The current Social Security system in the United States operates in a pay-as-you-go framework, which is administered by the federal government. Social Security taxes paid by today's workers enter into the general fund and are immediately used to pay current claimants (along with earned income from bonds in the two federal trust funds that support the Social Security program). Privatization would eliminate the pay-as-you-go process. Instead, each taxpayer's contributions would be invested in a separate account for their retirement, and its value would fluctuate with the value of their investments in the market.

Proponents of privatization claim that the current system generates insufficient returns and acts in some ways like a Ponzi scheme. They argue that a private system would result in higher standards of living for participants.

Those who oppose privatization counter that it would lead to unwanted investment risk and that it would be too difficult to move from the old system to a new one. Critics of privatization argue that doing so undermines the very principle of the social safety net and the guarantee that it provides older citizens.

Key Takeaways

  • Privatization would replace the pay-as-you-go Social Security system with a privately-run system in which each taxpayer has a separate account.
  • Those in favor of privatization believe this approach would result in a higher rate of savings, better returns, and a higher standard of living for retirees.
  • Those against argue that taxpayers would face investment risk and that replacing the current system would be too cumbersome. 

Today's Social Security System

Social Security has come under increasing scrutiny because of its pending insolvency. Too many retirees are living for too long and current workers are not paying enough to keep the program running.

The 2019 Social Security Trustees Report shows that retirement, survivor and disability funds will run out in the year 2035 and that, thanks to the country's demographics, fixes will have to be made if the funds are to remain solvent.

When Congress implemented the Social Security program in the 1930s, the average life expectancy in the US was 58 for men and 62 for women. Only 54% of men who reached age 21 would live to age 65, when it would be possible to collect Social Security benefits, according to the Social Security Administration (SSA).

In 1930, there were only 6.7 million Americans age 65 or older.

Today, there are about 53 million retired workers, their dependents, and survivors of deceased workers who collect Social Security benefits, according to the SSA. The average remaining life expectancy for men who reach age 65 is nearly 19 years; For women who reach 65, it's 21½.

79 Million

The number of Americans the SSA projects will be 65 and older by 2035.

Moreover, the value of a Social Security benefit has been hard hit by inflation. Even with Consumer Price Index (CPI) adjustments to their benefits, American seniors lost 33% of their buying power from 2000-2019.

Moreover, wage growth has been sluggish for decades, and slow wage growth will result in a lower rate of return on Social Security contributions for future generations of retirees.

How Privatization Might Work

Privatization is the transfer of a government-owned business, operation, or property to a non-government party.

Interest in privatization plans is linked to the financial problems that public retirement systems around the globe have been confronting.

Chile, for example, privatized a failing public system in 1981 with some success. However, Chileans' trust in their pension system plunged following the financial crisis of 2008, when some of the riskier funds dropped 40%. Currently, pensions in Chile are not large enough for a significant percentage of the population, thanks to inadequate contributions, increased life expectancy, and 10 years of lower investment returns.

Privatizing the US Social Security system would require depositing a worker's salary contributions—which would likely still be mandatory at 12.4%—into private investment companies or public-private management funds.

Workers could have the option to increase their contributions to retire earlier or to increase their payouts in retirement. Proponents say that the accumulation of assets in retirement accounts would lead to a big rise in the savings rate, with a ripple effect that would boost income growth, making it easier to afford the burden of a large retired population.

Under the current system, Social Security funds are invested in low-risk government bonds.

At retirement, workers would be able to choose from several different payout options that are found in the private sector, such as annuity or life payments.

Challenges to Switching

One challenge that would confront any privatization plan is the transition period from the current pay-as-you-go plan.

The government would have to cover benefits to workers who contributed to Social Security and are already retired or will retire soon. Policymakers would have to find money to pay those retirees while allowing younger workers enough funds to put into new private retirement accounts.

Some arrangements that would cut benefits or increase current workers' contributions would be needed, along with federal borrowing.

Americans would have to be willing to accept the sacrifice of smaller benefits and/or higher contributions in exchange for owning and overseeing their retirement accounts.