[House Hearing, 109 Congress]
[From the U.S. Government Printing Office]
EIGHTH IN A SERIES OF SUBCOMMITTEE
HEARINGS ON PROTECTING AND
STRENGTHENING SOCIAL SECURITY
=======================================================================
HEARING
before the
SUBCOMMITTEE ON SOCIAL SECURITY
COMMITTEE ON WAYS AND MEANS
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED NINTH CONGRESS
FIRST SESSION
__________
JUNE 23, 2005
__________
Serial No. 109-27
__________
Printed for the use of the Committee on Ways and Means
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COMMITTEE ON WAYS AND MEANS
BILL THOMAS, California, Chairman
E. CLAY SHAW, JR., Florida CHARLES B. RANGEL, New York
NANCY L. JOHNSON, Connecticut FORTNEY PETE STARK, California
WALLY HERGER, California SANDER M. LEVIN, Michigan
JIM MCCRERY, Louisiana BENJAMIN L. CARDIN, Maryland
DAVE CAMP, Michigan JIM MCDERMOTT, Washington
JIM RAMSTAD, Minnesota JOHN LEWIS, Georgia
JIM NUSSLE, Iowa RICHARD E. NEAL, Massachusetts
SAM JOHNSON, Texas MICHAEL R. MCNULTY, New York
PHIL ENGLISH, Pennsylvania WILLIAM J. JEFFERSON, Louisiana
J.D. HAYWORTH, Arizona JOHN S. TANNER, Tennessee
JERRY WELLER, Illinois XAVIER BECERRA, California
KENNY C. HULSHOF, Missouri LLOYD DOGGETT, Texas
RON LEWIS, Kentucky EARL POMEROY, North Dakota
MARK FOLEY, Florida STEPHANIE TUBBS JONES, Ohio
KEVIN BRADY, Texas MIKE THOMPSON, California
THOMAS M. REYNOLDS, New York JOHN B. LARSON, Connecticut
PAUL RYAN, Wisconsin RAHM EMANUEL, Illinois
ERIC CANTOR, Virginia
JOHN LINDER, Georgia
BOB BEAUPREZ, Colorado
MELISSA A. HART, Pennsylvania
CHRIS CHOCOLA, Indiana
DEVIN NUNES, California
Allison H. Giles, Chief of Staff
Janice Mays, Minority Chief Counsel
______
SUBCOMMITTEE ON SOCIAL SECURITY
JIM MCCRERY, Louisiana, Chairman
E. CLAY SHAW JR., Florida SANDER M. LEVIN, Michigan
SAM JOHNSON, Texas EARL POMEROY, North Dakota
J.D. HAYWORTH, Arizona XAVIER BECERRA, California
KENNY C. HULSHOF, Missouri STEPHANIE TUBBS JONES, Ohio
RON LEWIS, Kentucky RICHARD E. NEAL, Massachusetts
KEVIN BRADY, Texas
PAUL RYAN, Wisconsin
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C O N T E N T S
---------- Page
Advisory of June 16, 2005 announcing the hearing................. 2
WITNESSES
Social Security Administration, Hon. James B. Lockhart, Deputy
Commissioner................................................... 5
U.S. government Accountability Office, Barbara D. Bovbjerg,
Director, Education, Workforce, and Income Security............ 10
------
American Enterprise Institute, Alex J. Pollock................... 52
Congressional Research Service, Patrick J. Purcell............... 42
Federal Retirement Thrift Investment Board, Francis X. Cavanaugh. 67
National Academy of Social Insurance, Virginia P. Reno........... 74
National Women's Law Center, Joan Entmacher...................... 58
Wharton School, University of Pennsylvania, Olivia S. Mitchell,
Ph.D........................................................... 35
SUBMISSIONS FOR THE RECORD
Clark, Robert, North Carolina State University, Raleigh, NC,
statement...................................................... 89
Copeland, Craig, Employee Benefit Research Institute, statement.. 91
Cyr, Paul, Greene, ME, statement................................. 93
Jones, Ike, America's Community Bankers, statement............... 94
Lancon, Renee, West Hills, CA, statement......................... 96
Mitchell, Olivia, Wharton School, Univ. of Pennsylvania,
Philadelphia, PA, statement.................................... 99
Sewell, Robin, Littleton, MA, statement.......................... 104
EIGHTH IN A SERIES OF SUBCOMMITTEE
HEARINGS ON PROTECTING AND
STRENGTHENING SOCIAL SECURITY
----------
THURSDAY, JUNE 23, 2005
U.S. House of Representatives,
Committee on Ways and Means,
Subcommittee on Social Security
Washington, DC.
The Subcommittee met, pursuant to notice, at 10:00 a.m., in
room B-318, Rayburn House Office Building, Hon. Jim McCrery
(Chairman of the Subcommittee) presiding.
[The advisory announcing the hearing follows:]
ADVISORY FROM THE COMMITTEE ON WAYS AND MEANS
SUBCOMMITTEE ON SOCIAL SECURITY
CONTACT: (202) 225-9263
FOR IMMEDIATE RELEASE
June 16, 2005
No. SS-8
McCrery Announces Eighth in a Series of
Subcommittee Hearings on
Protecting and Strengthening Social Security
Congressman Jim McCrery (R-LA), Chairman, Subcommittee on Social
Security of the Committee on Ways and Means, today announced that the
Subcommittee will hold the eighth in a series of Subcommittee hearings
on protecting and strengthening Social Security. The hearing will
examine options for the administration of personal retirement accounts.
The hearing will take place on Thursday, June 23, 2005, in room B-318
Rayburn House Office Building, beginning at 10:00 a.m.
In view of the limited time available to hear witnesses, oral
testimony at this hearing will be from invited witnesses only. However,
any individual or organization not scheduled for an oral appearance may
submit a written statement for consideration by the Subcommittee and
for inclusion in the printed record of the hearing.
BACKGROUND:
The past two Administrations, the 1994-1996 Social Security
Advisory Council, and the 2001 President's Commission to Strengthen
Social Security, have laid out proposals to establish personal accounts
that are either integrated with Social Security benefits or in addition
to Social Security benefits. Personal accounts have been proposed as a
means to enhance individuals' retirement income, as Social Security's
Trustees have warned that current-law promised Social Security benefits
cannot be paid in full in the future absent action to address the
program's long-term insolvency.
An important aspect of the development of personal accounts
involves system design, including account management and recordkeeping,
investment options, and methods to pay benefits to workers at
retirement. An equally important aspect is that administrative expenses
must be kept low to preserve workers' account balances.
Numerous nonpartisan studies, including studies by the U.S.
Government Accountability Office and the Social Security
Administration, indicate that system design issues are of vital
importance for the successful widespread use of personal retirement
accounts. While the design possibilities are many and varied, the
experience derived from the management of other large-scale retirement
systems, such as the Federal Thrift Savings Plan, can provide valuable
insights.
In announcing the hearing, Chairman McCrery stated, ``As we
consider how personal retirement accounts would strengthen retirement
security, we must acknowledge that the proper design of a personal
account system is not a mere technical detail. Rather, we must
carefully consider key questions on implementation, administration, and
public education to ensure workers receive the quality service they
deserve, along with low expenses that preserve account balances.''
FOCUS OF THE HEARING:
The hearing will focus on options for designing a system of
personal retirement accounts to ensure that the accounts are managed
efficiently and accurately, with low administrative fees to preserve
account balances. Options for paying out account balances at retirement
will also be examined.
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noted above.
Chairman MCCRERY. The hearing will come to order. Good
morning. Welcome, everyone, to our eighth Subcommittee hearing
on protecting and strengthening Social Security. Today, we will
look at system design issues for personal accounts, including
account management and recordkeeping, annuities, administrative
fees, and issues related to converting account balances into a
monthly income. Yesterday, I and several of my colleagues here
on the Subcommittee, Mr. Shaw, Mr. Johnson, and Mr. Ryan, took
the first step on stopping the raid on Social Security. Our
Chairman, Bill Thomas, called this a common sense approach, and
I think the American people would agree. It is simple common
sense that the Social Security surplus needs to be preserved
for retirement income, and H.R. 3304, the ``Growing Real
Ownership for Workers (GROW) Accounts Act,'' will do just that.
The GROW accounts would be fully inheritable, voluntary,
and initially invested in safe, marketable Treasury bonds.
Naturally, the success of any type of personal account system
involves the careful consideration of system design issues.
America's workers and their families deserve a voluntary
personal account system that will give them excellent service,
offer prudent and diversified investment options, protect their
investments with good stewardship, and preserve their account
balances through low administrative fees. I welcome our
distinguished panels today, and I look forward to hearing your
views. Mr. Levin?
Mr. LEVIN. Thank you, Mr. Chairman. I am glad this hearing
has been called so we can delve into issues like offsets and
clawbacks, so that we can understand fully the administrative
complexities, and some of the testimony will very much focus on
that, and I think bring out some complexities that aren't
understood. We will also have a discussion of administrative
costs, and we need to do that. Indeed, the timing of this
hearing could not be more salient because of the developments
in the last 24 hours. It is very clear, if it wasn't before,
that privatization of Social Security is basically what this
argument is all about.
The proposals of the last 24 hours make it very clear that
privatization is at the heart of the Republican approach, the
replacement of Social Security with private accounts, but
privatization at any cost. What has been suggested in recent
hours, we would continue the use of Federal Insurance
Contributions Act (FICA) taxes other than for Social Security,
one way or another, solvency would be made worse. The fiscal
irresponsibility of this Congress and this President could
continue because Social Security funds could continue to be
used for other purposes, and uncertainty would really increase
for everyone. Instead of a guaranteed benefit in a Social
Security system for people who are retired or who are going to
retire, for people who become disabled, for survivors. Instead
of the certainty of a guaranteed benefit, we would end up with
uncertainty for everybody, for those who would be in the Social
Security system and for those who would have these private
accounts. So, I think it is useful now to delve into these
issues of what private accounts would mean in terms of
complexity, in terms of cost, in terms of offsets. So, let's
get with it.
Chairman MCCRERY. Thank you, Mr. Levin. Our first panel
this morning is a familiar one to us on the Committee on Ways
and Means, the Honorable James B. Lockhart, Deputy Commissioner
of the Social Security Administration (SSA) and Ms. Barbara
Bovbjerg, Director of Education, Workforce and Income Security
with the U.S. government Accountability Office (GAO). Welcome
back, it is nice to have you. We welcome your testimony this
morning. Your entire written testimony will be included in the
record. If you could summarize that in about five minutes each,
we would appreciate it. Mr. Lockhart.
STATEMENT OF THE HONORABLE JAMES B. LOCKHART, DEPUTY
COMMISSIONER, SOCIAL SECURITY ADMINISTRATION
Mr. LOCKHART. Thank you, Chairman McCrery, and Members of
the Subcommittee. Thank you for holding this series of hearings
on protecting and strengthening Social Security, and for
inviting me to discuss the administration of voluntary personal
accounts. The idea of creating a system of personal accounts as
part of reforming Social Security has received much attention,
including proposals developed by President Clinton and
President Bush's Social Security Commissions. There are a
number of models for administering a system of personal
accounts. The most recent personal accounts proposals envision
a voluntary program with a centrally administered system
modeled on the Thrift Savings Plan (TSP), and Social Security's
existing annual wage reporting system. This is not a
decentralized small business 401(k) model.
Assuming a centralized approach, Social Security
independent actuaries estimate an ultimate cost of 30 basis
points of assets under management for personal accounts. This
cost seems reasonable, and in my opinion, may fall as the
amount of assets under management grows. There will be
significant challenges, but I believe that over a reasonable
implementation period of perhaps 3 years, we could produce an
efficient, equitable, and accurate system of personal
retirement accounts. Social Security personal accounts could
quickly achieve very large economies of scale. Under the
President's personal accounts framework, there would be 120
million personal accounts, with assets totaling $602 billion by
the end of 2015. As a centralized system of personal accounts
is developed, its business processes should reflect a coherent
set of underlying designed principles.
As I detail in my written testimony, there are seven basic
processes: Education, Enrollment, Contribution, Investment,
Recordkeeping, Compliance, and Payout. There are proven, low-
cost models for each of these processes. Many proposals suggest
creating a new government agency with an independent board
similar to the TSP that would have primary responsibility for
administering the plan, with strong support from the SSA.
The TSP is a very good, low-cost model for personal
accounts. It has 3.4 million participants, and $157 billion of
assets under management. It offers five investment
alternatives, including a Treasury bond option, and four very
low-cost index funds which are designed to replicate the
returns of broad, corporate bond and stock market indexes. It
is also adding a life cycle fund this summer. The TSP's costs
are six basis points, and the investment manager receives very,
very little of that. Some people have suggested that the TSP is
not an appropriate model because there are about six-and-a-half
million employers in the United States, while there are only
about 130 government agencies providing payroll information to
the TSP. While this is true, I believe our proven and low-cost
wage reporting process could provide a single interface between
employers and self-employed individuals and the program's
central record keeper.
Social Security processes 240 million W-2s annually for
approximately 149 million workers. Over the last 6 years,
electronic filing has grown from just 7 percent to 65 percent.
In 3 years, we are targeting to hit 82 percent. Social Security
already makes software available that allows small employers to
report electronically. Social Security receives W-2s beginning
in January for the previous year. Due to the lag in reporting,
some plans suggest there could be a holding fund, where the
contributions would be deposited until individual accounts
could be credited, with not only the amount taken out from
payroll taxes, but also the interest on that amount.
A strengthened Social Security program that includes
personal accounts that provide individual Americans with
ownership and more personal control over their retirement
income is feasible. Using the model of the TSP, along with
systems already in place, costs could be minimized. As the
assets grow, more choices and flexibilities could be added at a
reasonable cost. As President Bush said in his State of the
Union Address, and I quote, ``The goal here is greater security
in retirement, so, we will set careful guidelines for personal
accounts.'' Commissioner Barnhart and I are committed to
strengthening and protecting Social Security, and to making
sure the SSA is ready to assist the Administration and Congress
in doing so. As the Social Security trustees, President Bush,
and many others have said, we need to take action soon to save
Social Security for future generations. Thank you, and I will
be happy to address any questions.
[The prepared statement of Mr. Lockhart follows:]
Statement of The Honorable James B. Lockhart, Deputy Commissioner,
Social Security Administration
I would like to thank Chairman McCrery and the Members of the
Subcommittee for holding this series of hearings on protecting and
strengthening Social Security and for inviting me to discuss the
administration of voluntary personal retirement accounts.
My remarks today are based on the work that has been done by many
groups as well as over 30 years of off and on personal experience with
corporate pensions. My experiences range from serving on the pension
committee of one of the largest corporations in the country, to
starting a 401(k) plan for a small business, to serving as the
Executive Director of the Pension Benefit Guaranty Corporation.
Over the past decade, the idea of creating a system of personal
accounts as part of reforming Social Security has received much
attention, including proposals developed by the 1994-96 Social Security
Advisory Council and the 2001 President's Commission to Strengthen
Social Security. As a result, SSA has looked at the issues involved in
administering such a program. We have also studied the Federal Thrift
Savings Plan (TSP) and met with their staff and their systems
contractor to discuss pertinent issues and draw on their experience. I
have also seen SSA successfully implement other large projects such as
our new electronic disability system and the rollout of the new
application for extra help with prescription drug costs under Part D of
Medicare.
A number of models for administering a system of personal accounts
have been discussed. Over the last several years, most personal account
proposals envision a voluntary program with a centrally administered
system modeled on the TSP.
Assuming this approach, Social Security's independent actuaries
reduce their estimate of real investment returns of 4.9% by an ultimate
annual cost of 0.3% (30 basis points) of assets under management for
personal accounts. A basis point is 1/100th of one percent, so 30 basis
points would equal $3 per $1,000 of assets. This cost seems reasonable
and, in my opinion, may fall as the system matures and gets larger.
There would be significant challenges, but I believe that over a
reasonable implementation period of perhaps three years, we could
produce an efficient, equitable, and accurate system of personal
retirement accounts.
I want to note that I have not been talking about a small business
corporate 401(k) plan model, which some critics of personal accounts
do. 401(k) plans are expensive for small businesses to administer
because of their small scale and because of the regulatory burden. Nor
am I using a large employer 401(k) model that has lots of choices,
although some do have annual fees less than 30 basis points. To the
contrary, I am focusing on a centralized model using the Social
Security Administration's existing annual wage reporting (Form W-2)
system and the proven TSP model. I believe that this approach is the
key to successful and timely implementation of a personal account
system.
Social Security personal accounts could quickly become the largest
defined contribution plan in the world and achieve very large economies
of scale. Assuming a two-thirds participation rate, the Social Security
actuaries project that under the President's personal account
framework, which phases in personal accounts from 2009 to 2011, there
would be about 120 million personal accounts with assets totaling $602
billion (in constant 2004 dollars) at the end of 2015.
As a centralized system of personal accounts is developed, its
business processes should reflect a coherent set of underlying design
principles. The goal should be to enable the pieces of the new system
to fit together in a seamless manner, keep administrative costs to a
minimum, speed implementation, and boost public acceptance. There are 7
basic processes in a personal account system, which are:
Education--The process of providing plan information at
various points in time and to distinct categories of individuals,
enabling them to make informed decisions.
Initially, the general public would need to be educated about the
plan's structure, operation, and participation benefits so that workers
could decide whether or not to enroll. Subsequently, those who enroll
would need more detailed information about investment opportunities and
the status of their accounts. Finally, those about to retire and
beneficiaries of deceased participants would need information that
outlines options available for accessing account assets.
In addition to the initial, one-time education of the
general public about the account plan, a continuous educational program
would need to be in place for the over 4 million new workers a year who
would need to make an enrollment decision.
Enrollment--The process of obtaining a worker's consent
and supporting information to create a personal account. The supporting
information includes the person's identifying information, investment
fund selections, beneficiary data, and contact information.
A plan could enroll workers via the Internet and machine readable
paper forms. Enrollment could be done by ``opting-in'' or ``opting-
out''. The latter means that a worker would have to fill out a form
stating that he or she did not want to volunteer for personal accounts.
In the corporate 401(k) world, opting-out has successfully raised
enrollment rates. No matter which enrollment option was chosen, the
administrator would likely need to mail out confirming ``welcome''
packages to enrollees that acknowledge receipt of the applications and
provide more detailed educational materials about the plan.
This process entails a large, initial start-up process to establish
accounts for current workers and then a continuing process to create
accounts for new workers.
Contribution--The process of collecting, verifying, and
crediting wage information and money from approximately 6.5 million
employers and 15 million self-employed workers.
The most efficient method for collecting the contributions would be
through the current payroll deduction process, as it would demand the
least change for employers. However, other options exist that would
entail more frequent employer reporting, electronic reporting, direct
employer reporting to the account administrator, or use of other
reporting/collection avenues, such as the State workforce agencies.
Investment--The process of quickly and accurately
investing contributions in funds chosen by the participants.
This process involves setting the plan's investment policies,
establishing available funds for participant investment, selecting
investment managers, making timely fund purchases, and updating account
balances based on fund performance.
Recordkeeping--The process of maintaining account
information and providing service to participants.
The process would need to provide participants with periodic
account statements and the ability to update account records as
personal situations change; for example, as addresses, marital status,
or beneficiary selections change. It would also need to allow
participants to modify how their contributions are invested and to
reallocate their assets between funds.
In addition, the plan would need to provide the means to answer
account or plan-related questions from participants, beneficiaries,
employers, and the general public. This would entail a large internet/
website operation as well as a large teleservice component.
Compliance--The process for monitoring the program to
ensure that workers, employers, beneficiaries, and fiduciaries comply
with statutes and regulations.
A plan would need to develop procedures to monitor transactions and
audit financial records, and make corrections to account records where
errors are detected. In addition, the plan would need to have an
appellate process that could hear worker or employer requests for
reconsideration of the corrective actions.
Payout--The process for dispersing account assets to
participants during retirement or to beneficiaries of workers who die
prior to retirement.
Many proposals envision that workers would annuitize to remain
above a poverty level-related threshold. Options for releasing the
remaining assets above the threshold include paying them out as lump
sums or as phased withdrawals.
Included in this process would be making various types of annuities
available to retirees and their spouses, and possibly the
administration of the entire annuitization program. Moreover, the
process would need to have procedures in place to locate beneficiaries
and deal with abandoned accounts.
There are proven, low cost models for each of these processes. As
others point out, there are also proven, expensive models. In designing
a personal account system, Congress should take care to choose options
that follow the low cost model. Over time, more flexibility and options
could be added as needed.
Many proposals suggest a new independent government agency with an
independent board similar to the TSP that would have primary
responsibility for most of these activities, with the strong support of
the Social Security Administration. In particular, SSA could play a key
role in the front-end education, enrollment and contribution phases and
potentially in the payout phase. The education process in particular
could involve many government agencies building on the Financial
Literacy and Education Council as well as business and not-for-profits
ongoing financial education efforts.
The TSP is a very good, low cost role model for personal accounts.
It has 3.4 million participants and $157 billion of assets under
management. It offers 5 investment alternatives including a Treasury
bond option and four very low cost indexed funds, which are invested to
replicate the returns of broad market indexes. These four TSP funds are
very comprehensive and include a corporate bond fund, a Standard and
Poor's 500 fund, a U.S. smaller companies fund covering U.S. stocks not
in the S&P 500, and an international equity fund.
In addition, by September 2005, TSP plans to add lifecycle funds
using a combination of investments in each of the 5 funds in their
system. These lifecycle funds gradually and automatically move assets
into less volatile investments as the participant gets closer to
retirement. For instance, the TSP lifecycle fund for younger workers
will have 85 percent invested in equities and by retirement age the
equity percentage would be reduced to 20 percent. The idea, which
President Bush has endorsed, is to lessen investment volatility as one
reaches retirement age. Life cycle funds are especially appealing to
persons who do not wish to make a fund selection or actively manage
their accounts. At payout or retirement, TSP offers lump sums, monthly
payouts, or annuities.
The TSP does all of that with only 90 people plus approximately 400
contract employees and a net cost of $95 million in FY 2005, or 6 basis
points of the assets under management. Almost all of this cost is
administrative fees. The fees of Barclays Global Investors, the TSP
investment managers, represent a very small portion of those 6 basis
points.
The TSP recordkeeping system would be an excellent model for the
administration of personal accounts even though it has more
capabilities than would be needed initially for a Social Security
personal account system. TSP and its contractor have told us that their
computer system could be adapted to Social Security personal accounts.
Some people have suggested that the TSP is not an appropriate model
because there are about 6.5 million employers in the United States
while there are only about 130 government agencies providing payroll
information to the TSP. While this is true, I believe the existing SSA
wage reporting process could provide a similar single interface between
eligible employees and self-employed individuals and the program's
central record keeper.
Using the existing wage reporting system would provide a low cost
and efficient way to collect contribution information. Social Security
processes 240 million W-2s annually for approximately 149 million
workers. We have a major push under way to increase electronic filing.
Over the last six years, electronic filing has grown from 7 percent to
65 percent and we are targeting 82 percent by 2008, and 95 percent by
2012. By law, employers with over 250 employees must report
electronically.
Social Security begins receiving W-2s in January for the previous
year. We begin processing immediately with 82 percent processed by
April 30th and 99 percent by September. Because of the lag in
reporting, the President's Commission on Strengthening Social Security
suggested that there could be a ``holding'' fund where contributions
would be deposited until individual accounts could be reconciled. This
reconciliation would occur once the individual's W-2 information was
processed and the personal account would receive the amount contributed
plus interest.
As you look at the design of a personal account system, you may
want to consider basic principles that would facilitate a simple,
efficient process that minimizes administrative burdens and participant
costs. These include:
Utilize existing and proven processes. As previously
discussed, the TSP and Social Security's annual wage reporting system
provide an excellent foundation for a timely, low cost and effective
implementation of a Social Security personal account program.
Minimize worker and employer burden. The public would
most likely prefer a system that causes little additional work for
workers and employers. Significant reporting responsibilities for
employers could raise business costs, and may adversely impact
employment.
Minimize the use of paper processes. Building a new
system would allow the unique opportunity to develop processes based on
new and innovative methods where cost-effective processes do not
already exist. Developing electronic-based means for collecting,
storing, and releasing information would be consistent with e-
Government concepts, could potentially reduce administrative costs,
speed processes, and allow smoother interface with other administrative
systems.
Limit investor-initiated changes. Limiting investors
initially to a few investment allocation changes per year would reduce
administrative costs.
Limit account reporting. Providing investors with
quarterly account statements would help to keep reporting costs low and
investor inquiries to a minimum. Reducing investor non-electronic
inquires about account statements would also help to reduce investor
support costs.
Prevent pre-retirement account access. By preventing
access to accounts before retirement, administrative costs could be
kept to a minimum, the process would be simpler, and the governing
rules would be more understandable to participants.
Limit distributional alternatives. Unlike the TSP, which
has multiple annuity and payout options, the personal account program
should limit distributional options in order to minimize administrative
costs. As the first retirees under a personal account plan would retire
10 years from enactment, there would be the opportunity to develop low
cost, flexible payout alternatives.
In conclusion, while specific issues and costs related to the
administration of personal accounts would vary with the specifics of
the plan, a strengthened Social Security program that includes personal
accounts that provide individual Americans with ownership and more
personal control over their retirement income is feasible. Using the
model of the Federal TSP along with systems already in place, costs
could be kept to an acceptable minimum. And as the assets under
management and account sizes grow, allowing additional economies of
scale, more choices and flexibilities can be added at a reasonable
cost.
As President Bush said in his 2005 state of the Union Address,
``The goal here is greater security in retirement, so we will set
careful guidelines for personal account.'' He also said, ``We'll make
sure there are good options to protect your investments--'' That is
very doable and I would add that a properly designed personal account
plan could ensure a better deal for younger workers.
Commissioner Barnhart and I are committed to strengthening and
protecting Social Security and to making sure that SSA is ready to
assist the Administration and Congress in doing so. Given sufficient
time and resources, SSA could successfully implement and administer our
share of a personal account program. I will be happy to address any
questions you may have.
Chairman MCCRERY. Thank you, Mr. Lockhart. Ms. Bovbjerg.
STATEMENT OF BARBARA D. BOVBJERG, DIRECTOR, EDUCATION,
WORKFORCE AND INCOME SECURITY, U.S. GOVERNMENT ACCOUNTABILITY
OFFICE
Ms. BOVBJERG. Thank you, Mr. Chairman, Members of the
Subcommittee. Thank you for continuing to invite me to discuss
Social Security reform issues before you; I really appreciate
it. Today, you have asked me to address issues of individual
account design. There are many options and issues to consider
when designing a system of individual accounts, and the choices
that we make could affect not only participation in the
accounts, but also, the benefits that might ultimately be
received. I would like to structure my comments today around
the three phases associated with retirement savings vehicles
generally: The contribution phase, the accumulation phase, and
the distribution phase. My remarks are drawn from a body of
work that we have done, much of it for this Subcommittee, over
the last several years. Let me begin with the contribution
phase.
Determining how contributions to an individual account will
be made involves choices as to size, whether the account is a
substitute or a supplement, and whether participation should be
voluntary or mandatory. Deciding whether accounts should be
voluntary or mandatory is one of the most important design
considerations. While offering the choice of whether to
participate may be desirable, voluntary accounts require
additional design considerations that mandatory accounts do
not. For example, voluntary accounts likely will require
incentives to induce participation, and these can be
substantial as well as difficult to estimate accurately.
Administration can be more complex for voluntary accounts,
especially if participants are permitted to opt in and out of
the accounts periodically. Although any changes to Social
Security, any changes at all, must be well explained to the
public, voluntary accounts make public education campaigns even
more important.
Let me turn now to the accumulation phase. Critical
decisions will be needed as to what investment choices will be
offered and how the funds will be managed. A wide range of
investment choices would offer individuals the ability to
customize their investments to their own financial needs and
preferences, but raises the risks that individuals could invest
unwisely, and find accounts insufficient to finance their
retirement. Wider choices also mean higher administration
costs. Limiting investment choice would help to minimize risk,
of course, but would limit the possible returns. Similarly, a
centrally managed system would take advantage of economies of
scale, as Mr. Lockhart mentioned, while a more decentralized
approach would be more flexible, but also more costly.
Essentially, the challenge is finding the right balance between
individual choice, and risks and costs to the individual and to
the government.
The last piece I will discuss is the distribution phase.
Individual accounts could use three basic ways to pay
retirement benefits: annuitization, timed withdrawals, and lump
sum payments. Individuals could be allowed to choose from the
three approaches, but offering such a range of choice could
risk individuals outliving their retirement resources, and
would represent relatively high administrative costs.
Alternatively, mandatory annuitization could help ensure
retirement income for the participants' lifetimes and would
minimize adverse selection, which, in turn, would keep annuity
prices lower, but would retain control over payouts from the
individual.
Most importantly, policy makers must also consider whether
to allow participants to borrow against their accounts at
relatively low interest rates, as is permitted with 401(k)
plans. Our work has shown that this option is important to
inducing participation in voluntary savings plans, but results
in lower account balances at retirement. While having access to
one's own savings may likely be considered a basic aspect of
account ownership, this consideration would have to be balanced
against the potential diminution of retirement income that such
a policy would risk. In conclusion, the wide range of possible
options complicates the design of an individual account system.
Our work shows that providing flexibility and choice generally
increases system costs and complexity, and these will be
important tradeoffs to consider if Social Security reform
includes such restructuring.
Although bigger picture policy concerns necessarily
dominate the Social Security debate at this stage, if
individual accounts are to be features of the reformed program,
design and administrative specifics much be addressed well in
advance to changes of the law. This is not only for ease of
implementation, but also to assure that time is allotted for
the necessary public education. Even if an existing account
structure, such as the TSP, were to be used for Social
Security, the sheer number and diversity of Social Security
participants and employers would complicate implementation and
would require careful planning. That concludes my statement,
Mr. Chairman. I am happy to answer any questions.
[The prepared statement of Ms. Bovbjerg follows:]
Statement of Barbara Bovbjerg, Director of Education, Workforce, and
Income Security, U.S. Government Accountability Office
Mr. Chairman and Members of the Subcommittee:
I am pleased to be here today to discuss options for designing a
system of individual accounts within the Social Security program.
Social Security forms the foundation for our retirement income system
and, in so doing, provides critical benefits to millions of Americans.
However, the Social Security program is facing significant future
financial challenges as a result of profound demographic changes. A
wide variety of proposals to reform the program are currently being
discussed, including restructuring the program to incorporate
individual accounts. When designing a system with individual accounts,
there are many options and issues to consider, such as whether the
accounts should be voluntary or mandatory, the amount of choice
individuals have over their investments, and how and when the funds are
withdrawn from the accounts. The choices that have to be made will
affect not only participation in the accounts, but also the amount of
savings accumulated in the accounts and the benefit received from the
account.
Today I will discuss options for the design of individual accounts
specifically corresponding to the phases of a pension or similar
retirement savings vehicle: the contribution phase, the accumulation
phase, and the distribution phase. GAO has conducted several studies
related to the design, implementation, and administration of individual
accounts. My statement is largely based on that work. \1\
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\1\ See the list of related GAO products at the end of this
statement.
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In summary, the creation of an individual account system faces key
design decisions in each of the phases that comprise the dynamics of a
retirement savings vehicle. For example, regarding contributions, the
size of the contribution and whether the accounts will be mandatory or
voluntary must be decided. This decision will be shaped to some degree
by the implicit relationship of the accounts to the current Social
Security program. In the accumulation phase, individual account design
must negotiate a number of trade-offs in setting, for example, the
amount of choice in investment options and the level of customer
service provided. Finally, individual accounts, like current defined
contribution (DC) plans and individual retirement accounts (IRAs), must
distribute accumulated account balances to individuals. A system of
individual accounts covering over 156 million workers would constitute
a fundamental change to Social Security and would be significantly
larger than any existing retirement investment program. Affected
individuals need to know about and understand the features of such a
new system to make informed life decisions about work, savings, and
retirement.
BACKGROUND
According to the Social Security Trustees' 2005 intermediate, or
best-estimate, assumptions, Social Security's cash surplus begins to
decline in 2009, and in 2017 cash flow is expected to turn negative. In
addition, all of the accumulated Treasury obligations held by the trust
funds are expected to be exhausted by 2041. Social Security's long-term
financing shortfall stems primarily from the fact that people are
living longer and having fewer children. As a result, the number of
workers paying into the system for each beneficiary has been falling
and is projected to decline from 3.3 today to about 2 by 2040.
A common feature of many Social Security reform proposals is the
creation of a system of individual accounts. Individual accounts would
generally not by themselves achieve solvency for the Social Security
system. Achieving solvency requires more revenue, lower benefits, or
both. Many proposals that incorporate a system of individual accounts
into the current program would reduce benefits under the current system
and make up for those reductions to some degree with income from the
individual accounts. Individual accounts also try to increase revenues,
in effect, by providing the potential for higher rates of return on
account investments than the trust funds would earn under the current
system, but this exposes workers to a greater degree of risk.
Three key distinctions help to identify the differences between
Social Security's current structure and one that would create
individual accounts.
Insurance verus savings. Social Security is a form of insurance,
while individual accounts would be a form of savings. As social
insurance, Social Security protects workers and their dependents
against a variety of risks such as the inability to earn income due to
death, disability, or old age. In contrast, a savings account provides
income only from individuals' contributions and any interest on them;
in effect, individuals insure themselves under a savings approach.
Defined benefit.Social Security provides a defined benefit (DB)
pension while individual accounts would provide a defined contribution
(DC) pension. Defined benefit pensions typically determine benefit
amounts using a formula that takes into account individuals' earnings
and years of earnings. The provider assumes the financial and insurance
risk associated with funding those promised benefit levels. Defined
contribution pensions, such as 401(k) plans, determine benefit amounts
based on the contributions made to the accounts and any earnings on
those contributions. As a result, the individual bears the financial
and insurance risks under a defined contribution plan until retirement.
\2\
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\2\ At retirement, individuals have the option of purchasing an
annuity with their defined contribution accounts, which then transfers
the financial and insurance risk to the annuity provider. Before
retirement, individuals may also have the option of purchasing deferred
annuities.
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Pay-as-you-go verus full funding. Social Security is financed
largely on a pay-as-you-go basis, while individual accounts would be
fully funded. In a pay-as-you-go system, contributions that workers
make in a given year fund the payments to beneficiaries in that same
year, and the system's trust funds are kept to a relatively small
contingency reserve. \3\ In contrast, in a fully funded system,
contributions for a given year are put aside to pay for future
benefits. The investment earnings on these funds contribute
considerable revenues and reduce the size of contributions that would
otherwise be required to pay for the benefits. Defined contribution
pensions and individual retirement savings accounts are fully funded by
definition. Both mandatory and voluntary individual account plans would
reflect all of these distinctions.
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\3\ Social Security is now temporarily deviating from pure pay-as-
you-go financing by building up substantial trust fund reserves. Social
Security is collecting more in revenues than it pays in benefits each
year partly because the baby boom generation makes the size of the
workforce larger relative to the beneficiary population. In 2017,
shortly after the baby boomers start to retire, the benefit payments
are expected to exceed revenues, and the trust fund reserves and the
interest they earn will help pay the baby boomers' retirement benefits.
For more detail about this temporary trust fund buildup and how it
interacts with the federal budget, see GAO, Social Security Reform:
Demographic Trends Underlie Long-Term Financing Shortage, GAO/T-HEHS-
98-43 (Washington, D.C.: Nov. 20, 1997).
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In addition to these key distinctions, options for the design of
individual accounts can be grouped in three categories corresponding to
the different phases of a retirement savings vehicle:
contribution phase: who should contribute, how much, and
with what funds;
accumulation phase: how are funds invested to make them
grow; and
distribution phase: how much of a benefit is received,
when is it received, and in what form is it received.
As we have reported previously with respect to Social Security
reform as a whole, as policy makers decide whether and how to create a
system of individual accounts, they must balance a range of difficult
concerns. These concerns include broad macroeconomic issues, such as
how to finance the accounts and how the accounts would affect the
economy and program solvency, as well as program benefit issues, such
as how to balance opportunities for improved individual investment
returns with the need to maintain an adequate income for those who rely
on Social Security the most. No less important is the need to consider
how readily individual accounts could be implemented, administered, and
explained to the public. An essential challenge would be to help people
understand the relationship between their individual accounts and
traditional Social Security benefits, thereby avoiding any gap in
expectations about current or future benefits. Individuals would also
need to be informed enough to make prudent investment decisions, which
would require investor education, especially if individual accounts
were mandatory. This would be especially important for individuals who
are unfamiliar with making investment choices.
DESIGN CONSIDERATIONS IN THE CONTRIBUTION PHASE
Determining how contributions to an individual account will be made
requires choices about the role these contributions play vis-`-vis the
current Social Security system. These choices include determining the
size and role of contributions, management of contributions, whether
the account is a substitute or a supplement, and whether participation
in the accounts should be voluntary or mandatory.
Size and Role of Contributions
An individual account plan can provide for contributions in a
variety of ways. For example, a plan might set contributions at a fixed
rate, such as 2 percent of pay, or allow a range of rates with,
possibly, a certain dollar limit. Some proposals provide for greater
average contribution rates for lower earners than for higher earners.
Individual accounts could be designed to include some progressive
features, which could mirror the redistributive effects of the current
Social Security program. For example, contribution rates may go down
gradually as earnings rise, or alternatively, all workers might pay a
fixed percentage but have a dollar cap on contribution amounts.
Ultimately the size of the individual account contribution rate
determines the relative role of the DC aspect of the account versus the
DB portion of the Social Security program. As a result, depending on
their design, individual accounts will have a varying effect on the
adequacy of benefits for certain subgroups of beneficiaries. For
instance, disabled beneficiaries leave the workforce sooner than
retired workers. With fewer years to make contributions (and accrue
interest), disabled beneficiaries will likely have smaller account
balances. At the same time, reform provisions that disfavor subgroups
of earners can be offset by other provisions that favor them. As a
result, any evaluations of reform proposals should not focus solely on
individual account proposals but should consider both the DC and DB
aspect of a proposal's provisions as a whole.
Management of Contributions
In managing individual accounts, contributions might be collected
and deposited by the government in a centralized process or by
employers or account providers in a decentralized process. Under a
centralized process, which would build on the current payroll reporting
and tax collection system, a federal agency, such as the Social
Security Administration, would assume record-keeping responsibilities.
Alternatively, a new centralized government clearinghouse could assume
responsibility for centralized record keeping, similar to the structure
for the federal Thrift Savings Plan. A decentralized structure could
build on the system that has grown up around employer-sponsored 401(k)
plans or individually managed IRAs. Under 401(k) plans, individual
records are maintained by either the employer or a separate entity
hired to manage the plan, or both. Under an IRA, the record-keeping
responsibility rests with the individual investor and the financial
institution where the funds are invested.
Substitute versus Supplementary Contributions
Individual accounts can either supplement current Social Security
contributionsor substitute for all or part of them.With supplemental
accounts, sometimes referred to as add-ons, the individual account and
contributions to it have no effect on existing Social Security
benefits. The supplemental account approach effectively leaves the
entire current 12.4 percent payroll tax contribution available to
finance the program while dedicating additional revenues for individual
accounts. With substitute accounts, or carve-outs, the existing Social
Security benefit is reduced (or offset) in some way to account for
contributions that have been diverted from the program. \4\ The obvious
effect is that less revenue is available to finance the current benefit
structure, which creates a problem of transition costs. Absent any
other reforms, these transition costs increase in proportion to the
individual account contribution rate. This means that either benefits
must be reduced or additional resources must be devoted to the defined
benefit portion of the Social Security program in the near term. The
trade-off to incurring transition costs is that the expected higher
rate of return on the individual accounts may permit somewhat higher
benefits to be paid, although with increased risk.
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\4\ In GAO's work to date, we have used the term ``add-on''
accounts to refer to accounts that would have no effect on Social
Security benefits, would supplement those benefits, and would draw
contributions from new revenue streams. In contrast, we have used the
term ``carve-out'' accounts to refer to accounts that would result in
some reduction or offset to Social Security benefits because
contributions to those accounts would draw on existing Social Security
revenues. Others have used these terms in different manners. For
example, some have used ``add-ons'' in connection with new individual
accounts funded from new revenue sources that result in a reduction or
offset to some or all Social Security benefits. In the final analysis,
there are two key dimensions: first, whether individual accounts are
funded from existing or new revenue sources; second, whether individual
accounts result in some reduction or offset to Social Security
benefits.
