What would privatized Social Security mean for Americans?

The current Social Security system in the United States operates in a pay-as-you-go framework; the Social Security taxes paid by today's workers enter the general fund and are immediately used to pay for current claimants. Privatization would eliminate the pay-as-you-go process. Instead, each taxpayer's individual contributions would be invested into a separate account for his own retirement.

Proponents of privatization claim that the current system generates insufficient returns, acts like a Ponzi scheme and 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.

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

When Social Security was implemented in the 1930s, the average life expectancy in the U.S. 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). By 1930, there were only 6.7 million Americans 65 or older.

Today, there are more than 40 million Americans who are past retirement age. The average remaining life expectancy for those who reach age 65 is nearly 20 years. 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 34% of their buying power from 2000-2012.

Privatizing Social Security would allow a worker's salary contributions – which would likely still be mandatory at 12.4% – to be deposited into private investment companies or public-private management funds. Workers would have the option to increase their contributions to retire earlier or to increase their payouts in retirement.

At retirement, the worker would also likely be able to choose from several different payout options that are found in the private sector, such as annuity or life payments. In fact, this very system has been running in Chile since May 1, 1981.

The Chilean government had a pay-as-you-go system in place prior to 1981, but budget shortfalls led to a revolution in late-age retirement savings. By linking benefits to contributions on an individual basis, the Chilean workers have been able to realize an average annual rate of return that exceeds 9%; the U.S. Social Security system theoretically pays a 1% to 2% rate of return.

Even when accounting for risk-adjusted return, the privatized system in Chile offers hope that privatized retirement savings could help retirees and reduce the national debt at the same time.