Social Security Reform. Again.

I intend for this column to be about self-help: How to deal with the financial world as it is, to make the best of it. The Two Legged Stool was not conceived as a political or policy forum. But forgive me if I occasionally stray, as I do today. I’m weak. I feel compelled now and then to take off my financial planner’s hat and put on my citizen’s hat.

Last week President-Elect Obama said he would be looking critically at both Social Security and Medicare as long-term sources of budget deficits. Which gives me an excuse to add my own two cents to the Social Security debate.

The concept, promoted by President Bush, of turning our Social Security benefits into individual accounts is a terrible idea. We already have that, in spades, with the large-scale abandonment by the private sector (and increasingly by the governmental employment sector) of traditional salary-for-life type pension plans (called defined benefit plans by the professional pension community). They have largely been replaced by individual account plans, such as 401(k) plans, where we already have the ability to build up large individual accounts. We don’t need to abandon the only—relatively modest—defined benefit plan most of us have. Diversity in all things, including the types of pensions we accumulate.

But according to the latest report from the Social Security trustees (http://www.ssa.gov/OACT/TRSUM/index.html), the Social Security Trust Fund is going broke. It is projected to be depleted by 2041, at which point Social Security taxes are expected to cover only 78% of projected benefits. Something must be done. My own personal favorite ideas for closing the gap are:
• Invest part of the Trust Fund in stocks. Virtually all private sector pension plan trustees invest a portion of their trust funds in stocks. Why shouldn’t the Social Security system do the same? Are all these trustees being imprudent? Of course not. To the contrary, the Social Security system is imprudent by design in limiting its investments to low-return Treasury securities.
• Invest part of the Trust Fund in corporate bonds and other private sector fixed income securities. The Trust Fund can then earn a premium over the meager return it gets on Treasury bonds. And today, more than ever, the private sector can use a large new source of credit.
• Gradually increase the retirement age. The Social Security system simply was not designed for today’s longer life expectancies. Increasing the retirement age by a couple of years is fair to all. This can be done gradually so as not to unfairly disrupt the expectations of those now nearing retirement age. That’s how we did it in 1983, the last time we “permanently” fixed Social Security.
• During your retirement, your Social Security benefit is indexed to changes in the cost of living. That’s fair and should be continued. But during your working years your benefit is indexed to average increases in wages—a historically more generous index. To save the system, benefits should be indexed, during both working and retirement years, just to changes in the cost of living and not to changes in average wages.
• To generate more tax revenue, increase the taxable wage base, which is currently capped at $106,800 in 2009. I suggest it be increased to $200,000. To be fair, a new tier of benefit should be added for those paying taxes based on the higher amount, but at a lower percentage than the current highest tier to preserve the progressivity of the system.

I love the Social Security system. I think Social Security is a great achievement in social security. But it needs to be made actuarially sound, and that requires everyone to give a little. What’s your favorite fix?