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Voluntary Contributions Require Additional Considerations
Another important design feature to consider with respect to the
contribution phase is whether the individual account is voluntary or
mandatory. As we have previously reported, voluntary individual
accounts require additional design considerations that mandatory
accounts do not. \5\ For instance a voluntary account could offer
participants the ability to opt in and opt out of the account
periodically; most U.S. proposals for voluntary accounts have not
explicitly considered whether people would face a onetime or a periodic
decision to participate. Individuals may consider the extent of such
flexibility in deciding whether to participate in the accounts.
Moreover, the need to track individuals' participation decisions
requires additional administrative tasks and complexity. Educational
efforts would be needed to inform individuals if their participation in
an individual account would be advantageous or not, especially if the
account substitutes for existing Social Security benefits.
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\5\ See GAO, Social Security Reform: Information on Using a
Voluntary Approach to Individual Accounts, GAO-03-309, (Washington,
D.C.: March 10, 2003).
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Voluntary individual account plans may also require incentives to
induce participation, while mandatory plans do not. In addition to
increasing participation, incentives generally add to the value of the
accounts and, therefore, ultimately to retirement income. Government
contributions and tax advantages are just a few of the potential
incentives for voluntary individual accounts. The costs of incentives
can be difficult to estimate and can be substantial. Further, in
certain circumstances, the net effect of voluntary individual account
incentives may not result in improving overall retirement income. For
example, if the voluntary account was also supplementary, then it might
be difficult to determine whether a voluntary account adds to total
retirement income, as it might merely substitute for other forms of
saving. On the other hand, if the individual accounts truly add to
total retirement income, they allow workers the opportunity and choice
to build up additional savings to meet both income and health care cost
needs in retirement.
Voluntary individual account plans can also affect the total system
costs to the government, providers, employers, or participants,
depending on design. In some cases, offering choice involves additional
administrative, incentive, and educational costs. In particular,
tracking individuals' participation decisions would require
administrative processes that do not arise in mandatory plans.
Moreover, the uncertainty of participation rates in turn creates
uncertainty for a variety of costs associated with voluntary individual
account plans. For instance if individuals accurately perceive any
built-in incentive in the benefit offsets, given their personal
circumstances, and make their participation decision accordingly, then
adverse selection could result. This occurs when certain groups of
individuals (for example, those with longer life expectancies) are more
(or less) likely to participate than others and when such participation
patterns result in a net cost to the government.
DESIGN CONSIDERATIONS IN THE ACCUMULATION PHASE
A system of individual accounts would provide workers with
opportunities to assert greater control over their retirement savings.
Therefore, when designing a system, critical decisions would need to be
made about who will manage and invest funds and what investment choices
will be offered. These decisions, in part, would determine the cost and
complexity of the system and the degree of public education needed.
Moreover, offering the level of customer service found in the private
sector, such as frequent deposits and accessibility of account
information, would add costs and administrative complexity to a system.
Options for Investment Management
Alternatives for designing the investment structure of a system of
individual accounts range from offering the individual a limited number
of preselected funds, such as those offered by the federal Thrift
Savings Plan (TSP), to offering a broad array of private market
choices, such as those available through IRAs. Options for managing
these investment choices could vary from a centralized, government-
managed system to a decentralized, privately managed system. A
centralized system would take advantage of economies of scale, which is
to say that the more accounts managed by a single entity, the lower the
cost for each; thus such an approach could have lower administrative
costs than a decentralized system. This is especially important when
considering that a number of individuals may initially have small
account balances. Depending on how administrative costs are assessed,
administrative costs may eat into the accumulated savings of all
accounts but could have a greater impact on smaller accounts.
Tradeoffs Between Investment Choices
There are trade-offs associated with the range of investment
choices offered. When individuals have more investment choices, they
have more opportunity to tailor their financial situation to their own
tastes and preferences and assert greater control over their personal
property. However, with a greater variety of choices comes the
possibility that individuals will not choose a diversified portfolio or
will simply make a bad selection, thus lessening their retirement
income from the individual account. As the range and variety of
investment choices grow, so does the range of possible outcomes for
individual account returns. This means that a number of individual
accounts could perform very well, while others will not perform well at
all. This results in increased risk to the government that individuals
with inadequate income will turn to the government for support through
other programs. In addition, a wider range of investment choices can
also lead to higher administrative costs, which, if not offset by
significantly higher returns, could undermine retirement income for
individuals. Limiting investment choice would help to minimize risk and
administrative costs, but doing so could also limit the possible return
on investments. Moreover, limiting choices raises concerns about the
role of government in selecting the investment vehicles and the
possibility of political influence over these selections. Essentially,
the challenge becomes finding the right balance between individual
choice and the related risks and costs to the individual and the
government.
Investment decisions become more complicated as the number of
choices increase. If individuals do not make an investment choice,
managers would need to decide how to invest the contributions for those
individuals. Some have proposed placing these contributions in the
lowest risk accounts. One such option would be to place these
contributions in a limited number of funds and then weight individual
portfolios differently depending on the age of the worker, similar to a
life-cycle fund, so that workers increasingly assume less risk as they
neared retirement.
Public education about the choices available and the risks
associated with each would be needed under any system. However, the
need to educate the public about the consequences of using different
investment strategies would be less under a system with limited choice
than under a system with a broader range of choice. When the number of
choices is limited, the degree of risk is more defined and the program
is less complex. However, as the number of choices increases, the
public would need a greater level of education to learn about the wider
variety of investment options, to understand and use the information
disclosed to them, and to fully appreciate the consequences of
investment choices.
Customer Service Considerations
Frequent statements indicating the actual account value, daily or
periodic valuation of account balances, and the ability to transfer
funds between investment options are some of the different services
that could be available with individual accounts. When more services
and more flexibility are offered, the costs and administrative
complexity of managing the investments increase. Moreover, if
individuals consider the individual accounts as their personal
property, they may expect options and service consistent with those
often provided by private sector fund managers, such as frequent
detailed account statements and allowing frequent interfund transfers.
DESIGN CONSIDERATIONS IN THE DISTRIBUTION PHASE
The final design element centers on how the accumulated earnings in
individual accounts would be preserved for retirement. Ensuring that
retirement income is available for the life of the retiree is a
fundamental goal of Social Security. With respect to the distribution
phase, individual account systems could use three basic ways to pay
retirement benefits: annuitization, timed withdrawals, and lump sum
payments. The appropriateness of additional distribution features such
as loans or early withdrawals, which are common in 401(k) plans, would
also need to be considered. While such features would enhance the
account holder's sense of ownership and control, loans or early
withdrawals create a risk for leakage of account income that could
diminish adequacy in retirement. Further, administrative aspects of the
distribution must be considered. These include any guarantees that may
be offered as well as the tax treatment of the distributions.
Annuities
Under a system of annuities, retirees would receive monthly
payments for an agreed-upon length of time, and the size of those
payments would depend on the total value of the individual accounts.
Under individual account proposals, annuities would be obtained either
through government agencies or the private market. Further, such
annuitization could be mandatory, voluntary, or some hybrid of both.
For example, some individual account proposals have suggested mandatory
annuitization up to an amount necessary to avoid poverty, and then any
remaining account monies could be distributed at the account holder's
discretion.
Mandatory annuitization could help ensure that the accounts
provided retirement income for the entire remaining lifetimes of
participants. Mandatory annuitization of accounts could also minimize
adverse selection. Adverse selection occurs, for example, when only
healthy people buy annuities and on average live longer than nonbuyers,
driving up the cost of annuities. According to one study, annuity
prices in a voluntary environment can be as much as 14 percent higher
than they would be if every retiree were required to purchase an
annuity. However, mandatory annuitization also effectively transfers
income from the shorter-lived to those that are longer-lived.
Additional design considerations for annuities include the type of
annuities that could be offered. For example, monthly income can be a
fixed amount per month (fixed annuity); a steadily increasing amount
based on an index, such as the Consumer Price Index (indexed annuity);
or a variable amount based on returns from investing the premium
(variable annuity). Under a single-life annuity, the annuitant receives
a guaranteed stream of payments that end with the annuitant's death.
Under a joint and survivor annuity, the payments continue to be made,
sometimes at a reduced rate, to a second annuitant, such as a spouse,
on the death of the primary annuitant. For a term-certain annuity,
payments are not contingent on the annuitant's life; instead, they are
guaranteed for a specified period of time, such as 5 or 10 years. With
a variable annuity, the annuitant assumes some of the risk from the
investment returns on the annuity.
The current Social Security retirement benefit provides a fixed
lifetime annuity that increases with inflation. In addition, Social
Security provides auxiliary benefits to workers' eligible spouses,
children, and survivors without reducing the size of the worker's own
annuity. While annuity providers could potentially replicate some of
the features of Social Security benefits, some important features would
not likely be replicated. Adding components such as inflation indexing
or a joint and survivor annuity will require the primary annuitant to
accept less monthly income than under a single-life annuity.
Furthermore, individuals with small account balances at retirement
could have difficulty purchasing annuities in the private sector
insurance market. Insurers may find provision of annuities to be
inefficient and costly for individuals with small accounts because of
the relatively high cost of issuing monthly checks and other
administrative costs.
Timed Withdrawals and Lumps Sums
Other options for the payout of accounts include timed withdrawals
(also referred to as self-annuitization) and lump sum payments. In a
timed withdrawal, retirees specify a withdrawal schedule with the
investment manager or record keeper. Each month, they receive their
predetermined amount, while the balance of the individual account
remains invested. Under a lump sum payment option, individuals may
liquidate their accounts through a single payment at retirement and
choose to spend or save their money according to their needs or
desires. Both timed withdrawals and lump sums give the individual the
most immediate control of their account. Such options also underscore
that increased personal choice comes with increased personal
responsibility if the retirement income is to be preserved for the long
term.
Guarantees
A unique distribution phase design feature of some proposals
involves a guarantee of a certain benefit level at retirement. This
guarantee could be provided in tandem with other benefit structure
changes such that the worker would be guaranteed a minimum benefit. One
such approach would guarantee the current Social Security defined
benefit. If the individual account provided less than the current
benefit, then the system would ensure that benefits were provided to
fill the gap. Such an arrangement might be desirable from a benefit
adequacy perspective but would require safeguards against the
government becoming an insurer of excessive risk taking by individuals.
This risk taking could occur if individuals assumed unwarranted
investment risk knowing that the government would still guarantee a
minimum benefit or rate of return.
Preretirement Access
While the above design features consider design options in the
distribution phase at retirement, individual account design may also
consider whether to allow preretirement access. For example, most
401(k) pension plans allow participants to borrow against their pension
accounts at relatively low interest rates. In past work we have shown
that preretirement access improves participation in 401(k) pension
plans and might also be an incentive for participation in a system of
voluntary individual accounts. \6\ However, those plan participants who
borrow from their accounts risk having substantially lower pension
balances at retirement and, on average, may be less economically secure
than nonborrowers. While some may argue that individuals should be
allowed the freedom to access income through borrowing from their
accounts before retirement, the added complexity and potential
diminution of retirement income need to be given serious consideration.
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\6\ Participants in plans that allow borrowing contribute, on
average, 35 percent more to their pension accounts than participants in
plans that do not allow borrowing. See GAO, 401(k) Pension Plans: Loan
Provisions Enhance Participation but May Affect Income Security for
Some, GAO/HEHS-98-5, (Washington, D.C.: Oct. 1, 1997).
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Tax Treatment
Any payout option, whether pre--or postretirement, would need to
consider the tax treatment of the individual account distribution.
Benefits from individual accounts could be taxed in a variety of ways.
For example, individual account benefits could be taxed like current
Social Security benefits. Persons who currently receive Social Security
benefits and have income over a certain amount may have to pay taxes on
their benefits. \7\ Generally, the higher one's total income, the
greater the taxable part of one's benefits. Typically, up to 50 percent
of one's benefits will be taxable. However, up to 85 percent can be
taxable if, for example, a person filed a federal tax return and one-
half of his or her benefit and all other income exceeds $34,000.
Alternatively, individual accounts could be taxed similarly to ordinary
income. Individual accounts could also be treated like pension payments
(such as DC pensions like 401k plans) or annuity payments from a
qualified employer retirement plan, which may either be fully or
partially taxable, depending on the type of retirement plan.
---------------------------------------------------------------------------
\7\ Individual income tax filers pay this tax if their adjusted
gross income plus tax-exempt interest income plus one-half their Social
Security benefits exceeds $25,000. A married couple filing jointly will
pay the tax if this income exceeds $32,000. These levels are not
adjusted for inflation, so the percentage of beneficiaries paying tax
on Social security benefits is expected to rise in the future.
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CONCLUSIONS
Clearly, the wide range of possible options complicates the design
of an individual account system. In general, our work shows that the
features that provide additional flexibility and choice may increase
system costs. Such features would include making participation
voluntary, rather than mandatory, and expanding the number of
investment options. \8\ Other key decisions also have cost
implications. For example, the contribution phase, the accumulation
phase, and the distribution phase could each be administered in a
centralized or decentralized manner, and at various levels by the
government or by private contractors. In general, costs of individual
accounts will rise with increasing decentralization.
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\8\ See GAO, Social Security Reform: Information on Using a
Voluntary Approach to Individual Accounts, GAO-03-309 (Washington,
D.C.: Mar. 10, 2003), and GAO, Social Security Reform: Implementation
Issues for Individual Accounts, GAO/HEHS-99-122 (Washington, D.C.: June
18, 1999).
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No matter what sort of features individual accounts include, any
related administrative, management, and data systems must be developed
and tested before the individual accounts are made available to
American workers. If reforms are implemented with haste and key
administrative functions are neglected, the ensuing problems have the
potential to undermine an otherwise well-designed accounts system. The
federal Thrift Savings Plan has been suggested as a model for providing
a limited amount of options that reduce risk and administrative costs
while still providing some degree of choice. While using this existing
model could mitigate administrative issues, a system of accounts that
spans the entire national workforce and millions of employers would be
significantly larger and more complex than the TSP.
The choice to include individual accounts as part of broader reform
could fundamentally alter the defined benefit aspect of current Social
Security benefits. Under its current structure, Social Security
redistributes benefits to lower-income workers. Mirroring the
redistributive effects of the current Social Security program,
individual accounts could be designed to include some progressive
features. However, it is important to distinguish between progressivity
and benefit adequacy. Greater progressivity is not the same thing as
greater adequacy and may result in less equity. As a result, any
evaluation of a Social Security reform proposal that includes
individual accounts should consider not only the overall costs to the
system but also, very importantly, the impact on individuals and
families. Administering the accounts and educating the public about a
system of individual accounts requires difficult choices and trade-
offs; and these choices will determine the degree and speed of public
acceptance. Ultimately, what matters most is that we maintain a strong
retirement security system for the millions of American workers and
their families.
Mr. Chairman and Members of the Subcommittee, this concludes my
prepared statement. I would be happy to respond to any questions you or
the other Members of the Subcommittee may have.
GAO Contacts and Staff Acknowledgments
For further information regarding this testimony, please contact
Barbara D. Bovbjerg, Director, Education, Workforce, and Income
Security Issues, on (202) 512-7215. Blake Ainsworth, Alicia Cackley,
Charlie Jeszeck, Michael Collins, and Charles Ford also contributed to
this statement.
RELATED PRODUCTS
Social Security Reform: Answers to Key Questions. GAO-05-193SP.
Washington, D.C.: May 2005.
Options for Social Security Reform. GAO-05-649R. Washington, D.C.:
May6, 2005.
Social Security Reform: Early Action Would Be Prudent. GAO-05-397T.
Washington, D.C.: Mar.9, 2005.
Social Security: Distribution of Benefits and Taxes Relative to
Earnings Level. GAO-04-747. Washington, D.C.: June 15, 2004.
Social Security Reform: Analysis of a Trust Fund Exhaustion
Scenario. GAO-03-907. Washington, D.C.: July29, 2003.
Social Security and Minorities: Earnings, Disability Incidence, and
Mortality Are Key Factors That Influence Taxes Paid and Benefits
Received. GAO-03-387. Washington, D.C.: Apr. 23, 2003.
Social Security Reform: Analysis of Reform Models Developed by the
President's Commission to Strengthen Social Security. GAO-03-310.
Washington, D.C.: Jan. 15, 2003.
Social Security Reform: Information on Using a Voluntary Approach
to Individual Accounts. GAO-03-309. Washington, D.C.: Mar. 10, 2003.
Social Security: Program's Role in Helping Ensure Income Adequacy.
GAO-02-62. Washington, D.C.: Nov.30,2001.
Social Security Reform: Potential Effects on SSA's Disability
Programs and Beneficiaries. GAO-01-35. Washington, D.C.: Jan.24,2001.
Social Security Reform: Information on the Archer-Shaw Proposal.
GAO/AIMD/HEHS-00-56. Washington, D.C.: Jan. 18, 2000.
Social Security: Evaluating Reform Proposals. GAO/AIMD/HEHS-00-29.
Washington, D.C.: Nov.4,1999.
Social Security: Issues in Comparing Rates of Return with Market
Investments. GAO/HEHS-99-110. Washington, D.C.: Aug.5,1999.
Social Security Reform: Implementation Issues for Individual
Accounts. GAO/HEHS-99-122. Washington, D.C.: June 18, 1999.
Social Security: Criteria for Evaluating Social Security Reform
Proposals. GAO/T-HEHS-99-94. Washington, D.C.: Mar.25,1999.
Social Security: Different Approaches for Addressing Program
Solvency. GAO/HEHS-98-33. Washington, D.C.: July22,1998.
Social Security: Restoring Long-Term Solvency Will Require
Difficult Choices. GAO/T-HEHS-98-95. Washington, D.C.: Feb.10,1998.
Chairman MCCRERY. Thank you, Ms. Bovbjerg. Mr. Lockhart,
first I want to commend you and Commissioner Barnhart on your
efficient and results-oriented management of Social Security
programs. Because of the aging of the population and the new
responsibilities you have under the Medicare Modernization Act
(P.L. 108-73), the President requested a 7.5-percent increase
in your appropriation for administration in 2006, and I am
pleased that the Committee on Appropriations was able to grant
almost all of that request, and the bill will be on the floor
today. So, congratulations.
Mr. LOCKHART. Thank you.
Chairman MCCRERY. Would you comment on the support that the
SSA could give to an independent board or other entity that
Congress would establish to administer personal accounts? Does
the SSA already do a lot of the work that would be done
ordinarily by such a board? If so, could that be dovetailed
with their work to reduce the administrative expenses?
Mr. LOCKHART. Most definitely we could be very helpful in
this process. Certainly, as I mentioned in my testimony, in the
collection phase, using our present annual wage reporting
system would reduce the cost very significantly. We also have,
as you know, 65,000 people, a very big tele-service operation,
and field offices all over the country, which are very
experienced in education. As you mentioned, right now we are in
the process of educating the American people about the Medicare
Drug Benefit Extra Help Program. So, we have a lot of
experience, and we could use our own people or use the
additional people that might be hired for this. I think we
would be very helpful in the education phase, the enrollment
phase, as I said, the contribution phase, and potentially even
in the payout phase.
Chairman MCCRERY. Thank you. In the next panel, we are
going to hear from a witness who says that due to a large
number of small employers, a TSP-type model of personal account
administration, as proposed under the President's Commission to
Strengthen Social Security, and several other proposals, would
have much higher administrative fees than is currently being
estimated by Social Security's actuaries. Do you agree or
disagree with that assessment?
Mr. LOCKHART. I really disagree. I have close to 30 years
experience in the world of pensions; I have sat on big company
pensions Committees, and boards; I have actually started a
401(k) for a small business, so, I have a lot of experience in
this area. My sense is the 401(k) small business model is not
the one we would follow here. The costs of that model are
reasonably high, and a lot of it has to do with the burden of
regulations and other things that have to be encompassed. The
model that I think would make sense would not be that model,
but a much more centralized model, using again, the annual wage
reporting system and something like the TSP. In fact, the TSP
already has systems in place that probably could be scaled up
to the size of the Social Security program.
Chairman MCCRERY. You touched on the effort to educate
seniors with respect to the new drug program under Medicare.
Obviously, if we go to a system of personal accounts, people
are going to need an education in their investment choices, in
the structure of their accounts, participation, benefits, so,
they can decide whether or not to enroll. Then once they are
enrolled, they need information on the investment opportunities
that will be presented to them. What does the SSA already have
in place that could be built upon in administering a system of
education to inform the public?
Mr. LOCKHART. Well, certainly, Social Security has a Web
site that is one of the most visited in government, and I think
that would be a real foundation for any educational effort. We
have a very large and effective communications group,
publications we put out all the time, and we have, again, the
field office structure, if we decide to go that way. I would
think, to a large extent, we would try to use, not only Social
Security, but other government agencies through the Financial
Literacy Council that has been created. We would also hope to
get nonprofits involved--there are several of them that have
been created over the last few years to improve financial
education. It can be a country-wide effort. I think the bottom
line would be that it would really be great for the country if
we could get more education about financial literacy and
investment choices.
Chairman MCCRERY. Thank you. Ms. Bovbjerg, you touched on
this in your testimony, I am going to see if you want to
expound on it a little bit. You talked about the balance
between offering more investment choices and the administrative
costs associated with offering more choices. Would you like to
expound on that just a little bit? Have you, in your own
research, come upon a balance that you think would be about
right for investment choices versus administrative expenses?
Ms. BOVBJERG. The balance you choose really depends on the
purpose of the program, and the proposals for individual
accounts, both here and in other countries, have varied widely
as to what ultimately they are inclined to achieve. Our main
message is that choice costs money. Choice also requires more
education. You may want to have more choice for a variety of
reasons. If you have more investment choices, you provide a
greater range of potential returns. So, while people are under
greater risk of having lowered returns than they expect, there
are also people who are going to get higher returns. If you
limit that choice, the opportunity narrows from both ends.
I did want to comment that I think that SSA is absolutely
well-positioned to be the center of a public education campaign
on retirement and Social Security, whatever happens with the
Social Security program. I think it is crucial that the SSA
work with the U.S. Department of Labor, the U.S. Department of
Education, and as Mr. Lockhart says, all the other agencies
that are involved in financial literacy and saver education.
We, as a government, have not done a good job of this in the
past. For everyone did not know the Social Secuirty retirement
age was rising. People to this day--the Subcommittee may not
believe this--do not know that their pension will be offset if
they work in non-covered employment. It is very difficult to
get the word out, even on smaller changes that we make to the
program. More comprehensive change would require a lot of
attention and preparation.
Chairman MCCRERY. Thank you. Mr. Levin.
Mr. LEVIN. Thank you. Welcome to both of you. Mr. Lockhart,
I just wanted to comment. You, in your testimony, say you are
committed to strengthening and protecting Social Security; that
is the lingo that is used. I think a more straightforward way
is to acknowledge that private accounts would not strengthen
and protect Social Security, but over time would replace them,
replace Social Security benefits. That is now even more clear
with developments of recent hours, it is privatization
replacing Social Security. Have you ever run a TSP program?
Mr. LOCKHART. No, I have not run a TSP program. I ran the
Pension Guaraty Corporation, but not the TSP.
Mr. LEVIN. Have you read Mr. Cavanaugh's testimony?
Mr. LOCKHART. Yes, I have read his testimony many times.
Mr. LEVIN. Are you going to be here--you won't be here, I
suppose, when he gives his testimony.
Mr. LOCKHART. No, I have another meeting.
Mr. LEVIN. He has run the TSP, as you know, and he has very
different ideas than your gloss about how relatively easy it
would be. So, it would be useful if you would take his
testimony and give us your response. Will you do that?
Mr. LOCKHART. Well, first of all, we will certainly give
you a detailed response, but I can give you some----
Mr. LEVIN. I would like you to go through it--I don't know
if you have read it today, but give us a written response. Can
you do that?
Mr. LOCKHART. I would be happy to. I can also say that we
have met with the TSP many times, including its chairman, the
Executive Director, and their systems contractors. Mr.
Cavanaugh was there in the startup phase, and now this is 20
years into the program. So----
Mr. LEVIN. Startup, he was there until 1994, right? He was
here from 1986 to 1994.
Mr. LOCKHART. Right.
[The information follows:]
Mr. Cavanaugh states that ``the Administration's estimate of 30
basis points is optimistically low. . . .'' To be clear from the
outset, the Administration makes no estimates of personal account
administrative costs. Rather, it relies upon estimates and projections
from the independent, non-partisan Office of the Chief Actuary at the
Social Security Administration (SSA).
Mr. Cavanaugh argues that similar low-cost estimates for the
administration of personal accounts have been based on large-employer
401(k) plans or the TSP which are unrealistic for consideration as PA
models. Instead, he contends the small business corporate 401(k) model
is a better predictor of administrative costs and burdens. He
illustrates his point by citing an annual $3,000 cost to employers for
maintaining a 401(k) plan--a cost he states that many small employers
can not afford. Mr. Cavanaugh also discusses other issues he believes
would be barriers to implementing a PA system, including the difficulty
of making timely investments and problems communicating with large
numbers of system participants.
Despite Mr. Cavanaugh's claims, personal accounts need not be
modeled after small business 401(k) plans. Under existing 401(k) rules,
employers not only decide investment options available to employees
under their plans, but also assume costs for ERISA compliance, setup
expenses, payroll administration, investment selection, and funds
reporting. Despite differences pointed out by Mr. Cavanaugh, personal
accounts could follow the Thrift Savings Plan (TSP) model, where a
central administrative agency would relieve the employers of these
administrative burdens.
A centrally administered system could collect account contributions
through the existing payroll deduction and wage reporting processes.
The calculation of contributions, transfers of money, and crediting of
personal accounts would occur between Treasury, SSA, and the PA
administrator. Employers would have no new administrative
responsibilities under this scenario because they would continue to
deposit and report payroll taxes as they do today.
Mr. Cavanaugh's numbers are highly inflated because he uses the
decentralized small business 401(k) model. Many of the cost studies
that use a centralized, simple PA model have mature cost similar to
Social Security's actuaries. The Employee Benefit Research Institute
study 1998, which he cites as backing his conclusions, also had a low
cost scenario of 10 basis points.
Although Mr. Cavanaugh is correct that the current wage reporting
system identifies individual employees and self-employed workers only
once a year, this would not preclude a PA system from providing
participants with earnings on their contributions throughout the
reporting period. Contributions could be deposited in a ``holding''
fund where they would accrue interest until the reporting and
reconciliation process is complete each year. The contributions plus
interest earned would then be credited to the individual accounts and
invested in the funds of choice.
Mr. Cavanaugh exaggerates the inability of small businesses to
report wages. He states that 72 percent of employer reports are on
paper and implies employers with 68 million employees would have
difficulty reporting. Social Security has a major effort underway to
increase electronic W-2 reporting, and we now receive nearly 61 percent
of W-2s electronically. Only 21 percent or 48 million W-2s are filed in
paper form and many of these are printed from small business computer
accounting systems. We have a successful, rapidly growing and award
winning W-2 online system that is designed for businesses with under 20
employees, it is helping to reduce the cost of annual wage reporting.
We would expect a major increase in electronic reporting by the time
PAs were implemented. Electronic reporting would allow more timely wage
reporting for PA account purposes.
Communications is another issue raised by Mr. Cavanaugh that lends
itself to central administration. It is worth nothing that TSP receives
over one-half of its inquiries on loan-related issues. The President's
proposal would not allow such loans and would likely generate fewer
inquiries on a participant percentage basis. A focused educational
campaign developed by a PA central administrator could reach virtually
the entire U.S. population through the use of the Internet, television,
radio, and print materials. In addition, a PA administrator could seek
voluntary assistance in delivering the educational information from
employers, unions, professional associations, financial educational
associations and other government agencies.
The 30-basis-point cost estimate cited by Mr. Cavanaugh was in the
final report of the President's Commission to Strengthen Social
Security and was provided by the Office of the Chief Actuary of SSA.
\1\ This figure applies to a mature system of personal accounts, but is
still significantly higher than the TSP's 6 basis point cost. The
estimated cost reflects realistic assumptions for a system having a
much broader participant universe and more limited administrative
features than the TSP. A centralized system would realize large cost-
savings as the result of aggregating the contributions of virtually the
entire U.S. workforce into a single, low-cost, limited-option system of
personal accounts, regardless of the size of individual employers. Due
to the potential economies of scale, in my opinion even the ultimate
30-basis-point estimate for the cost of personal accounts may prove to
be high in the long run.
---------------------------------------------------------------------------
\1\ President's Commission to Strengthen Social Security. 2001.
Strengthening Social Security and Creating Personal Wealth for All
Americans, p. 97.
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Setting up a system to accommodate millions of participating
workers would entail certain initial costs. However, administrative
costs would decline as a percentage of assets under management as the
system matured, startup expenses diminished, and assets accumulated. As
an example, the administrative costs of the TSP declined from roughly
30 basis points in 1988 to about 6 basis points in 2004, while adding
numerous new capabilities.
The differential between TSP and PA administrative costs would be
less than predicted by Mr. Cavanaugh. While the TSP has the benefit a
single employer as payroll agent, the existing SSA wage reporting
process could provide a single interface between PA participants and
the program's central record-keeper. Therefore, if the existing wage
reporting process were to be used, relatively little additional up
front administrative cost would be incurred under a PA plan.
In addition, most PA proposals call for fewer participant services
and options than the TSP simplifying administrative tasks and reducing
costs. Annual contributions would be fixed by wage level, whereas TSP
participants can alter what they contribute. PA account statements
could be issued annually or quarterly and changes to investment
allocations could be limited, rather than allowed daily as under the
TSP. In addition, a system of PAs would not provide for loans or early
withdrawal of account assets, both of which are currently available in
the TSP and are major cost drivers to that program. All of these
factors would reduce PA administrative costs relative to a 401(k) model
and keep them closer to those of the TSP. As with the TSP, more
capabilities could be added over time.
The current centralized administration of Social Security provides
direct evidence that Federal administrative costs for PAs could be kept
quite low. SSA provides efficient and effective service to the public
and employers while administering the complex Social Security and
Supplemental Security Income programs at very low cost. The Agency
manages staffing, facilities, automated systems, and business processes
with the capacity to service virtually the entire U.S. workforce of 159
million people. As example of Social Security's efficiency, the annual
``Social Security Statement'' is mailed to 144 million people at a per
statement cost of 38". The undeliverable mail returns are less than 4
percent, much lower than the 25 percent that Mr. Cavanaugh stated in
his testimony.
Based on his questionable small business model, Mr. Cavanaugh
arrives at a questionable recommendation, for direct investment in
corporate stocks and bonds by the trust fund. If done in any
significant size, as a CBO policy brief \2\stated, ``Government
ownership of stocks could affect corporate decisionmaking, interfere
with the nation's competitive market system, and impede the efficient
operation of financial markets--potentially limiting growth''. Despite
Mr. Cavanaugh's contention, direct investment by the trust fund in the
equities markets would have precisely the same transition issues as
would personal accounts. There is no ``multi-trillion dollar transition
cost'' that distinguishes individually owned investment from
government-controlled investment.
---------------------------------------------------------------------------
\2\ Congressional Budget Office, Acquiring Financial Assets to Fund
Future Entitlements, June 16, 2003, p. 1.
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In conclusion, Mr. Cavanaugh raises certain administrative cost
issues that are important factors in the discussion of creating
personal accounts. However, when examined closely, none of those issues
appear to be obstacles for the implementation of PAs. Looking beyond
premium-service small business 401(k) plans offered by some plan
managers, the low administrative costs of the TSP and basic-service
401(k) plans provide better cost models for designing personal
accounts.
Mr. Cavanaugh's assertion that ``the Administration's plan for
universal PAs is not feasible--'' is inconsistent with the experience
of the TSP, large company 401(k) plans, the experiences of other
nations, and the findings of non-partisan analysts ranging from the
Social Security Administration Office of the Actuary, to the
Congressional Budget Office. We believe that this inconsistency is
based largely on Mr. Cavanaugh's adoption of a number of assumptions
that do not reflect the personal account proposals that have been put
forward by the Administration or by many Members of Congress.
Mr. LEVIN. All right. Ms. Bovbjerg, let me just ask you: It
has been suggested that some of the payroll taxes that are
placed in the form of Treasury bonds would be given to private
accounts holders. If that were to happen, would the cash still
be in the Treasury?
Ms. BOVBJERG. It would depend on how the bill is written. I
have not seen bill language, but I think it would be important
to know where the cash goes, what the interactions are between
the rest of the government, the trust fund and individual
accounts, how that is scored from a budgetary perspective----
Mr. LEVIN. If bonds are given to individual holders, the
cash remains in the Treasury, doesn't it?
Ms. BOVBJERG. I am not sure how to answer that question
because I have not seen the language in the bill.
Mr. LEVIN. How would it not be in the Treasury if simply
you give bonds to private accountholders?
Ms. BOVBJERG. Well, I am not sure that that is the only
thing that is envisioned. I haven't seen it.
Mr. LEVIN. Say that is envisioned.
Ms. BOVBJERG. If that is the only thing, if you just give
bonds, it is only a promise to pay later, you are correct.
Mr. LEVIN. That money could continue to be used for any
purpose this Congress decided, right?
Ms. BOVBJERG. Correct.
Mr. LEVIN. Okay. Now let me ask you about annuitization;
mandatory versus voluntary. If annuitization is mandatory, is
there anything that a holder of an annuity policy can pass on
to heirs?
Ms. BOVBJERG. No. Unless it is a joint and survivor
annuity.
Mr. LEVIN. Unless it is joint and survivor. If there isn't
that provision, there is nothing to pass onto heirs, right?
Ms. BOVBJERG. Jim reminds me that there are different kinds
of annuities, but I was thinking of a lifetime annuity, and for
a lifetime annuity, that is correct.
Mr. LEVIN. All right. My time is up. Thank you.
Chairman MCCRERY. Mr. Shaw.
Mr. SHAW. Mr. Levin asked if the cash coming in as surplus
goes to the Treasury and bonds are issued, where is the money?
Well, obviously at that point it would be in the Treasury. If
the money or the surplus was invested in the private sector,
then the money would be in the private sector or the bond or
stock, whatever it would be, it would be in the individual
accounts. Or third, the surplus could just simply be put into a
vault and not draw any interest at all, which would just be
damn stupid. Now, is there anything else that can be done with
the money that you can think of, either one of you, other than
just let it go? The Social Security law was written in a way
that requires, at this particular time, the money that is not
spent be placed in a government-backed security. That is what
the law says; is that not correct?
Mr. LOCKHART. That is correct.
Mr. SHAW. So, you don't have the privilege right now to go
out and invest in the private sector or to make it like a
thrift account, you have to put it into the Treasury and you
have to receive government-secured--government bonds for that
particular cash.
Mr. LOCKHART. That is correct, Congressman.
Mr. SHAW. That cash does draw interest?
Mr. LOCKHART. The cash draws interest, yes.
Mr. SHAW. Now, if the Congress should pass a bill similar
to the one that Mr. Levin is referring to, that in no way stops
the Treasury bills from going back into the trust fund as they
do today. In addition, an additional bond in a negotiable
security in the name of the worker is placed into the Social
Security so that you actually have two sets of bonds. Now, does
that at all affect the liquidity of the trust fund? Remember,
we are not disturbing the existing model at all, and there is
two bonds being issued on the same money, one as it is today,
and then an additional bond with someone's name on it. Would
that not, in fact, increase the solvency of the Social Security
Trust Fund rather than decrease it? Is that not correct?
Mr. LOCKHART. Again, as Barbara said, I haven't read the
legislation, so, it is a little difficult----
Mr. SHAW. Well, nobody has.
Mr. LEVIN. Including you.
Mr. SHAW. It is being written right now, but we have put
the details----
Mr. LOCKHART. Well, certainly, from a Social Security Trust
Fund standpoint, if there is a bond that is issued to the trust
fund, there would be no change. Then, going forward, I don't
know the details if there is an offset or other issues--that
would all need to be looked at.
Mr. SHAW. The more bonds that are being held by the Social
Security Trust Fund, the more solvency you will acquire.
Mr. LOCKHART. That is right, but as you all know, when we
come to draw down on those bonds, we have got to go to the U.S.
Treasury. We need to get the money, and they are going to have
to----
Mr. SHAW. I understand that. That is a problem that we are
going to have to be dealing with. I think the question is, and
I think the problem that we are trying to address with this new
bill--and it is not really fair to be talking too much about
it, other than the fact that Sandy opened the door to my
questioning in this particular regard. The question is, how do
you account to the taxpayer for the surplus that is now being
spent by the Federal Government? The answer on the bill that
will soon be filed simply says, by putting the taxpayer's name
on a negotiable bond that is held in the trust fund, but
nevertheless, that that person's name is on it. This is a
question of we are not--it is not going to be contribute that
much to solvency, in fact, the preliminary figures we are
receiving is it only adds about 2 years to solvency. So, it
doesn't address the issue that the President wants to address,
but it does address one issue, which I think is very important,
and that puts ownership into Social Security, which is missing
the way Social Security is written now. Thank you, Mr.
Chairman. I yield back.
Chairman MCCRERY. Thank you, Mr. Shaw. Mr. Becerra.
Mr. BECERRA. Thank you, Mr. Chairman. Thank you for the
testimony, thanks for being here today. Ms. Bovbjerg, I think
we are going to be inviting you quite a bit, so, thank you for
always willing to be here. Let me make sure I have a correct
impression of where we are with the Social Security Trust Fund
surpluses. We are still running significant surpluses in Social
Security's account because we are collecting far more than we
are having to pay out on a yearly basis, and that is as a
result of the changes that were made in the early eighties,
because at that point we were approaching a crisis, and this is
what President Reagan and Congress decided to do to try to make
sure we didn't have to face that problem, and also because of
the demographics of the baby boomers, we decided to go ahead
and try to resolve the problem into the future as well. We are
collecting, what is it this year that we are collecting?
Mr. LOCKHART. Well, an extra $69 billion in taxes in 2004,
and then an additional $89 billion in interest.
Mr. BECERRA. Eighty-nine billion in interest. It is more
than we are collecting in the surplus--in taxes--because we
have got so much that has been collecting over time that all
those Treasury certificates earning this interest, that totals
$89 billion just this year alone.
Mr. LOCKHART. Right.
Mr. BECERRA. So, the $89 billion plus the $69 billion gives
us about $160 billion this year alone that Social Security will
have received or earned above what it needs to pay out benefits
to those who are currently required or are survivors of
American workers who died or are disabled and who qualify for
Social Security benefits. That is going to continue on. We
right now have an overall collective surplus in the Social
Security account of over a trillion dollars, close to $2
trillion, isn't it?
Mr. LOCKHART. Yes, $1.7 trillion.
Mr. BECERRA. That's $1.7 trillion today of surplus money.
That is going to continue growing until about what, 2017? To
about $5.6 trillion. My understanding is it will reach over $6
trillion by 2027 in surplus. That is the money that we will
then be able to turn to to make sure we can cover any shortfall
between what we collect in workers contributions, workers taxes
for Social Security, and what we need, and then start paying
out in retirees, survivor, and disability benefits, correct?
Mr. LOCKHART. Well, that is correct. You said money, and I
am not sure there is money there. The money will be there when
we turn in the bonds and get it from the U.S. Treasury--and
Treasury has to go raise the money, and that will be in the
form of borrowing new money or increasing taxes.
Mr. BECERRA. So, let me make sure about something, Mr.
Lockhart; are saying that you don't believe that those Treasury
certificates will be redeemable?
Mr. LOCKHART. No. I believe they will be redeemed, I am
just telling you how they have to be redeemed.
Mr. BECERRA. So, are you telling me that they are not as
good as money?
Mr. LOCKHART. I am telling you that they are as good as the
credit of the United States, and the credit of the United
States is the power to tax the American people.
Mr. BECERRA. So, unless you are telling me that you believe
that a President or Congress in the year 2027 or so, or 2017,
is going to change his or her philosophy and say we don't wish
to repay those Treasury certificates that American workers
helped create, it is as good as money.
Mr. LOCKHART. It is as good as money, yes, at that point.
Mr. BECERRA. I think that is important because, if indeed
the American public today is contributing this money for Social
Security, their Social Security, their parents' Social Security
or grandparents' Social Security, who are today retired, and
for their kids Social Security, who will be working in 20 years
and not retiring for 50 years, I think they want to know that
these Treasury certificates will be there into the future.
Mr. LOCKHART. Right. Well, the money has been spent as you
know, so, it will be new money in the future that will have to
be raised to redeem the bonds.
