Many retirees who have reduced spending power because of depleted 401(k) accounts are thankful that President Bush's plan to partially privatize Social Security was never realized. But the debate over personal Social Security accounts rages on.
The success of private retirement accounts is dependent on the amount a worker contributes, the investment strategy, and the unpredictable whim of the market. Workers who contribute more and get better returns will have more retirement income than those who tuck away less and achieve smaller gains. Social Security benefits, on the other hand, depend on lifetime wages and the age at which benefits are claimed. Workers who retire at the same age with the same earning record generally receive similar benefit amounts regardless of the year in which they claim benefits and the ups and downs in the financial markets.
Two economists recently published papers reaching opposite conclusions about private Social Security accounts. Gary Burtless, a senior fellow at the Brookings Institution, argues that only a few investors could obtain significantly higher returns if the system were partly or fully privatized. According to his calculations:
"Individual retirement accounts invested solely in the stock market offer a very shaky cornerstone for retirement income. Workers fortunate enough to retire when stock prices are high obtain big pensions, while workers with the bad luck to retire after markets plunge can be left with little money to live on in retirement...Social Security pensions have been far more predictable and have varied within a much narrower range. For that reason, traditional Social Security provides a more predictable basis for retirement planning and a much more reliable foundation for basic retirement income."
Andrew Biggs, a resident scholar at American Enterprise Institute, however, calculates in his paper that personal investment accounts would still have done well, even given the market's recent losses.
"Even workers retiring today would have increased their Social Security benefits by choosing a personal account. Despite the ups and downs of the stock market, every single group of retirees would have increased their benefits by investing in personal accounts. Total benefits would have increased by between 6 and 23 percent, with an average increase of 15 percent. The point here is not that stock investments are a free lunch. In an efficient market, the higher returns paid to stocks are nothing more than compensation for their higher risk, and we do not know that future market returns will be as good as those in the past. But accounts do provide a valuable tool to pre-fund future retirement benefits and reduce cost burdens on tomorrow's workers."
Both researchers assumed that workers contributed 4 percent of wages to the private accounts and that the account balance would be converted to a monthly annuity benefit at retirement, and both used historical stock and bond return data from the past century to reach their seemingly conflicting conclusions.
A major difference between the two papers was the investment strategies tested. Biggs made his calculations assuming investors would chose a life-cycle portfolio that would shift from holding 85 percent stocks through age 29 to only 15 percent stocks by age 55. Burtless calculated how much income private accounts would replace using three different conditions: a 100 percent stock investment strategy (which produced the highest returns), a portfolio composed of 50 percent stocks and 50 percent bonds, and a conservative 100 percent government-bond strategy.
Tell us, would you like a private Social Security account, or do you prefer guaranteed Social Security benefits?