Monday, January 07, 2013

Trouble Ahead for Social Security Recipients

As I described in a previous, December 11, 2012 post, a stock of productive capital is needed to generate the output and associated income needed to support people in retirement.

In other words, current workers need sufficient capital to enable them to produce enough goods and services to not only support themselves and their families but also current retirees.

The economy is like a pie in that the larger the pie, the more people it will feed and what retirees need is an economic pie that is large enough to feed them along with everyone else even though they are no longer working and producing.

The U.S. Social Security System has always been a risky bet at best, being basically a ponzi type system in which current investors (eg., workers) payments are used as payouts to existing retirees rather than being invested for their own retirement.

Like any ponzi type scheme, the system worked initially as the number of working people was more than enough to support existing retirees.

By having large families, the post war generation of workers ensured that the system would take care of them despite the fact that their life expectancy ended being considerably longer than that of the first generation of retirees under the system.

However, the post World War II Boomer Generation (of which I am a member) is not going to be so lucky.

First of all, this generation tended to postpone marriage and having children until later in life with the result that the generation immediately behind them is small.  As the boomers approached their forties, they did start having children and, on net, have a generation as large as their own behind them.

However, most of this generation was born late and is just now entering the workforce at the same time their parents are beginning to retire.

Second, the prolonged 2008 recession has resulted in double digit unemployment for the new generation just as they begin their careers.  Not only is this high unemployment among youth keeping any of them from working and paying Social Security taxes now, the late start in the labor force will impact their future wages which will further reduce money available for benefits.

Finally, the recession has also resulted in many members of the boomer generation losing their jobs and having to take Social Security early putting further pressure on the system.

Many people may be surprised to learn that Social Security is not a pension plan in the sense that benefits are paid out of earnings on the investments made with their tax payments.  Instead, the program has always been a simple transfer of income from current workers to retirees.

For the Social Security System to work as planned for the boomer generation, the U.S. will need a quick end to the current recession as well as strong economic growth.

Given what is happening in Greece and other places where Social Security type systems are breaking down, it is probably a good strategy for current recent retirees and those near retirement to have a back-up plan for possible cuts in the system.

I doubt that the system will disappear completely, especially for older retirees.  However, at a minimum the cost of living adjustment (which was not a part of the original law but an amendment added during the inflation of the late 1960s and early 70s) will be adjusted or eliminated completely.

There is also talk about means testing for benefits which means that benefits would be reduced or eliminated for those with other sources of income (pensions, IRAs, 401(k)s, part-time jobs or other household income.

As mentioned above, Social Security is not a pension plan but basically a welfare program designed to transfer income from those with wage incomes to those retired and not receiving a wage income.

While I doubt that the Social Security program will be eliminated completely (as retirees plus those who have been paying Social Security taxes for a number of years probably outnumber, in terms of votes, those who are just entering the labor force and have no real financial stake in the system, as either long time tax payers or recipients) but I will not be surprised if cuts and restrictions are enacted in the foreseeable future.

I elaborated these concerns about Social Security cuts and arguments supporting my concern (including links to Supreme Court cases stating that Social Security is not a pension system but a welfare plan which Congress can change at any time) in a HubPage article entitled The Social Security System's Achilles Heel

In a third and final post I will explain potential problems with employer administered defined benefit pension plans.

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