This is a topic I am very interested in. Here are a few brief points that may be helpful to anyone trying to understand Social Security and its current problems.
1) The actuarial soundness of the system remains intact. The actuaries say that some small adjustments are needed now to adjust for changing demographics. This can be some combination of a slight increase in monthly contribution, moving the income limit up a bit, moving the retirement age up a few years, or reducing benefits. If these adjustments are made now, the system will be sound for the foreseeable future. The adjustments needed will be minor, however, only if timely implemented. They must not be delayed.
2) Social security is not a Ponzi scheme. It is a well-planned and well-administered defined benefit plan. There really is a Social Security trust fund and it is 100% invested in securities issued by the U.S. government.
3) Social security has the advantage of shared risk. Private, defined contribution plans lack this feature. Under Social Security, those who die relatively young subsidize those who live relatively long. You can not exhaust your social security benefits.
4) Social security has the disadvantage that when you die there is no residual to pass on to heirs, whereas with private defined contribution plans there is at least some possibility of passing on residual to heirs.
5) Social security automatically includes both disability and survivor benefits. These must be purchased separately in the case of private, defined contribution plans.
6) Both Social Security and private plans have risk of default. The risk is generally less with social security, however, because governments have the power to tax and to create money. The primary risk for social security is that when it comes time for the Trust Fund to redeem its securities, the government may have insufficient resources to pay what is owed to the Fund. The government will then have to borrow. This could lead to inflation should all or part of the additional debt end up being monetized.
7) Besides default risk, private 401K, and similar plans, if invested in equities as opposed to bonds that will only be redeemed at maturity, have volatility risk. When funds are needed they may not be there, and there is no way to know many years in advance when the market will be up and when it will be down.
8) Historically, private, defined contribution plans have had the advantage of greater total return on invested capital, especially when compounded. Whether future returns of private plans will be sufficient to compensate for lack of a shared risk feature cannot be known in advance. This is an additional risk borne by private retirement plans.
9) Because of Social Security's shared risk feature, one contributes, on average, less per month to Social Security than to a defined contribution plan to guarantee a given monthly benefit that cannot be outlived. This is perhaps the single most important feature that distinguishes Social Security from private defined contribution plans. An essential aspect is that someone at the low end of the wage scale is able to afford a defined-benefit, shared-risk retirement plan, whereas they would have insufficient resources to afford a non-shared-risk plan whose benefits they could not outlive.
10) There are many special interests in the U.S. securities business that would benefit from social security being phased out in favor of private, defined contribution plans. These interests are behind intense lobbying and misinformation campaigns aimed at discrediting the U.S. Social Security System. So far, they have been quite effective, as many people believe wrongly that they are wasting their money when they contribute to social security, and that there won't be enough money to pay the benefits they are entitled to. Those same people seldom are aware of the risks and costs associated with private defined contribution plans. One only has to consider how unlikely it is that someone of limited education and financial knowledge would invest their retirement funds wisely and how easily misled they could be by not disinterested parties, to recognize how unwise it would be to convert everyone to individual, self-directed, defined contribution plans.
11) There is de facto inflation protection built into defined contribution plans in the early accumulation years, because inflation is one of the main drivers of the stock market. This inflation "adjustment" may be lost as assets are converted to fixed income instruments at retirement, depending on investment skill. Social Security however has actuarial inclusion of an inflation adjustment so that benefits after retirement are periodically adjusted for increases in the cost of living. (In more recent years the method of calculating cost of living has been altered several times. The effect has been to slightly underestimate the real cost of living increase.)
12) Upon retirement, U.S. citizens can depend on their base needs being met by Social Security. In addition, many U.S. citizens have sufficient disposable income to contribute to a supplemental defined contribution plan such as a 401K, 403b, Roth IRA, etc, and some may elect to purchase an annuity. It would be disastrous, however, for those at the low end of the wage scale not to have a low-cost, shared-risk plan available to them. Furthermore, even if it were possible for the middle class to opt out of social security it would be most unwise. Only the wealthy can afford the risks and costs of relying solely on a private defined contribution plan. Their contribution to the social security risk pool is important nevertheless, as social security depends on very broad participation to be efficient and effective.
One last point. You will often see Medicare and Social Security discussed together as "problem government entitlement programs," and so to imply that both programs are a hopeless mess. This is clearly wrong. Compared to Medicare and Medical costs in general, the problems of Social Security are trivial. One gets the idea, however, that there is a segment of the population, and thus of congress, that is philosophically opposed to the very idea of Social Security. And most certainly there are those in the securities business that would like nothing better than to see Social Security done away with. Perhaps these are the reasons why something so readily fixed has not been. It is clearly time to fix Social Security and move on to more weighty problems.
(although it's still poverty levels as is)