Mr. BECERRA. You raised a point. Money has been spent, and
there has to be future money raised. You do believe that the
money will be raised to pay these Treasury certificates that
the U.S. Government has put its full faith and credit behind.
Mr. LOCKHART. Certainly.
Mr. BECERRA. Okay. In terms of money being spent, when
President Bush took office in 2001, he had an operating surplus
where we didn't have to touch the Social Security surplus
moneys in order to pay for all the expenses of government,
correct?
Mr. LOCKHART. Well, the budget that he inherited already
had the deficit----
Mr. BECERRA. In 2001, if I recall--Mr. Lockhart, let me
make sure about something. Correct me if I am wrong. In 2001,
we experienced the largest budget surplus this country has ever
witnessed, correct? Which meant we didn't have to touch Social
Security surplus moneys. The President, in his State of the
Union Address in 2001 said, we have enough money that we can do
tax cuts--for mostly to wealthy folks--and we won't have to
touch a cent of the Social Security surplus. Yet, every year we
have touched and spent the Social Security surplus. So, it
seems to me that what we need to do is figure out ways to have
an operating budget, the one we had before, where we didn't
touch Social Security surpluses, versus figuring out how to
take the money out of the Social Security Trust Fund and use it
for private accounts. If we are trying to protect surplus
money, you don't need it put into personal accounts, you just
don't have to spend it on other activities.
Mr. SHAW. Will the gentleman yield to me on that point?
Mr. BECERRA. Certainly.
Mr. SHAW. This Committee had hearings on that very subject,
and what we did, in fact, we used the surplus to pay down the
general obligation debt of the United States. So, what we did
was to take the surplus cash coming in from Social Security, as
well as from taxes, and paid down general obligation debt.
Mr. BECERRA. Mr. Shaw, I think you are right, that may have
happened a little bit in 2001, but quickly thereafter, we now
have seen nothing but massive deficits. So, today, none of the
money that is in the Social Security surplus that is being used
by the Bush Administration is being used to pay down debt. In
fact, we are seeing debt increase more than we have ever seen
in the history of this country. It is even with the use of all
the Social Security surplus moneys that we still see debt and
deficits, annual deficits growing at massive rates. Thank you,
though. I appreciate your responses.
Chairman MCCRERY. Thank you, Mr. Becerra. Mr. Hayworth.
Mr. HAYWORTH. Thank you, Mr. Chairman. Hearings, of course,
are very useful to draw on both the experience and expertise of
the witnesses, but they also offer incite a recent
understanding of history and the perception that, of course,
departs from policy and becomes purely political. I welcome the
assessment of my friend from California because, carefully
ignored in his formulation of question was the sudden and
brutal attack on the American people of 9/11, and all the
commensurate economic difficulties, not to mention national
trauma and challenges that this Nation confronts in the wake of
that. Certainly, we are all entitled to offer instant
revisionism of history, or to ignore part of the challenges
that led to the current economic situation. One thing that I
thought was interesting, in recent weeks, and in terms of the
way the agenda is set, and certainly in a free press, it can be
buried back in the news sections, and maybe some who join us
today, Mr. Chairman, failed to notice, but I believe I heard in
the litany from my friend from California the refrain of tax
cuts, mostly to the wealthy, which we hear time and again.
Of course, what we discovered recently is that revenues to
the government actually increased. Yes, we have challenges that
abound, but certainly the crux of the argument simply comes
down to this: As we hear concerns about trying to deal with the
coming demographic challenges that Social Security will
confront, we do have a choice--I guess we could go back to what
was done in 1982, and certainly at least one Member on the
other side of the aisle to his credit has offered one plan
which calls for dramatic payroll tax increases, and that is an
option that we are free to pursue. Or perhaps we ought to
look--and this, again, is just more a question of philosophy
than policy, although it has great consequence for policy--we
can raise taxes, and indeed there are those that believe in
that command control, but there is a consequence to that, that
may not result in the great economic expansion that we have
seen historically when marginal tax rates are reduced, it fires
the engines of economic opportunity and actually increases
revenues to the government. So, there are different choices
here.
Again, we welcome the chance for a hearing and the chance
to see legislation put forth, not as some of my former
colleagues in journalism; rather than who, what, when, where,
and why, offer their own analysis and say this is an exit
strategy. I thought my friend from Florida made it very clear,
the ideas put on the table yesterday and the legislation being
formulated there is an entrance strategy to try and confront
this very real challenge. Of course, to the extent that policy
is predicated on politics, there is that holding pattern--I am
using a diplomatic turn, others might more accurately define it
as obstruction and no, no, no, no, no, no, no--which some may
feel strategically politically offers an advantage in the 2006
elections, doesn't do much for our kids and what transpires in
coming years, but it is interesting to get that insight. I see
my time is about to expire. Mr. Chairman, I ask your
indulgence. Just one question to Ms. Bovbjerg here. Given the
experience of the Federal TSP and private sector defined
contribution employer pension plans, how many investment
choices are workers usually provided?
Ms. BOVBJERG. It varies tremendously, it really does. The
TSP, I know, has currently five different funds, and I think
one of the things we have talked about in various work we have
done is a way to look at the range that you can provide that at
the same time offers some structure, some protections for
people who might otherwise invest unwisely.
Mr. HAYWORTH. You offered a cautionary note in your
testimony that I heard briefly. At what point do you think the
administrative and personal costs associated with increasing
the number of investment options outweighs the benefits of
having those options?
Ms. BOVBJERG. I am not really the person to judge that;
that is really a policy decision for the Congress. You must
consider whether it is more important to allow people to earn
higher returns but with assuming greater risk and how much you
think you want to spend in administrative costs. These are
really the trade offs; the more choice, the more it will cost
to manage it.
Mr. HAYWORTH. That is one of the challenges. Mr. Lockhart,
your assessment of----
Mr. LOCKHART. Well, in my experience, many 401(k) plans
offer a lot more options than the five that the TSP does. Some
of the studies I have seen show that if you offer too many
choices it confuses people, and they don't actually even sign
up for a 401(k). So, you have to be careful about offering too
many choices. The TSP range is pretty extensive--it really
covers the total U.S. stock market and bond market, and also
the international stock market. So, with those five funds, you
really capture a large part of the investment world.
Mr. HAYWORTH. Thank you, both. Thank you, Mr. Chairman.
Chairman MCCRERY. Thank you, Mr. Hayworth. Mr. Hulshof.
Mr. HULSHOF. Thank you, Mr. Chairman. As a quick aside, I
would say to my friends from Michigan and California, you might
want to rescue your colleague from New York, because I think
Mr. Ryan is actually making some headway with Mr. Rangel.
Mr. LEVIN. I am not worried.
Mr. HULSHOF. I don't know, they have been pretty animated.
Mr. RANGEL. Paul Ryan makes a lot of sense because he is
the only one that is discussing Social Security with me on the
Republican side.
Mr. RYAN. You are getting me in trouble again.
Mr. HULSHOF. Mr. Chairman, if you don't have any pride in
authorship, a Ryan-Rangel bill sounds pretty good.
Mr. LEVIN. I don't think you would like it.
Mr. HULSHOF. I do want to make a good point, and Mr.
Becerra is a good friend and a colleague, and we have had a
number of hearings, and you have consistently made the point
about excess payroll taxes and what has been done with them.
You and I have bantered back and forth about what happened in
the 19nineties, and then of course we did have a period of
surpluses, operating budget surpluses to use your term, and so,
that is why I think possibly what has been discussed in the
last 24 hours or 48 hours, as far as taking those excess
payroll taxes, those surplus funds that are coming in, as you
pointed out, all the way through 2017 and allowing those to be
used in a personal account for those who choose them--again, we
are talking about possible voluntary accounts. Ms. Bovbjerg,
let me just go directly to your written statement. On page six,
you aptly point out that voluntary individual accounts would
require additional considerations that mandatory accounts
don't. What I wanted to do was, and then you go on to state--
and again, for the record, since I know that this is being seen
by others, Members of Congress do pay into Social Security--I
know there is a misnomer out there that we don't. We do, but we
do have the TSP.
What I wanted to ask each of you, or either of you is, Ms.
Bovbjerg, you suggest that workers might be offered the
opportunity to opt in and out of participation periodically, in
other words, it is not just a one-time decision that I am never
going to participate, but you might see, for instance, a co-
worker who chooses to opt in that might see their portfolio,
this nest egg begin to grow, and they might decide well, I am
missing the boat here. I know Members of Congress have the
option to opt out of Thrift Savings; they don't have to take
Thrift Savings, but then they are allowed to participate as
they wish in certain additional amounts of contributions. What
would be some of the advantages or disadvantages of allowing
those who, making that decision to participate, allowing them
to enroll or disenroll periodically? What additional challenges
would we have if we were to allow that periodic opting in and
opting out?
Ms. BOVBJERG. It is partly a recordkeeping issue,
particularly if people are in and out, depending on how they
are feeling about the market. It is one thing to run--the TSP
is relatively small compared to what we would be talking about,
to run something like that and keep the records, it is a little
different thing when you are with two million people that they
are keeping records for. The SSA does really well at keeping
records for about 270 million members, but you would then have
to track whether you are accepting contributions, what is
happening with their investment. It would just complicate
things. It is not that it is impossible by any means, it just
makes it a little bit more complex. Your education effort is a
little different, it is not: okay, I have to decide by next
week if I am going to do this or not, and that is it. If it is
in and out, you are going to have a more ongoing educational
effort.
Mr. HULSHOF. Again, Mr. Lockhart, I want to get to you
before my time expires. For instance, again, the TSP, for folks
who don't understand the voluntary option that we have, there
are certain periods of time called open season, for instance.
We know that that is coming, it has been an educational
process, but we know that during this, say, 30-day calendar
period of time, we could choose to change--in fact, though, it
is even to the point where technology would allow us, I think
daily, should we choose to, to change the percentage of these
five different types of funds--and again, I understand that we
are talking about a finite number and then a larger number, but
Mr. Lockhart, I think in your testimony you indicated that even
with the complexity and the additional numbers, millions of
people that might choose this--again, it is voluntary--we are
talking about a cost of, administrative cost of only about 30
basis points; is that right?
Mr. LOCKHART. Yes. That is the ultimate cost that the
actuaries forecast. That is on a relatively simple system: if
you add more choice over time, it may go up somewhat in cost.
Certainly the idea of letting people come into the system over
time as they become more knowledgeable is probably a reasonably
good idea. Going in and out, as I think Barbara mentioned,
could be a paperwork problem.
Mr. HULSHOF. Just as a final point, Mr. Chairman, again,
for those in this education process, 30 basis points is 30
cents for every $100 in the account; is that, in essence, 30
basis points?
Mr. LOCKHART. That is correct.
Mr. HULSHOF. That would be the cost? Thank you, Mr.
Chairman.
Chairman MCCRERY. Thank you, Mr. Hulshof. Mr. Rangel. I am
going to recognize our distinguished Ranking Member of the full
Committee who has joined us. Welcome. You may use your 5
minutes, Mr. Rangel, to pose questions to the panel, or if you
would like to give us all a preview of the Ryan-Rangel bill, we
would like to hear it. You are recognized.
Mr. RANGEL. I really appreciate this courtesy. I do enjoy
talking with Mr. Ryan because we really talk about our
differences, and I think that if we did more of that, the
Committee would better understand each other and we could take
the political questions out of it. I want to deal with Social
Security to get a clear understanding as to the new roads that
we follow. We had presidential bills, then we had concepts,
then we had solvency, then we had personal accounts and private
accounts. As you understand this process, the Social Security
system in its present form is going to have a fiscal problem in
the future; is that correct?
Mr. LOCKHART. That is correct, it is unsustainable.
Mr. RANGEL. The President had the courage to take this
complicated political issue, to bring it to the Congress and
say that we have to fix it.
Mr. LOCKHART. Yes, he did, and he brought it to the
American people as well. I think they have started to get the
message that we really do need to do something about Social
Security, and do it soon.
Mr. RANGEL. I really think you are going beyond your
training in your subjective thoughts, and I think it would
depend on what community you lived in, but I will leave that
alone. Having said that, we are now dealing with the surplus
that we now have, part of that being put into a private
accounts, this new idea that we have come up with.
Mr. LOCKHART. Yes, that is what I understand.
Mr. RANGEL. Could you tell me how that deals with the
question of solvency, which you believe that Americans are
concerned about?
Mr. LOCKHART. Well, certainly President Bush and the SSA
has set as a goal achieving sustainable solvency, permanent
solvency. I think the Senate in mid March voted----
Mr. RANGEL. I know that, sir. I am just talking about the
concept of the surplus that we get, beyond what we are paying
the people. Assuming that when the Baby Boomers come, we won't
have that surplus, right?
Mr. LOCKHART. That is correct.
Mr. RANGEL. That is what makes the crisis.
Mr. LOCKHART. In three short years, the annual cash flow
surplus begins to decline.
Mr. RANGEL. All I am asking is, how does taking money out
of a non-existing surplus, what happens when the surplus goes
and you are trying to put a different type of bond in the
private account than you have in the so-called trust fund, how
does this concept--assuming that I bought the Ryan-Rangel
concept, how do I explain that I am taking away the problem of
solvency?
Mr. LOCKHART. Well, I am not sure I can comment on the
legislation that was discussed yesterday, but I can talk about
personal accounts in general if that would help.
Mr. RANGEL. No, please don't do that because every week
they come up with a new concept, and as soon as I understand it
they have another one. You are the expert, I want you to
comment the best you can, because Mr. Ryan understands and he
has left, and I only have you.
Chairman MCCRERY. Would the gentleman yield?
Mr. RANGEL. Yes.
Chairman MCCRERY. I am also to be an author of the
legislation that is not yet fully drafted, but I would be glad
to discuss it with the gentleman. The gentleman has not yet
characterized it correctly, and Mr. Lockhart is in no position
to comment on the effect on solvency on a proposition that he
hasn't seen.
Mr. RANGEL. Well, I haven't seen it either.
Chairman MCCRERY. I will tell the gentleman that we expect
the Social Security actuaries to score the bill, the bill we
are about to introduce, as increasing solvency by 2 years.
Mr. LEVIN. Would the gentleman yield? If Mr. Rangel would
yield?
Mr. RANGEL. This is just such a good answer----
Chairman MCCRERY. It is the gentleman from New York's time.
Mr. RANGEL. If the Chairman would explain, this surplus is
going to go the way that we enjoy now; is that correct? When
the Baby Boomers come?
Chairman MCCRERY. Yes, sir.
Mr. RANGEL. You announced--someone is saying that out of
the surplus, we are going to take the money to fund the private
accounts, right?
Chairman MCCRERY. We are going to put the equivalent amount
of money of the surplus in personal accounts, in marketable
securities, which will be in the name of individuals, yes, sir.
Mr. RANGEL. My question, Mr. Chairman, is what surplus?
Chairman MCCRERY. The surplus of revenues over outgo of the
Social Security system. Cash.
Mr. RANGEL. Is it not true that the money that goes into
the surplus is going into the General Fund?
Chairman MCCRERY. Yes, sir.
Mr. RANGEL. If you take that surplus and put it into a
private account, don't you leave a gap out there for general
funds?
Chairman MCCRERY. It depends on how you do that. In our
legislation that is not the way we intend to do it, and I will
be glad to discuss it fully with the gentleman so he
understands it after the hearing. We will have witnesses on the
next panel that can expound on various alternatives for doing
what the gentleman has described. I look forward to questioning
them when they get to the panel.
Mr. RANGEL. I thank you.
Mr. LEVIN. Will the gentleman yield briefly?
Mr. RANGEL. I hope the Chairman would allow me, yes.
Mr. LEVIN. Mr. Shaw indicated there would be two bonds. You
asked a good question, how can you transfer the surplus from
one place to another and address solvency. I am anxious to see
the details, because the only way to do that is to use general
funds. We will see. I think it was interesting, Mr. Rangel,
that Mr. Shaw gave you an answer we were going to have two
bonds. Let's see the details. The fact remains that FICA taxes
are being used for private accounts. That is the basic fact.
Thank you, Mr. Rangel, for yielding.
Mr. RANGEL. Thank you.
Chairman MCCRERY. Under our legislation, that will not be
the basic fact. Mr. Lewis.
Mr. LEWIS. Thank you, Mr. Chairman. Mr. Lockhart, right
now, who owns the Social Security Trust Fund? Is there a
personal account? Can a Social Security recipient say, this
money, this Social Security money, is mine, and I own it, it is
owed to me, and the Congress has to make sure that that money
is in my personal account?
Mr. LOCKHART. There are no personal accounts in Social
Security today. Some people sometimes think there are, but
there are none. In fact, it is a pay-as-you-go system, so the
taxes I pay go to pay my parents' Social Security benefits.
Mr. LEWIS. Absolutely. We rehash this over and over again,
but since we are talking about personal accounts today,
retirees do not own their Social Security money.
Mr. LOCKHART. That is correct, and as you know, by law,
Congress can change even the benefits under Social Security.
Mr. LEWIS. Any time. Any Congress. It is not secure. It is
only secure as long as Congress is willing to make sure that
that pay-as-you-go system continues.
Mr. LOCKHART. Correct.
Mr. LEWIS. So, every time I have a townhall meeting, I have
people say to me, when are you going to stop spending money out
of the Social Security Trust Fund and set it aside for the
Social Security recipients? Well, what we are talking about
here today is what we are creating, a system now where the
money will be set aside, the surplus money will be set aside,
and the recipients will be given a key to the box, to the
lockbox, and it will not be in the hand of Congress, its key
will be in the hand of the recipient, of the constituent. They
have been asking for that for a long time.
Mr. LOCKHART. I agree with you. I have probably done 50 or
more townhalls with Members over the last year or so--with
Democratic and Republican Members, with the AARP and the
American Federation of Labor and Congress of Industrial
Organizations (AFL/CIO). That is one of the most common
questions you get: Why isn't that money staying in Social
Security?
Mr. LEWIS. Exactly. So, going back to Mr. Becerra's
question a minute ago, again, we are rehashing this, but when
will the Social Security Trust Fund surplus hit the wall and
start on the road to insolvency?
Mr. LOCKHART. In 3 years the annual cash flow surplus
begins to decline. That is when the first Baby Boomers start to
retire. In 12 years there will not be enough taxes to pay
benefits. That is when we have to start drawing down the
interest on the bonds.
Mr. LEWIS. As Mr. Becerra asked you, will those be paid?
Mr. LOCKHART. I believe they will, yes, sir.
Mr. LEWIS. How will they be paid?
Mr. LOCKHART. There are really only three ways: increasing
taxes, borrowing the money elsewhere, or reducing government
spending.
Mr. LEWIS. What kind of tax increase will our children have
to bear to pay this? It was a great deal when there were 40
people paying in for one person on retirement. Now that it is
down to three for one, and eventually two for one, the pyramid
is coming to a point here. What kind of taxes are my kids going
to have to bear?
Mr. LOCKHART. Well, maybe your grandchildren. Over the 75-
year forecast, the independent actuaries' numbers and the
trustees' Report shows we will have to increase payroll taxes
by 46 percent by the end of the period, if you wanted to
continue to pay scheduled benefits. If you don't want to
continue to pay scheduled benefits, you would not have to.
Mr. LEWIS. We are going to have, as Mr. Becerra said, those
benefits paid. So, it seems to me like my colleagues across the
aisle, they have a plan, and the plan is this: We are just
going to tax the daylights out of future generations to meet
the obligations for Social Security. That sounds like a pretty
bad plan to me, and a very risky plan. I yield back my time.
Thank you.
Chairman MCCRERY. Thank you, Mr. Lewis. Mr. Lockhart, Ms.
Bovbjerg, thank you very much for joining us. We look forward
to seeing you again. At this time I call the second panel. We
have another distinguished panel to give us their views on
personal accounts and how they might be set up and managed.
Olivia S. Mitchell, Ph.D., Professor of Insurance and Risk
Management, Executive Director, Pension Research Council, and
Director, Boettner Center for Pensions and Retirement Security,
Wharton School, University of Pennsylvania. Patrick J. Purcell,
Specialist in Social Legislation, Domestic Social Policy
Division, Congressional Research Service (CRS). Alex J.
Pollock, resident fellow of the American Enterprise Institute.
Joan Entmacher, vice President and Director, Family Economic
Security, National Women's Law Center (NWLC). Francis X.
Cavanaugh, former Executive Director and chief executive
officer, Federal Retirement Thrift Investment Board. Virginia
Reno, Vice President for Income and Security policy, National
Academy of Social Insurance (NASI).
We welcome all of you for our hearing today. Your written
testimony will be included in the record in its entirety, and
we would ask you to try to summarize your written testimony in
about 5 minutes. The little device you see in the center of the
witness table, and likewise the little box up here has three
lights. The green light lasts 4 minutes, the amber light lasts
1 minute, and the red light should not last very long. With
that, we will begin with Dr. Mitchell.
STATEMENT OF OLIVIA S. MITCHELL, PH.D., PROFESSOR OF INSURANCE
AND RISK MANAGEMENT, EXECUTIVE DIRECTOR, PENSION RESEARCH
COUNCIL, AND DIRECTOR, BOETTNER CENTER FOR PENSIONS AND
RETIREMENT SECURITY, WHARTON SCHOOL, UNIVERSITY OF
PENNSYLVANIA, PHILADELPHIA, PENNSYLVANIA
Dr. MITCHELL. Thank you very much, Mr. Chairman and Members
of the Subcommittee. It is a pleasure to appear before you
today. My name is Olivia Mitchell, and I teach insurance and
risk management at the Wharton School at the University of
Pennsylvania. The views that I am expressing today are my own.
As we have heard, the Social Security system is running into
trouble with a shortage of revenue to pay benefits within just
a few short years. The 2001 Bipartisan Commission to Strengthen
Social Security, on which I served, believed in that having two
separate tiers would be the answer for a reformed Social
Security program. Social adequacy would be provided by the
first pillar of the traditional Social Security program, while
individual equity would be the goal of the personal accounts
component.
My testimony today focuses on two aspects of a personal
retirement account, namely, first, administrative fees and
charges; and, second, payout issues. What I will hope to
persuade you of is that voluntary personal retirement accounts
can and should be formulated so they offer participants some
investment choice, while still remaining relatively
inexpensive, they standardize disclosure regarding fees and
charges so participants can understand what it is they are
confronting, and require retirees to annuitize a portion of
their retirement assets so the combined benefit payments of
Social Security, the traditional piece, and the personal
retirement accounts will keep them out of poverty.
Regarding administrative fees and charges, I would like to
make four points. First of all, measuring pension expenses is a
tricky business. I believe that a standardized format for
reporting fees and charges would greatly enhance participants'
ability to compare products and make informed decisions.
Second, scale is very important. Large-scale plans, such as my
university's retirement plan, and the Federal TSP we have heard
about today, charge participants very low annual fees. Bigger
is cheaper. Third, private retirement systems are not
necessarily more expensive than Social Security. Rather, they
generally offer many more services. I believe privately managed
competitive fund providers can do better by taking advantage of
modern technology. Fourth, the Commission on which I served
proposed that investment choices in the personal accounts
should be limited to a few indexed funds. We talked about a
stock index fund, and a bond index fund. One of my personal
favorites is the Treasury Inflation-Protected Securities (TIPS)
Fund, which I think has a very crucial role in the retirement
portfolio, and a life-cycle fund would also be a useful
addition.
As you know from speaking to the prior panel, Employee
Retirement Income Security Act (P.L. 93-406) requires a minimum
of three funds in the private sector, so, some number between
three and five seems reasonable to me. The Office of the Chief
Actuary of Social Security estimated that the personal
retirement account model we proposed on the Commission would be
quite inexpensive, costing only about 0.3 percent of assets
annually to manage.
The next issue to which I wish to turn is the issue of
payouts; that is, how older participants in a personal account
system would access their funds at retirement. The related
question is what role annuities might play in such a payout
scheme. Annuities are, of course, financial products that
protect people from outliving their retirement assets. It is
very important, I would note, that the money's worth of many of
these life annuity products is very attractive in the United
States and abroad. With regard to annuitization, my Commission
proposed that partial annuitization should be required so that
the yearly income received from the traditional Social Security
pillar plus the joint annuity, if the person was married, would
protect either spouse from falling below poverty in retirement.
So, assets above what would be needed to achieve this poverty
protection could be accessed as a lump sum. My written
testimony discusses how retirees would learn about annuity
products, who would sell them, and so forth. I will only
mention a couple of points here. First of all, what annuity
products would be offered and to whom? I believe Congress
should set a default payout scheme such as a joint-survivor,
ideally inflation-indexed, annuity which retirees would
automatically get unless they opted for something else.
Second of all, I believe private insurers can offer the
types of products that retirees want, but there needs to be
enough oversight in this market to make sure that there is not
cherry-picking of just the rich retirees, or perhaps just the
people who are going to die soon, for the annuity market. I
would not support having the Federal Government sell the
mandatory annuities under the new system. A couple other points
bear mention, which we hopefully will hear more about today:
the government needs to think carefully about tax and transfer
policy regarding these personal accounts; and, second of all,
the Federal Government has a crucial role in making sure there
are enough assets for annuity providers to purchase, so they
can offer these inflation-indexed lifetime benefits.
In conclusion, I believe voluntary personal accounts can be
designed to provide participants with investment choice while
remaining inexpensive. They can build in incentives for
competition among fund managers, and they can sensibly require
retirees to annuitize a portion of their retirement assets.
Thank you for your interest. I am happy to answer any
questions.
[The prepared statement of Dr. Mitchell follows:]
Statement of Olivia S. Mitchell, Ph.D., \1\ International Foundation of
Employee Benefit Plans Professor and Professor of Insurance and Risk
Management, Executive Director, Pension Research Council, and Director,
Boettner Center for Pensions and Retirement Security, Wharton School,
University of Pennsylvania, Philadelphia, Pennsylvania
---------------------------------------------------------------------------
\1\ Olivia S. Mitchell is the International Foundation of Employee
Benefit Plans Professor and Professor of Insurance and Risk Management;
she is also Executive Director, Pension Research Council and Director,
Boettner Center for Pensions and Retirement Security, all at The
Wharton School of the University of Pennsylvania (3620 Locust Walk, St
3000 SH-DH, Philadelphia, PA 19104; email [email protected]; T
215-898-0424). The views offered here are solely those of the author
and do not represent those of any institutions with which she is
affiliated.
---------------------------------------------------------------------------
Mr. Chairman and members of the Subcommittee: Thank you for the
opportunity to appear here today. My name is Olivia S. Mitchell, and I
am a Professor of Insurance and Risk Management at The Wharton School
at the University of Pennsylvania.
As you know, Social Security faces imminent insolvency, with
payroll tax revenues threatening to fall below benefit payments within
6 years. The present system also contains many inequities and anomalous
redistribution patterns, and it offers current workers a surprisingly
low and very risky return. \2\
---------------------------------------------------------------------------
\2\ Cogan and Mitchell (2002).
---------------------------------------------------------------------------
The bipartisan Commission to Strengthen Social Security (CSSS), on
which I served in 2001, believed that offering two separate tiers under
a reformed Social Security program, each with its own function, would
improve the overall program's transparency and equity. Social adequacy
was to be the principal objective of the traditional defined benefit
piece, while individual equity was seen as the goal of a personal
accounts component.
My testimony before this Subcommittee today focuses on two aspects
that must evaluated in designing a Personal Retirement Account element
as part of a reformed Social Security: (1) administrative fees and
charges, and (2) payout issues. My views derive from the research
literature on administrative fees and payout issues, particularly
regarding how Personal Retirement Accounts might be invested and how
the funds at retirement might be deployed. The views I offer are my own
and do not represent those of any institutions with which I am
affiliated.
My conclusions are that the voluntary Personal Retirement Accounts
(PRAs) should be formulated so that:
They offer participants some investment choice while
still being relatively inexpensive;
They standardize disclosure regarding fees and charges so
participants can understand and compare them;
They require retirees to annuitize part of their
retirement assets in their Personal Accounts, so that the combined
benefit payments from Social Security will keep them out of poverty.
Administrative Fees and Charges
Experience with public and private pension plans the world over
indicates wide disparity in reported administrative fees and charges
across systems. Several lessons are worth highlighting:
Measuring pension expenses requires standardized
reporting and disclosure standards. Pension systems often structure
their charges in bewildering ways. For instance, fees can be levied as
flat commissions, a percent of contributions, or a percent of the
fund's annual yield. \3\ Such complexity makes it difficult for plan
participants to compare fund performance. A sensible response, adopted
by many Latin American pension supervisors, is to require disclosure
using a standardized table for reporting charges. This has the effect
of increasing the information available to participants and hence,
making the market more competitive. A more problematic tactic adopted
by the UK, for example, is to set a national fee cap. This may limit
competition and reduce participants' focus on holding down costs.
---------------------------------------------------------------------------
\3\ Mitchell (1998).
---------------------------------------------------------------------------
Scale is important in keeping costs down. \4\ Larger
money managers benefit from scale economies, centralized fund
administration, and centralized collection of contributions. For
example, in Australia, retail financial service providers charge three
times more in pension fees and charges than do institutional managers
of corporate pensions. While there is little agreement on the minimum
size of a cost-effective pension, managers of large defined
contribution plans such as the Federal Thrift Savings Plan which covers
civil servants and military employees, my University's retirement plan
(TIAA-CREF and Vanguard), and others, charge pension participants
annual fees between 0.1-0.4% of assets under management. These fees are
well below what savers pay in typical Individual Retirement Accounts.
---------------------------------------------------------------------------
\4\ See Mitchell (1998), Bateman and Mitchell (2004), and
Whitehouse (2005).
---------------------------------------------------------------------------
Private retirement systems might seem to be more costly
than Social Security, but this is a misleading conclusion as they
generally offer more and different services. Some have suggested that
the current U.S. Social Security system is one of the lowest-cost
programs around. Nevertheless, Social Security does not provide the
wide range of services provided by modern managers of asset-backed
retirement accounts. For instance, the government program does not
invest in the capital market, it holds no insurance-type reserves even
though it offers disability and survivors' insurance, and it takes a
very long time--more than a year--to post workers' contributions to
their records. \5\ By contrast, privately managed fund providers would
and can do better by taking advantage of modern technology.
---------------------------------------------------------------------------
\5\ Mitchell (1998).
Taking these and other factors into account, I and other Commission
members concluded that it would be reasonable to establish personal
accounts along the lines of the Federal Thrift Saving Plan.
Accordingly, and for a few years into the system, a central Governing
Board would be charged with collecting contributions, managing records,
and selecting private-sector managers who would invest participant
assets via a competitive bidding process. This Board could either
handle record-keeping and benefit payments itself, or these functions
could be outsourced via a competitive process.
We also proposed that investment choices in the personal accounts
would be limited but diverse. The options suggested include:
a Government Securities Investment fund (mainly short-
term U.S. Treasury securities);
a Fixed Income Index Investment fund (tracking a U.S.
bond market index);
a Common Stock Index Investment fund (tracking the
Standard & Poor's 500 Index of large-company stock);
a Small Capitalization Stock Index Investment fund
(tracking the Wilshire 4500 stock index); and
an International Stock Index Investment fund; and
a fund that invests in Government Treasury Inflation-
Protected Securities.
At some later date, plan participants might be permitted to move
their investments to licensed, supervised, private money managers
offering an approved set of low-cost investment options. The benefit
levels that might be expected from alternative investment approaches
for Personal Retirement Accounts appear in Table 1, along with a
comparison of current benefits, payable benefits, and scheduled
benefits.
The Office of the Chief Actuary at Social Security estimated that
the proposed CSSS approach would be quite inexpensive, costing only
about 0.3% of assets annually.
Table 1: Monthly Social Security Benefits Under Alternative Scenarios
Projected to 2052 (CSSS Model 2 $01)
I. Lifetime low-wage earner\*\
Today's benefit $637
Projected Benefit With Personal Account:
Low yield 867
Medium yield 1,050
High yield 1090
Current Program Payable 713
Scheduled benefit 986
II. Lifetime medium-wage earner\*\
Today's benefit $1,052
Projected Benefit With Personal Account:
Low yield 1,204
Medium yield 1,525
High yield 1,595
Current Program Payable 1,179
Scheduled benefit 1,628
III. Lifetime maximum-wage earner\*\
Today's benefit 1,366
Projected Benefit With Personal Account:
Low yield 1,565
Medium yield 1,907
High yield 1,983
Current Program Payable 1,557
Scheduled benefit under current law 2,151
\*\ These categories, developed by Social Security actuaries, are
specified (in $01) such that a lifetime ``low'' earner would have
averaged approximately $15,900 per year, whereas the medium earner
averaged $35,300 per annum and the high earner $56,400.
Source: Cogan and Mitchell (2003)
Payout Issues
When considering how to structure payouts from voluntary Personal
Accounts under a reformed Social Security system, naturally the
question arises as to whether and how access to the funds should be
permitted. CSSS members agreed that pre-retirement access to the money
should not be allowed to `leak' out before retirement, as early
consumption would likely increase the chances that the elderly would
then have to rely on old-age antipoverty programs. Yet, as the
Commission pointed out, ``a clear appeal of personal retirement
accounts is that they grant workers ownership over their own assets.''
After weighing competing arguments, we concluded that personal accounts
should be preserved until the nationally-agreed on early retirement
age, consistent with current Social Security policy which does not
permit pre-retirement access to old-age benefits.
By contrast there is more discussion regarding appropriate designs
for the pension decumulation process under Personal Accounts. This
refers to the process by which older participants access their
retirement assets, how they invest their money during retirement, and
whether annuities--which are financial products designed to cover the
risk of retirees outliving their assets--should play a central role.
Regarding post-retirement fund management, my Commission recommended
several methods of drawdown including phased withdrawals and annuities,
as well as possibly lump sums.
To highlight the importance of longevity risk, Table 2 shows that a
65-year-old U.S. male can anticipate living to age 81, but he has
almost a 20% chance of living to age 90 or beyond. A woman of the same
age can expect to live to 85, but she has more than a 30% chance of
living to age 90 or older (Table 2). In other words, people face
substantial risk of outliving their life expectancy, implying
substantial uncertainty regarding how long one must conserve and spend
retirement assets, combined with a high probability of running out of
money.
Table 2: Remaining Life Expectancy and Survival at Age 65 (in 2000)
Remaining Life Men Women
Expectancy (years): 16.4 19.6
Probility of Surviving to Age:
70 88% 92%
75 74 82
80 56 69
85 36 51
90 18 31
95 6 14
100 1 4
Source: Mitchell and McCarthy (2004)
A life-long annuity can help protect against this risk, by paying a
premium to an insurer who then pools a number of people with similar
longevity expectations. Though some have argued that such insured
products seem expensive, my research shows that the ``money's worth''
(MW) of such life income products is rather substantial. The MW refers
to the discounted cash flow of the lifetime payments received divided
by the product premium. For example, Table 3 shows that U.S. purchasers
of an immediate single-life annuity would expect back 93 cents on the
dollar from a life annuity; in exchange purchasers have the insurance
value that they will never outline their lifetime benefit payments. The
MW ratios are similar in Australia, Italy, and the UK.
Table 3. Money's Worth of Single Preium Nominal Life Annutities for 65-Year-Olds: An International
Comparison(using country Treasury yield curves and annuitant life tables)
Australia Canada Italy UK US
Men 0.986 1.014 0.958 0.966 0.927
Women 0.970 1.015 0.965 0.957 0.927
Source: Derived from Mitchell and McCarthy (2004)
These issues are complex and potentially politically delicate,
since some workers will fail to accumulate much in their accounts over
their worklives; also some retirees might anticipate relatively lower-
than-average life expectancies, making forced annuitization seem
punitive.
In balancing the various choices for payout design, the Commission
concluded that partial annuitization should be mandated so that ``the
yearly income received from an individual's Social Security benefit
plus the joint annuity (if married) would protect either spouse from
falling below the poverty line during retirement'' (CSSS 2001). Any
funds above those needed to buy the minimum annuity could be accessible
as a lump sum and/or bequeathed at death. This approach has the dual
benefit of both protecting the retiree from falling below the poverty
line while still allowing some access to the funds accumulated in the
Personal Retirement Account.
Remaining design issues include how retirees would learn about
annuity products, who would sell them, and whether the private
insurance market can do a good job meeting market demand. To date,
relatively few consumers have purchased payout annuities, making it a
bit difficult to forecast how the market will develop. Several key
issues will have to be decided:
Which annuity products will be offered and to whom?
Currently private insurers in the U.S. offer a wide and very
complex array of annuity products, including immediate versus
deferred benefit payments; fixed nominal payouts versus
programs with escalating or variable payouts; and term certain
versus other payment periods. Also annuities offered through
company pensions are mandated to use unisex mortality tables
whereas retail annuities do not.
A logical lesson from the behavioral finance literature is
that it would be sensible to establish a ``default'' payout
format such as a joint and survivor inflation-linked or
escalating life annuity, which retirees would automatically
receive unless they specifically opted for something else. As a
case in point, retirees in the UK are required to annuitize
their pension assets at age 75; in Germany, workers with assets
in so-called Reister-pensions may take 20% of their accumulated
assets in a lump sum, another 20% in a phased withdrawal
format; but at age 85, the retiree must annuitize his balance
and the benefit may not be lower than the periodic payment
received before that age.
Of course, since many retirees are not accustomed to thinking
about longevity risk, they would require financial education to
help them clearly understand the costs and benefits of
different ways to manage their Personal Retirement Account
assets.
Which annuity providers will be allowed in the market,
and how will they be regulated?
Evidence from other countries adopting personal accounts
indicates that private insurers can and do offer the types of
products that retirees want. For instance, in Chile, middle and
upper income workers generally prefer the annuity payout over a
phased withdrawal approach to retirement drawdowns.
Nevertheless, there will likely have to be some governmental
oversight over the annuity market. In Mexico, for instance, all
insurers are required to bid on all retirees, and when issuing
annuity bids, the companies may learn only a retiring worker's
age and sex (but not his identity, his health status, or his
account balance). This reduces the chances of ``cherry-
picking'' rich retirees or those anticipated to die soon.
Another issue has to do with whether unisex mortality tables
would be required for the annuities. Doing so, of course,
involves redistribution of wealth away from shorter-lived men
and toward longer-lived women, which is already true in the
current Social Security System. Requiring joint and survivor
benefits as a default would render this issue less important
quantitatively.
What role, if any, would the federal government have?
As an alternative to building up private annuity markets,
some have suggested that the federal government might directly
sell the mandatory annuities under the new system. \6\ While
this might hold down some costs, it can cause other problems.
For example, there could be political interference associated
with investing the annuity reserves--amounting to 15% of GDP at
maturity--and it raises questions about whether the reserves
could truly be saved, or whether they would be `spent' akin to
Social Security Trust Fund assets. Further, the government
would then have responsibility for mortality and capital market
risk, which would likely be incorrectly priced and managed.
---------------------------------------------------------------------------
\6\ NASI (2005).
---------------------------------------------------------------------------
One key role for the federal government in this context has
to do with tax and transfer policy. For instance, pension and
Individual Retirement Account assets are protected in
bankruptcy but are divisible in divorce; whether the same
treatment would be afforded PRA annuities and assets has yet to
be determined. Conversely, annuity flows and lump sums are
generally `counted' when retirees apply for SSI and Medicaid
benefits; payouts are taxed as income. Whether and how PRA
assets and annuities are to be treated for tax and transfer
purposes--as well as others (e.g. the estate tax vulnerability
of the PRA assets if the worker or spouse dies) will take
additional work to get it right.
Another role for the government is to enhance the range of
investments available to insurers providing the products. \7\
Many writers have noted the key role of federal government
provision of inflation-indexed bonds sufficient to meet market
demand. Expanding their supply would allow private insurers to
offer the kinds of indexed annuity products that would give
retirees better protection against inflation, which is a source
of substantial retirement insecurity.
---------------------------------------------------------------------------
\7\ Bodie et al. (2002).
---------------------------------------------------------------------------
Conclusions
My testimony has focused on the role of administrative fees and
charges in a PRA type approach, and also on payout considerations after
retirement. I conclude that voluntary Personal Retirement Accounts can
be designed so as to provide participants with some investment choice
while still being relatively inexpensive; they can build in incentives
for competition among fund managers, including disclosure regarding
fees and charges; and they can sensibly require retirees to annuitize
part of their retirement assets in their Personal Accounts, so that the
combined benefit payments will keep them out of poverty.
Thank you for your interest and I am happy to answer any questions
you may have about my remarks.
