Social security privatization is a hot topic and
everyone seems to be talking about it. But
what does it mean for you? How is
privatization going to work? What are the
risks and rewards? Who is right and who is
wrong? If you know nothing about social
security privatization issue, this is a primer.
We have already discussed how
social security works and if it is in trouble.
Complete coverage is also available in Social
Security Privatization news center. Here
we will discuss personal retirement savings
What is meant by privatization of social security?
||Privatization means taking some of the money
Americans currently pay into the Social Security system and diverting it into individually owned
personal retirement savings accounts, where each worker would bear some risk for how his or her investments performed. These accounts would be "carved-out" of Social Security. An individual will have more control over the account, but as everyone knows, while volatile investments can produce high rewards, they
also come with high risks. The details
on retirement accounts are still being worked out,
but according to preliminary information,
Americans will have a very few choices and the
program is likely to be structured along the lines
of thrift savings account.
(Related article: Tips
on guaranteed retirement income)
Under the proposal being discussed right now, workers would eventually be able to divert 4 percent of their income subject to payroll taxes to private retirement accounts, which could then be
invested in stocks and bonds. The choice will be limited unlike
401(k) savings plans where one can diversify easily. A 46-year-old earning the maximum income subject to Social Security taxation -- currently $90,000 -- could theoretically salt away $3,600 a year.
How to deal with rising prices?)
But the plan would be phased in slowly, starting in 2009 with an initial annual cap of $1,000 and rising by $100 a year. It would take an additional 26 years for someone at the taxable maximum to save the promised 4 percent. And in the short time period available to middle-aged workers, investment gains would have to exceed inflation by 3 percent for the accounts to make more money than the traditional Social Security system would provide. This is extremely difficult, if not impossible, for any investor. And even more difficult if you are
new to the stock market (as many Americans will be) and do not understand how it works.
(Related article: Private
retirement accounts produce negative returns)
Will investment in stock market not produce higher returns?
Most experts agree that over the long term, stock market produces high returns but investment in stock markets can be very risky if you do not get the timing right. Sometimes the stock market can be in a slump for years and if someone retires during that time, their savings can be literally wiped out leaving them with practically nothing. Plus, stock market investments are not for everyone. To fully understand all the risks and tricks of investing, every American will have to learn how to invest - that is not
easy to do. Plus, it is now well known that American corporations are not always honest and fair (as example of Worldcom, Enron, etc. has shown) and this will hurt Americans who can not keep on top of what is happening in the world of financial markets. Another point to remember is that even the smartest investors on Wall Street
with enormous resources at their disposal don't get it
right and have a hard time even doing as well as the overall market does. An average American can not be expected to survive by betting his/her lifetime savings in the stock market.
Thus, despite the very limited choices in personal
retirement savings account, it is important to
understand the higher level of risks (and of
course, potential for higher reward).
(Related article: Americans
need retirement help)
Social Security, by law, limits options to safe investments that ensures that money will simply not disappear. Even though the return is
relatively small, it is guaranteed and the principal will never disappear, which can easily happen with stock market investments.
This is the reason why many seniors and
risk-averse Americans prefer the current system.
Wouldn't these personal retirement savings accounts give me control over my own money?
Personal control can be
tempting since you can take high risk,
get lucky, and have a wonderful life.
In reality, very few people are that lucky. In addition to the risks, you also would run the risk of outliving your retirement funds or seeing them depleted over time. Social Security offers a reliable benefit that increases every year to help meet rising costs of living. It doesn't matter how long you live, you can't outlive your Social Security benefits. The government bears the risk of ensuring that Social Security benefits always get paid.
With personal retirement savings account, the
money is finite and you will have to make sure
yourself that your retirement income lasts your
Personal finance for empty nesters)
many Americans do not want to deal with the risk
of managing their own retirement accounts.
In a recent survey by Principal Financial Group,
workers were asked to rate their comfort level with the idea of managing their own
personal retirement account. About half (49%) said they were not comfortable with
managing their own personal accounts, a sign that Americans today rely heavily on "do-it-for-me" investment services and advice.
With the backdrop of Social Security
reform, workers are concerned about their long-term financial security today. Sixty percent of respondents say long-term
financial security is a top personal concern, followed by 31 percent of employees citing the ability to cover day-to-day expenses as a top personal concern.
Significantly more females (36%) than males (26%) said their biggest personal concerns include the ability to cover day-to-day expenses.
Related articles: What
is social security and if it is in trouble and
privatizing social security is a priority for Bush
Bush failed to create personal retirement
Money tips for couples
Tell kids about money
How to improve my income?
How to save money to have a real impact?
Do I need a household budget?
How to create personal wealth