In testimony before the Senate Budget Committee a few years ago, Federal Reserve Chairman Alan Greenspan gave lukewarm support to privatizing part of Social Security. He said, "I do think that the notion of moving some funds into private accounts is the appropriate thing to do."In 1981, county employees in Galveston, Texas, did just that; they stopped contributing to Social Security and made pretax contributions to a managed fund instead. According to a Social Security Administration report in 1998, here's how Galveston employee benefits compared to Social Security: Initial benefits for Galveston's single workers were higher, unless they were low-income employees. Middle- to very high-income employees had substantially higher benefits under the Galveston plan. For married workers, Galveston's initial benefits were lower, except for couples with very high incomes. After 15 years of retirement, all Galveston retirees except single employees with very high incomes would get more money under Social Security. After 20 years of retirement, all Galveston employees would receive lower benefits than they would get under Social Security.Why the difference? For one, the Galveston retirement system is not indexed for inflation, but Social Security is. As inflation reduces the value of the dollar, Social Security payments rise to keep real benefits the same.
Also, Galveston employees can only take out what they put in -- plus accumulated interest. Unless they earned a very high income, the money may run out if they live for many years after retirement. But Social Security continues until the worker dies, and beyond -- if the worker has qualifying family members.
In most circumstances, Social Security provides better benefits for family members, especially spouses and divorced spouses. Both systems' funds earned about the same rate of nominal return -- 8.89 percent for Social Security and 8.64 percent for Galveston.
As Henry Aaron of the Brookings Institution pointed out in Senate testimony on Social Security Reform, the fundamental difference between the two plans is that Social Security is social insurance. It's designed to make sure that everyone has some benefits when retired, disabled, widowed or left parentless at a young age. A defined-contribution plan -- like Galveston's -- is merely a retirement account and doesn't lift any boats but one's own, and only if you're rich enough to own a boat.
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Here are Seven Things You Should Know About Social Security Before You Retire.