References
Bateman, H. & O.S. Mitchell. ``New Evidence on Pension Plan Design
and Administrative Expenses.'' Journal of Pension Finance and
Economics. 2004: Vol 3(1): 63-76.
Bodie, Z., B. Hammond, and O.S. Mitchell, eds. Innovations in
Financing Retirement. Philadelphia, PA: University of Pennsylvania
Press, 2002.
Brown, J.R., O.S. Mitchell, J.M. Poterba. ``The Role of Real
Annuities and Indexed Bonds in an Individual Accounts Retirement
Program.'' In Risk Aspects of Investment-Based Social Security Reform.
Eds. J. Campbell and M. Feldstein. 2000: 321-360.
Brown, J., O.S. Mitchell, J. Poterba, and M. Warshawsky. The Role
of Annuity Markets in Financing Retirement. MIT Press, 2001.
Commission to Strengthen Social Security (CSSS), Strengthening
Social Security and Creating Personal Wealth for all Americans, Final
Report, Washington, D.C., December 2001.
Cogan, J.F. & O.S. Mitchell. ``Perspectives from the President's
Commission on Social Security Reform.'' Journal of Economic
Perspectives. 17(2). Spring 2003.
Mitchell, O.S. ``Administrative Costs of Public and Private Pension
Plans''. In Privatizing Social Security, Ed. M. Feldstein. NBER.
Chicago: University of Chicago Press, 1998: 403-456.
Mitchell, Olivia S. & David McCarthy. ``Annuities for an Ageing
World''. In Developing an Annuities Market in Europe. Eds. E. Fornero &
E. Luciano. Elgar, 2004: 19-68.
NASI Uncharted Waters: Final Report. http://www.nasi.org/info-
url_nocat2718/info-url_nocat_show.htm?doc_id=212573
Whitehouse, E. Testimony Before the Subcommittee on Social Security
of the House Committee on Ways and Means, Washington, D.C. June 16,
2005.
Chairman MCCRERY. Thank you, Dr. Mitchell. Somehow the
witnesses got scrambled on the table. I am going to follow my
list as I introduced the witnesses, if that is okay. You will
all get to speak. Our next witness is Mr. Purcell with the
Congressional Research Service.
STATEMENT OF PATRICK J. PURCELL, SPECIALIST IN SOCIAL
LEGISLATION, DOMESTIC SOCIAL POLICY DIVISION, CONGRESSIONAL
RESEARCH SERVICE
Mr. PURCELL. Mr. Chairman, Congressman Levin, Members of
the Subcommittee, my name is Patrick Purcell. I am a specialist
in pension issues with the CRS. Thank you for inviting me to
speak to you today about the TSP for Federal employees. The
thrift plan, as you know, is a savings plan for Federal workers
and members of the uniformed services. It was first authorized
by the Congress with the ERISA 1986. The thrift plan provides
Federal employees and members of the uniformed services with a
tax-deferred savings vehicle similar to those provided by many
employers in the private sector under section 401(k) of the
Internal Revenue Code. The thrift plan was designed by Congress
to be a key part of the retirement benefits for employees who
are covered by the Federal Employees Retirement System, which
covers all Federal workers hired since 1984.
Prior to enactment of the Social Security amendments 1983
(P.L. 98-21), Federal employees were not covered by Social
Security. They were instead covered by a separate system, the
Civil Service Retirement System (CSRS). The Social Security
System needed additional cash contributions to remain solvent,
and the 1983 amendments mandated coverage for civilian
employees hired in 1984 and later. Congress recognized at that
time that Social Security provided some of the same benefits
for retirement and disability as the Civil Service Retirement
System. Moreover, enrolling workers in both plans would have
required payroll deductions equal to more than 13 percent of
each employee's pay.
Consequently, Congress directed the development of a new
Federal employee retirement system with Social Security as the
cornerstone, and which would incorporate many features of the
retirement plans typical among large employers in the private
sector. The result of this effort was the Federal Employees
Retirement System (FERS) which consists of three elements:
Social Security, a traditional pension called the FERS Basic
Retirement Annuity, and the TSP. The legislative history of the
TSP indicates that in designing the system, Congress had the
goals of incorporating Social Security into Federal employee
retirement, providing a total benefit that was comparable to
that under the old CSRS, and also keeping costs to the Federal
Government approximately the same. Congress also for the first
time allowed employees the opportunity to save for retirement
on a tax-deferred basis through the TSP.
In the legislative history of the TSP, two things stand
out. First, Congress chose then, and has maintained to this
day, a system in which all of the thrift funds that invest in
private sector securities are index funds. This was a carefully
considered choice. As the House Committee report on the
legislation stated, ``The three funds authorized in the
legislation are passively managed funds, not subject to
political manipulation. A great deal of concern was raised
about the possibility of political manipulation of large pools
of thrift plan money. This legislation was designed to preclude
that possibility.'' Likewise, the Senate Committee report on
the legislation stated, ``Another concern the Committee
wrestled with was the potential for market manipulation through
political pressure. The Committee specifically designed the
plan to avoid this problem. The legislation provides for three
investment funds that are essentially self-managed.''
The second item that stands out in the legislative history
is the strong interest that Congress showed in establishing the
independence and authority of the Federal Thrift Investment
Board. The legislation established the Thrift Board as an
independent government agency, which is required by law to
operate the plan solely in the interest of plan participants.
The law charges the Thrift Board with responsibility for
developing the investment policies of the thrift plan, and
overseeing the management of the plan. The law authorizes the
Board to appoint an Executive Director who runs the thrift plan
on a day-to-day basis. Three members of the Board, including
the Chairman, are appointed by the President. The President
chooses a fourth member in consultation with the Speaker of the
House and the House Minority leader, and a fifth member in
consultation with the Senate Majority and Minority leaders.
Members of the Board are subject to Senate confirmation and
serve four-year terms. All members of the Board must have
substantial experience in managing financial investments and
pension plans.
The Federal Thrift Board receives no appropriations from
Congress. Administrative expenses are paid through agency
contributions forfeited by employees who leave Federal service
before they have investigated and by charges against
participant accounts. Congress conducts oversight of the TSP
through the House Committee on government Reform and the Senate
Committee on Homeland Security and governmental Affairs. The
TSP is a key component of Federal employees' benefits. It is an
efficient provider of retirement savings accounts to the
Federal workforce that has achieved high participation rates
and low administrative costs. This concludes my statement. I
would be happy to answer any questions.
[The prepared statement of Mr. Purcell follows:]
Statement of Patrick J. Purcell, Specialist in Social Legislation,
Domestic Social Policy Division, Congressional Research Service
Mr. Chairman and members of the subcommittee, my name is Patrick
Purcell and I am a specialist in pension issues with the Congressional
Research Service. Thank you for inviting me to speak to you today about
the Thrift Savings Plan for federal employees.
The Thrift Savings Plan is a retirement savings plan for federal
employees and members of the uniformed services. It was authorized by
Congress in the Federal Employees' Retirement System Act of 1986 (P.L.
99-335). The Thrift Plan provides federal employees and members of the
uniformed services with a tax-deferred savings vehicle similar to those
provided by many employers in the private sector under section 401(k)
of the Internal Revenue Code. The Thrift Plan was designed by Congress
to be a key part of the retirement benefits for employees who are
covered by the Federal Employees' Retirement System (FERS), which
covers all federal employees hired on or after January 1, 1984.
Origin of the Federal Employees' Retirement System
Prior to enactment of the Social Security Amendments of 1983 (P.L.
98-21), federal employees were not covered by Social Security. Federal
employees were covered instead by the Civil Service Retirement System
(CSRS). Because the Social Security system needed additional cash
contributions to remain solvent, the 1983 amendments mandated coverage
for civilian federal employees hired in 1984 or later.
Congress recognized, however, that Social Security provided some of
the same benefits as CSRS. Moreover, enrolling federal workers in both
plans would have required payroll deductions equal to more than 13% of
employee pay. Consequently, Congress directed the development of a new
federal employee retirement system with Social Security as the
cornerstone and which would incorporate many features of the retirement
programs typical among large employers in the private sector. The
result of this effort was the Federal Employees' Retirement System, or
FERS. FERS consists of three elements: (1) Social Security, (2) a
traditional pension called the FERS basic retirement annuity, and (3)
the Thrift Savings Plan.
The Thrift Plan is administered by an independent government
agency, the Federal Retirement Thrift Investment Board, which is
charged in statute with operating the Thrift Plan prudently and solely
in the interest of the participants and their beneficiaries. \1\ The
assets of the Thrift Plan are maintained in the Thrift Savings Fund,
which invests the assets in accordance with participant instructions in
five investment funds authorized by Congress to be included in the
plan.
---------------------------------------------------------------------------
\1\ See 5 U.S.C. Sec. 8472(h).
---------------------------------------------------------------------------
Federal employees who participate in FERS, or its predecessor, the
Civil Service Retirement System (``CSRS''), and members of the
uniformed services are eligible to join the Thrift Plan immediately
upon being hired. Generally, FERS employees are those employees hired
on or after January 1, 1984, while CSRS employees are employees hired
before January 1, 1984, who have not elected to convert to FERS. Each
group has different rules that govern contribution rates.
As of March 31, 2005, there were 3.4 million participants in the
Thrift Plan, with approximately 2.5 million contributing to the plan.
\2\ Among employees covered by FERS, 86% of those eligible to
participate in the Thrift Plan do so. Among CSRS employees, about two-
thirds participate. Assets of the plan totaled $154 billion as of March
31. In terms of both assets and number of participants, the Thrift
Savings Plan is the largest employer-sponsored retirement savings plan
in the United States.
---------------------------------------------------------------------------
\2\ See Table 1 for complete Thrift Savings Plan enrollment
statistics.
---------------------------------------------------------------------------
The Thrift Plan is legally a ``defined contribution'' plan. This
means that it specifies how much an employee may contribute and how
much the employing agency must contribute to each FERS employee's
account. The employee owns the account and his or her benefit is equal
to the account balance, which can be taken as a lump-sum, an annuity,
or a series of periodic withdrawals.
Contributions
In 2005, FERS employees can contribute as much as 15 percent of
basic pay on a tax-deferred basis, up to the $14,000 maximum specified
in section 402(g) of the Internal Revenue Code. Participants in FERS
are entitled to receive employer matching contributions on the first
five percent of pay that they contribute to the Thrift Plan. \3\
Participants age 50 and older who are already contributing the maximum
amount for which they are eligible are allowed to make supplemental
tax-deferred ``catch-up'' contributions of up to $4,000 in 2005.
---------------------------------------------------------------------------
\3\ The formula for agency matching contributions is specified in
law at (5 U.S.C. Sec. 8432(c)).
---------------------------------------------------------------------------
In 2005, CSRS employees and members of the uniformed services can
contribute up to ten percent of basic pay on a tax-deferred basis,
subject to the $14,000 maximum specified in the tax code. Members of
the uniformed services also may contribute up to 100% of designated3
special pay, incentive pay, and bonuses to the Thrift Plan. Neither
CSRS participants nor members of the uniformed services receive
employer matching contributions because both CSRS and the military
services provide pension benefits to career employees and career
military personnel that are substantially larger as a percentage of
career-average pay than the FERS basic retirement annuity.
All FERS participants receive from their employing agencies an
automatic contribution equal to one percent of basic pay. \4\
Participants may also transfer funds from a traditional individual
retirement accounts (IRA) or another eligible employer plan into the
Thrift Plan.
---------------------------------------------------------------------------
\4\ Basic pay is defined in statute at (5 U.S.C. Sec. 8401(4)).
---------------------------------------------------------------------------
Investment Options
As provided for in statute, Thrift Plan participants are offered
five investment funds. Participants may allocate their contributions
among any or all of the five investment funds, and they may reallocate
their account balance among the five investment funds. The four funds
that invest in private-sector securities are all index funds. These
funds purchase securities in the same proportion as they are
represented in an index of stocks or bonds, rather than through the
decisions of an investment manager. Index funds have lower
administrative costs than actively-managed funds, and because they
purchase securities in the same proportion as they are represented in
an index, there is little or no opportunity for the purchase of
securities by the fund to be influenced by third parties who might
benefit from having the fund invest in particular companies or sectors
of the economy.
The five funds in the Thrift Plan are:
the Government Securities Investment Fund, (the ``G
Fund''). This fund invests exclusively in U.S. Treasury Securities and
other securities backed by the full faith and credit of the United
States. Over the period from 1988 through 2004, the ``G'' fund earned
an average annual rate of return of 6.6%. \5\
---------------------------------------------------------------------------
\5\ See Table 2 for annual rates of return from 1988 through 2004.
---------------------------------------------------------------------------
the Fixed Income Investment Fund, (the ``F Fund''). This
fund invests in a bond index fund that tracks the performance of the
Shearson Lehman Brothers Aggregate (SLBA) bond index. These securities
consist of government bonds, corporate bonds, and mortgage-backed
securities. From 1988 through 2004, the ``F'' fund earned an average
annual rate of return of 7.7%.
the Common Stock Index Investment Fund (the ``C Fund'').
This fund invests in stocks of thecorporations that are represented in
the Standard and Poor's 500 index in the same proportion as they are
represented in that index. During the period from 1988 through 2004,
the ``C'' fund earned an average annual rate of return of 12.0%.
the Small Capitalization Stock Index Investment Fund (the
``S Fund''). This fund invests in the stocks of small and medium-sized
companies incorporated in the United States. Stocks in this fund are
held in the same proportion as they are represented in the Wilshire
4500 stock index. The average annual rate of return on the Wilshire
4500 from 1988 through 2004 was 12.7%.
the International Stock Index Investment Fund (the ``I
Fund''). This fund invests in the common stocks of foreign corporations
represented in the Morgan Stanley Capital Investment EAFE (Europe,
Australia-Asia, Far East) index. The average annual rate of return on
the EAFE Index from 1988 through 2004 was 6.1%
The Thrift Board has contracted with Barclays Global Investors to
manage the index funds in which the F, C, S, and I Fund assets are
invested. The contracts for each fund are open to competitive bids by
qualified investment managers every three to five years.
Participant Vesting
Thrift Plan participants are immediately vested in all of their own
contributions and investment earnings on those contributions. \1\
Participants also are immediately vested in agency matching
contributions made to their accounts and attributable earnings. In
order to be vested in the agency automatic (1%) contributions, a FERS
employee must have either 2 or 3 years of service as described in
section 8432(g) of title 5 of the U.S. Code. FERS employees who are not
vested and who separate from the federal government forfeit all agency
automatic contributions and attributable earnings. Forfeited funds,
consisting primarily of monies forfeited pursuant to 8432(g), totaled
$10,822,000 in 2004 and $7,824,000 in 2003. By law, these funds are
used to pay accrued administrative expenses of the Thrift Plan. If the
forfeited funds are not sufficient to meet all administrative expenses,
earnings on participant investments are then charged for administrative
costs. In its most recent annual report, the plan reported
administrative costs of six basis points, or six-hundredths of 1%.
Thus, the administrative expenses of the Thrift Plan are about 60 cents
for each $1,000 invested. \7\
---------------------------------------------------------------------------
\6\ To ``vest'' in a benefit is to gain a legally enforceable right
to receive it.
\7\ See Table 3 for the Thrift Savings Plan's assets, income, and
expenses in 2004 and 2003.
---------------------------------------------------------------------------
Participant Accounts
The Thrift Plan maintains individual accounts for each participant.
Participant accounts are credited with the participant's contributions,
agency automatic and matching contributions, and charged with
withdrawals. The value of the participant's account reflects the number
of shares and the daily share prices of the funds in which it is
invested. Administrative expenses are a component of the share price
calculation. The benefit to which a participant is entitled is the
participant's vested account. Thrift Plan participants can receive
account-balance information and conduct transactions by automated
telephone service or on the Thrift Plan's web site. \8\
---------------------------------------------------------------------------
\8\ The URL of the Thrift Savings Plan web site is www.tsp.gov.
---------------------------------------------------------------------------
Participant Loans
Participants may borrow from their accounts. There are two types of
Plan loans: general purpose and residential. General purpose loans can
be obtained for any purpose, with a repayment period from 1 to 5 years.
Residential loans can be obtained for the purpose of purchasing a
primary residence, with a repayment period from 1 to 15 years.
Participant loans may only be taken from participant contributions and
attributable earnings. The minimum loan amount is $1,000. The interest
rate for loans is the ``G Fund'' interest rate at the time the loan
agreement is issued by the Plan's record keeper. The rate is fixed at
this level for the life of each loan. Interest earned on loans is
allocated to the participant account upon repayment. Participants whose
loans are in default have until the end of the following calendar
quarter to pay the overdue amount. If not repaid by that time, the loan
plus accrued interest is treated as a taxable distribution to the plan
participant, which may be subject to the 10% penalty on retirement plan
distributions made before age 59\1/2\.
Benefit Payments
After leaving service, participants may elect benefit withdrawals
in the form of a partial withdrawal or a full withdrawal as a single
payment, a series of payments, or a life annuity. Participants may
choose to combine any two, or all three, of the available withdrawal
options. The Board has contracted with the Metropolitan Life Insurance
Company to provide annuity products to Thrift Plan participants. The
contract to issue Thrift Plan annuities is open to competitive bids
every three to five years.
The Federal Retirement Thrift Investment Board
The Federal Retirement Thrift Investment Board was established by
the FERS Act of 1986. \9\ The Board is responsible for developing the
investment policies of the Thrift Plan and overseeing the management of
the plan, which is under the day-to-day direction of an Executive
Director appointed by the Board.
---------------------------------------------------------------------------
\9\ See 5 U.S.C. Sec. 8472.
---------------------------------------------------------------------------
Three of the five members of the Board--including the Chairman--are
appointed by the President. The President chooses a fourth member of
the Board in consultation with the Speaker of the House and the House
Minority Leader and a fifth member in consultation with the Majority
and Minority Leaders of the Senate. Members of the Board serve 4-year
terms and all nominations are subject to Senate confirmation. The law
requires that all nominees to the Board must be individuals with
``substantial experience and expertise in the management of financial
investments and pension benefit plans.'' \10\
---------------------------------------------------------------------------
\10\ See 5 U.S.C. Sec. 8472(d).
---------------------------------------------------------------------------
The authorizing legislation that established the Thrift Board
defines the Board's authority and responsibilities, and provides for
substantial independence of the Board from political pressures.
Authority
The Thrift Board has the authority to:
Appoint the Executive Director of the Thrift Plan;
Remove the Executive Director for cause (This requires 4
votes of the 5-member Board.);
Establish investment policies for the Thrift Plan;
Instruct the Director to take whatever actions the Board
deems appropriate to carry out the policies it establishes;
Submit to the Congress legislative proposals relating to
its responsibilities under federal law.
Independence
Members of the Board are nominated by the President and confirmed
by the Senate, but once confirmed they cannot be removed from their 4-
year terms without good cause. The selection and nomination process are
designed to assure that Members of the Board are individuals who are
supported by the President and Congress. They serve in times of good
behavior, rather than at the pleasure of the President or Congress,
assuring that they can carry out the responsibilities of their
positions without of removal from office. The Federal Retirement Thrift
Investment Board receives no appropriations from Congress.
Administrative expenses are paid through agency-automatic contributions
forfeited by employees who leave federal service before they have
vested and charges against participant accounts.
Responsibility
The law requires that the members of the Board shall discharge
their responsibilities solely in the interest of participants and
beneficiaries. In practice, this means that the investment policies and
management practices of the fund are evaluated by the Board exclusively
in reference to the efficient and prudent management of the Fund's
assets. This exclusive responsibility serves to further insulate the
Board from pressures to adopt investment policies or management
practices that might not be in the long-term interest of preserving and
increasing the security and investment performance of the Fund's
assets.
Oversight
To assure that the Members of the Thrift Board remain aware of the
interests and concerns of Thrift Plan participants and beneficiaries,
the authorizing legislation established the Employee Thrift Advisory
Council. This 14-member council is appointed by the Chairman of the
Thrift Board and must include representatives of federal employee and
Postal Service labor organizations, managerial employees, supervisory
employees, female employees, senior executives, and annuitants.
All fiduciaries of the plan, including members of the Thrift Board
are required by law to be bonded. \11\ The Secretary of Labor is
authorized by law to investigate any suspected breach of duty by a
fiduciary of the plan. The financial statements of the Thrift Board are
audited regularly by an independent accounting firm. Congressional
oversight of the Thrift Plan is performed by the House Committee on
Government Reform and the Senate Committee on Homeland Security and
Governmental Affairs.
---------------------------------------------------------------------------
\11\ A ``fiduciary'' is a person in a position of trust or
confidence with regard to the property of another. A ``bond'' is form
of insurance against the potential malfeasance of a plan fiduciary.
---------------------------------------------------------------------------
Conclusion
The Thrift Savings Plan is an efficient provider of retirement
savings accounts to the federal workforce. It has achieved high
participation rates and low administrative costs. The Thrift Plan is a
key component of federal employees' retirement benefits. This is
especially true for workers in the middle and upper ranges of the
federal pay scale who would be unlikely to achieve adequate retirement
income from just Social Security, the FERS basic annuity, and the
government's automatic contribution of 1% of pay to the plan. Later
this year, the Thrift Plan will begin to offer life-cycle funds that
will allow employees to have their investments re-balanced with a
greater weight toward corporate and government bonds as they approach
retirement age, thus protecting their accumulated assets from a sudden
downturn in the stock market just as they are about to retire.
This concludes my testimony and I would be happy to answer any
questions that members of the subcommittee might have.
Table 1. Thrift Savings Fund Statistics
----------------------------------------------------------------------------------------------------------------
Fund balances, in millions March 2005 February 2005 January 2005
----------------------------------------------------------------------------------------------------------------
``G'' Fund 61,060 40% 60,066 39% 59,760 40%
----------------------------------------------------------------------------------------------------------------
``F'' Fund 10,079 7% 10,222 7% 10,279 7%
----------------------------------------------------------------------------------------------------------------
``C'' Fund 64,368 41% 65,589 42% 64,163 42%
----------------------------------------------------------------------------------------------------------------
``S'' Fund 9,847 6% 10,028 7% 9,681 6%
----------------------------------------------------------------------------------------------------------------
``I'' Fund 8,678 6% 8,325 5% 7,451 5%
----------------------------------------------------------------------------------------------------------------
Total $154,032 100% 154,230 100% 151,334 100%
----------------------------------------------------------------------------------------------------------------
Twelve-month returns
----------------------------------------------------------------------------------------------------------------
``G''Fund 4.45% 4.36% 4.38%
----------------------------------------------------------------------------------------------------------------
``F'' Fund 1.17% 2.36% 4.07%
----------------------------------------------------------------------------------------------------------------
``C'' Fund 6.76% 6.99% 6.24%
----------------------------------------------------------------------------------------------------------------
``S'' Fund 7.95% 10.42% 10.14%
----------------------------------------------------------------------------------------------------------------
``I'' Fund 14.96% 18.64% 16.22%
----------------------------------------------------------------------------------------------------------------
Participants (thousands)
----------------------------------------------------------------------------------------------------------------
FERS, contributing 1,539 1,543 1,553
----------------------------------------------------------------------------------------------------------------
FERS, agency 1% only 243 237 234
----------------------------------------------------------------------------------------------------------------
FERS participation rate 86.4% 86.7% 86.9%
----------------------------------------------------------------------------------------------------------------
FERS, without agency 1% 71 63 55
----------------------------------------------------------------------------------------------------------------
Total FERS with contributions 1,853 1,843 1,842
----------------------------------------------------------------------------------------------------------------
CSRS contributing 449 454 465
----------------------------------------------------------------------------------------------------------------
Uniformed services 476 478 458
----------------------------------------------------------------------------------------------------------------
Participants, not contributing 661 663 657
----------------------------------------------------------------------------------------------------------------
Total TSP participants 3,439 3,438 3,422
----------------------------------------------------------------------------------------------------------------
Loans outstanding
----------------------------------------------------------------------------------------------------------------
Number 859,386 872,240 883,357
----------------------------------------------------------------------------------------------------------------
Amount (millions of $) $4,908 $4,969 $5,033
----------------------------------------------------------------------------------------------------------------
Source : Federal Retirement Thrift Investment Board.
Table 2. Annual Rates of Return for Thrift Savings Plan Funds
----------------------------------------------------------------------------------------------------------------
Year G Fund C Fund F Fund S Fund I Fund
----------------------------------------------------------------------------------------------------------------
1988 8.8% 11.8% 3.6% 20.5% 26.1%
----------------------------------------------------------------------------------------------------------------
1989 8.8% 31.0% 13.9% 23.9% 10.0%
----------------------------------------------------------------------------------------------------------------
1990 8.9% -3.2% 8.0% -13.6% -23.6%
----------------------------------------------------------------------------------------------------------------
1991 8.1% 30.8% 15.7% 43.5% 12.2%
----------------------------------------------------------------------------------------------------------------
1992 7.2% 7.7% 7.2% 11.9% -12.2%
----------------------------------------------------------------------------------------------------------------
1993 6.1% 10.1% 9.5% 14.6% 32.7%
----------------------------------------------------------------------------------------------------------------
1994 7.2% 1.3% -3.0% -2.7% 7.8%
----------------------------------------------------------------------------------------------------------------
1995 7.0% 37.4% 18.3% 33.5% 11.3%
----------------------------------------------------------------------------------------------------------------
1996 6.8% 22.8% 3.7% 17.2% 6.1%
----------------------------------------------------------------------------------------------------------------
1997 6.8% 33.2% 9.6% 25.7% 1.5%
----------------------------------------------------------------------------------------------------------------
1998 5.7% 28.4% 8.7% 8.6% 20.1%
----------------------------------------------------------------------------------------------------------------
1999 6.0% 21.0% -0.8% 35.5% 26.7%
----------------------------------------------------------------------------------------------------------------
2000 6.4% -9.1% 11.7% -15.8% -14.2%
----------------------------------------------------------------------------------------------------------------
2001 5.4% -11.9% 8.6% -2.2% -15.4%
----------------------------------------------------------------------------------------------------------------
2002 5.0% -22.1% 10.3% -18.1% -16.0%
----------------------------------------------------------------------------------------------------------------
2003 4.1% 28.5% 4.1% 42.9% 37.9%
----------------------------------------------------------------------------------------------------------------
2004 4.3% 10.8% 4.3% 18.0% 20.0%
----------------------------------------------------------------------------------------------------------------
1988-2004 6.6% 12.0% 7.7% 12.7% 6.1%
----------------------------------------------------------------------------------------------------------------
Source: www.tsp.gov, www.wilshire.com, www.msci.com.
Note: Rates of return for the C, G, and F funds are shown net of TSP expenses.
Table 3. Financial Statements of the Thrift Savings Fund Statements of
Net Assets Available for Benefits as of December 31, 2004 and 2003 (In
thousands)
------------------------------------------------------------------------
2004 3003
------------------------------------------------------------------------
ASSETS:
------------------------------------------------------------------------
Investments, at fair value:
------------------------------------------------------------------------
U.S. Government Securities Investment Fund $56,670,880 $51,121,034
------------------------------------------------------------------------
Barclays U.S. Debt Index Fund 9,732,943 10,071,287
------------------------------------------------------------------------
Barclays Equity Index Fund 63,218,611 54,303,506
------------------------------------------------------------------------
Barclays Extended Market Index Fund 9,644,143 5,622,444
------------------------------------------------------------------------
Barclays EAFE Index Fund 7,021,069 2,211,875
------------------------------------------------------------------------
Participant loans 5,105,715 5,130,170
------------------------------------------------------------------------
151,393,361 128,460,316
------------------------------------------------------------------------
Total investments
------------------------------------------------------------------------
------------------------------------------------------------------------
Receivables:
------------------------------------------------------------------------
Employer contributions 166,045 151,497
------------------------------------------------------------------------
Participant contributions 507,034 446,574
------------------------------------------------------------------------
------------------------------------------------------------------------
Total receivables 673,079 598,071
------------------------------------------------------------------------
------------------------------------------------------------------------
Fixed assets, total: 41,839 39,715
------------------------------------------------------------------------
Other assets 5,460 11,236
------------------------------------------------------------------------
------------------------------------------------------------------------
Total assets 152,113,739 129,109,338
------------------------------------------------------------------------
------------------------------------------------------------------------
LIABILITIES:
------------------------------------------------------------------------
------------------------------------------------------------------------
Total liabilities 99,984 179,216
------------------------------------------------------------------------
------------------------------------------------------------------------
Funds restricted for the purchase of
------------------------------------------------------------------------
Fiduciary Insurance -4,829 -4,978
------------------------------------------------------------------------
------------------------------------------------------------------------
Net Assets Available for Benefits $152,008,926 $128,925,144
------------------------------------------------------------------------
------------------------------------------------------------------------
ADDITIONS:
------------------------------------------------------------------------
------------------------------------------------------------------------
Investment income (loss):
------------------------------------------------------------------------
U.S. Government Securities Investment Fund $2,346,104 $2,074,004
------------------------------------------------------------------------
Net appreciation (depreciation) in fair
value
------------------------------------------------------------------------
of Barclays funds:
------------------------------------------------------------------------
Barclays U.S. Debt Index Fund 408,397 455,956
------------------------------------------------------------------------
Barclays Equity Index Fund 6,115,843 11,316,657
------------------------------------------------------------------------
Barclays Extended Market Index Fund 1,249,934 914,990
------------------------------------------------------------------------
Barclays EAFE Index Fund 870,403 358,102
------------------------------------------------------------------------
Interest income on participant loans 237,684 222,422
------------------------------------------------------------------------
Asset Manager rebates 1,778 1,616
------------------------------------------------------------------------
Less investment expenses -4,503 -3,708
------------------------------------------------------------------------
------------------------------------------------------------------------
Net investment income (loss) 11,225,640 15,340,039
------------------------------------------------------------------------
------------------------------------------------------------------------
Contributions:
------------------------------------------------------------------------
Participant 11,980,077 10,366,123
------------------------------------------------------------------------
Employer 4,238,199 3,887,260
------------------------------------------------------------------------
Total contributions 16,218,276 14,253,383
------------------------------------------------------------------------
------------------------------------------------------------------------
Total additions 27,443,916 29,593,422
------------------------------------------------------------------------
------------------------------------------------------------------------
DEDUCTIONS:
------------------------------------------------------------------------
------------------------------------------------------------------------
Benefits paid to participants 4,110,891 2,774,685
------------------------------------------------------------------------
Administrative expenses 91,896 75,038
------------------------------------------------------------------------
Participant loans declared taxable 157,496 130,559
distributions
------------------------------------------------------------------------
------------------------------------------------------------------------
Total deductions 4,360,283 2,980,282
------------------------------------------------------------------------
------------------------------------------------------------------------
Change in funds restricted for the purchase
of
------------------------------------------------------------------------
Fiduciary Insurance 149 375
------------------------------------------------------------------------
Net increase 23,083,782 26,613,515
------------------------------------------------------------------------
------------------------------------------------------------------------
NET ASSETS AVAILABLE FOR BENEFITS:
------------------------------------------------------------------------
------------------------------------------------------------------------
Beginning of year 128,925,144 102,311,629
------------------------------------------------------------------------
End of year $152,008,926 $128,925,144
------------------------------------------------------------------------
Source: Financial statements of the Thrift Savings Plan [http://
www.tsp.gov/forms/financial-stmt.pdf].
Chairman MCCRERY. Just to advise the witnesses of the order
that I called, Mr. Pollock will be next, then Ms. Entmacher,
Mr. Cavanaugh, and Ms. Reno. Mr. Pollock, you may proceed.
STATEMENT OF ALEX J. POLLOCK, RESIDENT FELLOW, AMERICAN
ENTERPRISE INSTITUTE
Mr. POLLOCK. Thank you, Mr. Chairman, Ranking Member Levin,
Members of the Subcommittee, I would like to start by taking a
minute to look back into the insight of Congressman J.J.
Pickle, who died this last Saturday and who was, of course, a
Chairman of this Subcommittee, and who knew that in order to
protect Social Security, you had to change it. Chairman Pickle
told the Advisory Council on Social Security in 1995, ``The
public knows that change in the Social Security program is
necessary, and lack of action will be seen as failure in
leadership, not as protecting interests.''
Mr. Chairman, I think Chairman Pickle was absolutely right
in 1995, and his words are absolutely right today. The public
knows change has to happen, and the public knows something
else: That in exchange for the money that they send in to
Social Security, as Congressman Lewis was saying a minute ago,
they would like to have an individual right where there
actually exists an obligation for their retirement savings.
Congressman Becerra made a similar point: there should be such
an obligation. However, under the current Social Security
program with the current trust fund, as we call it, the Supreme
Court has made it clear there is no such obligation to any
individual, again, as Congressman Lewis so rightly said. Now,
we could create a clear and unquestionable obligation of the
United States to the citizens individually. There is an
instrument readily available to do that. It is called a United
States Treasury Bond. That is an inviolable contract
obligation.
This brings us to linking Social Security to the
philosophical ideal of ownership. Widely dispersed ownership
throughout the society is deeply embedded, and one of the best
elements of the American traditional political philosophy. It
goes back to John Locke, the philosophical father of
representative democracy, to the First Continental Congress,
and among American Presidents, particularly to Jefferson and
Lincoln. We have all kinds of programs in this country, and
rightly so, to promote ownership in the form of home ownership.
Ownership of retirement savings carries out the same principles
and would carry out the same philosophy.
Now, suppose there were a way to make at least part of
Social Security a truly inviolable ownership obligation for the
individual, which resulted in no cash shortfall to the
Treasury, no investment risk to households, no default risk, no
inflation risk, no increase in total government debt, and,
moreover, it were a voluntary program where individuals had the
choice to participate or not. I think everybody should support
such a program. Who could be against it? I certainly think that
the vast majority of the Americans who worry about what their
individual rights in Social Security are would support this
program.
Now, there is, in fact, a way to do this. I call it your
``personal lockbox.'' Here is how it would work. Consider the
current way we use the Old-Age and Survivors Insurance (OASI)
surplus, which was about $145 billion in 2004 and is expected
to rise to $200 billion annually, or so, during the next
decade. Americans pay their Social Security taxes. As we know,
the Treasury actually gets the cash, and Treasury issues a bond
to the trust fund. As we also know, this is an odd kind of
bond. It is debt of the government to itself. It is an ``I-owe-
me,'' as somebody has said. As we all know, economically and
financially, the size of the trust fund, whether it be large or
whether it be zero, has absolutely no, zero, economic effect on
the finances of the United States. So, now we need to make only
one simple change: Americans pay the same Social Security taxes
as now, Treasury gets the same cash they get now, the Treasury
issues a bond, just as it does now, but that bond goes to your
individual account, your personal lockbox.
It is now an IOU, it is a real bond, it is a real asset for
American families. It has become an inviolable contract. It can
be inherited, and since it is a Treasury bond, it has no
default risk. If we make it a TIPS, it will also have no
inflation risk. Mr. Chairman, as we know, inflation is the
greatest risk to retirement savings. So, putting TIPS into
these personal lockboxes, I think, takes a huge step forward in
making Social Security what I believe most Americans think it
should be. It will also be an exceptionally low-cost,
efficient, purely book entry system, very cheap to operate.
There are many details in my written testimony. I would
only say if we make this a voluntary option available to the
American people to get TIPS in their own accounts in exchange
for the surpluses, it will look to them just like payroll
deductions to buy savings bonds. We will have very little
educational effort, everyone will understand this immediately,
and I would be willing, Mr. Chairman, to bet a large amount of
my personal money that a large majority of Americans would
volunteer for this program. Indeed, how could anyone oppose
giving them this choice? Mr. Chairman, thank you very much for
the opportunity to be here today.
[The prepared statement of Mr. Pollock follows:]
Statement of Alex J. Pollock, Resident Fellow, American Enterprise
Institute Summary Statement
Good morning, Mr. Chairman, Ranking Member Levin, and members of
the Subcommittee. Thank you for the opportunity to testify today. I am
Alex Pollock, a Resident Fellow at the American Enterprise Institute,
and these are my personal views and recommendations.
Linking ownership of property to liberty in a free society is
deeply embedded in the American political philosophy, going back to the
ideas of John Locke and the First Continental Congress. Personal Social
Security accounts as vehicles for the expansion of ownership of
retirement assets are very much in keeping with this American
tradition.
By creating ``personal lock boxes'' invested in Treasury inflation-
indexed bonds, Congress can make such accounts a reality in a highly
efficient, low cost, low risk, sensible and easily understandable way.
It would also make social security at least in part what most people
think it should be: a retirement account building up your own personal
savings.
What is happening today, as we all know, is that some social
security contributions are diverted into general government
expenditures, evidenced by debt of the government to itself, or ``I owe
me's,'' in the social security trust fund. In contrast, without
diverting taxes or cash from the Treasury, personal accounts--``your
personal lock box''--can be created with real Treasury bonds held by
the public.
Consider how the ``investment'' of the social security surplus
currently works: Social Security taxes are collected by the Internal
Revenue Service and deposited in the general fund at the Treasury
Department, where they are spent on benefits but also on other federal
programs. In exchange for these ``invested'' Social Security funds, the
Treasury issues bonds to the Social Security trust fund. The bonds
represent government liabilities to itself (``I owe me's''), rather
than real obligations to the public.
I suggest creating personal accounts with the annual social
security surplus which protects it for retirement savings, without
diverting cash from payroll taxes. This could be done by changing the
current structure in one key respect: the Treasury would issue bonds
directly to personal accounts, bypassing the confusing role of the
trust fund, thereby creating ``your personal lock box'' of explicit
government obligations.
The personal accounts would be created by putting Treasury
securities in them, not cash. The current trust fund is an unnecessary
and confusing. The citizens and the U.S. Treasury are the only actual
principals involved. Personal lock boxes would protect the social
security surplus, make the accounting much clearer and more honest, and
make the citizens direct owners of top quality retirement assets.
There are perfect Treasury bonds for these accounts: Treasury
Inflation Protected Securities (TIPS). Inflation poses the largest
threat to retirement savings, and these default-free instruments also
fully protect against that threat, thereby minimizing risk.
Moreover, because these bonds operate on a book-entry basis, the
program would have very low operating and administrative costs.
According to the 2005 Annual Report of the Social Security
Trustees, the OASI program (excluding the Disability Insurance program)
ran a 2004 surplus of $145 billion. This represented over 30% of total
OASI contributions of $473 billion. The 10-year intermediate case
projection is for an aggregate OASI surplus of over $2 trillion.
Instead of continuing the ``I owe me'' approach with this surplus,
personal lock boxes could turn this $2 trillion into real assets of
American households, free of both default and inflation risk.
The Trustees' intermediate projection suggests that the OASI trust
fund would stay approximately level, and the going-forward surpluses
thus protected, if about half of the employee's social security tax
were converted to TIPS in personal lock boxes each year. This would
mean that Americans would receive real assets equal to 2.65 % (half
of5.3 %) of income subject to social security tax each year. For a
household with median 2003 income of $43,000, this would result in an
initial year personal lock box account of over $1,100.
I recommend the personal lock box as a purely voluntary program;
individuals could elect either to remain in the current program or to
receive TIPS in their personal accounts instead of future benefit
payments of equal economic value. After a certain restricted period (I
suggest five years), individuals could choose to reinvest their assets
in other financial instruments, although I believe a many would simply
stay with the TIPS ``default option.'' Ownership through personal
accounts would also allow for account holders to bequeath their assets
to future generations.
Think how much more meaningful direct ownership of these Treasury
bonds in a personal account--in ``your personal lock box''--would be
for American individuals and families than the obscure operations of
the current trust fund which few understand.
In my opinion, TIPS would be an extremely popular alternative--
simple, easy to understand, and attractive. By analogy to the federal
employees' thrift plan, it could be thought of as ``a G-Fund for
everybody.''
The personal lock box would result in greater and more widely
distributed ownership of financial assets among American households. It
would provide assets with no default risk and no inflation risk, with
the ability to pass them on to future generations. It would establish a
stronger and more honest financial relationship between government and
citizens. Treasury securities are in fact inviolable contracts, in
contrast to off-balance sheet future political formulas.
I believe a large majority of Americans would prefer to accumulate
inflation-protected retirement assets they actually own. They should be
given this choice.
``Your Personal Lock Box'':
A New Approach to Personal Social Security Accounts
Mr. Chairman, Ranking Member Levin, and Members of the
Subcommittee, thank you for the opportunity to testify today. I am Alex
Pollock, a Resident Fellow at the American Enterprise Institute, and
these are my personal views and recommendations.
