January 11, 2002

January 11, 2002 | Backgrounder on Social Security

Social Security Commission Report Shows Value and Feasibility ofIndividual Accounts

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.1 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.

The bipartisan commission was created by executive order to develop policy options for dealing with the impending financial crisis of the current Social Security system. The 16 members were told that any system of personal retirement accounts must be voluntary. In addition, President George W. Bush's principles for reform did not allow the commission to propose raising payroll taxes, cutting the benefits of those who were already retired or nearing retirement, affecting Social Security's disability and survivors programs, or allowing the government to invest part of the Social Security trust funds in the stock market.

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:
Chart 1

  • 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. 2 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.


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.

1. Both the commission's final report ( Strengthening Social Security and Creating Personal Wealth for All Americans: The Final Report of the President's Commission to Strengthen Social Security, December 21, 2001) and its interim report, which details problems with the current Social Security system, are available at http://www.commtostrengthensocsec.gov/reports/.

2. State Street Corporation, Administrative Challenges Confronting Social Security Reform, Boston, March 22, 1999


About the Author

David C. John Senior Research Fellow in Retirement Security and Financial Institutions
Thomas A. Roe Institute for Economic Policy Studies

Related Issues: Social Security