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Is Social Security an investment Ponzi scheme?

3:13 PM, Jun 22, 2011   |    comments
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By Matt Krantz, USA TODAY

Q: Is Social Security an investment Ponzi scheme?

A: There's just one thing that's worse than having a large chunk of money taken out of your paycheck: Taking a chance you won't get it back.

Workers who see Social Security deductions taken from their paychecks every pay period can't help but wonder if they'll ever see the money again. That's especially true with younger workers, whose contributions are being used to pay benefits to the swelling ranks of Baby Boomers, who are reaching retirement age or who are already retired.

Making things even more troubling is the amount investors need to save in order to retire is only increasing, even as incomes are flat, or even down. With average lifespans extending and wages stagnant and unemployment rates high, saving for retirement is a bigger challenge than ever.

The Social Security system is under intense pressure as its method of taking current workers' contributions to pay for current retirees is under strain. And it's that method, which often draws criticism for resembling a Ponzi scheme.

Before we can decide if Social Security's structure qualifies it as a Ponzi scheme, a quick definition is in order. A Ponzi scheme "is an investment fraud that involves the payment of purported returns to existing investors from funds contributed by new investors," according to the Securities and Exchange Commission.

Some investors think that the fact that Social Security pays existing investors with cash collected by new investors makes it a Ponzi scheme. But that's not true, says Jack Coffee, professor of law and securities law expert at Columbia Law School.

"This is less a question and more an aggressive assertion," he says.

Social Security is not a Ponzi scheme because it wasn't an intentional fraud, he says. In fact, the system has worked as expected since its creation in the 1930s. What's happening now is that, like many corporate pension plans, Social Security is running the risk of being underfunded as obligations grow faster than contributions. But again, Social Security wasn't created with this aim, he says.

"It was a system that was quite adequate for a long time," he says.

Changes are certainly needed to keep Social Security working to reach the goals it was established to meet, he says. Either benefits will need to be curtailed or the government will need to kick in funding, he says. But again, it's not a Ponzi scheme, but a retirement system where the demographics have changed, he says.

"It's a system where almost everyone agrees needs reform."

Matt Krantz is a financial markets reporter at USA TODAY and author of Investing Online for Dummies and Fundamental Analysis for Dummies. He answers a different reader question every weekday in his Ask Matt column at money.usatoday.com. To submit a question, e-mail Matt at mkrantz@usatoday.com. Follow Matt on Twitter at: www.twitter.com/mattkrantz.

USA TODAY

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