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It’s time to junk 401(k)s and IRAs and have Social Security finance our whole retirements

As markets go, the market for retirement savings is pretty awful. In a good world, there just wouldn't be much money to be made on helping people sock money away in 401(k)s and IRAs. The only retirement investment advice anyone really needs fits on a 4-by-6-inch index card:

Max tax-preferred savings, save 20 percent, etc.
Harold Pollack's famous financial advice index card.

Harold Pollack

The basics are really simple. Save 15 to 25 percent of your income (use this calculator to get an estimate for your specific situation); take advantage of tax-preferred savings like 401(k)s and Roth IRAs; buy low-fee index funds rather than picking stocks yourself or hiring an active fund manager to do it for you. If you're really rich, things can get more involved, but for most people it's not that complicated.

But handing out free index cards is not a lucrative business, so brokers have to figure out other ways to make money. Traditionally, one of those methods has been receiving kickbacks from mutual funds and other investment vehicles for convincing clients to invest. It's a practice that the White House Council of Economic Advisers estimates costs savers about $8 billion to $17 billion a year by directing people to buy less profitable assets.

Luckily, the Labor Department has finalized a rule that will crack down on that specific practice. But there are still millions of people picking and choosing stocks rather than just investing in index funds, and millions more who aren't saving enough, mostly because their present-day expenses in rent, health care, food, college tuition, etc. are so daunting.

So here's an idea. Instead of trying to repair our broken privatized retirement system, why not give the public sector a shot? Why not expand Social Security so that it functions not just as a backstop but as the primary source of retirement income for ordinary Americans?

Two shortcomings of Social Security

social security Chip Somodevilla/Getty Images

Social Security is a wonderful, wonderful program. It is the single most important anti-poverty program in the United States, apart from its primary social insurance functions, and it has a longevity and place in American culture that few other government institutions can match. And not for nothing, it's ridiculously popular.

The issue is that we need more of it. There are currently two big problems with retirement in America. The first is that there's still such a thing as senior poverty. The supplemental poverty measure (SPM), the census's superior metric for this kind of thing, puts the rate at 14.4 percent. But without Social Security, it would be 50 percent.

This tells us a couple of things. One is that Social Security is an enormously effective tool for keeping seniors out of poverty. Another is that there are still 6.6 million seniors who aren't getting enough from the program, or from Supplemental Security Income (which keeps only 1.2 percent of seniors out of poverty).

The way to fix this is simple: Guarantee every American over 65 (or 67, or whatever) a basic income. Make each senior person's Social Security benefit the greater of a) their benefit per the Social Security formula, or b) the SPM poverty threshold. That would definitionally end senior poverty in America.

This idea has gotten some play in Washington circles. On the right, American Enterprise Institute's Andrew Biggs has proposed replacing Social Security with a basic income set at the poverty line, plus an automatic savings program. On the left, Michael Lind, Steven Hill, Robert Hiltonsmith, and Joshua Freedman released a plan through New America that would add on a basic income set at about the poverty line (the specific number is $11,669) to existing Social Security. The latter proposal has a shortcoming in that only retirees with earnings get the benefit, but it's simple enough to expand.

The second problem is that many 65-plus Americans don't get adequate income from their work, savings, and Social Security. This is an area of considerable dispute among researchers, but the most optimistic assessments suggest that 28 percent of new retirees don't have enough wealth to maintain their standard of living, a percentage that's steadily growing.

Another assessment found that 52 percent of households in 2013 were 10 percent below their target retirement savings rate. As of 2013, the typical American household headed by someone between 55 and 64 had only $14,500 in retirement savings; excluding those who'd saved nothing, the median was $104,000, or only enough for a $5,000-a-year annuity:

Median retirement savings by age
From a Center for American Progress report.
Keith Miller, David Madland, Christian Weller

A pretty small minority of families headed by someone 65 or older even take out distributions from retirement savings — only 19 percent in 2009, and only 8 percent of the poorest families. Only 6 percent of black families 65 and older took out retirement money that year. Relying on asset income in retirement is the exception, not the norm.

So what if instead of relying on this patchwork system — Social Security as base, the almost-dead defined benefit pension system for a few, risky and fee-ridden 401(k) for everyone else (assuming they're rich enough to have jobs that offer retirement benefits) — we designed Social Security so that it could replace all of that?