By transforming Social Security, at least in part, to a program of
greater personal property for the average American, voluntary personal
accounts would be a key structural reform.
But most current proposals for personal accounts also have serious
disadvantages: they are complicated, to many people they are confusing
and they require diverting a portion of payroll taxes away from the
U.S. Treasury. How can there be effective management for millions of
small accounts? Isn't the stock market too risky? Won't many people be
confused by being forced to make choices they do not understand? Who
can be sure the benefits are worth the costs and risks?
There is, however, a better way to launch Social Security reform
using private accounts and inflation-indexed Treasury bonds (or
``TIPS''), which will deliver all of the benefits of personal accounts
with none of the costs or risks cited by their opponents.
I propose creating personal accounts, or ``Your Personal Lock
Box,'' with an extremely simple and clear financial structure, without
diverting any payroll tax receipts away from the U.S. Treasury, and
with low cost and efficient operations. The results will be greater
ownership of risk-free assets throughout American households, ability
for inheritance, clear links between one's own efforts and retirement
savings, and complete clarity in the dealings between the government
and the citizens. The transition could begin promptly.
The essential proposal is this: Social Security tax payments by
individuals and employers, and Social Security tax receipts by the
government would remain the same as they are now. Treasury would have
the same cash receipts from Social Security taxes as it does now. But
in exchange for the going-forward investment of OASI surplus
contributions, Treasury would not issue bonds to the Social Security
trust fund. Instead it would issue bonds--specifically, inflation-
indexed bonds or ``TIPS''--directly to the personal accounts of the
individual citizens themselves, which would become in effect their own
personal lock boxes. These accounts would not receive cash but would
automatically receive the safest possible investment for retirement
savings.
This is proposed as a voluntary alternative covering the portion of
Social Security taxes which represents mandatory savings of OASI
surpluses. Everyone would be given the choice to participate in the
proposed personal accounts or stay in the current Social Security
program. I believe that a large majority would choose the personal
accounts if they are designed as recommended, but this should be a
purely voluntary option.
This financial structure transparently shows the real transaction
which is taking place between the two real principals involved: the
American citizen and the U.S. Treasury Department. It cuts out the
unnecessary and confusing role of the Social Security trust fund, which
in fact is debt of the government to itself, or an ``I owe me.''
The government's total obligations would not increase. Some
Treasury debt would shift from being owned by the intra-governmental
trust fund to being owned directly by the citizens themselves in their
own personal lock box accounts. The bonds in the personal accounts
would represent an increase in Treasury debt owned by the public, but
would be issued, like bonds now sent to the government's trust fund, as
automatic private placements.
Simplicity
The simplicity of the proposed approach would remove from the
current political debates many distracting issues, such as whether we
could afford the transition costs, whether personal accounts would be
too risky, whether Wall Street would reap a bonanza, and whether
operating costs would be too high. It would make unnecessary the
proposed delay in implementation until 2009.
It would also remove a central objection made by the opponents of
personal accounts: that Social Security must be a moral imperative, an
inviolable promise and part of the social contract. Nothing could make
Social Security more imperative, inviolable, and a contract than to
turn it into a U.S. Treasury bond. Indeed, the only advantage which
might be argued for the current Social Security structure over the
proposed personal accounts is that the current structure leaves open
the possibility for the government to renege on its promises and reduce
benefits. This is presumably not an argument that opponents of personal
accounts will wish to emphasize.
How much of the current structure should be replaced by the
proposed personal accounts? The answer reflects the fact that Social
Security has two components: first, a mandatory savings program for
retirement and old age, applicable to citizens of all levels of income;
and second, a welfare or safety net program providing a minimum
retirement income and disability insurance.
The second component by definition requires commingling of funds
and should remain as it is. This would include the disability portion
of Social Security and the provision of a minimum retirement income for
low income households.
The proposed personal accounts apply to the first or mandatory
savings component: which is what most Americans think their Social
Security payments should be. I suggest that half of the employee's
share of Social Security taxes, which represents mandatory saving of
approximately the OASI annual surplus, should have available this
personal account option.
The simplicity of the proposed change to protect the surplus is
easy to see by reviewing the current structure of Social Security and
contrasting it with the proposal.
Current Structure for Social Security Surpluses
The current Social Security structure handles surpluses with the
following process:
A. Cash from the citizen, both directly from wages and indirectly
as employer contributions which could otherwise have been wages, is
sent to the government as Social Security taxes.
B. Social Security cash goes to the U.S. Treasury
C. Treasury issues a Treasury debt obligation to the Social
Security program. It is part of the total Treasury debt outstanding,
but is an ``I owe me.''
A New Structure for Personal Accounts
In the proposed structure, there would be no diversion of cash from
the Treasury. Social Security payroll taxes paid to the government and
cash received by the Treasury would stay the same as under the current
structure. If voluntarily chosen by the citizen, the portion of these
taxes representing the OASI annual surplus would be earmarked for
personal lock box accounts. However, these accounts would not receive
cash, but automatically receive an appropriate Treasury inflation-
indexed security.
The surplus investment function would thus work as follows:
A. Social Security taxes would be sent to the government, as they
are now.
B. Treasury's cash receipts would be the same as they are now.
There would be no cash shortfall.
C. Treasury would continue to issue a Treasury debt obligation, but
to the citizen's personal account, not to the trust fund--thereby
creating ``your personal lock box.''
That is all. Thus the citizen would own a risk-free investment very
well suited for retirement savings: an inflation-indexed Treasury
security. Treasury debt owned by the public in personal accounts has
increased, but debt owned by the trust fund has decreased. Treasury
owes the citizen explicitly and clearly, rather than confusingly owing
the government itself.
Since the savings are now in the form of a directly owned, actual
Treasury bond instead of future Social Security benefits, there must of
necessity be an equivalent reduction in future benefits to offset the
acquired Treasury security. The trust fund does not receive Treasury
bonds but by the same taken has reduced future benefit liabilities. For
the citizen, the replacement of future benefits with actual assets of
course applies only on a going-forward basis, as the personal accounts
grow. All benefits earned by past Social Security taxes, before the
private accounts transition, would remain unchanged.
The proposed structure is quite similar to a historically tried and
true long-term savings program: payroll deduction for the purchase of
U.S. savings bonds. It is also similar to a very popular option under
the Thrift Savings Plan for federal government employees: the ``G
Fund,'' which invests solely in U.S. Treasury obligations.
Such analogies, as well as the basic simplicity of the structure,
would make it easy for the public to understand. Would most people
choose to create their own portfolio of Treasury inflation-indexed
bonds rather than hoping for future payments from off-balance-sheet
political formulas? I think they would--by a large majority.
Relation to Future Benefits
If the economic value of the bonds acquired in the personal
accounts is exactly equal to the economic value of the reduction in
future off-balance-sheet future benefit promises, we would have created
the many advantages of ownership, but the aggregate Social Security
fiscal deficit would remain unchanged. However, this trade-off could be
given a progressive structure, analogous to recent proposals for
progressive changes to Social Security indexation formulas, for high-
income households.
In other words, for the majority of households the TIPS exchange
ratio would be 1 to 1, but for high income households it could be
greater than 1 to 1. Since many of these households believe that in any
case, their Social Security taxes will inevitably increase or their
future benefits be reduced, or both, the trade in exchange for
achieving personal accounts could be viewed as advantageous. The
transition to personal accounts would then reduce the Social Security
deficit, in addition to its other attractions.
The Specific Treasury Bond
The perfect candidate for the Treasury obligations to be issued to
the personal Social Security accounts is clear: Treasury Inflation
Protected Securities (TIPS). TIPS by definition preserve purchasing
power against inflation, the single greatest risk and an essential
consideration for retirement savings.
The TIPS would be issued in automatic private placements for each
personal account. Because all the TIPS involved will be book-entry
securities in fully automated form, small accounts and small amounts
could be easily handled, and operating costs will be low.
Suggestions for how the details of this would work follow. Details
could obviously vary around the essential structure.
The TIPS should have maturities based on the individual's expected
retirement date. For example, a twenty-five-year-old with an expected
retirement age of sixty-five might in the first instance receive a
forty-year TIPS. Note that it is proposed to consider creating long-
term TIPS to match the needs of retirement savings. All interest and
inflation adjustments should simply accrue, as with typical savings
bonds, so there is no problem of investing small amounts of cash.
Laddering maturities as discussed below would result in a sensible
pattern of cash flow during retirement.
The average real return of government bonds (i.e. the yield net of
inflation) in the long term is approximately 3 percent. The long-term
TIPS to be privately placed in the personal accounts with a restricted
period could have a real yield of about this same 3 percent. In an
average inflation of 2 or 3 percent, for example, this would result in
a compound annual return of 5 or 6 percent, respectively. A 3 percent
real yield would match the real 3-percent discount rate often used in
calculations of the value of future Social Security benefits.
For ownership to be effective, the TIPS received in the personal
accounts must be negotiable securities. However, it would make sense to
have a period after each private placement during which sale would be
restricted. After that, the citizen would be entirely free to sell in
order to make other eligible investments, if desired, provided of
course that all proceeds and investments must stay in the retirement
account until qualified for withdrawal.
The appropriate length of the restricted period before the
privately placed TIPS would become negotiable must be defined. A
starting suggestion would be five years, to insure a smooth transition,
while also allowing the future addition of private asset categories.
The maturities of the TIPS should be based on expected retirement
age but should not all mature at that date, which would cause a
difficult decision point and large reinvestment risk. The idea of
buying an annuity upon retirement does not address this problem, since
if at that time interest rates are low, annuities will be unattractive
to purchase--not to mention the need to address the credit risk of the
annuity writer. A preferable approach would be to automatically ladder
the maturities of the TIPS in the personal accounts to spread cash
receipts from maturing bonds over the retirement years. Recall in this
context that the safety net component of Social Security would also
continue to function.
Individuals who choose to continue working past retirement age
would continue to accumulate assets in their personal accounts. This
would provide an incentive to reduce the extended period of retirement
which is a central cause of Social Security's fiscal deficit without
having to mandate changes in retirement age that would naturally be
inappropriate in many individual cases.
In sum, the personal lock box accounts would represent a voluntary
way to hold mandatory savings, while explicitly protecting the social
security surpluses. Continuing to hold the TIPS past their restricted
period would also be voluntary.
But no investment decisions or risks would be forced upon the
citizen. Especially considering those who might feel confused or
intimidated, no action would be required to have a very sensible and
safe investment, with zero credit risk and guaranteed inflation
protection, very suitable for retirement savings, automatically
provided. This means that there is a robust ``default case,'' an
important element in a system of choices.
A safe prediction is that a significant proportion of these
securities would never be sold, but would be held to maturity. There
would be no rush and no pressure on the individual to have to do
anything, unlike the case of having to invest cash. In addition, the
restricted period should comfort any observers who might fear the
possibility, however unlikely, of a large initial outflow of TIPS into
the market.
Benefits for an Ordinary Couple
Suppose an ordinary couple signed up for the personal account
option when they were both twenty-five years old, with a household
income of $50,000 per year. What might their personal account
retirement assets look like at age sixty-five, assuming the ``default
case'' of simply holding their TIPS?
As an example, assume the real yield on TIPS is 3 percent, average
inflation of 2.5 percent, real wage increases of 1.5 percent, and half
the Social Security tax represents mandatory savings devoted to
personal accounts. At age sixty-five they would own investments
totaling over $800,000. If they worked to age seventy in line with
their greater expected longevity and health, the personal account
investments would total $1.15 million.
Now suppose two-thirds of the Social Security tax represents
mandatory savings which generate TIPS for the personal account. At
sixty-five, the investments would be more than $1 million; and at age
seventy, more than $1.5 million.
These would be real assets, really owned by ordinary Americans.
Conclusion
The proposed approach would lead to personal Social Security
accounts as a key transition and structural reform. It addresses all of
the objections to private accounts, as follows:
1. There would be no cash shortfall to the Treasury.
2. There would be no increase in the total national
obligations. Treasury debt owned by the public would increase,
but Treasury debt owned by the trust fund would decrease. Off-
balance-sheet future benefit liabilities would also decrease.
If the suggested progressive structure were adopted, future
liabilities would decrease by more than the value of the TIPS
issued, thus reducing the Social Security deficit.
3. There would be no need to market more Treasury debt--the
bonds involved would automatically be privately placed in the
personal lock box accounts.
4. No difficult choices would be imposed on individuals--if
they do nothing, a very safe and appropriate retirement
investment is automatically provided. The default case is
robust.
5. There is no pressure to take risk or ``roll the dice.''
TIPS are the exact opposite of rolling the dice. In particular,
they directly address the biggest risk to retirement savings,
namely inflation.
6. The obligation of the government for social security
surpluses is made truly inviolable by becoming an explicit
Treasury bond.
7. The use of TIPS would allow a very low cost, efficient
book entry system.
8. With investments automatically provided, there is no
windfall for Wall Street, and small accounts can be handled
efficiently.
9. Appropriate long-term investments matched to retirement
needs are automatically provided.
10. The proposal would allow prompt implementation.
Moreover, the idea is simple and easy to understand. As a voluntary
alternative, I believe having ``your personal lock box'' would be
readily chosen by a large majority of Americans.
Chairman MCCRERY. Thank you, Mr. Pollock. Ms. Entmacher.
STATEMENT OF JOAN ENTMACHER, VICE PRESIDENT AND DIRECTOR,
FAMILY ECONOMIC SECURITY, NATIONAL WOMEN'S LAW CENTER
Ms. ENTMACHER. Thank you, Mr. Chairman. I appreciate this
opportunity to testify on behalf of the NWLC. My written
testimony addresses some of the system design issues presented
when individual workers, particularly women, try to convert the
proceeds of a private account into a secure and equitable
income throughout retirement. Other witnesses have addressed
some of these issues, my remarks will focus on the question of
whether and how the proceeds of a private account are to
provide for the spouses, surviving spouses, divorced spouses,
and children who rely on the family insurance benefits that
Social Security provides. These issues are of special
importance to women. Nearly 14 million Americans receive a
spousal benefit from Social Security, and 98 percent of those
who do are women. So, women need to know when things like
``personal lockboxes'' are described, what will be the rights
of a spouse, a widow, a divorced spouse to the funds in those
accounts if Social Security spousal benefits are cut as part of
a private accounts plan, and many private accounts plans do cut
those benefits.
At retirement, for example, will married workers be
required to purchase a joint and survivor annuity to protect a
surviving spouse the way Social Security does? Without such a
requirement, a widow could be left with absolutely nothing from
his account to supplement her own probably lower Social
Security benefit and private account. Adding insult to injury,
she could be facing an additional reduction in her Social
Security widow's benefit precisely because he elected to
participate in a private account. Requiring the purchase of a
joint and survivor annuity would help protect elderly widows
from impoverishment and promote fairness. There are real trade-
offs, which perhaps is why the Administration has so far failed
to answer this very basic design question. Under Social
Security, a worker's benefits are not reduced because Social
Security provides payments to a surviving spouse. A private
account is a finite sum of money. Purchasing a joint and
survivor annuity means the worker will get lower payments.
Ms. Mitchell has suggested that accounts should be
annuitized to provide a poverty level benefit for both the
worker and spouse. This is not a requirement the President has
talked about so far, possibly because, the fact is, many
accounts simply will not be large enough to provide such
benefits for both people. In addition, annuities are
inflexible. They cannot respond to changes in marital status
that may occur after an annuity is purchased. Whether one is
widowed right before or right after annuitization could make a
big difference in what the widowed individual receives.
Then there are subsidiary questions: How large a survivor
annuity should be provided, and should waivers be permitted?
Second, will workers be permitted to leave an account to
anyone, as the President has sometimes said, or would widows
have the right to an inheritance from the account to mitigate
the impact of cuts in survivor benefits? If a young widow does
inherit account assets, would she have immediate access to the
funds to help support her family and supplement their reduced
survivor benefits, or would she be required to keep that money
aside for her own retirement, as several plans provide? Along
with an inheritance from the account, would she inherit the
obligation to pay back Social Security with interest out of a
reduction in her own Social Security benefits later? Would the
requirement to pay back Social Security apply to other heirs,
and would they have access immediately to the accounts? What
about minor children and adult disabled children who are
entitled to Social Security benefits on a worker's record,
would they have a right to inheritance from an account to
offset cuts in those benefits?
Third, how would accounts be divided at divorce? One
approach that has been suggested would divide the assets that
accumulate in accounts during the course of a marriage equally
between spouses. It sounds simple. It isn't. Simply
implementing the division of accounts at divorce will require
new reporting, verification, and dispute resolution mechanisms
well beyond those needed to administer either the current
Social Security System or the thrift savings system. About
100,000 applications for Social Security each year involve
establishing evidence of divorce. There are 10 times as many
divorces each year in the United States. The SSA doesn't need
to track marital status over the lifetime. It just figures it
out when application is made for benefits, and those benefits
are based on the worker's record. The TSP doesn't need to do
this either. It just follows the instructions that it gets from
a State divorce court. If a woman doesn't have a lawyer, and
doesn't know to ask for a share of a thrift savings account in
a divorce, she gets nothing. I would point out right now there
is no national registry with information about marriages and
divorces in the United States. To divide accounts based on
contributions during marriage would require the creation of
such a registry, and, apart from the cost, that would raise a
lot of new confidentiality issues.
Finally, one last point. In a system of voluntary personal
accounts, what would happen if one spouse decides to
participate and the other doesn't? How would any of the rules
created apply? I think the simplest answer to these questions
would be to focus on strengthening the safety net that Social
Security currently provides, rather than shifting resources
into private accounts. Thank you.
[The prepared statement of Ms. Entmacher follows:]
Statement of Joan Entmacher, Vice President and Director, Family
Economic Security, National Women's Law Center
Chairman McCrery, Ranking Member Levin, and members of the
Subcommittee, thank you for this opportunity to testify on behalf of
the National Women's Law Center.
My testimony will focus on the administrative and implementation
issues that would arise at the point that money is to be paid out of
private accounts created as part of Social Security. So far, most of
the discussion of administrative issues has focused on how a new system
of accounts would be created, how money would get into the accounts,
and how investments during the working years would be managed. Far less
attention has been paid to questions of how, if, and when money would
be paid out from accounts to workers and their family members. \1\
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\1\ This testimony is informed by my work as a member of the expert
study panel convened by the National Academy of Social Insurance to
examine issues relating to the payment of benefits from individual
accounts, two years of discussion with the thoughtful and knowledgeable
experts on the panel and the NASI staff, and the report issued by the
panel earlier this year: Reno, Graetz, Apfel, Lavery and Hill, eds,
National Academy of Social Insurance, Uncharted Waters: Paying Benefits
from Individual Accounts in Federal Retirement Policy (2005)
[``Uncharted Waters '']. However, I am testifying today solely on
behalf of the National Women's Law Center.
---------------------------------------------------------------------------
The administrative issues that arise at the payout phase are
critically important. If private accounts are supposed to make up for
reductions in Social Security benefits that now provide basic income
security for tens of millions of Americans and their families, a key
question is, how can the proceeds of an individual account be converted
into a secure, equitable, and adequate source of income for workers--
and their spouses and children--when workers retire, die, or are
disabled?
My testimony first discusses some of the issues that arise with
payouts at retirement to an individual worker, then moves to some of
the even more complex issues that arise because Social Security is a
family insurance plan, not just a worker retirement program. \2\ The
questions raised are difficult, and the tradeoffs presented are
inevitable and painful, because an individual account simply cannot
substitute for the range of insurance protections that it is possible
to provide for workers and their families through Social Security.
---------------------------------------------------------------------------
\2\ For more information about the family insurance benefits that
Social Security provides, and their special importance to women, see
Testimony of Nancy Duff Campbell, Co-President, National Women's Law
Center, to the Subcommittee on Social Security, Committee on Ways and
Means (May 17, 2005) [``Campbell Testimony''].
---------------------------------------------------------------------------
There may be a temptation to think that resolving these issues can
wait, because the retirement of workers who establish an account would
be several years away. But that would be a serious mistake. Workers
will need to know what the payout rules are before they can make a
decision about whether or not to contribute to a private account. Well
before they reach retirement age, some workers will divorce, some will
become disabled, some will want access to the funds in ``their''
accounts, and some will die--all events that require decisions about
payouts from private accounts, decisions that will have serious
consequences for the wellbeing of Americans who rely on the safety net
that Social Security provides for them and their families.
How Will Private Accounts Provide Secure Lifetime Income to Individuals
When They Retire?
When a worker retires, dies, or becomes disabled, Social Security
provides the worker and eligible family members with benefits that
cannot be outlived, are adjusted annually for inflation, and do not
fluctuate with the financial markets. In contrast, private accounts
represent a limited pool of assets; retirees will face the challenge of
deciding how to manage whatever they may have accumulated in an account
to provide for their own retirement security, possibly for the
financial security of a spouse or children, and for other goals.
Administrative issues and financial risks do not end when a worker
reaches retirement age. Retirees must make decisions in the face of
multiple uncertainties: how long they or a spouse might live, how much
prices will rise, and how the financial markets will perform.
The challenges of managing private savings throughout retirement
are not limited to accounts created within Social Security. But the
stakes are higher--and the issues more complex--if private accounts are
being relied upon to help make up for reductions in the basic income
that Social Security provides to workers and their families.
How will workers be protected against outliving the
assets in a private account?
With a plan that cuts Social Security benefits and relies on
private accounts to provide basic income security to retirees for the
rest of their lives, Congress will have to decide whether, when, and to
what extent to require workers to purchase a life annuity to insure
against the risk of outliving the assets in the account and becoming
impoverished in old age. Alternatives to life annuities have been
suggested as a way of preventing workers from exhausting their accounts
too quickly, such as taking phased withdrawals over the period of their
projected life expectancy. However, phased withdrawals do not provide
the assurance of lifetime income; indeed, as the Congressional Research
Service notes, on average, about 50 percent of those opting for phased
withdrawals will live longer than expected and exhaust the funds in an
individual account. \3\ Making the purchase of a life annuity
mandatory, at least to assure income up to some specified level, would
reduce income insecurity; broaden the annuity pool and increase annuity
payments on average; and reduce marketing expenses. \4\
---------------------------------------------------------------------------
\3\ Laura Haltzel, Congressional Research Service Report, Social
Security Reform: President Bush's Individual Accounts Proposal 7 (April
25, 2005).
\4\ See Uncharted Waters.
---------------------------------------------------------------------------
But requiring the purchase of an annuity poses tradeoffs. An
annuity requires payment up front; once it is purchased, the assets
used to buy it are no longer available. An annuitization requirement
would reduce the risk of outliving assets, but also would reduce the
control and choice workers could exercise over the accounts. An
annuitization requirement also could eliminate the possibility of a
bequest; the Bush Administration estimates that under its plan, 15
percent of all retirees and 30 percent of retirees with lower lifetime
incomes would have to spend all the assets in their accounts to bring
the combination of reduced Social Security benefits and payments from
the account up to the poverty level for their lifetimes, leaving
nothing in their accounts for discretionary spending or a bequest. \5\
---------------------------------------------------------------------------
\5\ [5] Associated Press, ``Survivor Benefits Face Cut, Official
Says,'' (May 12, 2005).
Will discrimination on the basis of gender be prohibited
---------------------------------------------------------------------------
in annuities purchased from private accounts?
Social Security pays monthly benefits on a gender-neutral basis. In
contrast, in the private annuity market, if a man and woman purchase a
life annuity with the same amount of money at the same time, the woman
will get lower monthly payments for life.
Federal law already bans differential pricing and benefits in group
annuities or pensions that are part of an employment relationship. \6\
If Congress creates private accounts as part of Social Security, it
must prohibit gender discrimination in annuities marketed to those with
private accounts. An effective prohibition on discrimination will
require more than passing legislation; regulatory oversight be needed
to avoid the design and marketing of annuity products specifically to
men or women to avoid the effect of the uniform pricing requirement.
\7\
---------------------------------------------------------------------------
\6\ See, e.g., City of Los Angeles Department of Power and Water v.
Manhart, 435 U.S. 702 (1978).
\7\ See Uncharted Waters at 78-80.
How will annuities from private accounts provide
---------------------------------------------------------------------------
protection against inflation?
Social Security provides payments for life that are adjusted
annually to keep up with increases in the cost of living. No private
annuities currently offer full protection against inflation, and
experts believe they are unlikely to evolve without the substantial
involvement of the federal government, even if the market for private
annuities expanded with the establishment of private accounts. \8\
---------------------------------------------------------------------------
\8\ See Uncharted Waters at 85-86.
How will workers be assured that annuity payments from a
---------------------------------------------------------------------------
private company will continue for life?
A person who purchases a life annuity pays the price up front, in
exchange for a contractual promise to make payments for the life of the
purchaser (and survivor, in the case of a joint and survivor annuity).
The purchaser counts on the company providing the annuity to make good
on the promised payments for years to come.
Today, life annuities are provided by life insurance companies that
are regulated by the states. States are responsible for setting
solvency standards, monitoring compliance with those standards, and
providing some protection in case an insurance company defaults. Every
state has a ``guaranty fund'' to deal with defaults--but unlike the
Federal Deposit Insurance Corporation, which ensures bank deposits, or
the Pension Benefit Guarantee Corporation, which ensures defined
benefit pensions, state guaranty funds are not pre-funded at all. \9\
In the event of a default, states make assessments against other
companies doing business in the state. States also make their own rules
about who is protected, and to what extent, by the state guaranty. \10\
For example, a retiree who purchases an annuity from a company doing
business in state A, then moves to State B, may not be entitled to
payments from State A's guaranty fund if the company defaults. \11\ The
risk that a large insurance company will default is not hypothetical,
as the case of the Executive Life Insurance Company of California and
its New York subsidiary shows; as this case also shows, policy holders
may suffer substantial losses in case of default. \12\
---------------------------------------------------------------------------
\9\ Id. at 76-82.
\10\ Ibid.
\11\ Ibid.
\12\ Ibid.
---------------------------------------------------------------------------
If Congress creates private accounts that are designed to replace
Social Security income, the federal government will have to intervene
in the annuities market, and probably act as guarantor, to make sure
that Americans get the payments they are counting on. But Social
Security already provides annuities that are adjusted for inflation,
nondiscriminatory, and secure; it would be far more efficient and
effective simply to protect and strengthen Social Security.
When will retirees be required to purchase the annuity?
Investment risk does not end when a worker has stopped contributing
to an account is ready to start drawing retirement income. Indeed,
converting account assets to a life annuity magnifies market risk. The
lifetime income that an annuity provides will be determined by the
value of the assets and interest rates at the moment of conversion--and
these can fluctuate greatly over short periods of time. The drop in the
stock market and interest rates between 2000 and 2003 meant that a
retiree purchasing an annuity in 2003 would have 60 percent less income
than a retiree who purchased an annuity in 2000--after a lifetime of
making similar contributions and investment choices. \13\
---------------------------------------------------------------------------
\13\ [13] Calculations by Gary Burtless, Senior Fellow, Brookings
Institution, quoted in Julie Kosterlitz, ``Cracking the Nest Egg,''
National Journal (April 22, 2005).
---------------------------------------------------------------------------
These market fluctuations are a source of concern--and hardship--
for workers in or near retirement who look to their IRAs or 401(k)s to
supplement their Social Security benefits during a market downturn.
When private accounts are expected to replace part of the basic income
provided by social insurance system, the risks are even greater.
In Chile, interest rates fell dramatically in 1996 and 1997,
greatly reducing the lifetime payments workers would get from their
accounts. Under Chile's partially privatized system, which requires
workers to annuitize their accounts when they claim retirement
benefits, workers who had planned to retire--some of whom had already
been pushed out of their jobs when they reached retirement age--were
simply told, ``Don't.'' \14\ In the United Kingdom, protests by workers
who were required to buy annuities under the UK's partially privatized
system at a time when interest rates (and thus annuity payments) were
down led the government, in 1994, to allow workers to defer their
annuity purchase until age 75. \15\ But many workers don't have
sufficient other resources to meet their needs while they wait for
market conditions to improve. And there is no guarantee of improvements
in the short term; indeed, in 1999, The Financial Times reported that
the income obtainable from a private account had dropped 16 percent in
the course of a year. \16\
---------------------------------------------------------------------------
\14\ Ibid.
\15\ Ibid.
\16\ Ibid.
---------------------------------------------------------------------------
Giving workers flexibility in the timing of an annuity purchase
raises new issues and administrative challenges; indeed, an extended
time frame could essentially negate an annuitization requirement. Many
workers would be unable to get by on their greatly reduced Social
Security benefits while they wait for market conditions to improve;
but, if they are allowed to start withdrawing assets from the accounts
while they wait to annuitize, there will be less left in the account to
assure lifetime income for workers and their spouses.
Deciding when to annuitize carries lifetime financial implications;
to take advantage of the added flexibility, workers will need
additional financial counseling (not that investment counselors are
necessarily successful at predicting short-term changes in asset values
and interest rates). Gradual annuity purchases could spread the risk of
interest rate fluctuations over a longer period--but would not
eliminate the risk, and would add to administrative costs and make
payment levels uncertain. \17\
---------------------------------------------------------------------------
\17\ Uncharted Waters at 70.
---------------------------------------------------------------------------
Workers deciding when to annuitize could be subject to conflicting
family pressures: children and other possible heirs may seek to delay
the purchase of an annuity which would leave little or nothing for them
to inherit; a spouse concerned about the depletion of assets may prefer
the purchase of a joint and survivor annuity. And workers with lower-
than-average life expectancies would probably seek to delay the
purchase of an annuity as long as possible; life annuities are not a
good deal for people with shorter life expectancies. But if individuals
with shorter life expectancies can effectively opt out of the annuity
pool by delaying the purchase of an annuity for years, those who
purchase annuities can expect lower payments.
How Will Private Accounts Help Make Up for Cuts in the Family Insurance
Benefits that Social Security Provides?
The various family insurance benefits that Social Security
provides, and their importance--especially to women and their
families--are described in the May 17, 2005 testimony to this
Subcommittee by Nancy Duff Campbell, Co-President of the National
Women's Law Center. Her testimony also explains why private accounts
cannot match the benefits that Social Security provides not just for
retired workers, but for workers if they are disabled, and for the
spouses and children of workers when workers retire, die, or are
disabled.
The best way to protect the safety net that Social Security
provides for women and their families is to reject plans that would
create private accounts out of Social Security, and work instead to
strengthen and improve Social Security.
However, if this Subcommittee is considering private accounts
plans, it must consider how the rules governing the payouts from
private accounts might mitigate--or exacerbate--the harm to family
members and disabled workers from the plan's cuts to Social Security
benefits--even though it will be impossible to protect them fully.
Will married workers be required to purchase a joint and
survivor annuity?
Social Security assures the spouse of a retired worker a benefit
equal to 50 percent of the worker's benefit; it assures the surviving
spouse a benefit of 100 percent, assuming both spouses retire at full
retirement age. Divorced spouses and divorced surviving spouses, if
married to the worker for at least ten years, are entitled to the same
benefits as current spouses. Social Security spousal benefits are paid
in addition to the worker's benefit; they do not reduce the benefit
that the worker, or the current spouse (or ex-spouse) of the worker
receives.
Because Social Security spousal benefits are calculated based on
the worker's Social Security benefit, cuts in Social Security benefits
for retired workers mean cuts in spousal benefits as well. Private
accounts plans may cut spousal benefits twice: first, as part of a
general benefit reduction applicable whether or not a worker has chosen
to contribute to a private account (even if these cuts are designed to
exempt workers with very low earnings, widows with very low income may
face benefit cuts, because their benefits are based on the record of a
worker who had earnings above the minimum level). Second, if a plan
cuts benefits specifically for workers who contribute to a private
account, benefits for the retired spouse and widow of a worker who
contributes to an account are also likely to be cut further. \18\
---------------------------------------------------------------------------
\18\ See Uncharted Waters at 174; no private accounts plan with an
offset applied it only to the accountholder's benefit.
---------------------------------------------------------------------------
In view of the importance of spousal benefits to women, now and in
the future, it is disturbing that the Administration has so far failed
to say whether its private accounts plan would require married workers
to purchase a joint and survivor annuity to help make up for reductions
in Social Security spousal benefits. Without such a requirement, a
married worker (call him Michael) could convert all the assets in his
account to a single life annuity, leaving his widow (call her Sarah)
with nothing from the account: no household income from his annuity
payments, no survivor payments for herself, and no inheritance. Yet she
may be facing a deep reduction in her Social Security benefits
specifically because Michael contributed to a private account. \19\
---------------------------------------------------------------------------
\19\ For a further discussion of how annuitization choices could
affect benefits for a couple, see Campbell Testimony.
---------------------------------------------------------------------------
In addition to deciding whether to require the purchase of joint
and survivor annuities, Congress also must decide their size and form.
What percentage of the payment to the annuity purchaser should be
required to be provided for a surviving spouse: 50, 67, 75 or 100
percent? A higher survivor benefit means more income security for the
widowed spouse--but lower payments when both are alive. If the spouse
is several years younger, payments during the life of the annuity
purchaser would be lower still.
Requiring survivor annuities will provide additional protection to
surviving spouses, but they cannot respond to changes in marital status
as Social Security can. Someone who enters retirement as a single
individual, purchases a single life annuity, then marries, cannot
change it to a joint and survivor annuity. Someone who is widowed or
divorced shortly after retirement cannot change a joint and survivor
annuity to a single life annuity with higher payments. And whether one
is widowed right before or after annuitization could make a big
difference in what the widowed individual receives. \20\
---------------------------------------------------------------------------
\20\ Uncharted Waters at 62-66.
Will waivers of the right to a joint and survivor annuity
---------------------------------------------------------------------------
be permitted?
There is no procedure in Social Security for a spouse, surviving
spouse, or divorced spouse to waive the right to spousal benefits. Nor
is there any need for such a waiver procedure; because the payment of
spousal benefits in Social Security does not reduce benefits for the
worker or current spouse, the issue does not arise.
Federal law requires that, in defined-benefit pension plans, the
default pension payment to a married worker must be in the form of a
joint and at least 50 percent survivor annuity, unless the spouse
consents, in writing and before a notary, to a less generous or no
survivor annuity.
In the context of retirement plans that are designed to provide
tiers of income on top of the basic Social Security benefit, allowing
for informed waivers of the right to a joint-and-survivor payment
balances the competing goals of protecting the rights and needs of
spouses and giving couples flexibility to make the financial
arrangements that best meet their goals. The spouse with the right to a
survivor payment may have other financial resources available, or both
spouses may prefer to receive higher income when both are alive, even
at the risk that the surviving spouse will only have Social Security to
rely on.
However, in the context of a plan that cuts basic Social Security
benefits, waivers would raise more difficult issues. The benefit cuts
under some proposals could leave many workers with retirement income
far below scheduled benefit levels, even if they maximized the payments
from a private account by purchasing a single life annuity. \21\
Providing a survivor annuity for a spouse would reduce the worker's
benefits even further. Workers might pressure their spouses to waive
the survivor benefit; even without undue pressure, some spouses might
waive their right to a survivor benefit to ensure a modest income for
the couple now--and worry about the future later. If waivers are
permitted, information about the options and their implications would
need to be provided to both spouses, adding to administrative
responsibilities and costs.
---------------------------------------------------------------------------
\21\ See Campbell Testimony.
Will workers be able to leave the account to anyone, or
---------------------------------------------------------------------------
will surviving spouses have the right to inherit?
The President has said repeatedly that under his plan, workers
could leave an account to anyone, never suggesting that a surviving
spouse would have the right to inherit. The Administration also has
confirmed that its proposal would reduce benefits for widows and
surviving children. \22\ Congress must decide whether a surviving
spouse will have a right to inherit account assets, and the nature of
that right. Would it apply to all the assets in the account? Could it
be waived?
---------------------------------------------------------------------------
\22\ Associated Press, ``Survivor Benefits Face Cut, Official
Says,'' May 12, 2005.
---------------------------------------------------------------------------
Other questions would arise if a spouse inherits account assets,
whether by right or designation. If a worker died young and left the
account to his widow, would she have immediate access to whatever small
amount the account might contain to help support her family and
supplement their reduced survivors' benefits? Or would she have to save
them for her own retirement, as several plans propose? With Social
Security, a widow is eligible for benefits based on the deceased
husband's work record both while she is raising their children and at
retirement--but funds in a private account can only be used once.
If account assets went to someone other than a surviving spouse,
would those heirs have immediate access to the funds they inherit?
Would children have any inheritance rights in a parent's account,
especially if a private accounts plan cuts their survivor benefits? If
the children live in a different household than the widowed spouse--a
not uncommon situation--how would their interests be balanced? What
would happen if a child made a claim after all the assets in an account
had been distributed--as could happen, if the deceased parent had not
had contact with the child for several years? Would all children have
inheritance rights, or only minor children and disabled adult children
entitled to benefits on the parent's work record? If the latter, would
the child's share be related to the number of years the child would be
reliant on reduced survivor benefits, so that a toddler or disabled
adult child would be entitled to a greater share of a parent's account
than a school age child? These questions highlight the impossibility of
expecting a private account to make up for cuts in the life insurance
benefits that Social Security provides to surviving spouses, surviving
divorced spouses, and children.
If a plan provides that workers must pay back the money they
contributed to a private account, with interest, out of a reduction in
their Social Security benefits, would the widow inherit this debt along
with any assets in the account? If so, would other heirs have the same
obligation? Transferring a debt along with account assets would greatly
diminish the value of any inheritance; in fact, if the account has done
very poorly, the bequest could be a net liability. On the other hand,
Social Security's finances will suffer if funds diverted from Social
Security to private accounts are not reimbursed by those who benefit
from them.
How would accounts be divided at divorce?
Social Security provides benefits for divorced spouses and divorced
surviving spouses who have been married for at least ten years.
Benefits for divorced spouses are calculated in the same way as
benefits for spouses and surviving spouses, based on the full work
history of the higher-earning spouse, not just the earnings during the
period of the marriage.
The question of how accounts should be divided at divorce raises
fundamental legal questions. \23\ If private accounts are considered
``property,'' they might be subject to state laws concerning marital
property--which differ between community property and common law
states, and among the states in each group. This would lead to
different rights for spouses in community property and common law
states, and for couples or individual spouses who move from state to
state. Congress could create a uniform system of federal rules
governing the division of accounts at divorce and other spousal rights
issues--or explicitly certain issues to the operation of state law--but
it must explicitly resolve the issue of whether state or federal law
will govern.
---------------------------------------------------------------------------
\23\ For an explanation and further discussion, see Uncharted
Waters at 120-137.
---------------------------------------------------------------------------
There are several possible approaches for dividing accounts between
spouses. \24\ One approach would involve contribution splitting during
marriage--that is, contributions to accounts made by either spouse
during the marriage would be shared equally between the spouses'
accounts. Because contributions would have been shared at the front
end, there might be no further division of account assets at divorce.
Another approach would divide the assets that accumulated in the
accounts during the course of the marriage equally between the spouses.
Or this 50-50 division could be the default, but other allocations
could be allowed by agreement of the parties or a court order.
---------------------------------------------------------------------------
\24\ Six options are identified in Uncharted Waters at 127.
---------------------------------------------------------------------------
If a plan provides that workers must pay back the money they
contributed to a private account, with interest, out of a reduction in
their Social Security benefits, Congress also must decide if and how
the debt, as well as account assets, should be divided at divorce. \25\
---------------------------------------------------------------------------
\25\ See Uncharted Waters at 178-179.
---------------------------------------------------------------------------
Implementing a system for dividing private accounts at divorce,
even one that calls for the automatic 50-50 division of accumulations
during the marriage at the time of divorce, will require new reporting,
verification, and dispute-resolution mechanisms well beyond those
needed to administer the current Social Security system. Social
Security needs to review evidence of marriage, marriage duration, and
divorce only at the point an individual applies to receive Social
Security benefits as a divorced spouse or divorced surviving spouse.
Approximately 100,000 new applications for Social Security in 2001
involved evidence of divorce--but that is just one-tenth of the roughly
one million divorces that occur each year in the United States. \26\
---------------------------------------------------------------------------
\26\ Uncharted Waters at 133.
---------------------------------------------------------------------------
Benefits for eligible divorced spouses are based on the full work
history of the higher-earning spouse, so Social Security needs no
additional information to calculate benefits for an eligible divorced
spouse. To divide contributions and accumulations during only the
period of the marriage would require historical records of year-by-year
(or quarter-by-quarter) contributions and investment earnings, along
with evidence and dates of marriage and divorce.
