Reconstructing Your Retirement
President Bush plans to take privatization from lofty theory to messy reality. Here's how a new system might work, and what it means for you
(MONEY Magazine) – When President Bush announced immediately after his re-election that reforming Social Security would be a priority of his second administration, there wasn't any doubt what kind of reform he had in mind. For years there has been talk about privatizing the program. How that might work in practice remains to be seen, but the broad outlines of the debate are clear. Currently, Social Security is a pure tax-and-transfer program in which workers' payroll taxes are handed over to retirees. The President would like to see it become a retirement system in which workers could invest some of the money they now pay as Social Security taxes into personal investment accounts that resemble 401(k)s (see the chart on the following page).
The administration has yet to propose a plan, and there will be plenty of wrangling in Congress before any big changes are made. But given the President's commitment to privatization, changes are coming. And for any taxpayer, that raises several questions about how all this is likely to play out.
1. I'm retiring in a few years. How would a move to personal accounts affect me?
It would be a non-event. Under virtually all the major personal-account proposals, people who are already receiving Social Security benefits, as well as those close to retirement (usually defined as someone 50 to 55 or older), would remain in the present Social Security system and receive the benefits they've been promised, including cost-of-living increases.
2. Would personal accounts be mandatory if I'm not retired yet?
It's unlikely that Congress would force people to open personal accounts. Almost all personal-account proposals give younger workers the option of remaining in the present system.
If you decided to stay, all of your payroll taxes—the 6.2% of your salary paid by you plus the 6.2% your employer kicks in—would continue to flow into Social Security's coffers, and at retirement you would receive your Social Security checks. If you chose a personal account, a portion of your payroll taxes would go into the account, while the remainder of your share as well as the taxes paid by your employer would go into the current Social Security system. At retirement, you would then collect benefits from Social Security and your own account.
One caveat. Currently, what you collect from Social Security is based on your career earnings, which are then adjusted upward to reflect growth in wages during the time you've been in the work force. In the future, your earnings are likely to be adjusted instead by inflation, which rises more slowly than wages. That means a smaller check for you. The reason for shifting the benchmark is that there's simply not enough money in the system to pay everyone the benefits now promised.
3. How much of my income would I be allowed to put into my personal account?
Amounts vary from proposal to proposal. No plan has established itself as a clear front-runner, but many observers believe that one recommended in the December 2001 report by the President's Commission to Strengthen Social Security might be a starting point. Under that plan, each year you could set aside 4% of your payroll taxes, up to an annual maximum of $1,000, in a personal account.
4. Would it offer as many investment options as my 401(k)?
Not at first. You would probably get to choose from a lineup of five or so stock and bond index portfolios much like those offered to federal employees in their Thrift Savings Plan: a Standard & Poor's 500 fund, a small-cap fund that tracks the Wilshire 4500, an international fund based on the MSCI EAFE index, a bond fund that mirrors the Lehman Brothers U.S. aggregate bond index, and a government securities fund. You might also have access to balanced funds that include both stocks and bonds.
Once your balance reached a certain amount—say, $5,000 —you might be able to transfer your account to a private investment firm. While brokerages and mutual fund companies could offer more investment options, their funds would still probably have to be diversified across market sectors. You wouldn't be able to put your stash in tech funds.
5. Would I be able to move money from one fund to another on a daily basis?
Doubtful. You'd likely be limited to switching investments once every 12 months. More lenient rules might apply to money in accounts at private investment firms.
6. What sort of fees would I pay on my personal account?
Annual costs for a lineup of index funds and a limited roster of services might range from 0.35% to 0.10% (which is the annual cost of running the federal Thrift Savings Plan). That compares with average annual costs of about 0.5% for large 401(k) plans and 1.5% for smaller plans. Private firms could offer more services, but naturally at higher prices.
7. Would I be able to withdraw funds from my account before retirement?
No. If you die before retirement, though, your account would go to your heirs.
8. Could I take my account balance as a lump sum at retirement?
Once you retire, you would likely have to buy an annuity or sign up for a systematic withdrawal plan that would guarantee a minimum annual income. If you had money left after that, you could take it as a lump sum.
9. Would my retirement benefit be bigger with personal accounts than under the current Social Security system?
That's difficult to say, since your account's value could vary widely based on the investments you choose, your age, your earnings and the specifics of the plan. Even the staunchest supporters of privatization agree, however, that personal accounts can't turn Social Security into a bonanza that will provide a cushy retirement. Bottom line: You will still have to save outside of Social Security if you hope to maintain anything close to your present standard of living.
10. Aren't private accounts riskier than the current system?
Neither approach is risk-free. With private accounts, you expose your nest egg to the ups and downs of the markets. The risk in the current system is political. Social Security benefits are "promised," not guaranteed. If the tax burden on future workers becomes too onerous, Congress could cut benefits, as it has in the past.