Some opponents of the President's plan to reform Social Security say that the government would seize the money in a worker's personal retirement account (PRA) at retirement. This charge is completely untrue. Such critics misunderstand the plan's simple mechanism to decide what proportion of a worker's retirement benefits would be paid through a monthly government check and what proportion would come from the PRA.

Under the President's plan, both the PRA and the traditional monthly benefit would be funded by the same Social Security payroll tax that today finances the traditional Social Security benefit alone. If workers were to invest some of their payroll tax in a personal account and receive retirement earnings from that account, it makes sense that they should not receive the same traditional Social Security benefits as someone who chose to leave all their taxes in the system. Without some means to adjust for the money directed into the PRA, workers would be double dipping-receiving both the full traditional monthly benefit without paying the full freight while also receiving income from a PRA financed with payroll taxes.

Under President Bush's plan, the 10.6 percent[1] Social Security payroll tax that today finances monthly retirement and survivors' benefits would be divided into two parts. When the plan is fully phased in, 4 percentage points would go to the worker's PRA and the remaining 6.6 percentage points would finance government-paid monthly retirement benefits. Quite appropriately, a worker would not receive the same level of government-paid monthly benefits from a 6.6 percent tax on wages as from a 10.6 percent tax. A PRA that is funded with a portion of the Social Security payroll tax would finance the worker's additional retirement benefits.

The Formula

With a PRA, retirees would receive benefits that are partly paid by the government and partly paid from the PRA. When workers retire, several steps would determine how much they receive from each part:

• First, a formula similar to the one used by Social Security today would determine the amount of a retiree's normal monthly benefit under Social Security.
   
• Second, the government would determine what traditional Social Security monthly benefits would be equivalent to the taxes the worker instead puts into their PRA. To do this, the Social Security Administration would calculate how much the taxes devoted to the PRA would have generated in earnings if they earned 3 percent annually after inflation (the average amount earned by government bonds). Then, the agency would calculate what this would be as a monthly retirement payment.
   
• Third, that monthly payment calculated in step two would be subtracted from the retirement benefit calculated in step one - because the worker's taxes would not all be going to earn traditional Social Security benefits. When the worker retired, he or she would get this appropriately lower traditional benefit plus monthly earnings from the PRA. So no double-dipping.
   
• Fourth, if the account had actually earned more than an average of 3 percent annually, the retiree would be ahead of the game and would keep the difference either as a nest egg or a higher combined monthly retirement benefit, or the retiree could spend the extra amount. The choice belongs to the retiree because the retiree owns that money. Keep in mind that PRAs in safe investments are expected to earn 4.6 percent annually, compared with the 3 percent rate used to determine the offset to traditional Social Security benefits.

An Example

When a worker retires, the Social Security Administration calculates that he should receive a total Social Security retirement benefit of $1,200 a month based on his income history. The hypothetical calculation shows that his PRA could pay $400 a month. Therefore, the government-paid monthly benefit would be $800 a month.

When the $800 is added to the $400 from the PRA, the $1,200 monthly benefit is reached. But if the PRA earned more than 3 percent annually after inflation, then the worker would either have money left over for a nest egg or could choose to take a higher monthly benefit.

This mechanism in the President's plan is a common-sense step to prevent double dipping. The government does not take away any of the retiree's PRA, and in no sense are the taxes devoted to PRAs a loan for speculative investment, as some have mistakenly claimed. Younger workers who are able to invest a portion of their payroll taxes in the PRAs described in the President's plan will almost certainly earn a greater rate of return than today's Social Security is able to provide. Critics' confusion about the operation of PRAs should not be allowed to obscure this fact.

David C. John is Research Fellow in Social Security and Financial Institutions in the Thomas A. Roe Institute for Economic Policy Studies at The Heritage Foundation.