For the entity administering a system of private accounts to obtain
reliable information about marital status is no simple matter; no
national registry of marriage and divorce information currently exists.
\27\ Creating such a registry would require new resources and raise new
confidentiality issues. Individuals could be asked to report changes to
their marital status. But accountholders might fail to report a
marriage, because they would prefer that a spouse not receive funds at
their expense. Social Security minimizes conflicts and disputes,
because the payment of benefits to a divorced spouse does not reduce
payments for the worker or his or her current spouse.
---------------------------------------------------------------------------
\27\ See Uncharted Waters at 134-135.
---------------------------------------------------------------------------
Once an account is divided at divorce, the assets are gone. The
spouse who is the net loser in the division will have less in an
account to supplement reduced retirement benefits or provide for
children or a new spouse.
What if only one spouse participates in a private
account?
If participation in a private account is voluntary, there will be
spouses who have made different decisions with respect to
participation. Such differences cannot be eliminated by requiring
married couples to make the same choice (and deciding whether
participation or nonparticipation is the default if they cannot agree).
Many Americans enter the labor force before they get married, and,
under some plans, would make an irrevocable choice at that time; new
marriages and remarriages would produce additional mismatches.
Conclusion
This testimony raises some important issues about the critical
payout phase of a private accounts plan. \28\ Some of these questions
have been raised before--but many still have not been answered by the
Administration. Before this Committee considers proposals that would
radically change a program on which millions of Americans rely, it must
address the fundamental questions: how would an account that fluctuates
with the market provide a secure, basic retirement income, and how
would an individual account make up for reductions in the family
insurance benefits that Social Security provides.
---------------------------------------------------------------------------
\28\ For a further discussion of these issues, and the many issues
concerning payments to people with disabilities and their families
which this testimony does not address, see Uncharted Waters.
---------------------------------------------------------------------------
Chairman MCCRERY. Thank you. Mr. Cavanaugh.
STATEMENT OF FRANCIS X. CAVANAUGH, FORMER EXECUTIVE DIRECTOR
AND CHIEF EXECUTIVE OFFICER, FEDERAL RETIREMENT THRIFT
INVESTMENT BOARD
Mr. CAVANAUGH. Thank you, Mr. Chairman, Members of the
Subcommittee. I welcome this opportunity to discuss the
administration of Social Security personal retirement accounts.
My comments will focus on the President's current proposal for
such accounts. The critical question, of course, is cost.
Individual accounts are proposed to provide a higher investment
return than would be realized by the Social Security Trust
Fund. On this basis, individual accounts would not be feasible
for the 68 million employees of 98 percent of the businesses in
the United States. That is the 5.6 million small businesses
with fewer than 100 employees. It just would not work.
To understand the cost to small business, we must first
understand why 85 percent of them do not now have retirement
plans. A major reason is that the 401(k) industry has found
that it cannot profitably provide services for a company for
less than approximately $3,000 a year. This is after 10 years
of competing with each other and the economies of scale. So,
even though they enjoy these economies of scale when combining
thousands of employers in their centralized computer system,
they cannot reduce the cost below this. Further, significant
economies of scale would not be realized by a central Federal
TSP-type agency because of the fixed costs of reaching out to
millions of small businesses. Nor can we assume that a new
central government agency would be more efficient than the
major 401(k) providers who now serve this market. Thus, the
cost per employee of a company with ten employees would be
$300, or 30 percent of the President's proposed initial annual
individual account contribution of $1,000. Most U.S. companies
have fewer than ten employees.
Accordingly, the initial expense ratio for employees of the
average-size business would be more than 3,000 basis points, or
100 times the Administration's estimate of 30 basis points.
This is not conjecture, Mr. Chairman, this is based on what the
market is actually doing and saying right now. Obviously, since
the administrative costs of individual accounts would exceed
their estimated returns from investments, a substantial
government subsidy would be necessary to make the individual
accounts attractive to employees of small business. If all
Social Security taxpayers eventually participated in the
individual account program, the administrative costs would be
more than $46 billion a year. In addition to the above costs,
which are based on what the current providers are actually
charging for establishing and servicing 401(k) plans, there are
overwhelming practical obstacles to modeling individual
accounts on the TSP or private 401(k) plans.
First, the TSP is administered by just one employer, the
U.S. government, with an extensive network of agency personnel
payroll and systems staff to provide the essential employee
education, retirement counseling, payroll deduction, timely
fund transfers, error correction functions, and so on. These
essential employer services in 401(k) plans could not possibly
be performed by small business employers or by a new TSP-like
central agency. It cannot be done. Second, the TSP is
computerized, like all other large plans, with investments made
promptly after contributions are deducted from the employee's
paycheck. With individual accounts it would be up to 22 months
after payday under current SSA procedures before the individual
accounts could be credited and invested. Third, the TSP is
balanced to the penny every day. The Social Security system is
never balanced. Each year there are billions of dollars of
unreconciled discrepancies. Fourth, the TSP and the Federal
employee agencies have a very effective system of
communication. The TSP mailings consistently have reached more
than 99 percent of employees, but 25 percent of Social Security
mailings are returned as undeliverable.
Since individual accounts are certainly not feasible for
employees of small business, the only practical way to give
higher returns for Social Security beneficiaries generally,
including small business employees, is to invest part of the
Social Security Trust Fund in equities. The likely increase in
trust fund earnings would be an effective way to help maintain
the solvency of the trust fund. Every State in the United
States has authorized public retirement fund investment in
stocks which can now be done through broad-based index funds,
which avoid the problem of direct government control over a
particular company. There is no longer any reason not to invest
the trust fund partially in equities. As is shown in the chart
on page eight of my statement, there is even less government
influence over private companies under the trust fund
alternative than under the TSP or the Administration's plan.
In conclusion, the Administration's plan for universal,
individual accounts is not feasible. The way for the Social
Security system to capture the higher returns available from
investments in stock is to diversify the Social Security Trust
Fund investments. The trust fund alternative, compared to
individual accounts, would be less disruptive of financial
markets, would save tens of billions of dollars a year in
administrative costs, and could be effective virtually
immediately rather than the 2009 starting date proposed for
individual accounts. The multi-trillion-dollar transition costs
of individual accounts would be avoided. The additional trust
fund earnings would go a long way to strengthening Social
Security finances and would thus reduce, if not eliminate, the
need for significant tax increases or benefit reduction. Thank
you for your attention. I would be happy to answer any
questions.
[The prepared statement of Mr. Cavanaugh follows:]
Statement of Francis X. Cavanaugh, former Executive Director and Chief
Executive Officer, Federal Retirement Thrift Investment Board
Mr. Chairman and Members of the Subcommittee:
I welcome this opportunity to discuss the administration of Social
Security personal retirement accounts (PRA). My comments will focus on
the Administration's current proposal for such accounts.
I am a public finance consultant, but I speak only for myself. I
have no clients with an interest in Social Security individual
accounts. From 1986 until 1994, I was the first Executive Director, and
thus the chief executive officer, of the Federal Retirement Thrift
Investment Board, the agency that administers the Thrift Savings Plan
(TSP) for federal employees. Before that, I was a financial economist
in the Treasury Department for 32 years, and was the senior career
executive responsible for developing federal borrowing, lending, and
investment policies, including those for the Social Security and other
federal trust funds.
The Administration's Proposal
While there is no specific proposal before your committee, the
Administration's current broad proposal, according to White House
statements and press reports, provides a basis for at least a
preliminary analysis of its administrative feasibility.
The following features of the Administration's approach would have
significant impacts on its feasibility:
PRAs would be voluntary for all Social Security taxpayers
under age 55, but would be mandatory for employers of employees who
chose PRAs.
A major purpose of PRAs would be to encourage savings by
young and low-income workers and employees of small businesses who do
not now have 401(k)s or other pension plans.
The maximum amount of an individual's initial annual
contribution to a PRA would be $1,000, which would increase by $100 a
year, to 4 percent of pay eventually. It would take more than 30 years
for the highest income individuals to be able to contribute the full 4
percent of pay.
Eligible investments for PRAs would be Treasury
securities and stock and bond index funds, which would be similar to
eligible investments of the TSP.
PRAs would be centrally managed, apparently by a TSP-like
agency with a part-time board, appointed by the President with the
advice and consent of the Senate, and a full-time executive director
and CEO appointed by the board. Following the TSP model, the board
members and the executive director would be independent of the
Administration, and would be fiduciaries required to act solely in the
interests of the holders of the PRAs and their beneficiaries.
Unlike contributions to 401(k)s or to the TSP, PRA
contributions would not be eligible for matching contributions or
exclusion from taxable income, and loans or withdrawals before
retirement would not be permitted.
Cost Analysis
A critical question, of course, is costs. PRAs are proposed to
provide a higher investment return than would be realized by the Social
Security trust fund. Thus PRAs would not be feasible if their
administrative costs were so high as to offset the advantage of
diversified investments in stocks and other securities that yield more
than the Treasury securities in the Social Security trust fund.
The Administration assumes that PRAs would earn an average
investment return of 4.9% after inflation, and that administrative
costs of.3%, that is, 30 basis points, would reduce the net return to
4.6%, or 1.6% more than the assumed net return of 3% on the Treasury
securities in the Social Security trust fund. Thus, if one accepts the
Administration's assumptions, PRAs would outperform the trust fund
investments so long as the administrative costs were less than 1.9%. In
my view and that of many other economists, the 4.6% assumption is much
too high; indeed, the Congressional Budget Office's estimate of the net
return is reportedly only 3.3%.
The Administration's estimate of 30 basis points is optimistically
low; even the Cato Institute, a leading advocate of individual
accounts, estimates PRA expenses at 55 basis points. Yet this higher
estimate is also too low. Like so many others I have heard, these
estimates are based mainly on experience with large 401(k)s for large
organizations, like the TSP, \1\ with economies of scale and
comprehensive payroll, personnel, and computerized systems support.
They have little relevance to the likely costs of a universal system of
PRAs. More than 85 percent of the 5.6 million small business employers
in this country offer no pension plans at all and, accordingly, have
none of the administrative apparatus to service them.
---------------------------------------------------------------------------
\1\ The administrative cost, or expense ratio, of the TSP is 6
basis points.
---------------------------------------------------------------------------
To understand the costs of bringing PRAs to employees of small
businesses, we must first understand why 85 percent of them do not now
have retirement plans for their employees. Fortunately, the 401(k)
industry has already done part of the job for us. Companies like
Citigroup, Fidelity Investments, Merrill Lynch, State Street
Corporation, and T. Rowe Price have been competing for two decades to
provide investment, record keeping, counseling, and other 401(k) plan
services to small businesses. They have found that they cannot
profitably provide these services for a company for less than
approximately $3,000 a year, even though they have for years enjoyed
economies of scale from serving thousands of employers in their
centralized computer systems. \2\ Further significant economies of
scale would not be realized by a central TSP-type agency, because there
would still be millions of small businesses or workplaces to be
reached. Nor can we assume that a new central government agency would
be more efficient than the major 401(k) providers who now serve this
market.
---------------------------------------------------------------------------
\2\ Francis X. Cavanaugh, ``Feasibility of Social Security
Individual Accounts,'' AARP Public Policy Institute, Washington, D.C.,
Sept. 2002, pp. 4-6. The $3,000 charge is still common today. See ``Big
Fees Hit Small Plans: Costs Take Huge Toll on Retirement Accounts of
Firms With Fewer Than 50 Employees,`` Wall Street Journal, Oct. 31,
2004, p. D1.
---------------------------------------------------------------------------
Thus the cost per employee of a company with 10 employees would be
$300, or 30 percent of the President's proposed annual PRA contribution
of $1,000--and most U.S. companies have fewer than 10 employees. \3\
---------------------------------------------------------------------------
\3\ See generally U.S. Department of Labor, Pension and Welfare
Benefits Administration, ``Study of 401(k) Fees and Expenses,''Apr.
13,1998. The study found that average charges by 17 major 401(k)
providers for plans with 100 participants and $2 million in assets
ranged from $114 to $428 per participant, and averaged $264. Id. at 51.
Charges obviously would be much higher for much smaller plans.
---------------------------------------------------------------------------
Even the largest business that is classified as a ``small
business,'' one with 100 employees, would therefore have an expense
ratio of at least 3 percent, which would be ten times the
Administration's estimate of 30 basis points. And for the 60 percent of
employers in this country that have fewer than 5 employees, the initial
expense ratio would be more than 60 percent, that is, 6,000 basis
points. In fact, commercial 401(k) providers routinely discourage small
businesses from establishing 401(k) plans if they have fewer than 10
employees and, in some cases, fewer than 25 employees.
Obviously, substantial and continuing government subsidies would be
necessary to make PRAs attractive to employees of small businesses. If
all Social Security taxpayers participated in the PRA program, the
administrative costs would be more than $46 billion a year (155 million
participants times more than $300 per account), which would be a
subsidy to PRA administrators for performing an uneconomic function.
These figures are reinforced by a number of studies, including those
cited in a review of administrative costs by the Employee Benefit
Research Institute. \4\
---------------------------------------------------------------------------
\4\ See, e.g., Employee Benefit Research Institute, Issue Brief No.
23, Nov. 1998. See also Ellen E. Schultz, ``Poodle Parlor Retirement
Plans,'' Wall Street Journal, Nov. 13, 1998, p. C1.
---------------------------------------------------------------------------
I recommend that your committee secure the testimony of individuals
from financial institutions that are actually providing 401(k) services
to the nation's businesses, large and small. Give them a specific set
of assumptions to cost out that reflects the makeup of our country's
5.7 million employers subject to Social Security--of which 98% are
small business employers of 68 million employees. \5\ Then and only
then will you know whether the Administration's proposal--or anything
similar--will produce reasonable net investment returns, or, in the
alternative, how much of a government subsidy would be necessary to
achieve them.
---------------------------------------------------------------------------
\5\ Patrick Purcell, Congressional Research Service, ``Social
Security Individual Accounts and Employer-Sponsored Pensions,'' Feb. 3,
2005, pp. 3, 5.
---------------------------------------------------------------------------
Critical Administrative Problems
In addition to the above costs, which are based on what the current
providers are actually charging for establishing and servicing 401(k)
plans, there are overwhelming practical obstacles to the creation and
maintenance of PRAs. Because President Bush seemed to idealize the
Thrift Savings Plan--the largest of all 401(k)-type plans--as the model
for PRAs in his February 2005 State of the Union message--and because
many others have done so as well--I would like to point out the
considerable dissimilarities between the TSP and the Administration's
proposal. (Most of these dissimilarities would hold true for a
comparison between any large corporate 401(k) plan and the proposal.)
Too Many Small Employers. The TSP is administered by just one
employer--the U.S. Government--with extensive personnel, payroll, and
systems staffs to provide the essential employee education, retirement
counseling, payroll deduction, timely funds transfers, and error
correction functions. The Thrift Investment Board is only a wholesaler
of services; the federal employing agencies deal with the individual
employees participating in the plan. In fact, the TSP statute directs
the Office of Personnel Management to provide for the training of TSP
counselors for each federal agency.
The Administration's plan is intended to reach all employees, but
it makes no provision for the performance of what are now essential
employer functions in 401(k) plans. They could not possibly be
performed by small business employers who are now responsible only for
the relatively simple payroll deduction and transmission of Social
Security taxes to the IRS. Since most businesses have fewer than ten
employees, they do not have the experience or resources to support the
new plan. These are barbershops, beauty salons, garages, restaurants,
laundries, lawn services, households, nanny services, and other very
small businesses that could not be expected to meet the high fiduciary
standards required of those responsible for educating and counseling
employees, for presenting a new plan in the context of the employer's
existing pension or other benefits, and for the timely and accurate
transfer of funds for investment. The new TSP-like agency obviously
could not provide such employer-type services to deal with tens of
millions of diverse employees, either directly or on a contract basis.
Consider, as but one example of several profound administrative and
legal issues, that about 650,000 businesses go out of business each
year. By whom and how would the enforcement of contributions by
delinquent or bankrupt employers be prosecuted? (Judicial remedies for
denial of TSP benefits must, in general, be pursued by the affected
individual TSP participant in the federal court system.) For that
matter, by whom and how would breach-of-fiduciary-duty suits be brought
against ``mom-and-pop'' fiduciaries? Can the employer of a housekeeper
or a manicurist be expected to exercise the ``care, skill, prudence,
and diligence'' demanded of every 401(k) plan fiduciary by current law?
\6\ What would be the measure--and the limit--of their personal
liabilities, say, for untimely or inaccurate investment of their
employees' contributions? These questions only scratch the surface of
the inevitable pathology of plan administration--pathology that, even
if represented in small percentages among 155 million Social Security
participants, would result in enormous absolute numbers.
---------------------------------------------------------------------------
\6\ See Employee Retirement Income Security Act (ERISA), 29 U.S.C.
Sec. 1104(a); Federal Employees' Retirement System Act (FERSA), 5
U.S.C. Sec. 8477(b)(1).
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Untimely Investments. The TSP is computerized, like all other large
plans, with investments made for each employee's account on the same
day that contributions are deducted from the employee's paycheck.
Social Security taxes are deducted on paydays, but many small
businesses send them to the IRS only once each quarter. In 2003, 72
percent of employer reports to the Social Security Administration were
submitted on paper. Moreover, individual Social Security taxpayers are
identified only once each year, with their employer's annual income tax
filings; and it would be up to 22 months after payday, under current
SSA procedures, before individual PRAs could be credited.
Furthermore, the Administration's proposal is to pay PRAs the same
annual return, regardless of when contributions were actually made
during the year. Thus a contribution in January would not earn any more
than a contribution of a similar amount in December. During a year of
highly volatile markets, the attempted explanation of this provision to
millions of outraged participants with irregular tax payments, because
of illness, seasonal, temporary, or other periods of unemployment,
would be a daunting challenge to the plan's telephone counselors.
Unbalanced Accounts. The TSP is balanced to the penny every day.
The Social Security system is never balanced. Each year there are
billions of dollars of unreconciled discrepancies between Social
Security taxes paid to the IRS and reported to the SSA. These
discrepancies are tolerated because they generally have little impact
on the ultimate calculation of employee benefits. Such discrepancies
are never tolerated by financial institutions responsible for timely
investment of individual funds. Theoretically, PRA contribution errors
might be largely corrected by a rigorous examination of employer
records. Yet the error correction procedures, including retroactive
adjustments of investment gains or losses in volatile markets, could
bring the entire system to a screeching halt.
Inevitable Account ``Leakage.'' Unlike the TSP, the
Administration's plan would prohibit loans and emergency withdrawals,
and would require individuals to purchase annuities on retirement. I
find it inconceivable, however, that Congress--or an Administration--
would long be able to resist calls for emergency access to funds before
a worker's retirement, and in lump sum amounts. Suppose, for example,
that an individual has suffered a devastating personal financial loss,
such as thousands experienced in last year's Florida hurricanes in the
destruction of their homes. Would these persons be told that they may
not access their PRA balances to mitigate such dire misfortunes? What
about a catastrophic illness, leaving a family's breadwinner unable to
work? Could such persons be denied their account balances to sustain
spouse and children? I don't think so. There are, of course, scores
more such examples, and with 155 million potential participants, you
can be sure that they all would arise. Administering the inevitable
emergency withdrawal or loan program would add enormously to the cost
of the Administration's plan.
Communication Problems. The TSP has a very effective communications
system, because it can rely on the federal employing agencies to
distribute plan materials and to educate and counsel their employees.
Even so, the TSP found it necessary to have the central record keeper
for its 3 million accounts maintain a staff of more than 200 telephone
counselors to respond directly to questions from individual
participants. Since more than 200 million Social Security taxpayers and
retirees eventually would be eligible for PRAs, the required number of
telephone counselors would be more than 13,000, based on the TSP
experience, and probably much higher because of the special PRA
deficiencies noted above. \7\ Also, TSP mailings consistently have
reached more than 99 percent of participants, but 25 percent of SSA
mailings are returned as undeliverable.
---------------------------------------------------------------------------
\7\ Fidelity Investments, a major 401(k) provider, has estimated
that the administration of a 401(k)-type plan for Social Security
taxpayers would require a total staff of 100,000. See Employee Benefit
Research Institute, Issue Brief No. 23, Nov. 1998, p. 166.
---------------------------------------------------------------------------
Congress would undoubtedly insist that every effort be made to
advise all Social Security taxpayers of the PRA benefits Congress
intended to provide them. The TSP sent summary plan documents to all 3
million eligible employees, which required 18 trailer trucks of printed
materials. Similar documents would have to be sent eventually to the
more than 200 million Social Security-covered employees and retirees.
The eventual costs of such massive efforts at this point are
unknown, but they clearly would have a significant impact on PRA
expenses.
Small Employer Antipathy. Even if small businesses were able to
perform normal employer functions for PRAs, would they want to? PRAs
would be voluntary for employees but, if employees elect to have PRAs,
mandatory for their employers.
The TSP and 401(k) plans generally are enthusiastically sponsored
and supported by the large employers who offer them as a major benefit
for their employees, and as a means to move away from defined benefit
retirement plans that require employers to bear substantial investment
risks. The major attractions of the TSP and 401(k)s generally are the
matching employer contributions and the immediate tax benefit from
excluding employee contributions from taxable income. The ability to
borrow or withdraw funds to meet emergency needs is also a significant
benefit. PRAs, as currently proposed, would offer none of these
benefits, and would be a relatively unattractive product that employers
might be reluctant to support, especially small employers who do not
have any pension plans. Moreover, it would be unrealistic to expect
small-business employers to act as large corporate employers do in
assuming the costs of investment losses because of, say, employer error
in transmitting funds for timely investment of 401(k) accounts, or for
myriad other commonplace employer errors. These serious concerns for
small businesses would have to be addressed during congressional
hearings on PRA proposals. (See the examples of legal issues on page 5
above.)
The Trust Fund Alternative
Since PRAs are certainly not feasible for employees of small
businesses--the vast preponderance of the business community--the only
practical way to give them the higher returns available from equity
investments is to invest part of the Social Security trust fund in
equities. That way, the overwhelming administrative costs and practical
problems of the Administration's plan would be avoided. The total
administrative cost of having the Social Security trust fund invest in
the private funds proposed for PRAs would be no more than one basis
point, based on the actual costs of market investments by the Thrift
Savings Plan. The likely increase in trust fund earnings would be an
effective way to help maintain the solvency of the trust fund without
having to resort to significant increases in Social Security taxes or
reductions in benefits.
Every state in the United States has authorized public retirement
fund investment in stocks. Yet the federal government still clings to
the old notion that governments should not have an ownership stake in
private companies, which made some sense when individual stocks were
involved. Today's broad-based index funds, however, remove the investor
from direct control over particular companies. Small business employees
should not be denied the benefits of portfolio diversification in the
Social Security trust fund simply because the federal government has
not kept up with the states in understanding the evolution of financial
markets.
Less Government Influence Over Private Companies. As shown in the
following chart, there is even less government influence over private
companies under the trust fund alternative than under the TSP or the
Administration's plan.
Government Influence Over Private Companies
Social
Thrift Administration Security
Savings Plan Trust Fund
Plan Alternative
Selection of stock and bond Government Same Same
index funds decides
Selection of fund managers Government Same Same
decides
Selection of private record Government Same N/A
keeper decides
Selection of auditors and Government Same N/A
consultants decides
Selection of annuity Government Same N/A
providers decides
Selection of allocations Individuals Individuals Government
among index funds decide decide decides
N/A--not applicable. (There would be no need for private record
keepers, auditors, consultants, or annuity providers for trust fund
investments.)
Sppecial Benefits for Trust Fund.Unfortunately, some political
leaders have convinced many of the public that the Social Security
trust fund is not really invested because it has been ``looted,'' and
that the trust fund consists of ``worthless IOUs.'' Nothing could be
farther from the truth, and such statements betray an apparent
ignorance of federal finance in our highest circles of government. The
trust fund is fully invested in the best securities in the world--U.S.
Treasury obligations. Private trust funds invest in Treasury securities
in the open market, but the Social Security trust fund buys its
Treasury securities directly from the Treasury, which is more efficient
than if the Treasury were to issue the securities in the market and
then buy them back for the trust fund.
Moreover, the trust fund actually gets a much better deal than the
private funds that buy Treasuries in the market. The trust fund, by
law, may redeem its securities before maturity at par value, rather
than at the sometimes deep market discounts suffered by private
investors during periods of rising interest rates. Also, since the
trust fund gets its securities directly from the Treasury, it avoids
the market transaction costs which private investors must pay. Finally,
the law requires the Treasury to pay the trust fund an interest rate on
all of its investments in Treasuries equal to the average yield on
long-term Treasury marketable securities. This is a significant benefit
to the trust fund, since long-term rates are generally much higher than
short-term rates. Thus in recent years, private investors have been
earning about two percent on their short-term Treasuries, while the
Social Security trust fund was earning about four percent on
effectively the same maturities. The public seems to be totally unaware
of these subsidies to the Social Security trust fund, which have been
there for many decades.
Trust Fund Dedicated to Social Security. The assets of the Social
Security trust fund consist of investments in Treasury securities
solely for future beneficiaries. Yet political leaders from both
parties complain that the Treasury has ``spent'' the trust fund surplus
on government programs. What on earth do they expect the Treasury to do
with the money--bury it in the Treasury's back yard? The Treasury also
spends the money it raises by issuing Treasury securities in the
market. Does that mean that the private investors in Treasuries are
also being ``looted'' by the Treasury? Of course not. The scandal would
be if the Treasury left the trust fund uninvested and not earning
interest. Then the Secretary of the Treasury would be in effect saying
``I don't owe you,'' and that indeed would be a worthless IOU.
So why do government officials find fault with perfectly sound
financial practices? From ignorance, as I suggested earlier?--or is it
is because they are trying to hide the real problem, which is the
unique way the Social Security program is treated in the budget? Social
Security expenditures are excluded from the budget and thus from the
restraints on other government spending, which is proper since they are
entitlements, and cannot be restrained under existing law. But the
Social Security surplus is then, inconsistently, included in the
calculation of the overall budget deficit, for the sole purpose of
appearing to have achieved deficit, and thus spending, reduction. Then,
having committed this accounting farce, officials have the audacity to
complain that the misleading budget treatment of the trust fund
surplus--which they could change--makes it available to finance other
programs. The problem here is not the financing of the trust fund, but
the political gimmickry of its budget treatment.
Conclusion
In conclusion, the Administration's plan for universal PRAs is not
feasible, and it should not survive the process of responsible
Congressional hearings. The only practical way for the Social Security
system to capture the higher returns available from investments in
stocks is to diversify Social Security trust fund investments. The
trust fund alternative, compared to PRAs, would involve less government
influence over private companies, would be less disruptive of financial
markets, would save tens of billions of dollars a year in
administrative costs, and could be effective virtually immediately,
rather than the 2009 starting date proposed for PRAs. The multi-
trillion dollar transition costs proposed by PRA proponents would be
avoided. The additional trust fund earnings would go a long way toward
strengthening Social Security finances, and would thus reduce, if not
eliminate, the need for significant tax increases or benefit
reductions.
Thank you for your attention. I would be pleased to answer any
questions.
Chairman MCCRERY. Thank you, Mr. Cavanaugh. Ms. Reno.
STATEMENT OF VIRGINIA P. RENO, VICE PRESIDENT FOR INCOME AND
SECURITY POLICY, NATIONAL ACADEMY OF SOCIAL INSURANCE
Ms. RENO. Thank you, Mr. Chairman, and thank you for the
opportunity to be here today. I will present findings from a
new study panel report from the NASI that is solely about how
money would be paid from individual accounts. I think you all
have a copy of the report available to you. This was the work
of 27 top experts in various fields over a two-and-a-half year
period led by bipartisan cochairs, Michael Graetz of Yale Law
School, who was a top Treasury official in the George Herbert
Walker Bush Administration, and Ken Apfel, who is now at the
LBJ School in Texas, and was Commissioner of Social Security
during the Clinton Administration. The ten chapters in this
report cover a host of payout issues about retirement, about
annuity markets, early access to the money, disability, spousal
rights, children's benefits, offsets, tax treatment and
financial demographics. I will focus today simply on the
retirement payout issues.
At retirement we face four kinds of risks. We don't know
how long we will live, how long our spouses will live, how our
investments will do, or how prices will rise. Social Security
covers these risks by automatically adjusting benefits for
inflation and paying spousal benefits. Individual accounts, in
and of themselves, do not provide for those risks, but
retirees, as Dr. Mitchell said, can buy annuities that turn
their savings into a lifetime income. That is why annuities
that pay out over a lifetime are so important. For a retiree,
the good news about a life annuity is that your money will last
as long as you live. The bad news about an annuity is you have
to pay the full price up front. That is how they work. You
can't change your mind. So, all of the money used to buy an
annuity is not available to leave to heirs.
In a sense, an annuity is a chance to trade ownership for
income security once you get to retirement. It is important to
recognize also that more security in retirement will cost more.
If a retiree wants inflation protection, his annuity will start
out at a lower level. If he wants to make sure his wife has a
survivor benefit, his annuity will start out again at a
somewhat lower level. Essentially, when choosing these
features, the retiree gets to choose current income over future
security. An important question our panel looked at is who
would provide inflation-indexed annuities since all seem to
agree that inflation indexing is very important. Our panel
concluded that it would take some help from the Federal
Government to have inflation-indexed annuities on a widespread
basis. The government might issue a large volume of TIPS that
my colleague mentioned, or it might simply issue the annuities
directly to retirees. In either case, the government would be
receiving a large amount of money for these transactions,
either from TIPS investors for private annuities, or from
annuity purchasers themselves. An important question that
hasn't received much attention is how would the government
manage, invest, or spend that volume of money it receives to
facilitate inflation-indexed annuities?
Another key question is, will the government insure the
insurers if annuities are provided privately? States now
regulate insurance companies that provide life annuities. If
Federal law required people to buy annuities, there might be an
expectation that the Federal Government would also guarantee
the solvency of those insurance companies. If so, it is
important to think through what that guarantee would look like.
Would it resemble the Federal Deposit Insurance Corporation or
the Pension Benefit Guaranty Corporation? Essentially, that is
a question that hasn't been fully resolved.
To wrap up, life annuities offer retirees the choice to
trade ownership for retirement security or to trade current
income for future security. The decisions have lifelong
consequences for the retiree and his or her family. Retirees
may need help to make informed choices. Finding and paying for
good consumer education will be important. In terms of consumer
education, there remains confusion today about exactly what we
call annuities. Two different products are called annuities, in
fact, and they are very different. Deferred annuities are
investment products. They don't guarantee income for life. Life
annuities are quite different. The deferred annuities are, in
fact, more actively marketed and are a much bigger market than
are life annuities. We are hearing stories today about how
elders are being misled about deferred annuities and end up
losing some of their lifetime savings.
To conclude, our cochairs have both emphasized that these
payout issues with individual accounts are first-order
questions, and it is really important that the Congress pay
attention to them. We are glad that you are doing that today.
Thank you.
[The prepared statement of Ms. Reno follows:]
Statement of Virginia P. Reno, Vice President for Income and Security
Policy, National Academy of Social Insurance
Mr. Chairman and members of the Subcommittee, thank you for this
opportunity to testify before you today. The National Academy of Social
Insurance is a non-profit, non-partisan organization of the nation's
leading experts on Social Security, Medicare, and related programs. Our
mission is to promote sound policymaking on social insurance through
research, education and the open exchange of ideas.
I will present findings of our new study panel report, Uncharted
Waters: Paying Benefits from Individual Accounts in Federal Retirement
Policy. Twenty-seven top experts contributed to this study. It was led
by bi-partisan chairs, Mike Graetz of Yale law school and a top
Treasury official in the George H. W. Bush Administration, and Kenneth
Apfel of the LBJ School at the University of Texas and Commissioner of
Social Security in the Clinton administration. The report is solely
about how money would be paid out of individual accounts. Why are
payouts important? Our co-chairs Mike Graetz and Ken Apfel said it
best:
``Payouts are important because the central goal of Social Security
is to assure some level of adequate income.'' ``To date, payouts have
been largely neglected. Yet it is crucial that policymakers resolve
issues in this report if they decide to add universally available
individual accounts to our current system of providing retirement
income.''
Our expert panel did not seek to agree on whether individual
accounts in Social Security are a good idea. Nor did they agree on a
blueprint for how to design payouts. Rather, they did agree that issues
in this report are the right ones and how the questions get answered is
critically important. The ten chapters cover such questions as:
(a) How would retirees get the money? (b) If annuities are
required, who would provide them, and how? (c) Could workers get the
money before they retire? (d) What rights would spouses have? (e) How
would accounts affect disability benefits? (f) How would children be
affected? (g) How might ``offsets'' affect payouts? (h) How would
payouts be taxed? I will focus on retirement payouts. First, I
summarize what we called ``financial demographics'' that set the stage
for considering accounts.
Financial Demographics
Social Security is the bedrock of income security for millions of
Americans. The 47 million beneficiaries account for about one in six
Americans living in one in four U.S. households. About two in three
beneficiaries age 65 and older rely on Social Security for half or more
of their total income. Women without husbands are the most reliant on
Social Security; three in four such women over age 65 get half or more
of their income from Social Security. For 44 percent of these women,
Social Security is nearly all they have, making up 90 percent or more
of their income.
Despite beneficiaries' reliance on Social Security, the benefits
alone do not provide a comfortable level of living. The average benefit
for a retired worker was about $955 a month, or $11,500 a year in
January 2005. Average benefits are somewhat lower for disabled workers
($894) and elderly widows ($920). Benefits for future retirees will
grow somewhat more slowly than earnings, which will cause replacement
rates to decline over the next 20 years as the age for full retirement
benefits rises from 65 to 67. Benefits for 65-year-old retirees will
replace a smaller share of prior earnings than is the case today or at
any time in the last 30 years. Because Social Security is not in long-
run financial balance, other changes might be enacted that will further
lower benefits or raise revenue.
Employer-sponsored pension plans have covered about half of
private-sector workers over the past 25 years. These plans are shifting
away from the defined benefits that dominated the 1970s and 1980s to
defined-contribution or 401(k)-type plans. The newer plans give workers
more choices about whether to participate and how much to contribute;
workers can take the accounts with them when they change jobs; and they
have choices about when and how to withdraw the money. At the same
time, workers finance more of the plans themselves and bear the
investment risk that employers took on in defined-benefit plans.
In 2001, about half of all U.S. families owned a tax-favored
retirement account. The median balance of those accounts was $29,000.
Older households had somewhat larger tax-favored savings, with a median
value of $55,000 for the 59 percent of families age 55-64 who had such
accounts. Tax-favored savings are concentrated among high-income
households; families in the top 20 percent of the income distribution
held two-thirds of all tax-favored retirement savings.
The heavy reliance on Social Security among retirees up through the
middle of the income distribution, the shift away from defined-benefit
pensions, and increased use of 401(k) plans amplifies the importance of
payout options that convert savings into guaranteed incomes during
retirement.
Financial Risks for Retirees
Retirees face four kinds of risks to their financial security. They
don't know how long they will live, how long their spouses will live,
how their investments will perform, or how much prices will rise in the
future. Social Security covers these risks by paying benefits for life,
with automatic cost of living increases, and automatic survivor
benefits. Individual accounts, in and of themselves, do not cover these
risks. But retirees can buy life annuities that turn their savings into
guaranteed income for life. That is why life annuities are important.
The Life Annuity Trade-Off
From the retirees' perspective, the good news in buying a life
annuity is that your income will last as long as you live. The bad news
is that you pay the full purchase price up front, and the purchase is
irrevocable. All the money used to buy the annuity is no longer
available to leave to heirs. For example, if you use $40,000 to buy a
life annuity and die a few months later, that $40,000 is gone. The
insurer uses the money from people who die early to cover the costs of
paying annuities to those who live a long time.
More Protection Costs More
If a retiree wants his annuity to keep up with the cost of living,
it will start lower. If he wants it to continue to pay his widow after
he dies, his payment will start out lower. For example, in one set of
assumptions, a 65-year-old retiree with $10,000 could buy a simple
annuity of $80 a month. If it is to keep up with the cost of living (at
say 3 percent a year), it would start out lower, $62 a month. If it
would continue to pay as long either the retiree or his wife lived, it
would start out at $50 a month. (These prices assume everyone would be
required to buy annuities. If annuities were optional, they would pay
less than shown here because of what is known in the insurance world as
adverse selection.)
Guarantees Might Provide for Heirs
Some annuities guarantee payments to a death beneficiary if the
retiree dies shortly after buying an annuity. A 10-year certain annuity
assures payment for 10 years if the annuitant dies in less than 10
years. This feature will lower the initial monthly payment to the
retiree (from $62 to $58, in the above example, if the annuity is
inflation-indexed).
Changes in Marital Status
In general, life annuities cannot be rewritten to shift from a
single-life to a joint-life annuity if one marries after retirement.
Nor can one ``undo'' the purchase of a joint-life annuity and shift to
a single life annuity if a marriage ends shortly after buying an
annuity. This could affect married couples' decisions about whether and
when to buy annuities. It could also produce very different incomes for
widows depending on whether they were widowed before or just after
buying annuities. For example, if John dies before buying an annuity,
Mary could inherit his account, combine it with her own, and buy a
single life annuity with the total amount. Consider this the base case.
If instead, John and Mary both bought joint-life annuities, each would
start out with a monthly payment that is about 81 percent of what a
single-life annuity would provide. When one died, the survivor would
receive 81 percent as much as the base case. The key point is that the
timing of annuity purchase interacts with the timing of widowhood to
produce very different results for retirees who are otherwise in
similar circumstances.
Who Would Provide Inflation-Indexed Annuities?
Inflation-indexed annuities are very rare in the private insurance
market. Our panel concluded that some help from the federal government
would be needed to develop such a market. If the federal government
increased the supply of long-duration (say 30-year) Treasury Inflation-
Protected Securities (TIPS), insurers could use them to hedge inflation
risk. Alternatively, the government could sell inflation-indexed
annuities directly to retirees.
In either case, the government could be receiving a large amount of
funds (from TIPS buyers or from retirees' annuity premiums) that would
represent contractual obligations to make long-term inflation-indexed
payments. For example, in a universal system, funds backing annuities
funded with 2 percent of workers earnings could amount to about 15
percent of GDP when the system is fully mature. A key question for
policymakers is, ``how would the government manage (or spend or invest)
the large volume of funds it received from TIPS buyers or annuity
purchasers?''
Insuring Insurers
Currently, state governments have sole responsibility for
regulating insurance companies and guaranteeing their solvency. If
federal law requires or encourages retirees to buy annuities, it might
also be expected to guarantee the solvency of the insurance companies
that have made long-term commitments to retirees. How that solvency
guarantee would be organized is an important question. Would it
resemble the Pension Benefit Guaranty Corporation, or the Federal
Deposit Insurance Corporation, or other federal models?
Recap of Annuity Choices
The design of retirement payout rules will confront inevitable
tension between offering choice and providing security. Hard and fast
rules might ensure some level of security, but will also create
pressure for exceptions. As accountholders approach retirement, they
will face choices such as:
(a)
Whether to buy a life annuity at all;
(b)
How much of one's account to spend on a life annuity;
(c)
Whether the annuity would be indexed for inflation;
(d)
When to buy a life annuity;
(e)
Whether to buy a guarantee feature and, if so, what kind;
(g)
If joint-life annuities are optional for unmarried retirees, whether to buy
one and with whom; and
(h)
If joint-life annuities are offered or required for married retirees, which
type to buy and what level of benefit to provide the secondary annuitant.
Decisions on these questions will have lifelong consequences. To
the extent that retirees have choices, it will be important that they
receive advice and assistance to understand the consequences of
different courses of action for themselves and for the well-being of
their spouses, dependents, and potential heirs. Organizing and paying
for trustworthy advice could become an important issue in a new system
that envisions many choices in the purchase of life annuities.
Finally, in the realm of consumer education, there is a risk of
confusion about what we mean by ``annuity.'' Two different products are
called ``annuities'' and they are very different. Deferred annuities
are investment products, not insurance. Only life annuities guarantee
payments for life. Deferred annuities are far more common and more
actively marketed by financial advisors, brokers or agents. In recent
weeks, a few news reports have pointed to problems in the marketing of
deferred annuities to seniors, who end up losing part of their life
savings because they bought products that were not appropriate to their
circumstances. (Moregenson 2005, Kirchheimer 2005).
