January 11, 2002 | Backgrounder on Social Security
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.
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.
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
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.
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.
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/.