Currently the program replaces 90 percent of your earnings up to $10,272 a year, 32 percent of your earnings between that and $61,884 a year, and 15 percent of earning from there to the $118,500-a-year cap. What if the formula were instead that you received the greater of:

  1. The poverty line, or
  2. 80 percent of average earnings, up to $61,884 a year

This wouldn't just eliminate senior poverty; it would also eliminate the need to save for retirement for the roughly three-quarters of people with average earnings under that amount. It would substantially reduce the need to save for people making above that. It would obviously require a large-scale increase in the payroll tax, getting rid of the income cap, increasing the rate for both employers and employees, and maybe subjecting some investment income to payroll tax (as already happens for Medicare).

But for workers already saving for retirement, that payroll tax increase would be offset, ideally more than offset, by reduced month-to-month savings. For workers not saving for retirement, it would lead to less take-home pay during their working years, but it would function as a forced retirement plan and ensure them a decent living after age 65. If they should've been socking away 15 to 25 percent anyway, it should make no difference if that's encouraged to happen through savings or through Social Security.

You could also eliminate tax breaks for 401(k)s and IRAs, which would at this point serve entirely as giveaways to the rich. And if the tax increases are progressive (by lifting the cap or subjecting investment income to more taxation or eliminating savings tax breaks), then the likely payroll tax increase for low- and middle-income workers should be easily less than what they would've needed to save on their own.

This goes way beyond the expansion proposals of people like Bernie Sanders, Martin O'Malley, and Elizabeth Warren. Sanders, for example, does an across-the-board benefit increase, using a faster-growing inflation measure for cost-of-living adjustments, and guarantees a poverty-level benefit to everyone who's worked at least 26 years. That's a great start — but he could go even further.

Would giant Social Security destroy America's savings?

Nieman Marcus Reportedly In Talks To Be Sold For $6 Billion
In the future, this store will belong to America.
Joe Raedle/Getty Images

The big concern with a plan like this is that it would crowd out private savings, hurting the economy. Fewer people saving for retirement means less demand for stocks and bonds, which makes it harder for corporations to finance themselves, hurting economic growth.

It's unclear if this is an actual problem in the United States at the present moment. Interest rates have been very low for a while, which might be a function of monetary policy but could also reflect a fundamental excess of demand for investments, which would drive down their price and lower their returns. You could see the case for responding to this by discouraging personal savings by Americans, perhaps by massively expanding Social Security.

Even if you don't buy that argument, it's worth questioning how much savings this would crowd out. The rich save vastly more for retirement than the poor, millions of whom don't have any savings at all at the moment; they wouldn't be crowded out, they'd just be benefited, greatly. Moreover, rich households probably aren't going to settle for a maximum retirement payout of around $50,000 a year. They'll still need some retirement savings.

But let's say we run the numbers and this idea still depresses private savings by an unacceptable amount. There's an easy solution: Establish a Social Security sovereign wealth fund! Currently the program invests entirely in US government treasuries. Those are very safe assets, but investing in them doesn't do anything to benefit the private sector. So some Social Security analysts, like Boston College's Alicia Munnell, have long called for the program to diversify its assets and invest in equities as well.

Canada's pension system already invests in a wide variety of assets — it owns Neiman Marcus, for example — and Singapore has a somewhat related system in which people are forced to save in a big government-managed fund. Sovereign wealth funds in general are a pretty widespread practice; China has one to manage its pension system, as well as another to manage exchange rates and two more in Hong Kong, and oil-rich countries like Kuwait, the United Arab Emirates, Saudi Arabia, Qatar, and Norway all have them as well.

The US even has one already: the Alaska Permanent Fund, which uses revenue from natural resources to pay out a dividend ($2,000 last year, but usually lower) to every man, woman, and child in the state.

A sovereign wealth fund wouldn't just solve the savings problem for expanded Social Security; it would provide a way to direct investments toward underfunded projects, like infrastructure development. "It could be through this fund that we bring capital to underserved communities," NYU professor Dalton Conley, a vocal sovereign wealth fund advocate, writes. "Or it could be the basis of an investment agenda in green technologies."

So the real reason to oppose massively expanded Social Security isn't concern over private savings; it's that you fundamentally don't think the government should have this level of control over investments. That's a reasonable enough position, but given the persistence of senior poverty and the continued inadequacy of 401(k)s, we could do worse than expanding the most successful retirement program in America.

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