Workers could receive higher retirement benefits
under a Social Security system that incorporated personal
retirement accounts than the current system is capable of paying.
This is the key finding of the final report issued by the
President's Commission to Strengthen Social Security. In
addition, the commission found that (contrary to critics'
arguments) creating such accounts is quite feasible and their
annual administrative costs could be quite low.
A Two-Tiered
Social Security System
One
of the commission's less publicized, but nonetheless important,
decisions was to designate any system of personal retirement
accounts as "Social Security Part B," underscoring the fact that
such accounts would be part of Social Security rather than being
separate from the system or a replacement for the current system.
Within this two-tiered scenario, the traditional benefits system
would be designated as "Social Security Part A."
The
monthly retirement checks of workers who decide to open a Part B
account would be paid from a combination of both Social Security
Part A (the traditional government-paid benefit) and Social
Security Part B (the personal retirement account). Opening a
personal account would be entirely voluntary. If a worker decided
not to do so, his or her existing promised benefits would not be
affected by any of the three scenarios outlined below.
Three Scenarios for Reform
The
commission recommended three approaches that could be used to
establish Part B accounts, giving Congress and the President
greater flexibility as they work to develop the final legislation.
The three scenarios for voluntary Part B individual retirement
accounts are:
- Reform Model
1. This model would allow workers to invest an amount of
their payroll taxes equal to 2 percent of income in Part B
accounts. Part A (current system) benefits would be offset by the
amount to which the Part B account would grow if it earned a rate
of return equal to 3.5 percent after inflation. (Ten-year Treasury
Bonds currently earn 5.76 percent interest.) If Part B accounts
earned more than 3.5 percent after inflation, workers would get
higher retirement benefits. In the extremely unlikely event that
their accounts did not earn at least 3.5 percent, benefits would be
reduced by the difference between what they actually earned and the
3.5 percent figure. Workers who decided not to start a Part B
account would be guaranteed the same level of benefits that they
are currently promised. Under this scenario, the commission
anticipated that other changes in the Social Security system would
be necessary in the future to further reduce its cash flow
deficits.
- Reform Model
2. This model would allow workers to invest an amount of
Social Security taxes equal to 4 percent of their income (up to a
maximum of $1,000 annually) in Part B accounts. The Part A (current
system) benefits of these workers would be offset by the amount to
which their Part B accounts would have grown if they earned a rate
of return equal to 2 percent after inflation. (Series I U.S.
Savings Bonds currently pay a guaranteed 2 percent rate of return
plus inflation.) If their Part B accounts grew at a higher rate,
workers would receive increased retirement benefits. Again, in the
unlikely event that their accounts did not earn an average rate of
return of at least 2 percent, the benefits of these workers would
be reduced by the difference. In all cases, Part A benefits would
be calculated using an inflation index rather than the current
index, which is based on the growth of wages in the economy. This
change slows the rate at which future retirees' Social Security
benefits would grow while preserving the purchasing power of their
benefits. This approach also establishes a minimum retirement
benefit.
- Reform Model
3. Under this scenario, workers could invest an amount
equal to 2.5 percent of income from their Social Security taxes (up
to a maximum of $1,000 annually) in personal retirement
accounts--but only if they agreed to invest an additional amount
equal to 1 percent of their wages in their account. Part A benefits
would be offset by the amount to which the 2.5 percent of income
would have grown if it earned an annual rate of return equal to 2.5
percent. As in the previous approaches, if the Part B account did
not earn that much on average, total retirement benefits could be
reduced. However, any reduction would likely be offset by the
earnings of the additional 1 percent of income that this approach
requires workers to invest. In all cases, Part A benefits are
adjusted as if the retirement age increased with the growth in
longevity of the population. In other words, workers would have to
work to a later age in order to get their full benefits. The
approach also establishes a minimum retirement benefit.
Any
of these three approaches could be used to establish Part B
accounts. In addition, other alternative approaches that could be
adopted would likewise help to stabilize the system and increase
benefits. These might include larger Part B accounts that could
yield even higher retirement benefits and other types of benefit
adjustments.
Prospects for Increased Retirement
Income
According to the commission report, Social
Security Part B accounts would likely increase retirement benefits
in the future. All three of the alternative approaches that were
suggested would pay higher monthly benefits to future workers than
the current system can afford to pay. This is especially true with
regard to low-income workers.
For
example, under Reform Model 2, the monthly retirement benefits of
low-income workers are projected to increase by 46 percent by 2032
and 78 percent by 2052. Medium-income workers' retirement benefits
would increase by 18 percent by 2032 and 59 percent in 2052, while
the retirement benefits of high-income workers would climb by 17
percent by 2032 and 51 percent by 2052. (See Chart 1.) Reform Model
3 is projected to result in even greater increases in benefits.
In
addition to increasing retirement income--particularly among
minorities, low-income workers, and those workers who are divorced
or widowed--the commission found that Social Security Part B
accounts could be expected to increase asset ownership and boost
the economy by improving national savings and labor force
participation rates.
Minimizing Administration Costs
On
the basis of its own research and that performed under the previous
Administration, the commission recommended that Part B accounts be
administered according to the model that is currently used for the
retirement investments of federal employees. Under such a system,
workers would be allowed to choose to invest in any of three
diversified portfolios of bonds and stock index funds, all of which
would be managed by qualified private investment companies. Once
workers' accounts reached a specified size, they would be allowed
to shift the management of their accounts to individual funds
managers. However, investment choices would have to be approved as
suitable for retirement investing.
This
structure would be low-risk and would have very low administrative
costs. One study cited by the commission estimated that the
administrative costs that would be charged on these accounts could
be as low as $3.50 to $6.75 a year. It is anticipated that, once
the system is up and operating, average administrative charges
would be approximately $0.30 for every $100 in the account.
Conclusion
The
report of the President's Commission to Strengthen Social Security
is just the first step in reforming a Social Security system that
cannot be sustained in its current form. Throughout the year,
President Bush should lead a national dialogue to consider whether
Part B accounts should be established and, if so, how they should
be structured.
Although the outcome of such a discussion
remains to be seen, one thing is certain: Social Security personal
retirement accounts would provide a vehicle for future generations
to improve the rate of return on their Social Security taxes and to
improve their retirement incomes. The only alternative is either
unsustainable tax increases or massive benefit reductions.
David C.
John is Senior Policy Analyst for Social Security at The
Heritage Foundation.
Both the commission's
final report ( , December 21, 2001) and its interim report, which
details problems with the current Social Security system, are
available at .