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Personal Finance > Retirement

Social Security reform: A guide
There's lots of disagreement about what to do with the system. Here's a rundown of some key issues.
January 8, 2005: 9:42 AM EST
By Jeanne Sahadi, CNN/Money senior writer

NEW YORK (CNN/Money) - Social Security reform is on lawmakers' agenda. You know what that means.

There will be wrangling, consternation and spin, not to mention multimillion-dollar PR campaigns reducing complex issues into soundbites. The words "crisis" and "trillions of dollars" will be used ... a lot.

You will be tempted to reach for the Advil.

So here is a primer on some of the key issues that will arise.

Money in, money out

Social Security is primarily as a pay-as-you-go system: the Social Security taxes taken out of your paycheck are used mostly to pay today's retirees their benefits. (They also pay for survivor and disability benefits.)

Each worker must pay in 12.4 percent of wages up to a certain income limit ($90,000 in 2005). If you're self-employed, you pay the whole amount. If you work for someone else, your employer kicks in half (6.2 percent).

Social Security has been taking in more money than it has had to pay out since the 1980s. It will continue to do so through 2017. But the surplus isn't cash that's locked away. Rather, it is loaned to the U.S. Treasury, which puts it in the general revenue pool. As such, it is spent on anything the government deems fit.

In exchange, Social Security receives special Treasury bonds, backed by the full faith and credit of the U.S. government. At the start of 2004, those Treasurys were worth $1.5 trillion and paid more than $80 billion in interest annually.

Come 2018, when its revenue will be less than its costs, Social Security is expected to tap its Treasurys to pay benefits in full through 2042.

After that, Social Security will only be taking in enough revenue to pay out around 75 percent of its obligations, according to the Social Security trustees.

Another report, by the Congressional Budget Office, offers a more optimistic projection. The CBO estimates that Social Security will exhaust its Treasurys supply by 2052, at which point the tax revenue it takes in will be able to pay out 81 percent of its obligations.

But even at those reduced levels, the benefits retirees get would be higher in today's dollars than current retirees receive.

Why the shortfall?

Starting in a few years, there will be a swell of retirees thanks to the Baby Boomers. And they will be living longer thanks to increased life expectancy.

Coupled with a lower birth rate post-Boomers, there will be fewer workers to provide the level of Social Security benefits promised to retirees who succeed the Boomers. The number of workers to retirees as high as 16-to-1 in 1950 will shrink to 2-to-1 within 40 years.

In 1983, Congress made several adjustments to Social Security, including raising the retirement age and accelerating payroll tax increases. The goal was to create a surplus that would bring the system into actuarial balance through 2058. That time period accounts for the full retirement of most Baby Boomers.

One of the complaints of those who criticize the government's handling of Social Security is the fact that the government spends the surplus on other programs. (For more on the contentions about the surplus, click here.)

Another is that lawmakers in 1983 didn't address the fact that after 2018 the system's costs will continue to outpace revenue. "At some point there's going to be some decision to reduce the cost," said Craig Copeland, director of the nonpartisan Social Security Research Program of the Employee Benefit Research Institute.

The debates

The debate today centers around two key questions: What changes are needed to make Social Security solvent and when should we make them?

But within those, there's a caldron of issues that will be contested. Among them:

Is there really a crisis? Some claim the system is in crisis because of the expected shortfalls. They further argue that the system needs a complete overhaul not only to ensure solvency, but to "modernize" the system, moving away from a pay-as-you-go set-up.

Then there are those who say there is no crisis and argue that any claims of crisis are manufactured for ideological purposes and will potentially damage what is one of the most popular and successful government programs.

Who's gonna pay? President Bush has said any change to the system must preserve the full benefits promised to current retirees and near-retirees.

So workers not near retirement and those still too young to enter the workforce -- are the ones most likely to foot the costs of any changes.

What's the damage? There are a number of options to plug up the anticipated shortfall for Social Security:

How does privatization fit in? President Bush has made clear he wants reform that would give younger workers the option of creating personal investment accounts and using some of their Social Security taxes to invest in those accounts.

The most talked about proposal thus far is Model 2 from the President's Commission to Strengthen Social Security. Under this plan, you could redirect 4 percent of your taxable wages (that is, about a third of your 12.4 percent payroll tax obligation) up to $1,000 a year. That cap would be indexed to wage growth.

You could invest the money in a small number of diversified portfolios, but not in individual securities. Come retirement, your Social Security benefits would be reduced by a formula tied to the amount of money you redirected to your account.

Among the benefits, proponents say, are the possibility of better returns and ownership of the assets. Critics say such accounts take the "social" and the "security" out of Social Security.

What both agree on, even the White House, is that personal accounts won't make Social Security solvent. That's why key proposals in the personal-account camp seek to lower future retirees' benefits by changing the formula for calculating starting benefits.

What's more, if personal investment accounts are created, the money redirected to them would create a shortfall when it comes to paying current retiree benefits. That shortfall is estimated to be between $1 trillion and $2 trillion.

The White House has said it expects the government will borrow money to help finance those transition costs.

Whose money is it anyway? The debate over Social Security is as much philosophical as it is fiscal. Should money you pay into Social Security be earmarked for your retirement or, if you don't use the funds, for your heirs?

Or is it money that should be paid as a social insurance tax to ensure a steady base of income for the nation's elderly, with the understanding that when you retire you will receive support as well?  Top of page

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