Social Security vs. stocks: another look

In the escalating debate for the future of Social Security, forecasts are popping up faster than prairie dogs at dawn. But forecasts without context can be misleading.

Here are answers to some key questions on the issue - and a correction. First, the questions:

Will today's young people receive healthy Social Security pensions when they retire?

Yes, for political reasons, if none other. The share of seniors in the voting-age population is projected to reach 27.2 percent by 2040. If Congress falls over itself to issue subsidies to farmers, who make up less than 2 percent of the population, it's inconceivable that politicians would offend such a huge bloc of voters by not providing adequate financial care for their retirement. Even if lawmakers approve a system of private accounts and the financial returns are poor - as they have been in Britain - Congress would step in to look after those hardest hit by the losses.

Will the Social Security system run out of money?

Yes, in 2042, if the current system is untouched. That's the estimate by the Social Security Administration. The Congressional Budget Office puts off that date 10 years. But even if the trust fund runs dry, the system would still be collecting payroll taxes. So after 2042, Social Security would be able to pay at least 70 percent of promised benefits. That 70 percent will have more purchasing power than today's Social Security pensions because pensions are based on average incomes at retirement. Presumably, American real incomes will rise over the next nearly four decades.

But taxpayers will feel the pinch starting in 2018. That's when Social Security is expected to begin paying out more than it takes in. As the system dips into its trust fund, Congress will have to act. For decades, it has disguised the size of US budget deficits by counting the trust fund as income. In effect, it has spent money promised to future retirees. The solution is to raise taxes, cut spending, add to government debt, or reduce Social Security benefits. Given retirees' voting clout, don't expect benefit cuts.

Are these projections accurate?

It depends. Demographic projections are reasonably good, since most of those born today will be around in 75 years. But other long-term assumptions, such as growth rates for the economy and for productivity, are really unknowns, yet crucial to calculations. If longevity rises faster than in the past, the Social Security system will have a bigger problem supporting more old people. If families decide to have more children than they do today, the extra workers in 20 years would ease the strain. Future immigration levels will also play a role.

Now, the correction, with an apology. On Dec. 27, this column cited a calculation by Stanley Logue, a retired defense-industry analyst, that suggested that investing in the stock market didn't necessarily produce a superior return, even over long periods. Mr. Logue took the Social Security payroll taxes he paid in his 45-year career and compared the return of the Dow Jones Industrial Average with what the Social Security Trust Fund earned in those years. His surprising conclusion: The trust fund did a bit better, even though it invested in government bonds, than the Dow, made up of blue-chip stocks.

Since that column, however, a federal government expert reviewed those calculations and found the numbers given the Monitor did not include cash dividends to shareholders (although stock dividends and stock splits were included). Adding in cash dividends makes a huge difference. The Dow Jones amount rises to "around $500,000," he writes in an e-mail, almost double the $255,499 in the Logue calculation.

The message is clear: If Social Security could have invested in the stock market instead of government bonds during Logue's career, it would have come out much further ahead.

Of course, all this is theoretical. Social Security can't invest in stocks, and individuals can't invest easily in the Dow itself. And, as the Dec. 27 column pointed out, Social Security is an insurance program, not a retirement account. So it aims to guarantee retirees a fixed income for the duration of their lives.

"I wouldn't claim this proves anything," the official wrote about his recalculated results. "And certainly your warnings about risk are well-founded."

Logue had done the same statistical exercise as the government official. But to reflect the "real world," he assumed paying taxes and investment fees on money invested in stocks. By his calculation, if after-tax dollars were invested in the Dow Jones average during his working years, the amount accumulated would shrink by about half to about $255,000 - not quite the amount earned by Social Security.

In the future, of course, such private retirement accounts probably would be tax-deferred. Even with tax deferral, however, a private account invested in stocks would face other expenses. These include broker commissions or management fees. Under Britain's privatized system, for example, providers' charges can absorb 20 percent to 30 percent of individuals' retirement savings, a Pensions Commission report noted last fall. Such costs might be trimmed if a Bush plan for Social Security private accounts limited investment choices to a number of index funds.

Still, if a retiree wants a lifetime of income at retirement, similar to that provided by Social Security, a private account owner would have to buy an annuity. These instruments also carry fees.

Finally, there's no guarantee that the average return on stocks will be matched in the future. So the debate will continue as Americans sort out the balance of risk and return that they want from their retirement system.