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Could This Be a Low-Cost Fix
for Social Security?
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Social Security is in financial trouble
• Social Security’s Trust Funds are on track to empty in 2033. If nothing changes, that will force benefits to be cut by about 23%.
• An average retiree currently gets $1,328 per month. With a 23% cut, that will become an inflation-adjusted $1,022.56.
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Source: Social Security 2014 Trustees Report
Over the long haul, the costs are staggering
• $10.6 trillion through 2088.
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All hope is not lost
Charts excerpted from Social Security
Despite the challenges, Social Security still has a lot going for it:• Its Trust Funds have nearly $2.8 trillion in them• Its tax and investment income brought in nearly $0.9 trillion last year
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So why is there a problem?
Social Security’s Trust Funds are invested very conservatively:• The Trust Funds are entirely in US Treasury bonds• Their rate of return is abysmal – about 3.5%• The investments choose “absolute” certainty over return potential
This is an issue because:• Social Security has a substantial annual inflow from taxes that can
handle most of its benefit payments. It doesn’t need all its assets in ‘high certainty’ investments to make near term payments.
• Social Security’s payment structure includes an annual inflation adjustment, which generally increases payments each year. It needs a higher rate of return to compensate for those higher costs.
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What could be done better?
If Social Security’s Trust Funds were invested like a well-managed traditional pension plan, its funding pressure would be reduced.
• Current year’s payments would be paid via tax revenues, cash, and maturing bonds – virtually identical to the current process.
• Next few years’ payments would have a “bond ladder” reserve to cover the expected shortfall from taxes not covering benefits.
• Longer term reserves would be invested in a low-cost broad stock market index such as Vanguard’s Total US Stock ETF (NYSEMKT: VTI).
• The bond ladder reserved would be replenished from interest payments, dividend payments, and liquidating portions of the stock market index investment, as needed.
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What’s a Bond Ladder?
Source: pixabay.com
Cash 6-12 months of
expenses
Bonds6-10 years of
expenses
StocksEverything else
A bond ladder is a portfolio structure that holds:• Cash for short term needs,
• Bonds that mature each year for the next several years to replace that cash as it gets spent, and
• Stocks for long term returns and to replenish the top of the bond ladder as those bonds age.
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How a pension plan could look at the numbers Social Security’s best estimates for 2015-2023 cash flows look like this:
Social Security’s assets at theend of 2014:$2.8 trillion in US Treasury bonds
Total cash and bond ladder needed to cover 7 years of cash flow gaps: $0.6 trillion
That leaves $2.2 trillion that can be invested for longer term needs
That money has a better shot at decent long-run returns in a diversified stock portfolio than it does in low-interest Treasury bonds .
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Projecting out a “pension style” investment plan
Trust Funds in 2033:This plan: $2.4 trillionCurrent Social Security: $0
This wouldn’t “cure” Social Security, but it sure would help…
Key return assumptions:• Cash: No interest, Bonds: 1% interest, Stocks: 9% Returns
Source: Author’s estimates based on information in the 2014 Social Security Trustee Report
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What are key challenges to adopting this plan?
Unfortunately, spreadsheets behave differently than financial reality, which would add substantial challenges to adopting this plan.
• Social Security’s current holdings would need to be liquidated: The US government debt held by the Trust Funds would need to be refinanced by the Treasury. That could get very expensive for the government, especially if it happened quickly.
• Social Security’s new investments could not be made quickly: Social Security would dominate trading for a period measured in weeks to months to get its new portfolio in place. That would certainly move the market and put its total return potential at risk.
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Not to mention the politics…
On top of the financial concerns come political ones:
• Can Uncle Sam be a neutral owner of company stocks? Stock ownership generally comes with proxy votes. $2 trillion-plus of investment brings with it a lot of potential board room influence.
• Can Uncle Sam stomach a market downturn? The market goes down as well as up. A bad market, particularly early on in the conversion, could cause lawmakers to panic, reverse course, and “sell low”, making Social Security’s position worse than before.
• Can Uncle Sam stay the course in a good market? If the market has another multi-year run, the Trust Funds’ balances could swell. That would create a huge pot of money tempting lawmakers to spend on some other priority.
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Still, it’s worth considering
Despite the challenges in adopting a pension-style investment plan for Social Security, it’s still worth considering for these two key reasons:
• It extends the Social Security Trust Funds’ viability by allowing investments with potentially higher returns.
• It reduces the need for higher taxes and/or lower benefitsassociated with Social Security’s traditional patching process.
Millions of Americans are depending on Social Security to fund a substantial portion of their retirements. Doesn’t it just make sense to make changes that give the program a real chance at a better long term future?
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Can this Social Security secret boost your retirement income by $60,000?