we shall see.

        Two tasks must be undertaken now. First, the problem of the present system, namely, the inadequacy of trust-fund assets to pay promised benefits to future beneficiaries under present law, is well known and must be promptly addressed and solved. There will be no money left after 2039 according to middle-of-the-road assumptions by Office of the Chief Actuary.

        The second task is to plan, legislate, and implement the new system--Social Security II. Upon maturity it will never put the budget under strain again nor expose other spending programs to risk of cuts. The transition will take 70 to 80 years. The requirements of these two tasks are entirely different. Therefore they should and must be kept independent. The second can and will reduce future Federal outlays to zero to pay for social-security retirement benefits. It will also provide materially higher payments to retirees at an earlier age than current law permits. This will require moderate transitional funding until the new plan becomes self-funding and continuously self-sustaining.

        Three considerations are intrinsic to abolishing the old and starting the new. The first is, what are the measurable obligations of the old plan and its related cash flows? Actuarial accounting provides the answers. The second consideration, more difficult, relates to fiscal policy and politics. This new funding is not currently planned for, but it will be self-reducing as mortality affects the old plan and funding and contributions build the new. A temporary reordering of tax-spending priorities must take place to accommodate the transition mandated in these two bills. This obviously requires some political trade-offs, but it can be accomplished. The third consideration is packaging and presenting the overall plan and its benefits to the media and the public to gather maximum political support for enthusiastic endorsement by congressional sponsors and the president.

        Much can be said of Social Security II, but it is not necessary to overburden this text with all of that. The basic logic line is brief and easy to follow. Start with the typical duration of a working-life span. It is roughly 40 years, say from age 20 to age 60. This may vary somewhat depending on type of work, profession, age of entry, and personal disposition, but 40 is ideal to demonstrate the concept, provide validation, and become the template for Social Security II.

        When the worker retires at age 60 or 62, his or her investments no longer accumulate but commence disbursal. Thus the investment life-to-maturity of a pension plan is 40 years. In the remaining 20 years, or so, to mortality, the plan pays benefits to the retiree then vests to his family. Therefore, 40 years is the singular and exclusive span over which to consider returns from investments. The popularized mutual-fund reporting periods of quarterly, annual, triennial, decennial, and so on, are inappropriate and irrelevant. Social Security II annual 'Wealth Reports' to participants will show the sum of the cumulated fractional values of total returns on contributions through the date of the report.

        Since 1871 in the U.S., all 40-year periods (there were 89) have produced average accumulated terminal wealth of $465 for stocks and $108 for Treasury bonds after investing $1 each year in each asset class for 40 years, giving stocks more than four times the retirement advantage over bonds. Neither stocks nor bonds suffered any terminal wealth loss in any period. But bonds have cumulated real losses in final buying-power dollars several times since 1911. Stocks did not. The worst final buying-power index in constant dollars for stocks was 50.3. For bonds, it was negative 46.1. You could only buy 46% less goods and services when you retired for all the money you put into Social Security over a lifetime of work. Treasury bonds are no match for stocks.

        A simple but demonstrative example illuminates the vast riches available from stocks. A young person earning $30,000 a year today will have a final paycheck of close to $100,000 forty years from now due to inflation (3% yearly). If you freeze social-security deductions at today's tax rate of 12.4%, this wage earner will have $2,300,000/ in personal assets on the first day of his or her retirement based on the average 40-year-period return from stocks since 1871 excluding the three best years in that record. (The comparable figure for Treasury bonds is $396,000.)

        In a fixed investment with a 5% return at retirement, annual income will be $115,000 (incentive for early retirement!). Actual benefits will vary with the value of cumulated assets. The probability of final wealth greater than $1,100,000 is 85%. At this level, benefits would be 55% of final pay, but with full ownership of the assets vs. 33.2% of final pay and no claim on any assets under current law.

        As to the question, to whom do these assets belong, the answer is 100% to each individual worker in a private account. Can the plan fail? Anything can. But the best probable answer is, No. Social Security II, after it gets traction, will become entirely self-funding and self-sustaining on the individual level and massively self-adjusting on the economic, standard-of-living, and investment-return levels. Will there be differences in benefit levels among annual cohorts? Yes, the annual variances will be large and psychologically unacceptable but readily tractable to actuarial smoothing. Will not the plan cost more to administer? Yes, but not much--at the most an extra 0.16%, more likely 0.06%, or less, per year. Added to the currently existing administration expense, total annual cost will be less than 0.4%. This will cause no raise in current taxes. Growth projections in the paragraphs above are based on net 12% of payroll.

        This fixed-contribution level should be carried forward as a ceiling. Based on the historic examples above, the average worker retiring in the future under Social Security II will have abundant personal wealth in his or her own Government-sponsored individual, private, investment account to enjoy the entitlements of retired old age.

        Are you saying that each employee will control his or her own investments? Yes, but within limited choices as to 'enrolled' investment managers (similar to ERISA's enrolled actuaries). In turn, these managers would be specialists in and limited to investments in a few broad or very broad common-stock indexes, not individual securities. It is indeed unlikely that a well informed workforce will choose anything but equities, nevertheless each participant will have the asset choice of 100% in Treasury bonds or stocks or a set balance between the two.

        Other questions remain. Among them, what will be the impact on the capital markets, especially on the equities markets when demographic shifts begin to mature and end? A general answer is, there will be large-scale changes, but mostly gradual and mutually offsetting, with each phase change having its own self-corrective free-market adjustments until equilibrium is reached--continuously.

        All the details are manageable. The important thing is to restore a layer of self-determination to the American worker with a secure safety net beneath him or her to prevent mortal financial damage during retirement years and to remove the Nation from the fiscal/political quicksand of too costly social promises or not enough money for them when intermittently needed.

        There is an added advantage. Social Security II makes equity ownership in America universal.

        And think of the effect this will have on U.S. productivity when coupled with optional retirement whenever each individual's wealth is sufficient to fund his or her personal retirement at 100% of final pay.

stocks and stock market timing best profits in the U.S.

                        $3,500,000 projected as of 3Q 2004

based on median wage $32,864

Click chart showing Real Returns Stocks and Treasury Bonds, smoothed version, and enlarged version to show Bonds' real negative returns after inflation

Milton Friedman called the previous article upon which this one is based "fascinating and the conclusion suggested by (the) calculations striking. . . a very informative set of calculations." Click here for Complete Previous Article with sources, notes, and tables that underlie the historic examples used here

Written by 'Copernicus'
January 12-March 24, 2002
(paragraph 2 amended March 4, 2003)
Orlando, Florida, U.S.A.
--1476 words--

Note. If you agree that what you have read here is reasonable (based on the historic record since 1911), then write to your U.S. Senator, Representative, and the President at once. Send an email to each telling them that you actively support their sponsorship of this solution in what they may want to call the "Employee Retirement Wealth Act of 2004." And your voting friends and neighbors support the bill too. Select and copy the URL of this page in the address-bar window above and paste it into your message.

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