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Retirement
Privatizing Social Security
May 24, 2001: 10:20 a.m. ET

Workers may someday be able to invest part of their contributions
By Staff Writer Martine Costello
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NEW YORK (CNNfn) - A new commission appointed by President Bush will develop a plan to save Social Security that includes a provision allowing people to invest part of their contributions in the U.S. stock market.

The controversial plan to "privatize" Social Security will likely trigger intense debate as supporters argue it offers workers better returns and critics contend it cuts benefits.

 
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Meanwhile, the government has already looked to Wall Street for retirement savings on a smaller scale with the Thrift Savings Plan for federal employees, which is managed by Barclays Global Investors.

"We're 20 years after the birth of the 401(k), and what we're excited about in Social Security reform is that it will provide an environment for dialogue about retirement investing," said Richard Malconian, chief executive, U.S. defined contribution at Barclays Global Investors. "We are passionate about the investing process, meaning balancing risk, returns and cost."

Social Security, the program established by President Franklin D. Roosevelt in 1935 as a safety net for working Americans, is running out of money. By one forecast, the program will be insolvent in 2038. Other estimates say the program will start running a deficit as early as 2015.

President Bush appointed a 16-member commission May 2 to make recommendations to modernize and preserve the program without increasing Social Security payroll taxes. Bush said he wants the plan to include "controlled, voluntary personal retirement accounts."

 
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Bush also requested that benefits not be cut for existing or new retirees.  It will be up to the committee to decide how much of workers' money will go into the market, but during the campaign Bush had pushed for a plan that would allow up to 2 percent of contributions.

The panel of eight Republicans and eight Democrats includes retired U.S. Sen. Daniel Patrick Moynihan, D-N.Y., and Richard Parsons, chief operating officer of AOL Time Warner, the co-chairmen. (AOL Time Warner is the parent of CNNfn.com). Efforts to reach Moynihan and Parsons were unsuccessful.

Efforts to reach other panel members were also unsuccessful, including Robert Pozen, who is stepping down at Fidelity. A representative of Moynihan said members were staying away from press interviews until after the panel starts meeting.

The commission will issue a final report this fall with recommendations for new legislation. The topic is sure to trigger fireworks in Congress, where Republicans mostly support privatization but Democrats are more divided. Many watchers don't expect changes for two or three years.

The defection of Sen. James Jeffords of Vermont from the Republican Party may also throw a monkey wrench into the equation. The move shifts power to the Democrats for the first time since 1994.

 
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"I think the election of 2002 will be about Social Security reform," said Paul Hewitt, a consultant to the National Commission on Retirement Policy.  "The situation is very polarized."

But Hewitt said the government's move to allow federal employees access to the market had been smooth.

The Thrift Savings Plan began in 1987 for 2.5 million federal workers. The government contributes 5 percent of your salary and you can contribute up to 10 percent, or $10,000.

Barclays won the job through competitive bidding, Hewitt said.

Up until this month, Barclays has offered two investing choices: an S&P 500 index fund and a bond index fund. The Federal Retirement Thrift Investing Board, the panel established to administer the plan, offered a third choice, a Treasurys index fund.

Barclays recently added a small companies index fund and a global index fund. The management fee varies on the size of the account, but the cost for the S&P 500 fund is about 0.02 percent a year, the company said.

Index funds make sense because they are cost-efficient and eliminate the possibility of "style drift," which is when a fund goes outside its investing mandate, Malconian said.

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The Thrift Savings Plan was the model for another Social Security reform bill proposed in 1998 by U.S. Sens. Judd Gregg, R-N.H., and John Breaux, D-La., Hewitt said. In that plan, which never got out of committee last year amid election-year hoopla, people would put 2 percent of their Social Security contributions into an investing account.

The bill came out of a study by the National Commission on Retirement Policy, a bipartisan commission chaired by Breaux and Gregg.

"This is a 401(k)-styled defined contribution plan," Hewitt said of the Thrift Savings Plan. "It has performed very, very well."


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Besides the 2 percent "carve-out" -- meaning the money would leave the Social Security coffers and go into the market -- the retirement age would have increased and benefits to spouses would have decreased.

Still, there have been questions about the administration of the Thrift Savings Plan, a job now handled by the thrift board, said Dallas Salisbury, president of the Employee Benefit Research Institute, a non-profit research group.

The thrift board has been trying to hire an outside administrator for three years to make the plan more flexible, like a 401(k), Salisbury said. Now, employees have less flexibility in changing their investments and contribution levels.

For example, it takes Social Security 18 months to record your income after you get your W-2, Salisbury said.

"The magnitude for trying to create an administrative system and make it functional for 140 million people (in Social Security) could be done, but it will take years," Salisbury said. "The federal thrift program is having problems and that's a lot fewer people."

The privatization debate heats up

Mike Tanner, director of the Cato Institute's Project on Social Security Privatization, argued the rate of return people get for their contributions is much too low. The average worker earns 1.4 percent on his investments,  but many younger workers actually lose money.

The Cato Institute, a Washington-based think tank, advocates 100 percent privatization of Social Security.

"Social Security is a bad deal," Tanner said.

Private accounts would also give workers ownership of their money, Tanner said. Right now, the government has control of your contributions until you retire.

"This will benefit low- and moderate-income people," Tanner said. "The rich will always have retirement plans. This is an opportunity for lower-wage workers to get in and invest."

But critics argue privatization will chip away at the program.

David Smith, director of public policy at the AFL-CIO, pointed out that if you take money out of the system for private accounts, Social Security will have to come up with the money to pay benefits somewhere. That means a cut in benefits or higher payroll taxes.

"Going to private accounts imperils Social Security from meeting its obligations," Smith said.

Since Bush has called for no payroll tax hike, the private accounts would likely mean a higher retirement age, Smith said. And the cost to maintain millions of tiny accounts would be enormous, Smith argued.

"I don't think it's a done deal at all," Smith said. "These folks have been prowling around about privatization for years. But the more people hear about it, the less they like it."

The impact of market risk on retirement also is grave, Smith said. Workers will lose a guaranteed benefit that is inflation-adjusted and not affected by market fluctuations.

"Even if everybody uses the accounts, 2 percent of a rich person's income is worth a lot more than a lower-income salary," Smith said.

Speculation about a new bill

How might the new bill look?

Hewitt thinks there might be a government match for lower-income employees, similar to the contributions private employers make in 401(k) plans. The match would phase out as a worker's salary increased. Democratic presidential candidate Al Gore had proposed such a plan.

Tanner thinks it should include a wider array of investing options, from stocks and bonds to mutual funds.

But it wouldn't be a free-wheeling environment in which you could choose the riskiest investments, Hewitt said. The money would be insured by Social Security similar to how pension benefits are insured through the Pension Benefit Guarantee Corp., Hewitt said.

"This is Social Security, and the government is not going to get itself into a situation where it has to cover for a lot of cowboys out there," Hewitt said. "There will be standards and they probably will be written tighter...we have a pretty good private pension system and it's very regulated, and there are surprisingly few blow-ups." graphic

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Market indexes are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer LIBOR Warning: Neither BBA Enterprises Limited, nor the BBA LIBOR Contributor Banks, nor Reuters, can be held liable for any irregularity or inaccuracy of BBA LIBOR. Disclaimer. Morningstar: © 2014 Morningstar, Inc. All Rights Reserved. Disclaimer The Dow Jones IndexesSM are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use. All content of the Dow Jones IndexesSM © 2014 is proprietary to Dow Jones & Company, Inc. Chicago Mercantile Association. The market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. FactSet Research Systems Inc. 2014. All rights reserved. Most stock quote data provided by BATS.