Privatize Social Security? The Right Way to Save It

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Is it possible to privatize Social Security? What would be the best way to do it, and would it work?

Social Security privatization is one option for addressing the financial strain on the program. This strategy is politically divisive and would need careful execution.

Read more about the way to privatize Social Security.

The Right Way to Privatize Social Security

Given the ever-increasing financial strains on Social Security, policymakers have long sought ways to shore up the program. One oft-considered avenue of reform is Socia Security privatization— transitioning the program from a defined-benefit plan to a defined-contribution plan. (George W. Bush, for example, attempted to privatize Social Security partially in 2005 but was defeated.)

Many of the decision-making risks associated with private retirement plans—complex options, confusing language, incomplete information—would likely be present with a privatized Social Security program. And so responsible choice architecture on the part of the government, in alignment with libertarian paternalistic principles, is paramount.

Sweden’s experience with privatizing Social Security (their version of it) offers some important lessons for US reformers. The Swedish plan:

  • Included a carefully chosen default fund with a smart asset allocation (high investment in equities, with significant holdings in foreign equities; 10% in bonds as a backstop against market corrections; 60% of funds across asset classes indexed) 
    • Choice Architecture Grade: Good (takes into account human inertia)
  • Encouraged Swedes to choose their own retirement portfolio by advertising heavily and urging citizens not to rely on the default fund
    • Choice Architecture Grade: Good (if choosers are well-versed in finance); bad (if choosers aren’t)
  • Allowed any fund meeting certain fiduciary standards to be available through its program, resulting in hundreds of options (as of August 2007, there were nearly 800 funds available) 
    • Choice Architecture Grade: Bad (too many choices with no hierarchy)
  • Mandated that information like fees, past performance, and risk be provided to participants in book form
    • Choice Architecture Grade: Neutral (this information is essential, but can be misunderstood by novice investors. For example, past performance is no indication of future returns.)
  • Allowed individual funds to advertise directly to citizens
    • Choice Architecture Grade: Bad (advertisements omitted or obscured key information like fees)

The Swedish plan, in sum, adopted the “just maximize choices” approach of libertarianism (without the paternalism part). This resulted in Swedes’ investing in high-fee, high-risk, badly leveraged funds that ended up underperforming the default fund.

If the U.S. chooses to privatize Social Security, the plan should feature:

  • A good default fund (as the Swedes’ did) with a mix of assets, the majority of which are passively managed/indexed to reduce fees and risk;
  • A web-based choice process that begins with a simple question—“Do you want the default fund?”—and builds from there (for example, the next screen might offer a choice of five funds, the one after that a dozen, etc.)

These are the ways that Social Security privatization might work.

Privatize Social Security? The Right Way to Save It

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  • Why subtle changes, like switching the order of two choices, can dramatically change your response
  • How to increase the organ donation rate by over 50% through one simple change
  • The best way for society to balance individual freedom with social welfare

Rina Shah

An avid reader for as long as she can remember, Rina’s love for books began with The Boxcar Children. Her penchant for always having a book nearby has never faded, though her reading tastes have since evolved. Rina reads around 100 books every year, with a fairly even split between fiction and non-fiction. Her favorite genres are memoirs, public health, and locked room mysteries. As an attorney, Rina can’t help analyzing and deconstructing arguments in any book she reads.

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