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September 14, 2011

A New Social Security Solution

Encouraging all workers to invest intelligently into their retirements is the key to personal income sustainability in retirement and low social cost.

Social Security was created in the 1930s to give retirees a steady income so that they do not sink into poverty as they age. While, over the past seventy-five years, America’s financial institutions have become more diversified with private retirement solutions, and companies have developed various pension plans, our Social Security system remains relatively the same.
The problem with Social Security is that it is essentially a Ponzi scheme. Consider the following two quotes:

The current Social Security system works like this: when you work, you pay taxes into Social Security. The tax money is used to pay benefits to:
  • People who already have retired;
  • People who are disabled;
  • Survivors of workers who have died; and
  • Dependents of beneficiaries.
From the SEC website:

A Ponzi scheme is an investment fraud that involves the payment of purported returns to existing investors from funds contributed by new investors.

My new solution may not save the Social Security program from solvency, however, it does provide an individual worker with a sound retirement, and guarantees that the government would potentially have zero liability on that individual worker. Additionally, it gives Americans a choice to essentially “opt out” of the program.

The solution is simple. The individual worker continues to pay 4.2% or 6.2% (depending on tax policy) to the federal government. At the end of the tax year, for every $2 the worker saves for retirement, they get $1 back in tax refund, up to the amount paid to Social Security. Let’s assume a worker makes $40,000 before taxes.

Under the 4.2% tax (which is likely to stay around through 2012), this individual would pay $1,680 in Social Security taxes. If that worker were to put $3,360 in a Roth IRA, 401k, 403b, or other qualified retirement plan, the government should send a check back to that individual for the entire $1,680 they paid during the year.

The individual invests in their retirement at half price, but the plan does not end there.
The employer (which pays 6.2%) is eligible for half of its payment back if it contributes to the employee’s individual retirement account, however the ratio would need to be different to incentivize a corporation to join. In this case, they can receive $2 back for every $1 contributed up to ½ of their total tax or 3.1% of the individual employees salary.

For our example, the $40,000 salaried employee generates $2,480 in Social Security tax liability for the firm. The firm can get a $1,240 refund from the federal government in exchange for $620 (or maybe it can be increased to $930) in contributions towards the individual worker’s personal retirement account.

Ultimately, as a worker making $40,000 per year, you would get close to $4,000 placed in a retirement account at a cost of $1,680 (in this case I refer to cost as a reduction of disposable income, the money is not expensed, but simply transferred from a cash account to a retirement account).
Like many dynamic strategies, this plan is under continued review and scrutiny. I would appreciate your thoughts, comments, and concerns regarding this plan. I believe this plan is viable for all workers under the age of 40. In a few weeks, I will present a plan for workers over the age of 40.

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