What does "fully funded" and "defined contribution" for social security mean?
fully funded by WHO?
Answers:
Fully funded usually means that the assets in a plan will be sufficient to pay the promised benefits in the future. This requires lots of actuarial assumptions like assuming rates of return on the plan assets, the ultimate benefit levels of plan participants, future contributions by plan participants and/or employers, actuarial longevity and much more. None of that means the assets will actually be there, just that the best estimate is that they will be.
Defined contribution is a term used to describe plans where we know how much a person (and maybe employer) is required to contribute to a plan. Contributions are added to the plan and invested. Normally, an individual account is maintained to keep track of the amount that relates to each employee. Upon retirement, you then know the amount of the assets attributable to your contributions and earnings on those contributions and the retirement benefits can be computed based on those assets. You don't know in advance what benefits might be. Most retirement plans today are defined contribution plans, they define what goes in, not necessarily what comes out, since that depends on the value of the assets at the time of retirement. There is no front end promise of mathematically computable benefits at retirement.
A defined benefit plan defines what the benefit at retirement is to be, often a percentage of ending compensation (or a three to five year average of compensation). For example the plan might say that you get a pension equal to your last rate of pay multipled by 2% and then multiplied by the number of years of participation in the plan (as an example, assume ending pay of $40,000, a 2% factor and 25 years of service. The promised benefit would be $45,000 x .02 x 25, or $22,500 a year). Since the plan is targeting a promised benefit, actuaries do approximately annual computations of longevity, use assumed asset rates of return, future pay increase estimates, employee turnover, maybe an inflation factor and other esoteric assumptions. If the assets look like they may be insufficient based on the actuarial assumptions, the contribution rate will normally be changed to keep the plan solvent. The rate on contributions into the plan will vary depending upon investment returns, possilbe changes in the rates of pay and so on. All in all, it is an attempt to have enough assets at the end of the day to pay the promised benefit amount.
Social security is the worst of both worlds. It promises benefits in an amount that can be computed by referring to statutes (it is based on covered or taxed compensation) but the contribution of employer and employee is not directly used to compute the amount necessary to fund the promised benefits. Social security has promised benefits that have not been funded adequately so, while it is like a defined contribution plan insofar as contibutions in are concerned, it is more like a defined contribution plan when benefits are paid out. Since the plan has not coordinated contributions and benefits as required by a defined benefit plan and the defined contribution has been inadequate, the plan is not fully funded, that is, it has fewer assets than are estimated to be needed to pay the promised future benefits.
Worse yet, social security assets are invested in debt of the United States. So, get this, the government itself operates at a deficit. To fund its deficit operation, it borrows money from social security (and other sources, social security doesn't have enough assets to fund the entire federal deficit). So now we have a retirment program whose assets are debts of the United States. How does the United States pay its debts? Taxes. Or it borrows the money form another source. That is the future problem. The socail security assets are only assets if the government can pay and payment requires taxes or more borrowing. Both of those can cause inflation that makes the benfits worth less or drives the next generation to repudiate the plan's promises.
In a private pension plan, the operator of the plan would be in prison for similar investment activity.
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