In February, President George W. Bush released his plan to reform Social Security with Personal Retirement Accounts (PRAs). In the months since, there has been great discussion and debate over how the Bush plan would affect individuals. Using details of the President's plan from the White House, along with reasonable assumptions and inferences, analysts at the Heritage Foundation's Center for Data Analysis have constructed a model of the Bush plan that shows how workers who choose to open a personal account would fare. Implemented as an online calculator, this model allows any individual to see how the Bush plan would affect him or her, relative to today's Social Security.[1]

This paper presents three examples of how the President's plan could affect individuals. The first example is a typical middle-aged man, aged 47, who earns a median salary of $42,709. The second example is a typical young woman, aged 27, who earns a median salary of $21,992. The final example is a married couple, aged 33, earning median wages of $36,000 for the primary earner and $26,000 for the secondary earner. These workers' characteristics are based on data from the Census Bureau's Current Population Survey. All figures are in 2004 dollars.

As a basis of comparison, Heritage's model calculates payable benefits under today's Social Security. Promised Social Security benefits have little meaning because the program is not required, under current law, to meet its promised obligations. According to Social Security's trustees, the program will be able to pay only 74 percent of promised benefits in 2041, after its trust fund runs dry.

The Heritage model of the Bush plan gives workers two options on how to manage their personal accounts when they reach retirement. First, workers can choose to retire with a nest egg, a sum of money that they can use as they see fit. In this case, a retiree uses only a portion of his or her PRA to purchase an annuity that will fund a portion of monthly benefits. The remainder stays in the personal account, where it can continue to compound and grow. The Heritage model reports the value of this nest egg at the time of retirement. If the retiree chooses to keep this money in the PRA, perhaps to pass it on to a child or grandchild, it could appreciate significantly. Or the retiree could choose to tap into the nest egg and use the money for his or her own needs.

Second, a retiree can choose to maximize his or her monthly retirement benefits by using his or her PRA to buy the largest annuity possible. Workers choosing this option forgo a nest egg and completely cash out their PRAs. This option allows a worker to receive the greatest monthly benefit during retirement.

Example One: A Typical Middle-Aged Man

This example focuses on a typical middle-aged male, who is 47 years old and earns a median salary of $42,709. Under the Bush plan, this worker could open a PRA in 2009. In his first year of participation, he would deposit the maximum of $1,000 into his PRA. Each year thereafter, he would deposit the maximum amount until his retirement at about age 67.

Today's Social Security promises this worker monthly benefits of $1,545. But that's not what Social Security can afford to pay. Adjusting for the future insolvency of the Social Security trust fund and the cut in benefits that it will require under current law, this worker will receive only $1,310 each month, on average, during retirement.

Under the Bush plan, this worker would retire with a PRA balance of $30,196, assuming a 4.9 percent annual real rate of return and administrative costs of 0.3 percent.

At retirement, this worker could choose to maximize his monthly benefits. If he uses his entire PRA to buy the largest annuity possible, he would receive total monthly benefits of $1,529. Of that total, $1,319 would come from traditional Social Security and $210 would come from the annuity. With this option, he would deplete his nest egg but receive total benefits that are $219 larger than what today's Social Security can afford to pay.

Alternatively, this worker could choose to retire with a nest egg. If he chooses to purchase an annuity just large enough to match his benefit had he not opened a PRA, he would still receive $1,503 per month and have a nest egg of $3,644 at retirement. That may not seem like much, but it is more than the current system allows ($0).

Example Two: A Typical Young Woman

This example focuses on a typical young woman, aged 27, who earns a median salary for her age. She will be able to open a PRA in 2010 and could, in her first year of participation, contribute the maximum four percent of her salary because her contributions would not exceed the $1,000 cap. Her contributions would start at about $880 and then increase along with her earnings.

Today's Social Security promises to pay her $1,497. But that's not what Social Security can afford to pay. This young worker will not reach Social Security's normal retirement age for 40 years, after the trust fund has run dry. After adjusting for the cut in benefits that this will require, this young worker will receive benefits of only $1,112, in real terms, during retirement.

Under the Bush plan, this worker would retire with a PRA balance of $102,636, assuming a 4.9 percent annual real rate of return and administrative costs of 0.3 percent.

At retirement, this worker could choose to maximize her monthly benefits. If she uses her entire PRA to buy the largest annuity possible, she would receive total monthly benefits of $1,611. Of that total, $899 would come from traditional Social Security and $712 would come from the annuity. With this option, she would forgo a nest egg in Social Security but receive total benefits that are $219 larger than what today's Social Security can afford to pay.

Alternatively, this worker could choose to retire with a nest egg. If she chooses to purchase an annuity just large enough to match her benefit had she not opened a PRA, she would still receive $1,406 per month and have a nest egg of $29,583 at retirement. She could choose to spend that money herself or keep it invested and let it grow to pass on to her children or grandchildren.

Example Three: A Typical Married Couple

This example focuses on a typical married couple, aged 33, with median earnings. This couple will be able to open personal accounts in 2010. In that first year of participation, the primary earner deposits the maximum, $1,100, into his PRA, while the secondary earner deposits $1,040.

Social Security will not be able to pay its promised benefits during this couple's retirement. After adjusting for the cut in benefits that current law requires after the Social Security trust fund runs dry, this couple will receive benefits of only $2,716, in real terms, during retirement.

Under the Bush plan, this couple would retire with a PRA balance of $202,815, assuming a 4.9 percent annual real rate of return and administrative costs of 0.3 percent.

At retirement, this couple could choose to maximize their monthly benefits. If they use their entire PRAs to buy the largest annuity possible, they would receive total monthly benefits of $3,735. Of that total, $2,411 would come from traditional Social Security and $1,324 would come from the annuity. With this option, the couple would forgo creating a nest egg in Social Security, but they would receive total benefits that are $1,019 larger than what today's Social Security can afford to pay.

Alternatively, this couple could choose to retire with a nest egg. If they choose to purchase an annuity just large enough to match their individual benefits had they not opened PRAs, they would still receive $3,415 per month and have a nest egg of $48,357 at retirement, in real 2004 dollars. They could choose to spend that money themselves or keep it invested and let it grow to pass on to their children or grandchildren.

The Bush plan is a particularly good deal for two-income families like this one. When both partners have personal accounts, the couple can take fuller advantage of their retirement taxes and earn more money than they could in today's Social Security system.

Conclusion

These examples show that the Bush plan to reform Social Security with personal accounts is a realistic and achievable way for individuals to get a better return on their Social Security taxes and have more control over how they retire.

The President's plan is notable for its cap on PRA contributions, which starts out at $1,000 in 2009 and increases $100 per year, plus wage inflation, thereafter. This mechanism helps to keep transition costs low while, at the same time, letting low-income and younger workers take greater advantage of PRAs and the higher returns that they offer. For instance, while the middle-aged worker in example one never contributes a full 4 percent of his earnings into his PRA, the younger worker in example two is able to contribute a full 4 percent of her earnings every year.

Though the amounts involved for individuals may be modest-especially in a debate where trillions of dollars is the usual unit of measure-Heritage's model of the Bush plan demonstrates that personal accounts are in integral part of restoring solvency to Social Security while improving individuals' returns and increasing flexibility and choice.

Rea S. Hederman, Jr., is Manager of Operations and a Senior Policy Analyst in the Center for Data Analysis at The Heritage Foundation.