Sources:
Reno, Virginia P., Michael J. Graetz, Kenneth S. Apfel, Joni
Lavery, and Catherine Hill (eds.), (2005). Uncharted Waters: Paying
Benefit from Individual Accounts in Federal Retirement Policy, Study
Panel Final Report, Washington, DC: National Academy of Social
Insurance.
Morgenson, Gretchen, ``Who's Preying on Your Grandparents?'' New
York Times--Business Section, Sunday, May 15, 2005
Kirchheimer, Sid, ``Deviled Nest Eggs,'' Consumer Alert, AARP
Bulletin, June 2005.
Chairman MCCRERY. Thank you, Ms. Reno. We have, we think,
one vote on the floor. We are going to run over to the floor,
vote, and come right back. The Committee will be in recess
until we return.
[Recess].
Chairman MCCRERY. The hearing will come to order. Thank you
all for your patience. We are glad to be back to ask you a few
questions about your testimony, which was excellent. We
appreciate very much your being with us today to share those
views with us. Mr. Pollock, I appreciate your thoughtful
approach to establishing personal accounts using the Social
Security surplus. In your proposal, you recommend having
workers initially invest in inflation-indexed Treasury bonds.
Why do you recommend this particular type of bond? How large is
the market now for that type of bond? Would having individuals
invest solely in those specific forms of Treasury securities
affect the market in any way?
Mr. POLLOCK. Mr. Chairman, I view the biggest risk to
retirement savings to be inflation. Especially if you own
straight bonds, if we should get into a situation of monetary
expansion which results in inflation, it is a way to lose the
real purchasing power of your savings. With the inflation-
protected securities, you are automatically covered by the
inflation indexation of the bonds against this single biggest
risk. For decades, inflation-indexed securities have been
promoted as the right idea by economists. They have been
introduced by many countries including this country, during the
nineties. They have been extremely popular. There are many
mutual funds that offer them to the public, and they have been
welcomed by public investors. I picture the TIPS in personal
accounts being a private placement, another similarity to what
happens now with the trust fund. The bonds now are privately
placed with the Social Security trustees. This would be a
private placement into a personal account, so, there would be
no need to sell the bonds, nobody would have to beg foreign
investors to buy them; in the first instance, you wouldn't move
the market.
I also recommend in my detailed comments that there be some
restricted period, I suggest perhaps 5 years, where these
couldn't be sold, just in case--I don't think it would happen,
but just in case--there would be an outflow from the accounts
that would be market moving. If you had a 5-year period,
another advantage is that then these accounts would
automatically buildup to a size where they would become
economically easier to evolve into other investment
opportunities if we wanted to at that point.
Chairman MCCRERY. Now, talk to us about the advantage--I
assume you think there is an advantage--in issuing these
Treasury securities in the names of individuals, as opposed to
simply issuing Treasuries to the Social Security Trust Fund.
Expound upon that.
Mr. POLLOCK. I think the single most important advantage,
Mr. Chairman, is that it is a philosophical advantage, as I
said in my testimony. It is consistent with the deep and
extremely important trends in American political philosophy of
trying to create widespread ownership throughout American
society, where the ordinary citizen is an owner of property as
part of the American social miracle. This plan would promote
widespread ownership of retirement savings, as I said before,
just as we promote widespread home ownership. So, I think there
is a huge advantage in the fundamental philosophical message we
are giving.
Now, from the individual's point of view, you are, in
addition, gaining an absolute obligation of the government, a
true right, in exchange for the very large amount of money you
are giving over to the Social Security system, as opposed to a
future political formula which may or may not be there. As we
know from public surveys, a very large number of people,
especially young people, simply don't believe they will ever
get money from Social Security. We can say that the citizen
knows that if all you do is raise taxes to pay Social Security
benefits, net, you haven't done anything but taken money and
given it back. So, this plan would establish a true obligation;
you would own a U.S. Treasury bond. I go on in my detailed
testimony--and I can comment if you want me to, Mr. Chairman,
as to how that might further link to actually decreasing the
long-run Social Security deficit, which I think it could do in
an efficient way.
Chairman MCCRERY. So, I believe you are saying, Mr.
Pollock, that by taking an equivalent amount in Treasury
bonds--an amount in Treasury bills equivalent to the amount of
the cash surplus in Social Security, and putting those in the
names of individuals, you are at least protecting, for those
individuals, that surplus to be paid as part of Social
Security?
Mr. POLLOCK. Yes, sir. You are protecting it by making it
into a real Treasury obligation, a real asset that they
actually own.
Chairman MCCRERY. Thank you. Dr. Mitchell, you and other
members of the President's Commission to Strengthen Social
Security concluded that it would be reasonable to establish
personal accounts along the lines of the Federal Thrift Savings
Plan. Why did you use the TSP as a model?
Dr. MITCHELL. We used the TSP as a model for several
reasons. One is, it is very clear, efficient and low cost; as
was testified to by Mr. Purcell earlier today, the fact that it
has large scale means that it is quite inexpensive to offer.
Also, the fact that it has relatively few investment choices, a
reasonable array--I would personally add, probably, a lifecycle
fund, maybe a TIPS fund--but a reasonably small number of
funds, makes it inexpensive. Also, the fact that the plan is
fairly well communicated, fairly well understood, it has been
around a long time, and it seems to have some history behind it
offers an example of how it might work.
Chairman MCCRERY. Thank you. Mr. Cavanaugh, in your
testimony, you talk about the administrative expenses being,
perhaps, very high if we were to try to go to personal accounts
in Social Security; and you back up your assertion by pointing
to administrative expenses of small 401(k) plans, small defined
contribution plans, and, particularly, small employer plans.
While I think what you say is true in terms of the cost of
those plans, I am not sure how that is relevant to establishing
personal accounts in Social Security. After all, the Social
Security system itself is kind of like a big 401(k) plan. There
are personal contributions collected by the employer and sent
to the central government. What most personal account proposals
propose is for basically the same thing to happen, except
instead of the money--all the money going into a central pot,
it goes into individual accounts, which as we heard in
testimony from the SSA this morning--the SSA seems to indicate
that we have the capacity to do that at a much lower cost than
you have estimated. Do you want to comment on that, and maybe
clear that up?
Mr. CAVANAUGH. Yes. What you are saying, I think, was what
many people in the 401(k) industry believed a decade or so ago,
because they had already got all the business they could get
from large corporations where everybody had a 401(k). So, they
started to try working with smaller businesses and bringing
them in, to provide them the services, and they had the notion
that they could get economies of scale. I think they did a
great job. They bring in businesses, some not too small, and
some of the smaller ones, and they get thousands of them into
their computerized system, and that way they get the economies
of scale, just like the TSP.
But, what they find is that in order to do this, they have
to deal with each one of these businesses and their employees.
You have to go in there and explain the plan document. You have
all sorts of explanations of different investment options; and
you have a fiduciary responsibility to make sure that you don't
give investment advice, but at the same time you give
information. It is a very tricky business. It requires
professional people to do it, and that is why they can't do it
for less than 3,000 bucks a year, even though they have these
tremendous economies of scale that they have achieved over the
last 10 years and fierce competition.
The difference between that and the TSP is, the TSP is just
one employer, the government, not five-and-a-half million. The
first thing I did when I started the TSP was to announce that,
Hey, I am a wholesaler, I am not going to do the retail. I left
it to the Federal agencies and their field offices all over the
world to do the face-to-face; the consultation, the advice, and
all that sort of thing, passing on the forms, helping people
fill them out.
Congress required that Office of Personnel Management train
trainers in every Federal agency for this purpose, a very
demanding task. So, they did the retail for me. They had
systems in place, they had the computers, they had the payroll
offices. Small businesses have none of that, and that is
fundamentally why you just can't reach them. Sixty percent of
businesses in the United States have less than five employees,
which means the cost, or expense ratio, would be twice what I
testified on. You can't get there from here.
Chairman MCCRERY. Couldn't we address some of those
concerns, though, in a different way from the 401(k) model?
Since this is going to be basically a government-administered
plan, as was suggested by Mr. Lockhart this morning, the SSA
itself could play a role in educating workers as to the choices
in their Social Security account. Couldn't we relieve that
burden from the small employers?
Mr. CAVANAUGH. Yes. I think politically, as well as a
practical matter, virtual guarantees have been given to small
business: You are not going to have to do anything more than
what you are doing now. There are two problems there. What they
are doing now, while adequate for the purposes of the Internal
Revenue Service (IRS) and the SSA, is totally inadequate for an
investment function when the SSA cannot reconcile $10 billion a
year to individual accounts. You can accept that in Social
Security because of the way they credit the benefits; you
cannot accept that in a financial institution. I balance the
TSP to the penny every day, and that is the way banks have to
operate. So, the information system is just totally inadequate.
When you talk about alternatives--of course, in my
testimony, I was focusing, as I said, on the Administration's
plan, which is the 401(k)-type structure, there is little
difference between the two. I think the reason why you find
very few proponents of alternatives like Individual Retirement
Accounts (IRAs), Great Britain and Chile stumbled doing that
sort of thing, is because you have millions of people out there
that are financially unsophisticated, at the mercy of a whole
bunch of financial institutions. Certainly in the United
Kingdom they learned never to do that again.
Chairman MCCRERY. Right.
Mr. CAVANAUGH. So, then you get into Simple IRAs, which
some small businesses use, but they require employer
contributions, which a little business just can't handle. So,
what you get down to is--even though you say to small
businesses, you don't have to do any more than what you are
doing--what they are now doing is inadequate for investment
purposes. Second, if they are not going to do the normal
employer functions in a 401(k), who is going to do them? I can
take you through the traces on it. You wind up with a 401(k)
provider having to do them, people like Fidelity Investments,
and T. Rowe Price, and Vanguard, and all those people; they
will go in and they will do them for you as they have been
trying to do. They will come out with the same economics. You
still have to pay 3,000 bucks a year--more, actually, than
that, because right now the 401(k) industry has pushed the
frontier, getting into more and more businesses, and some
smaller ones. Beyond that it is a jungle which they can't
penetrate; little tiny businesses, you just can't deal with
them. So, you would be back in the hands of the 401(k)
providers, God bless them, but you can't ask them to do it
without a government subsidy.
Chairman MCCRERY. Well, it seems to me it is kind of apples
and oranges when we are talking about a central government
system and lots of 401(k)s. I understand. I get your--one of
your points that the educational process would be difficult,
but I don't know that it would be so difficult that we couldn't
do it if we managed it correctly. Do any of the other panelists
have a thought on this subject? Mr. Cavanaugh has brought up
something that is provocative. Mr. Pollock.
Mr. POLLOCK. Mr. Chairman, I think one of the advantages of
the sort of plan that I was proposing, which is the creation of
book entry government securities, is that it solves a lot of
the administrative problems. It makes a purely book entry,
computerized system, possible, which would have very low costs,
even granting the existence of problems at Social Security,
which Frank brings up. A second reason is that, as an education
project, it is exceptionally simple. It is essentially the same
as acquiring savings bonds. I think if you explain to the
American people that this is in exchange for part of your
Social Security; and I stress the ``part,'' because we are
talking about the surplus. We are not talking about disability
insurance or the other welfare aspects of Social Security; we
are talking about the savings aspects of Social Security. For
that we are creating an actual savings program, which looks
just like a payroll deduction, to acquire a savings bond. In
particular, it looks like an I Bond, which is an inflation-
indexed savings bond. People will understand that, and I think
they will like it very much.
Chairman MCCRERY. Mr. Purcell.
Mr. PURCELL. I think I agree with both Mr. Pollock and
Frank Cavanaugh. You certainly could have a low-cost system of
individual accounts, one that is essentially invisible to the
employer, they would do nothing more than they do now. However,
that system would not look like the TSP. The fundamental
roadblock is that, although, as was testified earlier today by
Mr. Lockhart, more than 60 percent of W-2s are submitted
electronically, more than 70 percent of employers submit W-2s
on paper. Four out of 5 employers in the United States have
fewer than 10 employees. They could eventually do all of that
electronically; maybe in 10 or 20 years, and then it will be
very easy, relatively easier, to design a system that somewhat
resembles the Thrift Plan.
Today, you have employers submitting large blocks of tax
money to the local Federal Reserve Bank, which consists of both
income tax withholding and Social Security taxes. The Federal
Government doesn't know how much of that money is payroll tax
and how much is Social Security tax, much less how much is mine
versus a co-worker, until the employer files the W-2 once a
year. That is what slows things down. You can't allocate those
taxes into specific investments until you know how the employee
wants to invest it; and if that is done on paper, it is going
to be done very slowly.
So, you could have a system that is built entirely on the
current payroll tax structure, but you are going to have a
delay; and the current delay, according to the SSA, could be 7
to 22 months in getting a worker's payroll tax into the account
that they choose to put it in. They will probably have the
opportunity to redirect that investment from the bond fund to
the stock fund once a year. They wouldn't be able to log onto a
Web site and monitor their account daily and redirect their
investments; that is what you can do with the TSP. So, it is
simply -it is not a matter of, Can it be done? Certainly it can
be done. There will be tradeoffs between choice and control by
the participant, versus cost borne either by the employer or
through a government subsidy.
Chairman MCCRERY. Bear in mind that carving out part of the
payroll tax is not the only way to fund personal accounts. So,
don't get caught in that trap that everything has to be in that
universe. It doesn't. There could be default options until the
employee's paperwork was received by the Federal Government.
So, I think, again, we can get around those----
Mr. PURCELL. I agree completely. It is simply a matter of
the public understanding that this is what it will look like,
and is that okay with you. If it is, it will work.
Chairman MCCRERY. But, mechanically, and from a cost
standpoint, I still believe we can solve those problems without
the kinds of administrative expenses Mr. Cavanaugh is talking
about. Ms. Entmacher.
Ms. ENTMACHER. I did want to point out that if the accounts
are supposed to be divisible at divorce, that is, the
contributions that are made during the course of the marriage
are supposed to be divided at the time of the divorce, there
would be additional information that would need to be collected
throughout about marital status. The timings of contributions
would have to be related to the information about marital
status. The contributions during marriage would have to be
segregated from the amounts that were in the account prior to
the marriage, which would be separate property. Then, you sort
of start looking at, okay, what goes in during the marriage and
what are the accumulations on that; and if that is the divorce
division that is planned for, then you would have to know that
from the front end, and plan for it.
As I say, there is no system that currently does that. The
TSP doesn't do it. We don't have a national registry. There is
no national center that collects this information, even on a
statistical basis, much less with respect to individuals. There
would, quite frankly, be concerns if the Federal Government
said, Okay, we are going to start collecting information about
the marriages and divorces of all Americans--confidentiality
issues. So, I think that--this is why so many of these payout
issues have to be confronted at the front end, because you
might say, Well, that is what we are going to do and then
discover you don't really have enough information to implement
a fair division of accounts.
Chairman MCCRERY. Why couldn't the personal retirement
account be an asset like any other asset in a divorce, and have
the court decide how it is divided and communicate that to the
SSA?
Ms. ENTMACHER. Well, that is an extremely expensive way of
doing it for the individuals. What happens today with many of
those assets is that people who are not represented by lawyers
don't get a fair share. I think what most people don't realize
is that in a majority of divorce cases, at least one person is
not represented by a lawyer. So, it is going to be very
haphazard whether anyone would get a share of an account. It is
particularly troubling because we don't know how much benefits
might be reduced because a spouse contributed to an account.
So, leaving it to a court to decide--plus you would get
different results all over the country. Some States have
community property, some States don't.
Chairman MCCRERY. You get that now, though, with assets.
Ms. ENTMACHER. Yes, and it results in a lot of women not
getting a fair share of assets at the point of divorce. If we
are talking, again, not about accounts that supplement Social
Security benefits, but that are designed to replace them, we
are talking about the core benefit, the benefit that people
rely on to stay out of poverty--not a supplement. We are
talking about the bottom half of the income distribution. The
401(k)s and IRAs held mostly by higher income people. This is
the basic tier of retirement income, so, it is especially
important to make sure that women get a fair share.
Chairman MCCRERY. I don't disagree with you, but, couldn't
we--in order to cut through some of that disparity from State
to State, jurisdiction to jurisdiction, overlay a Federal
requirement with the disposition of these accounts so that the
court would have to take into account the Federal requirement,
and make that part of the judgment?
Ms. ENTMACHER. Well, but the issue has to come to the
attention of the State court, and figuring out--what does that
mean? Do you--if you are not a community property State, do you
use community property principles to divide the account? Where
do you get that? You then have to turn to the SSA, or the TSP,
or whoever is administering the accounts for information and
say, ``Okay, tell us how much money went in during the course
of the marriage and what were the accumulations?'' The
information still has to be generated by somebody for the court
to do that.
Chairman MCCRERY. Well, again, I agree with you that there
are complications, and believe me, we have looked at these. I
think there are ways to work all those out to provide the
maximum amount of protection for both spouses. You make some
good points, and we need to pay attention to that.
Ms. ENTMACHER. Thank you.
Chairman MCCRERY. Mr. Levin.
Mr. LEVIN. I will get back to the TSP. Let me just ask you,
Mr. Pollock, right now we have a Social Security system that is
progressive, right, replacement rate differs according to
income? Under your approach, that would not be true?
Mr. POLLOCK. Under my approach, the progressivity would
remain the same.
Mr. LEVIN. How is that?
Mr. POLLOCK. It remains the same because, as is explained
in my detailed submission, Congressman, in exchange for getting
TIPS that you actually own in your own account today, you give
up an equivalent value of future benefits; that is,
economically you must do that, that is your choice. The future
benefits, what I call the ``exchange rate'' between the future
benefits and the TIPS today, have built into them, and into the
exchange rate, all of the formulas which govern Social Security
benefits. So, the result of all of that progressivity stays
exactly the same.
If I may comment further, Congressman--suggest that if we
want to use this promotion of ownership and creation of real
assets in exchange for Social Security payments, we want to use
that, in addition, to reduce the deficit, we could make that
exchange rate itself more progressive; that is to say, for
higher income people you would give up more than a dollar's
worth of present value of future benefits for a dollar today.
It is my belief that since higher-income people doubt very much
that they will ever receive the scheduled benefits, they would
choose to go into the program.
The result--excuse me, if I could just finish the thought.
The result would then be that in addition to creating ownership
and true assets, we would also be reducing the Social Security
actuarial deficit. The liabilities of the Social Security
program would be falling faster than the odd assets in the
trust fund, and its finances would be improving.
Mr. LEVIN. Indexing into it, you are suggesting--I don't
know what you mean by ``higher income.'' Let's suppose that
everybody with 20,000 and above was classified as higher.
Disability would be separated out?
Mr. POLLOCK. Congressman, in all of my mathematical work on
this, I start by excluding the disability insurance program,
dealing only with OASI, because disability insurance, by
definition, is insurance--you must commingle funds to have
insurance work.
Mr. LEVIN. Survivor benefits?
Mr. POLLOCK. Is the same. I think there is a little
confusion, if I may say so, when we talk about creating
personal accounts or personal lock boxes, because people tend
to characterize all of Social Security as one thing, whereas,
in fact, Social Security is two quite different things.
Mr. LEVIN. Okay. I just have limited time.
Mr. POLLOCK. I am sorry. You agree with that point, though,
I think, Congressman, that it is part insurance or a welfare
program and it is part a savings program.
Mr. LEVIN. I wouldn't call it a welfare program. I think
the public--you size up the public very incorrectly, I think
the public has spoken pretty loudly about personal accounts. It
is interesting, we are spending a lot of time on the TSP,
though what I think has been suggested in the last 24 hours
doesn't involve TSP. So--and maybe they listened, Mr.
Cavanaugh, to your admonitions about the complexity of it.
There is plenty of complexity with this concept. I guess they
are including two bonds and somehow an increase in solvency; we
will see how they work out without taking general revenue
moneys or making promises as to the future. We spent a lot of
time on the TSP. It is in the President's plan; it is not,
apparently, in this concept. Ms. Entmacher, just if you would,
the greatest dangers you think of what Mr. Pollock has
suggested are what?
Ms. ENTMACHER. I think the greatest danger is really
embodied in this idea that it is an individual lock box. First
he talked about, well, that doesn't apply to disability, and I
wonder whether he is including the family disability benefits
in that as well. Particularly women, when they reach retirement
age and take benefits at 62 and above, many, many women rely on
the higher benefit that they get as a spouse and as a widow.
Millions of working women, women who work in the paid labor
force, who have earned their own Social Security benefit, get a
supplement that Social Security provides to spouses and widows.
Despite the fact that more women are in the paid labor
force for longer periods of time, it is still the fact that
they earn less than men and take more time out of the labor
force. So, when they reach retirement, their income security
really depends on the higher benefits that they get as spouses.
What has been referred to as the individual savings component
of Social Security--they benefit from the fact that it is not
an individual savings component; it is a family savings
component that protects workers and their spouses and surviving
spouses. So, I think that is the biggest concern. We could, in
a few years, see a return of the poverty rates, particularly
among elderly women who already are the large majority of the
elderly poor, to what they were back before Social Security was
created.
That is my nightmare. When I look at the benefits that
women will get under Social Security in the future, 40 percent
of women are going to be receiving spousal benefits 40 years
from now; they are still going to be relying on them. When I
look at what women have in their 401(k)s and IRAs, it is 60
percent of what men have. They are still disadvantaged. So, if
it is every man for himself in this brave new world, I worry.
That is my biggest worry.
Mr. LEVIN. My time is up. Let me just ask Dr. Mitchell
about the Hirschel Organization, and they would have to buy--
what would keep them out of poverty? We are talking about 20,
30 years, right, for the average woman?
Dr. MITCHELL. Right.
Mr. LEVIN. Twenty or 30 years; we are talking about a long
period of time. How do you calculate an annuity so that you are
sure it will keep people out of poverty when you are not sure
what the poverty level is 5, 10, 15, 20 years from now; how do
you do that?
Dr. MITCHELL. Well, practically speaking, the poverty line
in the United States is defined according to a real standard,
that is, an inflation-indexed standard. So, what you would do,
practically speaking, is compute the annuity that you would
take from your personal account, make it an inflation-indexed
annuity, add the traditional defined benefit pillar that you
would still keep getting from Social Security, which is also
inflation indexed, and if the two of those were projected to
exceed the poverty line, which is also inflation indexed, then
it would work out. So, technically speaking, it is easy to do.
Mr. LEVIN. I am going to ask you further questions, because
the way that Social Security is now indexed, I think people
would come out differently. I think it is difficult to
calculate the annuitization so, it would really work, but my
colleague is here, and so I may ask you to give us an answer
for the record.
Dr. MITCHELL. If you could restate the question, that would
help me, please.
Mr. LEVIN. I will do that.
Chairman MCCRERY. Mr. Neal.
Mr. NEAL. Thank you, Mr. Chairman. Mr. Pollock, I
appreciated your references to Jake Pickle. For those of us who
served with him, nobody could more succinctly take care of an
argument than Jake Pickle. Having said that, I think everybody
at the table would agree, the President's plan really has gone
nowhere. In fact, the numbers have gone down the more time he
spends trying to explain his proposal. As Jake Pickle would
have said, ``That dog won't hunt.'' Why is the President having
such difficulty in getting traction with his plan?
Mr. POLLOCK. Congressman, I would prefer to answer that
question by saying, how can we improve the plan? I think the
way to improve it is to make it exceptionally simple and easy
to understand. The objections to the President's plan, as I
read them, have been, first of all, it is risky. We are going
to invest in equities. People have compared investing in
equities to gambling in Las Vegas and so on. Second, people say
it will be exceptionally expensive to operate. I am speaking of
administrative costs. Thirdly, they say you are going to take
this cash away from the Treasury, and--have to borrow it from
Asian central banks or something. There is a fourth objection,
which is that people will be confronted with confusing and
complex decisions that they don't wish to make, and Wall Street
will be all over them with dozens of options and things.
I think if we had a simple plan, which had none of these
problems, which doesn't suggest to people they will be in Las
Vegas with the equity market, that they are not obliged to make
confusing and difficult decisions they don't wish to make, that
the administrative costs are very cheap, and that it doesn't
deprive Treasury of any money, they would like it a great deal.
At least that is my bet, as I said before.
Mr. NEAL. Thank you. Dr. Mitchell, you indicated during
your testimony that you thought that private accounts would be
a good idea based upon a very limited number of opportunities
to invest?
Dr. MITCHELL. Correct.
Mr. POLLOCK. Mr. Chairman, may I be excused?
Mr. NEAL. Feel free to disagree with this, but I must tell
you, having been here the last 17 years, the same people in
this Congress who are suggesting that there be a limited number
of opportunities to invest, that they all be safe, anybody who
knows how Washington works--that if we were sitting here five
or six years ago with the dot-coms, that same chorus would be
yelling to put that money in riskier investments. Do you know
what? In this Congress there would be a sympathetic ear for
trying that. Now, I try to remind people for those of us who
were here during the Savings and Loan difficulty, that that is
precisely what happened. You will not be able to rein in this
Congress on the issue of safe investments. Feel free to comment
or disagree and maybe suggest how you would argue that we would
do it then. I think you know of what I speak.
Dr. MITCHELL. I can answer on two fronts. As you know, in
the private pension arena, defined contribution plans are
required to have a minimum of three options, and typically you
find a stock index fund, a bond index fund, and some sort of a
cash money market fund. Moreover, in the private sector you
will typically find employers putting employees into a default.
If you choose not to choose, then we are going to put you in
something. It has been a money market in the past, or slowly
but surely, life-cycle funds are growing in popularity, where
you start out, maybe, a little bit riskier; the older you get,
you move into a more conservative account.
When we were talking on the Social Security Commission in
2001, we grappled with the issue of cost versus choice in great
detail. What we proposed was that nobody should be allowed to
buy a single company stock. I think with Enron and World Com
and Tyco, in everybody's minds that simply would not be
permissible. These would have to be indexed accounts, so that
you wouldn't be able to pick just high-tech or just low-tech,
but you would have to diversify. I really like the idea of
life-cycle. I think you are right, most people don't have the
time, the energy, or perhaps even the education to go and
decide how to allocate their portfolios, day in and day out;
plus they probably shouldn't be doing that. So, one thing we
have seen, for example, is that countries all over the world
that have defined contribution plans have moved to life-cycle
funds.
Mr. NEAL. Do you think there is some validity to the point
that I raised about the safeguards that have to be built into
this? Only because, given that S&L issue, when one tracks what
happened, it is very simple to conclude that people got into
doing that business when they shouldn't have been in. We have
deregulated that industry, no questions were asked, and the
disaster awaited the American people. I am very concerned that
if this is not meticulously addressed, we run the risk of
having the dot-com industry drive retirement arguments around
here. Maybe I can go to Mr. Cavanaugh for a second, Mr.
Chairman, if I could. I know my time has expired. Mr.
Cavanaugh, could you talk about how difficult it would be to
administer a series of small accounts?
Mr. CAVANAUGH. You want me to talk about the difficulties
in administering?
Mr. NEAL. Yes.
Mr. CAVANAUGH. Well, the problem is, 60 percent of
businesses have less than five employees; they don't have
personnel offices and payroll offices. As Mr. Purcell was
pointing out, 72 percent of them are reporting on paper; they
are not electronic. They don't have the education, and they
have been virtually assured by the Administration, as I
understand it, that they wouldn't have to do any of the things
that employers in 401(k) plans do. They just can't do it. They
don't have the education. We are talking about people that cut
your grass and cut your hair and run the local garage and
beauty salon and whatever. These are not institutions that can
handle complex financial matters. The industry--this is not
speculation--is trying to get in there, the 401(k) industry and
get these people signed up, and they find they just cannot do
it at a low enough cost. There are too few people to spread the
administrative expenses over; it just doesn't work.
Mr. NEAL. Thank you. Thank you, Mr. Chairman.
Chairman MCCRERY. Thank you, Mr. Neal. Mr. Levin, do you
have anything else?
Mr. LEVIN. No, thank you very much.
Chairman MCCRERY. Yes, thank you all very much. Mr.
Pollock, by the way, told us prior to the hearing that he had
to leave at 12:45. He was not upset with anyone at the witness
table or, I don't think, with the Members.
Mr. LEVIN. Can I just say that Mr. Pomeroy isn't here
because of a Base Re-Alignment Commission commission hearing in
his home State. He wondered where he should go, and I said it
is your judgment, but we understand if you decide to attend a
base closing in your home State. Congresswoman Stephanie Tubbs
Jones had an emergency she had to take care of, that is why she
is not here.
Chairman MCCRERY. Thank you for that information. Thanks,
once again, very much, and the hearing is adjourned.
[Whereupon, at 12:50 p.m., the hearing was adjourned.]
[Submissions for the record follow:]
Statement of Robert L. Clark, Dillingham, Arkansas
Mr. Chairman, thank you for the opportunity to provide written
testimony to the Committee on the need for enhanced financial education
for American worker in order for them to better plan for their
retirement income.
Throughout our economy, more and more American workers are being
required to assume greater responsibility for their own retirement
saving. The continuing trend toward greater use of defined contribution
plans means that a larger proportion of the labor force must make key
decisions on whether to participate in employer-provided pension plans,
how much to contribute to these plans, and how to invest plan assets.
The changing nature of defined benefit plans allowing lump sum
distributions and the conversion of traditional defined benefit plans
to cash balance plans are providing more options for workers as they
change jobs and have the opportunity to access pension funds. Plan
terminations and reduced generosity of existing plans mean that workers
must decided whether to increase their own saving in voluntary
supplemental retirement plans offered by their employers or in their
own private savings plans. Adoption of individual accounts in
conjunction with other Social Security reforms will further extend the
choices individuals face in planning for their retirement and increase
the responsibility that each of us has for our own retirement income.
Financial education and a comprehensive understanding of investment
options are necessary if workers are to successfully achieve their
retirement objectives. As public and private pension systems shift more
responsibility to individuals, who bears the responsibility for
providing an appropriate level of financial knowledge to American
workers? Is it the responsibility of each worker to acquire sufficient
knowledge to make appropriate saving decisions? Should firms that offer
retirement plans be required to provide financial education programs
for their workers? If in the future, Social Security offers workers the
option of placing a portion of their contributions into personal
accounts and deciding how these funds will be invested, does the
Federal government bear some responsibility to provide adequate
financial knowledge to Social Security participants so that they can
make informed choices?
Available survey data indicates that many workers lack the required
knowledge to determine how much to save each month to accumulate the
desired level of income in retirement. In addition, they lack basic
information on how to invest their retirement funds. The challenge for
workers, firms, and the government is how can the level of financial
literacy be improved so workers have the needed information to
successfully plan for retirement in the coming years.
Employer Pensions and Private Savings
If individuals have insufficient knowledge concerning the saving
process, they are unlikely to be able to make optimal retirement plans.
A lack of financial education may result in workers starting to save
too late in life and saving too little to reach their retirement goals.
As a result, they are unlikely to achieve the desired balance between
consumption while working and consumption in retirement. In addition, a
lack of information concerning the risk-return distribution of various
investments might lead workers to misallocate their retirement
portfolios.
In a series of recent papers, my co-authors and I have examined the
response of individuals to participation in retirement education
seminars. Our research has shown that financial education can produce
significant changes in how individuals think about and plan for
retirement. In financial educational programs, workers may learn that
they have based their desired retirement age and income in retirement
on insufficient saving and investment behavior. After participating in
educational programs, many workers tended to revise their goals and
concluded that they wanted to alter their savings behavior.
Individuals with low desired retirement ages often reported that
they raised their expected retirement ages based on the information
provided in the seminars. In addition, participants that entered the
seminars with low retirement income goals tended to increase their
retirement income targets toward a level more consistent with having
retirement incomes similar to their net income while working. Many
workers decided to alter their retirement saving behavior and planned
to open new retirement savings plans and increase contributions to
existing plans.
Another important finding is that plans for changes in retirement
savings made during the seminar were not immediately acted on by many
respondents. Whether due to inertia, myopia, or changed circumstances,
many participants who expressed a desire to change their savings
behavior at the time of the educational program failed to do so in the
months following the seminar. Thus, it would be useful if participants
in such programs are offered the opportunity to change their
contributions to retirement plans at the conclusion of educational
programs so that they can immediately institute their desired changes.
Our results indicate that there are significant differences in the
reaction of individuals to the information presented in the seminars.
Younger workers were more likely to indicate that they planned changes
in their retirement savings as were women and participants in clerical
and blue collar positions. Further research is needed to explore the
actual responsiveness of participants to educational programs, the
reasons why desired actions are not taken, and what policies would
increase the link between desired changes in retirement plans and the
actions necessary to achieve new retirement goals.
The results of our studies are interesting and have direct policy
implications for plan sponsors and workers. The analysis indicates that
financial education matters and ignorance is not bliss in the area of
retirement planning. Quality educational programs encourage workers to
reassess their retirement goals, to make more realistic plans, and to
change their behavior in order to achieve their objectives. Follow
through on plans made during a seminar remains problematic and
introducing methods for immediate action would be useful additions to
educational programs. Employees, employers, and appropriate government
agencies should consider how to enhance the financial knowledge of
American workers so that they will be better able to handle the
increasing responsibility for their own retirement savings.
Implications for Personal Accounts in Social Security
Surveys of Americans reveal a dearth of financial knowledge. The
lack of understanding of financial mathematics, investment options, and
the level of savings needed for an adequate retirement income means
that many Americans save too little, start too late, and are unaware of
the implications of their actions for their standard of living in
retirement. As life expectancy increases and employer pensions place
more responsibility on workers for their own retirement income, the
state of financial education becomes more important. The inclusion of
individual accounts as a component of Social Security further enhances
the importance of developing financial education programs for working
Americans.
Inadequate financial education will have adverse affects if workers
are offered personal accounts as part of Social Security. Workers who
do not understand risk and uncertainty, financial mathematics of
compounding, and expected rates of return to investment choices are
likely to make poor decisions concerning the use of personal accounts.
If Congress chooses to enact Social Security reforms that include
personal accounts, I believe that Congress should develop financial
educational materials and programs that provide appropriate information
for American workers. Such materials should help them make the best
choices within a future Social Security system.
This financial information and education should be unbiased and
provide a clear picture of the investment choices. With such
information, workers can choose to allocate a part of their
contributions to these account and make appropriate investment choices
that will maximize their retirement income or to refrain from selecting
this option. Without such education, many workers will make poor
choices based on inappropriate or bad information. As this Committee
considers Social Security reforms, I recommend that you include as part
of your deliberations how to provide high quality financial information
and education to workers so that they will be able to adequately deal
with the new environment.
The research showing that individuals respond to employer-provided
financial education by altering their retirement goals and private
savings behavior has important implications for Social Security
personal accounts. Results of my research studies are reported in the
publications cited below. Thank you for this opportunity to discuss
with you the importance of financial education and its impact on
retirement savings.
Research Papers on Financial Education
Clark, Robert and Madeleine d'Ambrosio. July 2002. ``Saving for
Retirement: The Role of Financial Education,'' TIAA-CREF Institute
Working Paper 4-070102-A. Published on-line in Retirement Implications
of Demographic Family Change Symposium, Society of Actuaries, http://
www.soa.org/library/monographs/retirement_systems/m-
rs_2_tableofcontents.html.
Clark, Robert and Madeleine d'Ambrosio. 2003. Ignorance Is Not
Bliss: The Importance of Financial Education, TIAA-CREF Institute
Research Dialogue No. 78.
Clark, Robert, Madeleine d'Ambrosio, Ann McDermed, and Kshama
Sawant. 2003. ``Financial Education and Retirement Savings.'' Paper
presented at Sustainable Community Development: What Works, What
Doesn't and Why, a conference sponsored by the Federal Reserve System.
Washington, March 2003.
Clark, Robert, Madeleine d'Ambrosio, Ann McDermed, and Kshama
Sawant. 2004. ``Sex Differences, Financial Education, and Retirement
Goals'' in Olivia Mitchell and Stephen Utkus (eds.), Pension Design and
Structure, Oxford, UK: Oxford University press, pp. 185-206.
Clark, Robert and Sylvester Schieber. 1998. ``Factors Affecting
Participation Rates and Contribution Levels in 401(k) Plans,'' in
Olivia Mitchell and Sylvester Schieber (eds.), Living with Defined
Contribution Plans. Philadelphia: University of Pennsylvania Press, pp.
69-97.
Statement of Craig Copeland, Ph.D. and Jack L. VanDerhei, Ph.D.,
Employee Benefit Research Institute
Individual Social Security Accounts: Administrative Issues
We are pleased to provide this written testimony on administrative
issues within proposed Social Security reforms. All views expressed are
our own, and should not be attributed to the Employee Benefit Research
Institute (EBRI). Established in 1978, EBRI is committed exclusively to
data dissemination, policy research, and education on financial
security and employee benefits. EBRI does not lobby or advocate
specific policy recommendations; the mission is to provide objective
and reliable research and information. All of our research is available
on the Internet at www.ebri.org
President Bush has made a strong push for the inclusion of
individual accounts within the Social Security system. The inclusion of
individual accounts brings forth many issues that are not currently
present under the traditional defined benefit system structure of
Social Security. While individual accounts have been debated heavily on
its political attractiveness, the details of how the system would
operate or the administration of the individual accounts have not been
thoroughly discussed. However, the discussion on this issue has greatly
expanded from the first time the Employee Benefit Research Institute
focused attention on these administrative issues in their November 1998
EBRI Issue Brief.
The political and policy debate has been on going, but from a
practical perspective, the debate so far has virtually ignored any
specific considerations about how to administer such accounts. Any
discussion of whether to create individual accounts must also address
the basic but critical questions of how they would work: Who would run
them? What would they cost? Logistically, in what form are they
possible?
This testimony presents an overview of the most salient
administrative issues facing the current Social Security reform
debate--issues that challenge policy makers to carefully think through
how their proposals could be implemented, in order to achieve their
policy goals.
Speeches, media articles, books, and television reports have
frequently suggested that if the federal employee Thrift Savings Plan
can work, and if private employers can make 401(k) plans work, then
individual accounts in (or in addition to) Social Security can be
easily administered. There is a way to design a system of individual
accounts that could potentially be administered in a cost-effective and
timely way--but for a variety of inescapable reasons, that system most
likely will bear little or no resemblance to a modern 401(k) plan. If a
typical Internet-based 401(k) with easy access to account information
and investment options can be described as the ``Porsche'' of
retirement savings plans, then the public should realize that a
workable, cost-effective individual account within Social Security is
most likely to look like a ``Model T'':
401(k) plans typically offer an average of 14 actively
managed investment choices (the `Porsche' offers virtually unlimited
options through `mutual fund windows' and `self-directed brokerage
accounts'), versus a very limited number (five for the Federal Thrift
Savings Plan) of index investment options for a startup universal
individual account system (probably one initially).
401(k) plans typically offer daily access through the
telephone, and the `Porsche'' offers 24/7 internet-based self-
management with immediate access to account information, updated daily,
versus something closer to an annual account statement for a startup
universal individual account system.
401(k) plans typically offer participants loans or
hardship withdrawals from their accounts, with the `Porsche' providing
the ability to `do it yourself' on the internet; a startup universal
individual account system would likely find it impossible, setting
aside desirability arguments, to offer either
Workers' 401(k) contributions typically come out of every
paycheck, with rapid crediting to investment accounts; a startup
individual account system tied to Social Security would involve `bulk'
contributions, with annual reporting of contributions to the Social
Security Administration at the worker level, with crediting as much as
18 months later as the paper is processed. `Porsche' 401(k) plans do
both contributions and allocations on an every pay period fully
automated basis. The startup individual account system could not, as a
majority of employers file with the government on paper.
401(k) plans allow participants to modify their
contributions regularly, with `Porsche' plans allowing it 24/7 on the
internet for next pay period implementation, versus a more likely once
a year when the employee fills out their withholding form (per
employer) for a startup individual account system.
`Porsche' 401(k) plans rely upon employers and
administrators to be completely automated with computer interface of
all data; a startup individual account system would have to allow
employers to continue using pen-and-paper reports--as most currently
do--if there was a desire to avoid high new employer administrative
costs.
The issues and options in administering individual accounts raise
concerns that cut across ideology. The object of this report is neither
to dissuade the advocates nor support the critics of individual
accounts. Rather, it is to bring practical considerations to a
political debate that must ultimately deal with the pragmatic
challenges of designing individual accounts that would not be too
complex for participants to understand, nor too burdensome for small
employers to administratively support, nor too difficult for a record
keeper to administer, nor too expensive for low- and moderate-income
participants to afford.
