The U.S. Social Security old age pension system has become the model for the entire Western developed World. It is not, of course, a Ponzi scheme. Every congressman and senator should be required to take a course in how social security is designed to work, as many obviously don't understand it. The system is based on actuarial computation using the principle of shared risk.
You will often hear such ridiculous statements as there are too few current workers to support those already retired. This is absurd. It does not matter how few current workers there are!, because current workers do not support retired workers. It only appears that they do to those who do not understand that social security dollars just collected and those in the 2+ Trillion trust fund are fungible. Thus paying pensions from current receipts is equivalent to paying pensions from trust redemptions and putting current receipts into the Trust.
What's meant, or should be, when you read or hear someone say that there are not enough current workers to support retirees is that the contribution rate is too low to keep the system sound and must be increased. More about that later.
Social security dollars are off budget and, by statute, can not be used for any other purpose. However there are ways that Congress can indirectly dip into the Social Security funds.
Fundamentally, social security works like this. A very large pool of people deposit monthly into a fund invested in U.S. Special Treasury Bonds. (These bonds are like other Treasury bonds in that they are backed by the full faith and credit of the United States except in one respect. Unlike regular Treasury bonds, with fixed maturities, the special bonds, designed by the Treasury specifically for the S.S. Trust may be redeemed for their face value plus accrued interest at any time.) Then when you reach retirement age, your draw a perpetual pension based on your contributions. If you exit the system before you reach that age, or if you die before you have exhausted your own contributions plus interest, you leave the residual in the system.
Your S.S. pension, is a defined benefit pension. Currently your pension is based on your 35 highest earning years. The formula used to compute pensions gives more weight to early contributions than more recent ones. The formula also skews the ROI in favor of lower wage workers. Although all pensioners enjoy a positive average ROI, those at the bottom enjoy a very healthy average ROI of around 8%. Those at the top receive a much smaller ROI. There is partial compensation for this which we will go into later. (Go to social.security.gov to see a simplified formula that closely approximates the actual formula that is used to compute pensions.)
To understand why the U.S. Social Security system has been so widely emulated, it is necessary to understand what its great advantages are for a major fraction of the population, and what trade offs must be made to achieve these advantages.
Consider first defined contribution plans, 401K,403b plans and IRAs would be examples. In some of these plans employees and employers both contribute in various ratios. The employer contribution is owned by the employee after the vesting period, and the employee always owns their own contributions. When the employee eventually retires they will have a combination of social security pension plus periodic withdrawals from their defined contribution plans to live on.
Assuming one has socked away enough in their defined contribution plans they will have a well funded retirement. They can not outlive their S.S. pension, but they could outlive their defined contribution plan. This will depend on how much they have chosen to set aside in their plan, how wisely the money is invested, and how rapidly they draw down the balance after retirement. In other words, with defined contribution plans, an individual assumes the entire risk of running out of money. On the other hand, if one dies before exhausting all of their defined contribution funds, then the residual is passed to heirs. With Social Security there is no possibility of outliving one's pension, but there is also no possibility of leaving an estate of unused contributions and earnings. This is then one of the trade-offs between social security and a defined contribution plan. But this is not the most important trade off, and the one that makes social security so valuable to society. (see below)
What I have just described is the ideal retirement situation of a carefully crafted defined contribution plan, backstopped and augmented with social security-- excepting of course for those who have lived their entire lives on unearned income from inherited wealth and therefore have no need for either social security or defined contribution plans.
Unfortunately we generally don't have a very reliable estimate of how long we will live until long after it is too late to adjust our retirement contributions. Once we're retired, we can only adjust the withdrawal rate. And we may, during our working years, find ourselves in a situation where we simply can not afford to sock enough away in defined contribution plans to guarantee a comfortable retirement into advanced old age.
Although the upper middle class can generally look forward to pleasant retirement from defined contribution plans backstopped by social security, consider the lower half of the middle class and the working poor -- essentially Romney's 47%. Practically speaking, the folks who find themselves in this economic stratus do not have enough income to adequately fund a defined contribution retirement plan on top of Social Security. If their employer doesn't do it for them, without social security, or a family to fall back on, they are going to be destitute in their old age.
Here is where social security, and the genius of its design is most needed and its impact is most evident. Because of social securities shared risk feature, wherein those who die at an actuarial young age, or otherwise leave the system, abandon their contribution and its earnings to the system, and to the benefit of others who live an actuarial longer than average life, those of meager means can afford the much smaller monthly contribution vis-à-vis that required by a defined contribution plan to guarantee an equivalent pension that can not be outlived. Without this shared risk feature, it would be impossible for lower income workers to set aside enough of their earnings in a defined contribution plan to guarantee a pension equivalent to social security's; a pension that can not be outlived! To work its "magic" in the most efficient and actuarial safe way, the pool of risk sharing must be as large as possible. It is folly to allow some to opt out, and equally so to even contemplate privatizing, partially or wholly, the Social Security old edge pension system. This would eventually bring the entire system down.
What are the problems then? Then main problem is relentless pressure from Wall Street. Investment bankers, for self-serving purposes, are leading an immoral war against Social Security and are the source of many myths, and unfounded accusations. There are those in Congress who intentionally, there can be no other explanation, drag their heels when the Trustees ask for small increases in the contribution rate called for by the actuaries. They do this knowing full well that to ignore these requests year after year weakens the system. We must turn those in Washington working against the well-being and stability of our nation out of office.
One must guard against speaking of the Old Age and Survivors Benefit Trust, the Disability Trust, and the Medicare trust as though they are one and the same. They are not. And the difficulties faced by these separate Trusts are quite different. The pension trust will remain sound indefinitely so long as the Trustees recommendations are timely followed. Just raising the cap would be the best way to solve current problems with regard to the long range soundness of pension trust. Even then, those whose income is above the cap would still, on average, recover their contributions with ROI that would keep them at least even with official inflation.
Earlier I mentioned that those at the top end are at least partially compensated for their lower ROI. This is because they live statistically longer on average then the lower middle class and the poor, and this is well established. Those at the top, on average, draw their social security pensions for more years.
