The drawback of Richard Thaler's 401(k)-Social Security idea? Social Security itself

Observers think Congress would need to address Social Security's funding levels and offer enhanced protections for the concept to work

Apr 22, 2019 @ 4:03 pm

By Greg Iacurci

Nobel laureate Richard Thaler's idea to increase retirees' Social Security payments by using a portion of their 401(k) accounts is drawing criticism from some corners of the financial-advice industry, primarily due to the current less-than-stellar health of the Social Security system.

Mr. Thaler, who won the Nobel Prize in 2017 for his work in the field of behavioral economics, proposed that Americans be able to voluntarily send the Social Security Administration up to roughly $250,000 from their 401(k) accounts to increase Social Security income in retirement.

The idea, he said, would simplify the complexity in drawing down retirement assets for 401(k) savers and offer them an inflation-adjusted, lifetime income stream better than they could purchase in the private sector.

While many observers believe the idea has merit, they think Congress would first need to address the Social Security system's low funding levels, which overshadow the potential benefits of Mr. Thaler's idea.

"Fixing Social Security would have to be something done first before you could ever imagine a buy-in," said Jamie Hopkins, director of retirement research and vice president of private client services at Carson Group.

Funding in the Social Security program — which paid benefits to 47 million retired workers and dependents of retired workers in 2018 – has declined, largely because longer life spans have caused the government to pay benefits over longer time periods.

The Social Security Board of Trustees said Monday that the total annual cost of the program is projected to exceed total annual income in 2020, for the first time in nearly four decades.

Jack Dolan, a spokesman for the American Council of Life Insurers, a trade group representing insurance companies, said the group has "many concerns" with Mr. Thaler's idea in light of the program's financial stability.

Having annuities provided by life insurers in the private sector, which are backed by guarantees supported by company reserves and "strictly regulated" by states, is a "highly preferable arrangement than asking workers to invest their hard-earned retirement savings into the financially strapped Social Security system, a pay-as-you-go program slated for insolvency in 2035," according to Mr. Dolan.

2035 is the year in which combined asset reserves in Social Security's two trust funds — the one for retirees and the other for disabled workers — are expected to be depleted. The fund for retirees is projected to become depleted in 2034, at which time only 77% of benefits will be payable.

Aside from the funding, Julio Lopez-Brito, a financial adviser at Portfolio Resources International Group, believes lawmakers would have to change the structure of Social Security itself to provide greater protection to retirees.

"You don't have a right to your Social Security benefits, actually," he said. "Those are not like your savings. The government can cancel that any day."

However, Mr. Lopez-Brito endorses the concept behind Mr. Thaler's idea.

"Social Security is the best income annuity there is. You can't buy that type of income annuity in the private market," he said.

Social Security can offer a higher payout to retirees than private-sector annuities due to lower overhead costs, since insurers must pay for functions like marketing and distribution, Mr. Hopkins said. Private insurers typically have overhead costs of 30%-40%, he added. By comparison, the Social Security program cost 0.7% of total expenditures to administer last year.

While annuities have features Social Security couldn't offer, such as access to a policy's account value, insurers would still likely see Mr. Thaler's proposal — if it comes to fruition — as direct competition.

"I think you would see an incredible amount of opposition from insurance companies to that idea," Mr. Hopkins said. "It's really the government expanding its reach into retirement products."

Congress is currently weighing a bipartisan bill — the SECURE Act — that would address retirement security. Among other things, it would make it easier for small employers to offer a 401(k) plan and boost legal protections for plan sponsors who offer annuities to employees.

Dan Zielinski, spokesman for the Insured Retirement Institute, said its members are "focused on what's doable today, and we have a bill out there that's doable today," referring to the SECURE Act.

"In the end, any ideas that really open up the Social Security system — even tangentially like this one seemingly does — you're touching the third rail of politics," Mr. Zielinski said of Mr. Thaler's proposal.

Beyond the issue being potentially politically fraught, Andrew Biggs, a resident scholar at the American Enterprise Institute who studies Social Security and pensions, thinks many retirees — especially lower-income individuals — wouldn't elect to send more money to the Social Security Administration.

"I support it as an option for people," said Mr. Biggs. "I think probably not that many people will take the option."

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