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January 7, 2013

Galveston-Style Entitlement Reform Is On The Money

Entitlement Reform's Prefunded Solution
  Investor's Business Daily

The fiscal cliff agreement provides a lot more federal spending and zero entitlement reform. Maybe that's for the best, since the only entitlement legislation that Republicans seem to support these days are raising the retirement age and cutting benefits, including adjusting the cost-of-living formula.

They appear to have abandoned their long-held support for the only permanent solution to Social Security and Medicare's unfunded liabilities: pre-funded personal accounts.

To be sure, the stock market has been volatile, and when the market slips so does support for personal retirement accounts. But there is a financially safe pre-funded alternative to the current pay-as-you-go system that has been operating for 30 years, and workers have never lost a dime.

Galveston County in Texas opted out of Social Security in 1981, and Matagorda and Brazoria counties followed in 1982. County employees have since seen their retirement savings grow every year, including during recessions. Today, county workers retire with more money and have better supplemental benefits in case of disability or an early death. And the counties face no long-term unfunded pension liabilities.

What's known as the Alternate Plan follows a banking model, rather than an IRA or 401(k) model. Workers contribute the same 12.4% of their pay, half from workers and half from the county employer (Galveston voluntarily contributes a little more), as they would under Social Security.

That money is pooled by a financial planner who lends it to financial firms that pay interest, like a passbook savings account. Workers in the Alternate Plan do not make their own investment decisions. Those institutions guarantee a base interest rate — usually 3.75% — which can rise if the market does well. Over the past decade, the accounts have earned 3.75% to 5.75% every year, with an average of 5%.

The 1990s often saw even higher interest rates, 6.5% to 7%. Thus, when the market goes up, employees make more; when it goes down, employees still make something.

While returns depend on a worker's income level, interest rates and length of time in the plan, those who are in most of their working careers could receive twice as much or more retirement income than they would under Social Security. And that money belongs to them; any balance after death becomes part of the estate.

Social Security is also social insurance that provides a death and disability benefit and survivors' insurance. So does the Alternate Plan. Part of the employer contribution provides a term life insurance policy that pays four times the employee's salary, up to $215,000. That's 850 times Social Security's death benefit of $255. There is also a disability benefit that pays immediately upon injury, rather than Social Security's six-month wait plus other restrictions.

Although the Alternate Plan is only a Social Security replacement, that model could be easily adapted to Medicare. While Medicare historically has been a defined-benefit health plan, it now has a defined contribution arm.

About 25% of seniors voluntarily choose the Medicare Advantage program, in which the government pays a health plan a defined contribution to cover a senior's health care needs for a year. But why should workers send their Medicare payroll tax to the government for 40 or 45 years only to have the government hand a retiree's health plan a check every year, as it does in Medicare Advantage?

Eliminate the government middleman and let workers set aside their 2.9% Medicare payroll tax — 3.8% for families making more than $250,000, thanks to ObamaCare — in their own retirement account. Then they can write their own check to the health plan after retirement.

Critics will claim this plan doesn't address the current unfunded liabilities. True, but that's a separate problem, one Congress will have to address regardless.

The current system is robbing younger workers of their payroll taxes by taking more and promising less.

Switching to a pre-funded system similar to the Alternate Plan, even if it is only for new workers entering the system, means a day will come when we won't be adding even more unfunded liabilities or robbing from those who have paid in their entire working lives.


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