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America’s pension promises will go unmet without sweeping reform

This year, anybody receiving an annual statement from America’s mighty social security system might notice a tiny ticking time bomb — if they possess sharp eyes.

Tucked into a footnote is a website link that explains that the two funds in this system — called “Disability Insurance” and “Old Age and Survivors Insurance” — have $2.9tn to plug the shortfall between expected payouts and what is gathered each year from payroll taxes. Those trillions sound soothingly big. But they are projected to run out in 2034.

The website cheerfully points out that the system has “reached the brink of depletion of asset reserves” in the past. In both 1977 and 1983 Congress had to come to the rescue.

It also notes that “even if legislative changes are not made before 2034, we’ll still be able to pay 78 per cent of each benefit due.” This is presumably meant to sound reassuring. However, the underlying message is not: if Congress does not act in the next decade, the government’s pension promises will be subject to a partial default.

Does this matter? Not for everyone. An American couple currently in their sixties with an annual salary of a third of a million dollars, say, will get a putative $60,000 a year under the current system, according to a handy calculator provided by the AARP. This is not to be sneezed at. But it pales in comparison to the income that wealthier Americans typically earn from assets and/or 401K retirement accounts.

The Center for Retirement Research at Boston College calculates that half of all Americans are “at risk” of falling short of the savings they will need to retire with the same living standards. Meanwhile a report from PwC suggests a quarter have absolutely no retirement savings at all.

While many middle-class Americans blithely assume that rising home values will be a piggy bank, because a decade of super-loose monetary policy has delivered continual asset inflation, this now seems an increasingly dangerous bet; as Wednesday’s US rate rise underscored, we are moving into a world of higher rates and inflation.

Thus for poor (and not-so-poor) voters, the prospect of even a partial future pension default is nasty — both in practical and psychological terms. No wonder that a survey by Allianz this year found that “63 per cent of non-retirees fear running out of money more than death” (versus 46 per cent of those already retired.) And the ranks of those affected is swelling: while 49mn Americans were older than 65 in 2016, that number will jump to 73mn by 2030.

So is there any solution? Yes: several. One (potentially unappealing) option would be to raise the payroll taxes currently imposed on America’s 150mn-odd workers to fund the programme. Back in 2010, the system’s trustees calculated that “an immediate increase [then] in the combined payroll tax rate from 12.4 per cent to 14.4 per cent”, would fix the issue for the next 75 years; more would be required now.

Another option would be to raise the pension age. The 1983 reforms already increased this from 65 to 67, for future pensioners, in terms of receiving full benefits, but more could be done. And while progressives hate this idea, since it is much harder for manual workers to keep toiling later in life than white collar ones, the fact is that longevity today is far longer than envisaged in 1935, when the system was created. Unsurprisingly, the proportion of older Americans who are working longer is also on a long-term rising trend, as a Pew survey shows.

A third option, which could make age rises more palatable, would be to means test the system and direct the benefits away from the rich (who do not need this) towards those who desperately do. A fourth possibility would be to trim the cost of living adjustment, although this would be wildly unpopular if inflation continues to surge.

Then there is the fifth, and most sensible, option: Congress could enact a more sweeping overhaul of the country’s fragmented and convoluted pension structure. It could introduce mandatory (or near-mandatory) retirement savings practices for employees, and make pensions more portable when workers switch jobs.

It could also overhaul the pension tax system to make it less regressive. This is badly needed. One particularly deplorable detail about the current structure is that 87.2 per cent of pension tax breaks go to the wealthiest fifth of households.

All these ideas require a sensible proactive debate — and bipartisan action in Congress. Flashes of this have already emerged: this spring the Secure Act 2.0, a bill to enact modest reforms, actually did receive bipartisan House support. Hooray. But since it is still languishing in the Senate, it is unlikely to be enacted soon. And there is no sign yet of the type of holistic overhaul that America needs.

So the most likely outlook, then, is that default continues to be buried in the small print of US social security statements — and will grow bigger in the coming years, alongside the country’s other trillions of unfunded liabilities. No wonder that surveys show a mood of gnawing anxiety among American voters about the future, particularly the young. That footnote is just one small symbol of the battle America now faces to maintain cohesion amid a growing gulf between old and young — and rich and poor.

gillian.tett@ft.com

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