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How does what you consider to be an overly complex benefit formula affect retirement planning?
There is work that has been done in the past where we looked at what people thought their benefit was going to be, relative to what it turned out to be. It showed that even people who were right on the verge of retirement are all over the place in terms of being able to predict the benefit.
A virtue of a defined benefit is that it is defined–you understand what it is. The Social Security benefit formula is a lot more complicated than the benefit formula for a traditional private sector benefit. It is just beyond the comprehension of the typical person. So if you wake up on the first day of retirement and your benefit is 25% lower than you thought it would be, that’s the same as waking up and learning your 401(k) dropped 25%. It’s a big thing.
I think simplifying the benefit formula really makes sense. All the fine-tuning that has been done hasn’t really helped that much. It just makes the system more complicated.
The environment for somebody filing for retirement these days is hard because they have to decide how much to save on their own in the 401(k) or IRA, but to do that they need to know how much they are getting from Social Security. If Social Security is the foundation of your retirement, the “security” part you should be able to understand and know what you get. This isn’t rocket science, and yet we are making it into rocket science.
How, in your opinion, should Social Security evolve in the coming years?
Social Security should be reoriented, to a degree at least, to focus more closely on its safety net and poverty protection elements.
That may mean reducing benefits for high earners and probably increasing the retirement age as well, to keep people in the labor force a little bit longer.
If you can pay good benefits to high earners, that’s great. But we have enormous demands on taxpayers’ resources going forward. Social Security is not the only problem we face, it is not even the biggest problem we face. Medicare and Medicaid are enormous problems.
With Social security, particularly for a middle- or high-income person, if there is a reduction in your Social Security benefits, you can save a little bit more in your 401(k) or you can work an extra year to make up for it. Those are relatively easy choices to make. Something like Medicare is a lot harder, and if we reduce your benefits it is not something you can easily make up for on your own. Social Security should be solved as much on the benefit side as possible, because we know we have a lot of other programs we need to solve more on the tax side.
The idea of universal enrollment in a 401(k) plan, where if you go to your job they automatically sign you up for a 401(k), that can do a lot to increase the amount that people are saving for retirement. If everybody saved for retirement as they should, then Social Security’s job is a lot easier. It can focus on low-income people who really can’t afford to save and, even if they did save responsibly, wouldn’t have enough for retirement.
Decreasing benefits, even for higher-wage earners, would probably create some backlash.
With Social Security you don’t need a service, you need a check. Each year, we send you a thing in the mail that says, “Here is how much you are going to get from Social Security.” If your benefits are cut, you know they have been cut. There is a salience to it that isn’t there with some of these health care programs. Social Security is providing you with a dollar benefit each month. Health care is providing you with a service, and people don’t understand services quite as well.
Andrew G. Biggs is a resident scholar at AEI.
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