The House Republican budget plan put forth last week by Wisconsin Rep. Paul Ryan marks the beginning of the debate on government entitlement reforms — a rancorous clash sure to play out through the next presidential-election cycle and beyond.
While the newly revealed Republican budget had no specifics on Social Security reform, Mr. Ryan's previously issued “A Roadmap for America's Future” — like the Bush administration's plan before it — would give workers under 55 the option of investing about a third of their Social Security taxes in personal retirement accounts.
But unlike earlier GOP attempts to privatize Social Security, Mr. Ryan's scheme actually has a chance of winning a fair amount of backing. That's particularly true among the financial advice industry. Why? Because his plan looks like a flat-out sweet deal.
“Individuals who choose to invest in personal accounts will be ensured every dollar they place into an account will be guaranteed, even after inflation,” the Ryan roadmap says.
For working clients, that's a surprisingly generous — and intriguing — offer, advisers said.
“For the right client, this could make a lot of sense,” said Richard Salmen, senior vice president of GTrust Financial Partners.
Mr. Ryan's plan also has something of a track record, given that it's patterned after the existing federal Thrift Savings Program.
“I like the idea,” said Jason Reiman, founder of Solid Path Financial LLC, who charges retainer fees. “I was in the military, and I saw the TSP as an excellent plan for the government worker — very cost-effective and efficient.”
Of course, some wonder how the government would pay for the plan, which would combine upside potential with no downside risk to principal. Certainly, the scheme would be sorely tested if millions of participants made lousy choices, or worse, the markets tanked.
“A guarantee is dangerous and expensive,” said Robert Arnott, chairman of money manager Research Affiliates LLC.
The plan by Mr. Ryan, who heads the House Budget Committee, would offer five index funds and a life cycle fund. Once an account topped $25,000, additional options would be made available. At retirement, participants could access their funds by purchasing an annuity from a government entity to provide monthly tax-free payments.
The Social Security Administration, in an April 2010 analysis, said the cost of the guarantee would be relatively small, from 0.01 to 0.02 percentage points of payroll (out of 12.4% total).
But the agency assumed that private-account participants would earn some fairly generous returns — 2.9% above the inflation rate. That rate is based on a mix of 65% stocks and 35% bonds, with real returns for equities of 6.4% and 3.4% for corporate bonds.
Mr. Arnott feels that those numbers are unrealistically high.
“Those are reasonable nominal returns, not reasonable real returns,” he said.
Stocks today are priced to return 3% to 4% after inflation over the next two or three decades, Mr. Arnott said, and bonds about 2%.
Using half the rates of return that the Social Security Administration assumed, he said, the cost of the guarantee would more than double.
Other problems may bedevil the plan. Ed Easterling, president of Crestmont Holdings LLC, a research firm that also manages and advises hedge funds, said the GOP proposal “relies upon the fallacy of the long-term average and ignores the reality of secular stock market cycles with above-average and below-average decades.”
Risks would be minimized if participants had a sufficiently long time frame and were required to participate continually, Mr. Easterling added.
Advisers seem to agree.
“You might have to make it so that participants can't touch the money,” said Robert Kargenian, founder of TABR Capital Management LLC. Within the pool of private-account participants, “you have to deal with the lowest common denominator.”
In an analysis of the plan, the Social Security Administration acknowledged the chance that returns could come up short if people “make unlucky changes in portfolio allocations in an effort to "time the market.'”
SWINGING FOR THE FENCES
The guarantee, in fact, might encourage people to swing for the fences in their investments. After all, they have nothing to lose. That, in turn, might force the government to establish an “appropriate asset allocation” for those who choose private accounts, said Troy Sapp, an adviser at Commencement Financial Planning LLC. He added that such restrictions might be politically impossible.
Of course, the biggest hurdle for private accounts remains the upfront costs. Diverting current FICA taxes into private accounts creates “a fairly large hole that you have to either make up or borrow somewhere else,” said Josh Gordon, policy director at the Concord Coalition, a policy group that works on entitlement issues.
Mr. Ryan's road map does not address the upfront cost.
A spokesman for Mr. Ryan did not return calls.
The so-called “transition cost” helped doom a privatization push by former President George W. Bush in 2005. An internal Bush administration memo estimated that a transition to private accounts would cost as much as $2 trillion in the first decade.
But over the very long term, the Social Security Administration said, Mr. Ryan's private-account plan could help eliminate structural deficits because participants in such plans would get lower benefits from the government upon retirement.
Given current projections, the Social Security fund will be able to pay full benefits only until 2037.
E-mail Dan Jamieson at email@example.com.