Social Security and Market Risk
Tuesday, July 31, 2001
by Liqun Liu, Andrew J. Rettenmaier, and Zijun Wang
Table of Contents
Is Prepaying Social Security Risky?
"Even with bonuses, the year-to-year difference in total pension benefits would be less than 4 percent."
As we have seen, with a 2 percent contribution rate, personal retirement accounts will not totally replace scheduled Social Security benefits and as a result, the redistributive benefit formula can remain unchanged if desired. Workers who experienced high returns on their private accounts will be able to replace more of their Social Security benefits than workers who had lower rates of returns while in the labor force. Taxpayers will be called on to make up the difference between the scheduled Social Security benefits and the amount offset by the annuitized PRAs.
But this does not mean that taxpayers will have to bail out retirement account holders on a regular basis. As long as the annuity return exceeds the rate of return on Social Security taxes paid, the personal retirement accounts have gained ground on Social Security and will result in lower future taxes than would be needed to continue to pay benefits under the current system.
We previously estimated the returns that current and future retirees can expect from Social Security taxes they have paid.16 For new entrants to the labor force, we estimated that the rate of return Social Security delivers for the typical single male worker will be 1.64 percent. The report of the 1994-1996 Advisory Council on Social Security estimates that the rate for the average single male will be 1.57 percent and for an average two-earner couple 2.15 percent.
Table X identifies the percent of returns from the personal retirement account annuities that exceed returns of 2 percent and 2.5 percent.
- The return from a 100 percent stock portfolio always exceeds 2 percent, and exceeds 2.5 percent return about 98 percent of the time.
- The return from a portfolio with at least 60 percent stock holdings exceeds 2 percent about 98 percent of the time, and exceeds 2.5 percent nearly 93 percent of the time.
"As long as Social Security offers a guaranteed benefit, taxpayers already act as the guarantors."
Of course, during the start-up phase of a transition to partially prepaid Social Security, older workers will participate for a few years and then retire. As was indicated in Table II, the shorter investment horizons may produce returns less than the Social Security return. If this occurs, assuming a policy decision to continue to insure stable Social Security benefits, taxpayers would have to make up the difference between the realized rate of return and the Social Security rate of return. Note, however, that as long as Social Security offers a guaranteed benefit, taxpayers already act as the guarantors.