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Testimony Before the Subcommittee on Social Security, Committee on Ways 
and Means, House of Representatives:

United States Government Accountability Office:

GAO:

For Release on Delivery Expected at 10:00 a.m. EDT:

Thursday, June 23, 2005:

Social Security Reform:

Considerations for Individual Account Design:

Statement of Barbara D. Bovbjerg, Director, Education, Workforce, and 
Income Security:

GAO-05-847T:

GAO Highlights:

Highlights of GAO-05-847T, a testimony before the Subcommittee on 
Social Security, Committee on Ways and Means, House of Representatives:

Why GAO Did This Study:

Social Security forms the foundation for our retirement income system, 
providing 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. 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 
individual accounts.

The Subcommittee asked GAO to discuss options for the administration of 
individual accounts, including the major design issues that are raised 
within the contribution, accumulation, and distribution phases of a 
retirement savings vehicle.

What GAO Found:

Because Social Security is so deeply woven into the fabric of our 
nation, any proposed reform should be considered as a package and with 
respect to all of the major elements of the Social security program 
(e.g., retirement, disability, and survivors). Individual accounts can 
be a part of that reform, and in fact, many proposals include 
individual accounts. However, any proposed reform must consider the 
program in its entirety, rather than one aspect alone. Likewise, an 
individual account system must address key design issues associated 
with the phases of a retirement savings vehicle.

Contribution phase: Designing the contributions for individual accounts 
requires making choices about the role that contributions play with 
respect to the current Social Security system. These choices include 
determining the size of the contribution rate, how the contributions 
are collected, whether the funds come from existing revenue sources, 
and whether participation is voluntary or not.

Accumulation phase: Once contributions have been made, the accumulation 
phase requires making decisions about what to do with the funds to make 
them grow. These decisions include how much choice individuals would 
have in selecting funds, who would invest their funds, and what the 
range of their investment choices would be. These decisions, in part, 
would determine the cost and complexity of the system and the degree of 
public education needed.

Distribution phase: Distributing the accumulated earnings in individual 
accounts needs to focus on how these funds would be preserved for 
retirement. This includes making choices about when individuals can 
gain access to their funds, how much money they receive, and in what 
form they receive the funds. Other considerations that arise include 
the tax treatment of distributions and whether there will be a 
guarantee of a specified level of benefits.

Overall, when designing individual accounts, it is important to keep in 
mind that more features tend to increase costs. For example, more 
investment choices can result in more administrative fees. 
Administering the accounts and educating the public about a system of 
individual accounts requires choices and trade-offs. However, any 
related administrative, management, and data systems must be developed 
and tested before the accounts become available to workers in order to 
maintain confidence in the system. Individual accounts could also be 
designed to include some progressive features, which would mirror the 
redistributive effects of the current Social Security program. 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.

www.gao.gov/cgi-bin/getrpt?GAO-05-847T.

To view the full product, including the scope and methodology, click on 
the link above. For more information, contact Barbara D. Bovbjerg at 
(202) 512-7215 or bovbjergb@gao.gov.

[End of section] 

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.[Footnote 1]

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 versus 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 versus defined contribution. 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.[Footnote 2]

Pay-as-you-go versus 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.[Footnote 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.

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 
contributions or 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.[Footnote 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.

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.[Footnote 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.

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 the 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 Lump 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.[Footnote 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.

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.[Footnote 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.

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.[Footnote 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.

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.

[End of section]

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.: May 
6, 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.: July 29, 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.: July 22, 1998.

Social Security: Restoring Long-Term Solvency Will Require Difficult 
Choices. GAO/T-HEHS-98-95. Washington, D.C.: Feb. 10, 1998.

FOOTNOTES

[1] See the list of related GAO products at the end of this statement.

[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.

[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).

[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.

[5] See GAO, Social Security Reform: Information on Using a Voluntary 
Approach to Individual Accounts, GAO-03-309, (Washington, D.C.: March 
10, 2003).

[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).

[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.

[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).