Over the last month, millions of students have been celebrating their college graduation. These students have been saving, studying, and looking forward toward to that moment for years. Now with graduation behind them, their next big investment could be a car, a house, or even open a portfolio for retirement. Unfortunately, a recent Pew poll found that only eight percent of millennials expect to receive full Social Security benefits when they retire. With a bleak postgraduate job climate, the prospects for government-backed retirement insurance may be even worse. The Social Security system in the U.S. is in financial ruin and requires structural changes in the form of private retirement account options to ensure Millennials receive benefits upon retirement.
According to Pew, 51 percent of Millennials believe they will receive no Social Security money by the time they retire. 39 percent believe the system will provide benefits at reduced levels. Indeed, a mere 6 percent believe they will receive benefits enjoyed by current retirees at the same levels.
Social Security is the single largest program the federal government operates, constituting 23 percent of the federal budget. In fact, it is arguably the largest government program in human history. However, the federal government did not anticipate such exponential growth at its inception. In fact, 55 percent of American workers were covered by Social Security in 1940. Today, that number is now 95 percent.
What happened over the past 64 years to cause such a tremendous spike? American life expectancy grew tremendously alongside medical improvements. In 1940, life expectancy after age 65 was about 12 years. Today, that number is 19 years. While retirees are living seven years longer, the Social Security eligibility age has only been shifted two years.
While Americans should cheer on the increasing of life expectancy, the 70+ million Baby Boomers that are currently transitioning from work into retirement will pose major challenges to the system. Within fifteen years, the number of Americans reaching retirement age will increase 70 percent while the number of working-age Americans will increase by just 6 percent. When Social Security started in 1935, 17 workers paid for the benefits of one retiree. As a result of its unsustainable growth, it’s estimated that by 2035, the ratio will be two workers per retiree. Very simply, unless reform is implemented, future retirees will receive a fraction of benefits.
In recent years, the system was negatively affected by the great recession where revenues were down. Before the crisis, the trust fund was estimated to run out by 2042. Now, the day of reckoning has been pushed up to 2038. In total, unfunded obligations have been estimated at over $20 trillion dollars. It’s clear this system is unsustainable.
Former President Bill Clinton has correctly pointed out three ways to deal with Social Security unsustainability: raise taxes, cut benefits, or introduce private investment. Economists have estimated that a 30+ percent hike in payroll taxes would be needed to pad the shortfalls. Cutting benefits seems politically impossible since people are expecting their benefits and have fashioned their life around them. So the key to Social Security reform seems to be private investment accounts.
Retirement savings are built on expected benefits and a safe rate of return. Medium-income workers born in the 1960s could expect a 1.9-2.7 percent rate of return on their social security investment. However, average returns on the S&P averaged 6-9 percent from 1926 to 2002. So private accounts would bring a higher rate of return, but how would they work practically?
A plan devised by the libertarian Cato Institute proposed a solution without changing the benefits workers over the age of fifty receive. Under the plan, workers younger than fifty would have the option of remaining in the current system or opting for the new personal account system. Not much would change for those who choose the government plan. For those who opt out, workers would divert half of their payroll taxes (6.2 percent) to their personal retirement account. The federal government would also provide a safety net to those who have not had enough private account assets. On top of that, personal accounts would be regulated by the federal government — managed in diversified, balanced portfolios, not just thrown in risky stocks.
In this difficult economy, college grads are getting a raw deal for retirement savings after they receive their diploma. Social Security is a major feature of the American economy and needs desperate reform — even if it’s not politically convenient to do so. Let’s transition from government-sponsored retirement and enable young people to choose their plans and receive more in benefits than they could ever imagine with Social Security. It’s time to focus on the college graduates and not the Baby Boomers, regardless of who comes out to the voting booth.