The major findings in this analysis include:
Adding individual accounts to Social Security could be
the largest undertaking in the history of the U.S. financial market,
and no system currently exists that has the capacity to administer such
a system . The number of workers currently covered by Social Security--
the largest single entitlement program in the nation--is at least four
times higher than the combined number of all active tax-favored
employment-based retirement accounts in the United States, which are
administered by hundreds of entities.
Direct comparisons between employment-based retirement
savings plans and Social Security reform are difficult at best . Social
Security covers workers and businesses that are disproportionately
excluded from employment-based plans. Because of these differences, a
system of individual Social Security accounts would be more difficult
to administer than employment-based plans, and total administrative
expenses could be larger relative to benefits due to most employers not
using automatic payroll systems, large numbers not using direct
deposit, the vast millions of short service and young workers that are
not included in either public or private employer savings plans, and
the high relative cost of even one phone conversation with the holder
of an account (commonly estimated to be an average of $10 per phone
conversation).
Credit-based systems such as the current Social Security
program are less difficult to administer than cash-based systems, which
must account for every dollar. Inherent in the individual account
debate is generally the presumption that individual account benefits
would be based on cash contributions and investment returns. The
current credit-based system tolerates small errors in wage reporting,
because they rarely affect benefits. But every dollar counts in a cash-
based individual account system. To ensure that benefits are properly
provided, an individual account system would require more regulation,
oversight, and error reconciliation than the current Social Security
program.
Social Security individual accounts cannot be
administered like 401(k) plans without adding significant employer
burdens--especially on small businesses. Under the current wage
reporting and tax collection process, it would take at least seven--19
months for every dollar contributed to an individual's account to be
sorted out from aggregate payments and credited to his or her IA. This
seven--19 month ``float period'' could result in substantial benefit
losses over time. Options for preventing such losses involve difficult
trade-offs, such as increased government responsibility, increased
complexity, greater employer burdens, and/or investment restrictions
for beneficiaries. Elimination of this ``float period'' by requiring
faster action by small employers would lead to significant new
administrative burdens and costs.
If legally considered personal property, the individual
accounts of married participants could pose significant administrative
challenges. Social Security today must obtain proof of marriage only at
the time spousal benefits are claimed. But some individual account
proposals would require contributions to be split between spouses'
individual accounts, requiring records on participants' marital status
to be continuously updated to ensure that contributions are correctly
directed. Also, dealing with claims on individual account contributions
in divorce cases could place individual account record keepers in the
middle of spousal property disputes.
The current body of knowledge is too uncertain, and in
general the proposals to date are too vague, to make an objective
estimate of how much an individual account system would cost to
administer or whether it would succeed in accomplishing its policy
goals . Uncertainty exists over how individual account proposals would
address key policy areas affecting administrative cost and complexity,
how administrative costs operate in the current employer-sponsored
retirement arena, and how lessons from the employment-based system
apply to Social Security reform. For instance, in July 2001 the Federal
Retirement Thrift Investment Board terminated and sued a contractor for
failure to design a workable administrative system after nearly three
years of effort. Given the relatively small size of the Federal Thrift
Savings Plan (less than 3 million participants) compared with the total
U.S. workforce (more than 148 million), a great deal could be learned
by policy makers from this apparent system upgrade failure.
Individual account benefits would be highly sensitive to
administrative costs, according to results using the SSASIM policy
simulation model. Workers born in 1976 and 2026 would receive between
14 percent and 23 percent lower total benefits under high
administrative cost assumptions \1\ than under low-cost assumptions,
indicating that additional research on administrative costs is
essential to assessing how--or whether--IAs could achieve the lower-
cost assumptions. Proposals to use a flat percentage administrative
charge could approach the lower-cost assumptions if the system had a s
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\1\ For further details about these points, see ``Individual Social
Security Accounts: Administrative Issues.'' EBRI Issue Brief no. 237,
September, 2001. (www.ebri.org/publications/ib)
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Statement of Paul A. Cyr, Greene, Maine
Thank you for giving me this opportunity to write to you.
I am fifty-eight and a half years old and I work for the state of
Maine Department of Transportation as a Highway Worker II. My jog is
driving truck--winter and summer. And when I am not actually driving I
am doing heavy physical work. I've worked for the state of Maine for
approximately ten and a half years. The first three and a half years
were as a Highway Worker I. The job was mainly flagging for eight to
ten hours a day, and at forty--seven years old it wasn't easy standing
on hot top all day or being out in 10 below zero weather. While doing
this job I've had the driving public swear at me for holding them up
for three minutes, or people going by and hollering at me to get a real
job. There have also been numerous times when I was almost hit by cars
and in some cases the drivers actually laughed about it. I took the
insults and obscenities thinking I would just do what I had to and it
would pay off in the long run--that when I retired I would have a
pension from this job to go along with my social security.
Before I went to work for the state of Maine I was a sheet metal
journeyman. I spent four years going to school at night to get my state
license as a sheet metal worker. I worked for a company while going to
school and stayed with them for approximately twenty-five years. After
that I worked for another metal shop for about four years until they
filed for bankruptcy. And than it was another metal shop company for
three years until I was let go for supposedly not being able to keep up
with the younger people. These companies had very few benefits--no
pension, no paid vacations, no bonuses, some paid holidays, and some
had very limited health insurance. During all those years I installed
duct work in dirty paper mills, in buildings with asbestos, and out in
the cold and heat. I was paying into Social Security during this time
and thought I would have a SS check when I retired. I couldn't put
money into savings for retirement because it took all I had to be able
to get by and pay my bills.
Than after working with no benefits or pension all those years and
being out of work for two years, I landed a job with the state of
Maine. After being a state worker for seven years I went to a
retirement seminar and learned about the GPO and WEP. I was very upset
by what I was told, so I went to my Social Security office in Auburn,
Maine. The person I spoke to told me I would loose about a third of my
Social Security benefits because I worked for the state of Maine. To
add insult to injury, she than told me that I should not have taken
this job, but should have found work somewhere else! But as I told her,
I had been out of work for two years when I got the job with the state
and figured that with their pension and Social Security I would be able
to get by when I retired. But now the way I feel they might as well
bury me in my work clothes, because I'll probably be working until I
die.
From what I see the future does not look very good for me. With
taxes going up all the time, as well as the cost of living (gas,
lights, insurances, etc.), I'll never have enough to make ends meet if
I retire. Also, there has been a woman in my life for many years but we
can't get married, because if we do and she draws any of my state of
Maine pension after I die she will get penalized on her Social
Security. And I won't do that to her. Why should she get penalized
anyway?
In my opinion the GPO and WEP should be repealed. Just give me the
money that I earned and put into Social Security over the years--all of
it, no more and no less. And do not penalize my fiancee either. Please,
please repeal these two unjust laws so people like myself that have
worked so hard for so many years (four of which were serving this
country in the military) can end our working days with dignity an a
sense of self worth and accomplishment.
Statement of Ike Jones, America's Community Bankers
America's Community Bankers (``ACB'') \1\ is pleased to submit this
written statement in connection with the Subcommittee's eighth hearing
on ``Protecting and Strengthening Social Security.'' ACB commends
Chairman McCrery and Chairman Thomas for their leadership in crafting
social security reform legislation. ACB firmly believes that personal
accounts should be a part of any social security reform legislation,
and that a ``Community Bank Option'' should be available to workers
under a system of personal accounts.
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\1\ America's Community Bankers is the member driven national trade
association representing community banks that pursue progressive,
entrepreneurial and service-oriented strategies to benefit their
customers and communities. To learn more about ACB, visit
www.AmericasCommunityBankers.com.
---------------------------------------------------------------------------
Personal Savings Accounts
The debate over creating a more solvent Social Security retirement
system has gained momentum over the past few years, especially with the
Administration putting the issue front and center. Because Social
Security operates almost entirely as a pay-as-you-go system, it is
highly sensitive to the dramatic demographic changes that are
increasing the average ages of our population. Increased life
expectancies mean more retirees collecting benefits for more years. The
resulting decline in the ratio of workers to beneficiaries is pushing
the system toward insolvency, and personal savings accounts may be one
way to create a more secure Social Security system.
For several years now, ACB has supported allowing workers the
choice of investing at least a part of their Social Security taxes in
personal accounts. This approach will give individuals greater control
over how their retirement security funds are invested and can create a
more solvent system. Social Security reform should give workers the
option of relying on their community banks and the investment products
those banks offer, including insured deposits, in addition to those
investment options available on Wall Street.
Community Banks Are Experienced Investment Advisers
Community banks already offer a variety of retirement investments,
including FDIC-insured Individual Retirement Accounts (IRAs),
certificate of deposits (CDs), mutual funds and annuities. Because
community bankers understand the creation of wealth and their
customers, they are in an excellent position to help consumers choose
appropriate investments for these personal accounts.
ACB believes that any Social Security reform should ensure that
consumers have the option of seeking advice on their personal accounts
from people they already trust--their local community banker.
FDIC-Insured Accounts (the Community Bank Option)
For decades, American workers have trusted FDIC-insured financial
institutions with their retirement savings. As of the end of 2003,
banks and thrifts managed $246 billion in retirement funds invested in
IRAs and Keogh plans.
FDIC-insured retirement accounts should be an option for workers
choosing personal accounts. Workers of all ages could benefit from an
FDIC-insured deposit option or what is now being called the Community
Bank Option. Some workers, while wanting a greater return than the
Social Security program currently provides, will be wary of investing
all of their retirement funds in equities and other retirement products
that carry much higher risk. For these workers, a long-term deposit
account would be the most appropriate investment for all or part of the
funds freed up under Social Security reform legislation to invest in
personal accounts.
Certainly, as workers near retirement age, their tolerance for
taking risks in the stock or bond markets will dramatically decrease.
ACB believes that FDIC-insured accounts would benefit these older
workers not only as a place to invest new funds, but also as a safe
product in which to rollover funds from riskier personal account
products.
In addition, FDIC insurance has given millions of American families
the confidence for over 70 years that the money they deposit in banks
will be there when they need it. Allowing FDIC-insured accounts as an
option under Social Security reform would encourage workers to choose
the personal account option and increase support for reform among
consumers.
The Facts Support FDIC-Insured Account Option
Many Americans depend on FDIC and NCUSIF-insured IRAs as part of
their retirement savings plans. According to a January 2005 report of
the Employee Benefit Research Institute, American families had $270
billion invested in FDIC and NCUSIF-insured IRAs as of the end of 2003.
These funds represent 9 percent of all IRA assets.
In addition, a 2001 Federal Reserve survey of consumer finances
showed that 12.3 percent of all American households held insured IRA
deposit accounts. The survey also indicates that households in all age
brackets rely on these insured accounts for retirement savings, not
just households headed by older Americans. American workers should also
have insured deposit accounts as an option under any program of
personal investment accounts.
Age Distribution of IRA Accounts at Insured Institutions
------------------------------------------------------------------------
Percent of all
households in For each age group
each age group IRA deposit at
Age of head of household that have IRA insured
accounts at institutions as
insured percent of total
instutions IRA funds
------------------------------------------------------------------------
< 35 5.3 25.0
------------------------------------------------------------------------
35-49 11.1 116.4
------------------------------------------------------------------------
50-64 17.0 18.4
------------------------------------------------------------------------
65-69 18.5 28.0
------------------------------------------------------------------------
> = 70 16.1 27.4
------------------------------------------------------------------------
All Ages 12.3 21.2
------------------------------------------------------------------------
Data were provided by Federal Reserve Board staff based on the 2001
Survey of Consumer Finances (the most recent survey available)
published in 2003.
IRA accounts refer to all IRA and Keogh accounts, excluding IRA-SEPs and
similar accounts maintained as part of an employer-provided retirement
benefit.
Insured institutions include banks, thrifts, and credit unions.
IRA deposits refer to the sum of IRA account balances of all household
members at all insured institutions used by the household.
Community Bank Option Invests In Local Communities
Allowing investments in FDIC-insured accounts returns money to the
local communities where taxpayers live and work. Community banks will
invest these funds in their local communities by providing loans to
local businesses, mortgage loans to families, education loans to
students headed off to college, and in many other ways. If this option
is adopted, it could result in reduced rates for these loans.
Increase Deposit Insurance
Providing a substantial increase in deposit insurance coverage for
all retirement accounts would further enhance the community bank role.
Currently, the FDIC provides up to $100,000 of deposit insurance for
the retirement accounts (e.g. IRAs and Keoghs) of a depositor in a
bank. The shift in America from defined benefit plans to IRA and
401(k)-type savings has increased the burden on individuals to manage
their own assets. Retirement assets often exceed the current $100,000
coverage limit by substantial amounts. A substantial increase in FDIC
coverage of retirement accounts would strengthen the viability of the
insured deposit account option. And it is important to note, the FDIC
is funded through assessments on banks and savings associations, not
taxes.
Conclusion
ACB strongly believes that FDIC-insured retirement accounts, or the
Community Bank Option, should be available for workers choosing
personal accounts. Workers of all ages could benefit from an FDIC-
insured deposit option. Some workers will be wary of investing their
retirement funds in equities and other retirement products that carry
risk. For these workers, an FDIC-insured long-term deposit account
would be the most appropriate investment for all or part of the funds
freed up by Social Security reform.
Statement of Renee Lancon, West Hills, California
Our community is proud of our strong work ethic. We believe in
rewarding and supporting hard work and citizens who make contributions
to our society. That's why our congressional delegation simply must
support legislation (Representatives McKeon (R-CA) and Berman (D-CA)
have introduced the Social Security Fairness Act of 2005 (H.R.147) to
address the unfair cuts to the retirement benefits of public employees
who have dedicated their lives to serving their communities and their
country. I urge our Senators and Representatives to support legislation
to address these discriminatory penalties for public service:
Government Pension Offset (GPO) and Windfall Elimination Provision
(WEP), and on the issue of mandatory Social Security coverage
Too much is at stake to ignore this common-sense legislation!
I have recently retired and was shocked to find out when I went to
the Social Security Office last week that I cannot collect ANY of my
spouse's Social Security OR my own earned Social Security!
I earned my own 40 quarters when I worked in jobs other than
teaching and cannot collect my own! I also cannot collect on my
husband's because I chose to spend my career teaching!!!
I also moved from one state to another to follow my husband's
career and was not permitted to leave my ``retirement'' in the previous
state, so have worked as a teacher since 1962, and retired recently and
only have ``credit'' for 20 years of teaching! It is NOT enough to live
on!!!
I was supposed to be able to collect $500 a month IF I had not been
a teacher!!!
The Social Security would have helped enormously! I also help
support two children, one of whom is handicapped!!!
This Offset is unfair, inequitable and discriminatory. Most
teachers are women and this affects them enormously! We have a severe
teacher shortage in Los Angeles and in many other places and this
hinders our recruitment efforts even more!
And, the ``pension'' I do collect, I paid into!!! I also saved in a
403B. I did all the things that I thought would allow me independence
after a long career of public service! But, NOW, I am on the brink of
poverty after dedicating myself to teaching special needs children for
almost 40 years!!!
Nine out of 10 public employees affected by the GPO lose their
entire spousal benefit, even though their deceased spouse paid Social
Security taxes for years. The WEP causes low-paid public employees who
work both inside and outside the Social Security system to lose up to
60 percent of their Social Security benefits. The loss of these
benefits may make some people eligible for poverty-based assistance,
such as food stamps.
Please join
I have also attached additional information from National Education
Association's (NEA)
On behalf of the 2.7 million members, we would like to thank you
for the opportunity to submit comments on the Government Pension Offset
(GPO) and Windfall Elimination Provision (WEP), and on the issue of
mandatory Social Security coverage. We commend the Subcommittee for
holding this important hearing on a matter of great concern to
educators and other public employees.
NEA strongly supports complete repeal of the Government Pension
Offset and the Windfall Elimination Provision, which unfairly reduce
the Social Security and Social Security survivor benefits certain
public employees may receive. We oppose requiring public employees to
participate in Social Security. Our testimony will cover both of these
issues.
The Government Pension Offset: A Devastating Loss of Benefits for
Widows and Widowers
The Government Pension Offset reduces Social Security spousal or
survivor benefits by two-thirds of the individual's public pension.
Thus, a teacher who receives a public pension for a job not covered by
Social Security will lose much or all of any spousal survivor benefits
she would expect to collect based on her husband's private-sector
earnings.
Congress and the President agreed in 1983 to reduce the spousal
benefits reduction from a dollar-for-dollar reduction to a reduction
based on two-thirds of a public employee's retirement system benefits.
This remedial step, however, falls well short of addressing the
continuing devastating impact of the GPO.
The GPO penalizes individuals who have dedicated their lives to
public service. Nationwide, more than one-third of teachers and
education employees, and more than one-fifth of other public employees,
are not covered by Social Security and are, therefore, subject to the
Government Pension Offset.
Estimates indicate that nine out of 10 public employees affected by
the GPO lose their entire spousal benefit, even though their deceased
spouse paid Social Security taxes for many years. Moreover, these
estimates do not include those public employees or retirees who never
applied for spousal benefits because they were informed they were
ineligible. The offset has the harshest impact on those who can least
afford the loss: lower-income women. Ironically, those impacted have
less money to spend in their local economy, and sometimes have to turn
to expensive government programs like food stamps to make ends meet.
NEA receives hundreds of phone calls and letters each month from
educators impacted by the GPO. Many are struggling to survive on
incomes close to poverty, fearing they will be unable to cover their
housing, medical, and food expenses on their meager incomes. For
example, consider the following stories:
From NEA member Frances in Louisiana:
``My husband, a Baptist minister, passed away [in 2001] after
paying Social Security for 42 years. At times we had to take a second
loan on our home to pay the Social Security. Now, I had to pay back the
loan, but discovered that I will not get benefits because I receive a
small teacher retirement''
From NEA member Stella in Colorado:
``I am a 72-year-old widow. . . . I was happily married to the same
man for 391/2 years. My husband was a World War II disabled veteran who
worked and paid into Social Security for 50 years. . . . He passed away
11 years ago thinking I would be able to receive his Social Security
and Veterans Widow pension. . . . But now I'm living in poverty.''
The Windfall Elimination Provision: A Shocking Loss of Earned Benefits
The Windfall Elimination Provision reduces the earned Social
Security benefits of an individual who also receives a public pension
from a job not covered by Social Security. Congress enacted the WEP
ostensibly to remove an advantage for short-term, higher-paid workers
under the original Social Security formula. Yet, instead of protecting
low-earning retirees, the WEP has unfairly impacted lower-paid retirees
such as educators.
The WEP penalizes individuals who move into teaching from private-
sector employment, or who seek to supplement their often insufficient
public wages by working part-time or in the summer months in jobs
covered by Social Security. Educators enter the profession often at
considerable financial sacrifice because of their commitment to our
nation's children and their belief in the importance of ensuring every
child the opportunity to excel. Yet, many of these dedicated
individuals are unaware that their choice to educate America's children
comes at a price--the loss of benefits they earned in other jobs.
While the amount of reduction depends on when the person retires
and how many years of earnings he or she has accumulated, many public
employees can lose a significant portion of the Social Security
benefits they earned in other jobs. Like the GPO, the WEP can have a
devastating impact on educators' retirement security. For example:
From NEA member Carolyn in Kentucky:
``I started a direct sales business from my home at nights and
weekends to supplement my teacher retirement. I earned my necessary
quarters, reached my 62nd birthday, and then learned of the Windfall
Elimination Provision. I was told that I was eligible to receive
approximately $158 monthly; however, because of the WEP, this would be
reduced to $78 a month. By the age of 65, my payments had risen to $84,
but after paying $66 for Part B of Medicare, I now have $18 to deposit.
I have been forced because of the economics of the day to return to the
classroom to substitute teach for a paltry sum of $61 a day. . . . This
is certainly not the American dream I had in 1956 to become a
teacher!''
The ``Double Whammy'': Educators Impacted by Both the GPO and WEP
Many NEA members report that they are subject to double penalties--
losing both their own benefits and spousal benefits due to the combined
impact of the GPO and WEP. For example NEA member Martha from Texas
reports:
``By 1978, when I started my teaching career, I had already earned
my 40 quarters of Social Security and over the years depended on these
benefits as part of my retirement. I should be entitled to $415 a month
at the age of 62. However, because of the Windfall Elimination
Provision, I will now be entitled to $206 a month, and this reduction
in my earned retirement is a big loss. [In addition], according to the
Social Security Administration, I should be entitled to approximately
$970 a month for widow's benefits. However, because of the Government
Pension Offset, I can only receive $21 a month. Both the Government
Pension Offset and Windfall Elimination Provision are devastating to
teacher retirees and me.''
The National Impact of the GPO and WEP: Undermining Teacher Recruitment
Efforts
The GPO and WEP have an impact far beyond those states in which
public employees like educators are not covered by Social Security.
Because people move from state to state, there are affected individuals
everywhere. The number of people impacted across the country is growing
every day as more and more people reach retirement age.
Perhaps most alarming, the GPO and WEP are impacting the
recruitment of quality teachers to meet urgent national shortages.
Record enrollments in public schools and the projected retirements of
thousands of veteran teachers are driving an urgent need for teacher
recruitment. Estimates for the number of new teachers needed range from
2.2 million to 2.7 million by 2009.
At the same time that policymakers are encouraging experienced
people to change careers and enter the teaching profession, individuals
who have worked in other careers are less likely to want to become
teachers if doing so will mean a loss of Social Security benefits they
have earned. Some states seeking to entice retired teachers to return
to the classroom have found them reluctant to return to teaching
because of the impact of the GPO and WEP. In addition, current teachers
are increasingly likely to leave the profession to reduce the penalty
they will incur upon retirement, and students are likely to choose
other courses of study and avoid the teaching profession.
The GPO and WEP also impact other critical public services fields,
including police and firefighters. Our nation can ill-afford to allow
the very real fear of poverty in retirement to force talented,
dedicated individuals out of these professions.
The GPO/WEP Solution: Total Repeal
Representatives McKeon (R-CA) and Berman (D-CA) have introduced the
Social Security Fairness Act of 2005 (H.R.147). This bipartisan
legislation, which already has over 260 cosponsors, would eliminate the
GPO and WEP, thereby allowing public employees, like all other
employees, to collect the benefits they earned and need. NEA urges the
Subcommittee, and the entire House of Representatives, to take
immediate steps toward passage of the McKeon-Berman Bill.
Mandatory Coverage: An Unwise and Unnecessary Approach
NEA's position on repeal of the Government Pension Offset and
Windfall Elimination Provision should not in any way be interpreted as
support for requiring public employees to participate in Social
Security. NEA strongly opposes mandatory coverage. Instead, NEA simply
believes that educators should be able to receive the benefits they or
their spouse earned by working in covered employment, without
jeopardizing their public pension.
Many existing public employee programs are tailored to meet the
needs of specific employee groups. Forcing educators into Social
Security would jeopardize these state and local plans. In addition,
Social Security trust funds can be invested only in U.S. Treasury
bonds. State and local governments permit a greater diversity of
investment options, thereby potentially achieving a greater rate of
return.
Mandatory coverage of educators would also increase the tax burden
on public-sector employers. Ultimately, these increased tax obligations
would lead to difficult choices, including reducing the number of new
hires, limiting employee wage increases, reducing cost-of-living
increases for retirees, and reducing other benefits such as health
care.
Finally, mandating coverage of educators will not solve the Social
Security system's financial difficulties. The amount of money gained by
mandating coverage would be relatively small and would not solve the
long-term Social Security crisis. Requiring new state and local
employees to pay into Social Security would enable the federal
government to continue borrowing money from Social Security trust
funds, and, therefore, could exacerbate financing problems.
We thank you for your consideration of these comments.
Statement of Olivia S. Mitchell \1\, Wharton School, University of
Pennsylvania, Philadelphia, Pennsylvania
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\1\ Olivia S. Mitchell is the International Foundation of Employee
Benefit Plans Professor and Professor of Insurance and Risk Management;
she is also Executive Director, Pension Research Council and Director,
Boettner Center for Pensions and Retirement Security, all at The
Wharton School of the University of Pennsylvania. The views offered
here are solely those of the author and do not represent those of any
institutions with which she is affiliated.
---------------------------------------------------------------------------
Mr. Chairman and members of the Subcommittee: Thank you for the
opportunity to appear here today. My name is Olivia S. Mitchell, and I
am a Professor of Insurance and Risk Management at The Wharton School
at the University of Pennsylvania.
As you know, Social Security faces imminent insolvency, with
payroll tax revenues threatening to fall below benefit payments within
6 years. The present system also contains many inequities and anomalous
redistribution patterns, and it offers current workers a surprisingly
low and very risky return. \2\
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\2\ Cogan and Mitchell (2002).
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The bipartisan Commission to Strengthen Social Security (CSSS), on
which I served in 2001, believed that offering two separate tiers under
a reformed Social Security program, each with its own function, would
improve the overall program's transparency and equity. Social adequacy
was to be the principal objective of the traditional defined benefit
piece, while individual equity was seen as the goal of a personal
accounts component.
My testimony before this Subcommittee today focuses on two aspects
that must evaluated in designing a Personal Retirement Account element
as part of a reformed Social Security: (1) administrative fees and
charges, and (2) payout issues. My views derive from the research
literature on administrative fees and payout issues, particularly
regarding how Personal Retirement Accounts might be invested and how
the funds at retirement might be deployed. The views I offer are my own
and do not represent those of any institutions with which I am
affiliated.
My conclusions are that the voluntary Personal Retirement Accounts
(PRAs) should be formulated so that:
They offer participants some investment choice while
still being relatively inexpensive;
They standardize disclosure regarding fees and charges so
participants can understand and compare them;
They require retirees to annuitize part of their
retirement assets in their Personal Accounts, so that the combined
benefit payments from Social Security will keep them out of poverty.
Administrative Fees and Charges
Experience with public and private pension plans the world over
indicates wide disparity in reported administrative fees and charges
across systems. Several lessons are worth highlighting:
Measuring pension expenses requires standardized
reporting and disclosure standards. Pension systems often structure
their charges in bewildering ways. For instance, fees can be levied as
flat commissions, a percent of contributions, or a percent of the
fund's annual yield. \3\ Such complexity makes it difficult for plan
participants to compare fund performance. A sensible response, adopted
by many Latin American pension supervisors, is to require disclosure
using a standardized table for reporting charges. This has the effect
of increasing the information available to participants and hence,
making the market more competitive. A more problematic tactic adopted
by the UK, for example, is to set a national fee cap. This may limit
competition and reduce participants' focus on holding down costs.
---------------------------------------------------------------------------
\3\ Mitchell (1998).
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Scale is important in keeping costs down. \4\ Larger
money managers benefit from scale economies, centralized fund
administration, and centralized collection of contributions. For
example, in Australia, retail financial service providers charge three
times more in pension fees and charges than do institutional managers
of corporate pensions. While there is little agreement on the minimum
size of a cost-effective pension, managers of large defined
contribution plans such as the Federal Thrift Savings Plan which covers
civil servants and military employees, my University's retirement plan
(TIAA-CREF and Vanguard), and others, charge pension participants
annual fees between 0.1-0.4% of assets under management. These fees are
well below what savers pay in typical Individual Retirement Accounts.
---------------------------------------------------------------------------
\4\ See Mitchell (1998), Bateman and Mitchell (2004), and
Whitehouse (2005).
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Private retirement systems might seem to be more costly
than Social Security, but this is a misleading conclusion as they
generally offer more and different services. Some have suggested that
the current U.S. Social Security system is one of the lowest-cost
programs around. Nevertheless, Social Security does not provide the
wide range of services provided by modern managers of asset-backed
retirement accounts. For instance, the government program does not
invest in the capital market, it holds no insurance-type reserves even
though it offers disability and survivors' insurance, and it takes a
very long time--more than a year--to post workers' contributions to
their records. \5\ By contrast, privately managed fund providers would
and can do better by taking advantage of modern technology.
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\5\ Mitchell (1998).
Taking these and other factors into account, I and other Commission
members concluded that it would be reasonable to establish personal
accounts along the lines of the Federal Thrift Saving Plan.
Accordingly, and for a few years into the system, a central Governing
Board would be charged with collecting contributions, managing records,
and selecting private-sector managers who would invest participant
assets via a competitive bidding process. This Board could either
handle record-keeping and benefit payments itself, or these functions
could be outsourced via a competitive process.
We also proposed that investment choices in the personal accounts
would be limited but diverse. The options suggested include:
a Government Securities Investment fund (mainly short-
term U.S. Treasury securities);
a Fixed Income Index Investment fund (tracking a U.S.
bond market index);
a Common Stock Index Investment fund (tracking the
Standard & Poor's 500 Index of large-company stock);
a Small Capitalization Stock Index Investment fund
(tracking the Wilshire 4500 stock index); and
an International Stock Index Investment fund; and
a fund that invests in Government Treasury Inflation-
Protected Securities.
At some later date, plan participants might be permitted to move
their investments to licensed, supervised, private money managers
offering an approved set of low-cost investment options. The benefit
levels that might be expected from alternative investment approaches
for Personal Retirement Accounts appear in Table 1, along with a
comparison of current benefits, payable benefits, and scheduled
benefits.
The Office of the Chief Actuary at Social Security estimated that
the proposed CSSS approach would be quite inexpensive, costing only
about 0.3% of assets annually.
Table 1: Monthly Social Security Benefits Under Alternative Scenarios
Projected to 2052 (CSSS Model 2 $01)
I. Lifetime low-wage earner\*\
Today's benefit $637
Projected Benefit With Personal Account:
Low yield 867
Medium yield 1,050
High yield 1090
Current Program Payable 713
Scheduled benefit 986
II. Lifetime medium-wage earner\*\
Today's benefit $1,052
Projected Benefit With Personal Account:
Low yield 1,204
Medium yield 1,525
High yield 1,595
Current Program Payable 1,179
Scheduled benefit 1,628
III. Lifetime maximum-wage earner\*\
Today's benefit 1,366
Projected Benefit With Personal Account:
Low yield 1,565
Medium yield 1,907
High yield 1,983
Current Program Payable 1,557
Scheduled benefit under current law 2,151
\*\ These categories, developed by Social Security actuaries, are
specified (in $01) such that a lifetime ``low'' earner would have
averaged approximately $15,900 per year, whereas the medium earner
averaged $35,300 per annum and the high earner $56,400.
Source: Cogan and Mitchell (2003)
Payout Issues
When considering how to structure payouts from voluntary Personal
Accounts under a reformed Social Security system, naturally the
question arises as to whether and how access to the funds should be
permitted. CSSS members agreed that pre-retirement access to the money
should not be allowed to `leak' out before retirement, as early
consumption would likely increase the chances that the elderly would
then have to rely on old-age antipoverty programs. Yet, as the
Commission pointed out, ``a clear appeal of personal retirement
accounts is that they grant workers ownership over their own assets.''
After weighing competing arguments, we concluded that personal accounts
should be preserved until the nationally-agreed on early retirement
age, consistent with current Social Security policy which does not
permit pre-retirement access to old-age benefits.
By contrast there is more discussion regarding appropriate designs
for the pension decumulation process under Personal Accounts. This
refers to the process by which older participants access their
retirement assets, how they invest their money during retirement, and
whether annuities--which are financial products designed to cover the
risk of retirees outliving their assets--should play a central role.
Regarding post-retirement fund management, my Commission recommended
several methods of drawdown including phased withdrawals and annuities,
as well as possibly lump sums.
To highlight the importance of longevity risk, Table 2 shows that a
65-year old U.S. male can anticipate living to age 81, but he has
almost a 20% chance of living to age 90 or beyond. A woman of the same
age can expect to live to 85, but she has more than a 30% chance of
living to age 90 or older (Table 2). In other words, people face
substantial risk of outliving their life expectancy, implying
substantial uncertainty regarding how long one must conserve and spend
retirement assets, combined with a high probability of running out of
money.
Table 2: Remaining Life Expectancy and Survival at Age 65 (in 2000)
Remaining Life Men Women
Expectancy (years): 16.4 19.6
Probility of Surviving to Age:
70 88% 92%
75 74 82
80 56 69
85 36 51
90 18 31
95 6 14
100 1 4
Source: Mitchell and McCarthy (2004)
A life-long annuity can help protect against this risk, by paying a
premium to an insurer who then pools a number of people with similar
longevity expectations. Though some have argued that such insured
products seem expensive, my research shows that the ``money's worth''
(MW) of such life income products is rather substantial. The MW refers
to the discounted cash flow of the lifetime payments received divided
by the product premium. For example, Table 3 shows that U.S. purchasers
of an immediate single-life annuity would expect back 93 cents on the
dollar from a life annuity; in exchange purchasers have the insurance
value that they will never outline their lifetime benefit payments. The
MW ratios are similar in Australia, Italy, and the UK.
Table 3. Money's Worth of Single Premium Nominal Life Annuities for 65-
Year Olds: An International Comparison (using country Treasury yield
curves and annuitant life tables)
Australia Canada Italy UK US
Men 0.986 1.014 0.958 0.96 0.92
6 7
Women 0.970 1.015 0.965 0.95 0.92
7 7
Source: Derived from Mitchell and McCarthy (2004)
These issues are complex and potentially politically delicate,
since some workers will fail to accumulate much in their accounts over
their worklives; also some retirees might anticipate relatively lower-
than-average life expectancies, making forced annuitization seem
punitive.
In balancing the various choices for payout design, the Commission
concluded that partial annuitization should be mandated so that ``the
yearly income received from an individual's Social Security benefit
plus the joint annuity (if married) would protect either spouse from
falling below the poverty line during retirement'' (CSSS 2001). Any
funds above those needed to buy the minimum annuity could be accessible
as a lump sum and/or bequeathed at death. This approach has the dual
benefit of both protecting the retiree from falling below the poverty
line while still allowing some access to the funds accumulated in the
Personal Retirement Account.
Remaining design issues include how retirees would learn about
annuity products, who would sell them, and whether the private
insurance market can do a good job meeting market demand. To date,
relatively few consumers have purchased payout annuities, making it a
bit difficult to forecast how the market will develop. Several key
issues will have to be decided:
Which annuity products will be offered and to whom?
Currently private insurers in the U.S. offer a wide and very
complex array of annuity products, including immediate versus deferred
benefit payments; fixed nominal payouts versus programs with escalating
or variable payouts; and term certain versus other payment periods.
Also annuities offered through company pensions are mandated to use
unisex mortality tables whereas retail annuities do not.
A logical lesson from the behavioral finance literature is that it
would be sensible to establish a ``default'' payout format such as a
joint and survivor inflation-linked or escalating life annuity, which
retirees would automatically receive unless they specifically opted for
something else. As a case in point, retirees in the UK are required to
annuitize their pension assets at age 75; in Germany, workers with
assets in so-called Reister-pensions may take 20% of their accumulated
assets in a lump sum, another 20% in a phased withdrawal format; but at
age 85, the retiree must annuitize his balance and the benefit may not
be lower than the periodic payment received before that age.
Of course, since many retirees are not accustomed to thinking about
longevity risk, they would require financial education to help them
clearly understand the costs and benefits of different ways to manage
their Personal Retirement Account assets.
Which annuity providers will be allowed in the market,
and how will they be regulated?
Evidence from other countries adopting personal accounts indicates
that private insurers can and do offer the types of products that
retirees want. For instance, in Chile, middle and upper income workers
generally prefer the annuity payout over a phased withdrawal approach
to retirement drawdowns.
Nevertheless, there will likely have to be some governmental
oversight over the annuity market. In Mexico, for instance, all
insurers are required to bid on all retirees, and when issuing annuity
bids, the companies may learn only a retiring worker's age and sex (but
not his identity, his health status, or his account balance). This
reduces the chances of ``cherry-picking'' rich retirees or those
anticipated to die soon.
Another issue has to do with whether unisex mortality tables would
be required for the annuities. Doing so, of course, involves
redistribution of wealth away from shorter-lived men and toward longer-
lived women, which is already true in the current Social Security
System. Requiring joint and survivor benefits as a default would render
this issue less important quantitatively.
What role, if any, would the federal government have?
As an alternative to building up private annuity markets, some have
suggested that the federal government might directly sell the mandatory
annuities under the new system. \6\ While this might hold down some
costs, it can cause other problems. For example, there could be
political interference associated with investing the annuity reserves--
amounting to 15% of GDP at maturity--and it raises questions about
whether the reserves could truly be saved, or whether they would be
`spent' akin to Social Security Trust Fund assets. Further, the
government would then have responsibility for mortality and capital
market risk, which would likely be incorrectly priced and managed.
---------------------------------------------------------------------------
\6\ NASI (2005).
---------------------------------------------------------------------------
One key role for the federal government in this context has to do
with tax and transfer policy. For instance, pension and Individual
Retirement Account assets are protected in bankruptcy but are divisible
in divorce; whether the same treatment would be afforded PRA annuities
and assets has yet to be determined. Conversely, annuity flows and lump
sums are generally `counted' when retirees apply for SSI and Medicaid
benefits; payouts are taxed as income. Whether and how PRA assets and
annuities are to be treated for tax and transfer purposes--as well as
others (e.g. the estate tax vulnerability of the PRA assets if the
worker or spouse dies) will take additional work to get it right.
Another role for the government is to enhance the range of
investments available to insurers providing the products. \7\ Many
writers have noted the key role of federal government provision of
inflation-indexed bonds sufficient to meet market demand. Expanding
their supply would allow private insurers to offer the kinds of indexed
annuity products that would give retirees better protection against
inflation, which is a source of substantial retirement insecurity.
---------------------------------------------------------------------------
\7\ Bodie et al. (2002).
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Conclusioin
My testimony has focused on the role of administrative fees and
charges in a PRA type approach, and also on payout considerations after
retirement. I conclude that voluntary Personal Retirement Accounts can
be designed so as to provide participants with some investment choice
while still being relatively inexpensive; they can build in incentives
for competition among fund managers, including disclosure regarding
fees and charges; and they can sensibly require retirees to annuitize
part of their retirement assets in their Personal Accounts, so that the
combined benefit payments will keep them out of poverty.
Thank you for your interest and I am happy to answer any questions
you may have about my remarks.
References
Bateman, H. & O.S. Mitchell. ``New Evidence on Pension Plan Design
and Administrative Expenses.'' Journal of Pension Finance and
Economics. 2004: Vol 3(1): 63-76.
Bodie, Z., B. Hammond, and O.S. Mitchell, eds. Innovations in
Financing Retirement. Philadelphia, PA: University of Pennsylvania
Press, 2002.
Brown, J.R., O.S. Mitchell, J.M. Poterba. ``The Role of Real
Annuities and Indexed Bonds in an Individual Accounts Retirement
Program.'' In Risk Aspects of Investment-Based Social Security Reform.
Eds. J. Campbell and M. Feldstein. 2000: 321-360.
Brown, J., O.S. Mitchell, J. Poterba, and M. Warshawsky. The Role
of Annuity Markets in Financing Retirement. MIT Press, 2001.
Commission to Strengthen Social Security (CSSS), Strengthening
Social Security and Creating Personal Wealth for all Americans, Final
Report, Washington, D.C., December 2001.
Cogan, J.F. & O.S. Mitchell. ``Perspectives from the President's
Commission on Social Security Reform.'' Journal of Economic
Perspectives. 17(2). Spring 2003.
Mitchell, O.S. ``Administrative Costs of Public and Private Pension
Plans''. In Privatizing Social Security, Ed. M. Feldstein. NBER.
Chicago: University of Chicago Press, 1998: 403-456.
Mitchell, Olivia S. & David McCarthy. ``Annuities for an Ageing
World''. In Developing an Annuities Market in Europe. Eds. E. Fornero &
E. Luciano. Elgar, 2004: 19-68.
NASI Uncharted Waters: Final Report. http://www.nasi.org/info-
url_nocat2718/info-url_nocat_show.htm?doc_id=212573
Whitehouse, E. Testimony Before the Subcommittee on Social Security
of the House Committee on Ways and Means, Washington, D.C. June 16,
2005.
Statement of Robin Sewell, Littleton, Massachusetts
I worked to earn 40 quarters and had social security payments taken
out of my paycheck for yeas. As I completed my undergraduate degree and
master's degree in my late 20's and 30's, I started another career as
an employee for the town of Littleton as a teacher over 17 years ago.
Because I began my teaching career later in life, I will have a very
difficult time putting in my years of service to even come close to
reaching a moderate percentage from my municipal retirement.
And, if my husband should pre-decease me, my widow benefits, even
though he paid the maximum for social security each year, will also be
severely impacted.
Please consider that the current provisions penalize those
``qualified'' workers who have a career change or start working for a
municipality later in life.