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Report to the Ranking Minority Member, Special Committee on Aging, U.S. 

Senate:



United States General Accounting Office:



GAO:



March 2003:



Social Security reform:



Information on Using a Voluntary Approach to Individual Accounts:



Social Security Voluntary Accounts:



GAO-03-309:



GAO Highlights:



Highlights of GAO-03-309, a report to the Ranking Minority Member of 

the Special Committee on Aging, United States Senate



Why GAO Did This Study:



Many proposals have been offered to restructure the U.S. Social 

Security system to include individual retirement savings accounts. 

Since 2000, however, some key proposals would make participation in 

the accounts voluntary rather than mandatory. While any individual 

account plan can offer a variety of choices regarding contributions, 

investments, and withdrawals, the choice of whether or not to 

participate is fundamental to a voluntary approach. That choice could 

have significant effects on individual retirement incomes and on the 

costs to the government as well.



GAO was asked to report on the implications of using a voluntary 

approach to individual accounts. Accordingly, we are reporting on (1)

how voluntary plans can affect individuals, (2) how they could affect 

the total costs of the retirement system, and (3) the role of 

educational efforts relating to the participation decision. 

Throughout this report, GAO focuses on the issues that pertain 

specifically to a voluntary approach as distinct from a mandatory 

approach.



GAO studied 3 nations that have enacted voluntary individual account 

plans—the Czech Republic, Germany, and the United Kingdom.



What GAO Found:



If policymakers decide to restructure Social Security to include 

individual accounts, making participation voluntary has significant 

implications for designing and administering the plan. While 

offering the choice to participate may be desirable, doing so 

substantially increases the complexity of an individual account plan 

and potentially its total costs. A variety of voluntary plan design 

features have potentially significant effects on individuals and 

total system costs.



The design features of voluntary individual account plans can affect 

whether individuals participate in the accounts and what retirement 

incomes they will receive. For example, some voluntary plans, such 

as those in the three countries we studied—the United Kingdom, the 

Czech Republic, and Germany, offer people the ability to opt in and 

opt out of the account periodically. Individuals may consider the 

extent of such flexibility in deciding whether to participate in 

the accounts. Also, voluntary plans generally offer incentives to 

participate, while mandatory plans do not need them. In addition to 

increasing participation, incentives generally add to the value of 

the accounts and therefore ultimately to the retirement income the 

accounts will provide. The three countries we studied offered 

incentives such as government contributions and tax advantages.

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 related 

to individuals’ participation decisions. In particular, tracking 

individuals’ participation decisions would require administrative 

processes that do not arise in mandatory plans. All 3 countries we 

studied used a centralized government authority to track 

participation and handle account contributions. Moreover, the 

uncertainty of participation rates in turn creates uncertainty for 

a variety of costs associated with individual account plans. For 

example, in the United Kingdom, participation in the individual 

accounts was much greater than expected, which resulted in 

unexpectedly high incentive costs. In addition, costs would arise 

from the need to educate individuals to help them make informed 

decisions about participating in voluntary accounts.



Significant education efforts may help individuals make informed 

participation decisions. Individuals face complex participation 

decisions in addition to the contribution, investment, and 

withdrawal decisions they might face in a mandatory plan. To make 

informed participation decisions, individuals need to understand the 

effects on their government retirement, disability, and survivor 

benefits and on their retirement income as a whole.



www.gao.gov/cgi-bin/getrpt?GAO-03-309.



To view the full report, 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.



Contents:



Letter:



Results in Brief:



Background:



Design of Voluntary Plans Can Affect Individuals’ Participation and 

Retirement Incomes:



Giving Choice of Participation Could Affect Total Costs and Increase 

Uncertainty:



Significant Education Efforts May Help Individuals Make Informed 

Participation Decisions:



Concluding Observations:



Agency Comments and Our Evaluation:



Appendix I: Summary of the United Kingdom’s Retirement System:



Description of Current System:



Key Design Features of Voluntary Individual Accounts in the United 

Kingdom:



Appendix II: Summary of the Czech Republic’s Retirement System:



Description of Current System:



Key Design Features of Voluntary Individual Accounts in the Czech 

Republic:



Appendix III: Summary of Germany’s Retirement System:



Description of Current System:



Key Design Features of Voluntary Individual Accounts in Germany:



Appendix IV: Comments from the Social Security Administration:



Tables:



Table 1: Design FeaturesThat Can Influence Voluntary Account 

Participation and Individual Retirement Incomes:



Table 2: Key Design Features of Voluntary Individual Accounts in the 

United Kingdom:



Table 3: Schedule of Government Matching Contributions for Czech 

Voluntary Supplementary Insurance:



Table 4: Average Inflation-Adjusted Rate of Return for Czech Pension 

Funds, 1995-2001:



Table 5: Key Design Features of Voluntary Individual Accounts in the 

Czech Republic:



Table 6: Key Design Features of Voluntary Individual Accounts in 

Germany:



Figures:



Figure 1: Overview of the United Kingdom’s Retirement Income Sources:



Figure 2: Overview of Czech Retirement Income Sources:



Figure 3: Average Monthly Participant Contribution and Average 

Government Contribution to Czech Voluntary Supplementary Pension 

Insurance, 1994-2001:



Figure 4: Number of Pension Funds Providing Czech Voluntary 

Supplementary Pension Insurance, 1994-2001:



Figure 5: Overview of German Retirement Income Sources:



Abbreviations:



CSSS: Commission to Strengthen Social Security:



DWP: Department for Work and Pensions:



IRA: Individual Retirement Account:



MIG: Minimum Income Guarantee:



NIC: National Insurance Contributions:



SERPS: State Earnings-Related Pension Scheme:



S2P: State Second Pension:



SSA: Social Security Administration:



TSP: Thrift Savings Plan:



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United States General Accounting Office:



Washington, DC 20548:



March 10, 2003:



The Honorable John Breaux

Ranking Minority Member

Special Committee on Aging

United States Senate:



Dear Senator Breaux:



Many proposals have been offered to restructure the U.S. Social 

Security program to include individual retirement savings accounts. 

However, some key proposals would make participation in the accounts 

voluntary rather than mandatory. Under a mandatory approach, all 

covered workers would typically have individual retirement savings 

accounts, and some portion of their Social Security contributions would 

automatically be deposited in the accounts. Under a voluntary approach, 

all covered workers would have a choice whether or not to have such an 

account as part of their Social Security package. While any individual 

account plan can offer a variety of choices regarding contributions, 

investments, and withdrawals, the choice of whether or not to 

participate is fundamental to a voluntary approach. That choice could 

have significant effects on individual retirement incomes and on the 

costs to the government as well.



You asked us to report on the implications of using a voluntary 

approach to individual accounts. Accordingly, we are reporting on 

(1) how voluntary plans can affect individuals, (2) how they could 

affect the total costs of the retirement system, and (3) the role of 

educational efforts relating to the participation decision. Throughout 

this report, we focus on the issues that pertain specifically to a 

voluntary approach as distinct from a mandatory approach.



To provide this information, we studied the experiences of selected 

nations, experiences with U.S. retirement savings accounts, and 

proposals to add individual accounts to the U.S. Social Security 

program. We conducted an extensive review of the relevant literature 

and interviewed researchers in the field and officials at multinational 

organizations, such as the World Bank, and at U.S. government agencies. 

On the basis of this preliminary research, we identified 3 countries 

with voluntary individual account plans that illustrate a variety of 

circumstances and key design features--the Czech Republic, Germany, and 

the United Kingdom. For example, the individual account plans of these 

countries have been in operation for different lengths of time, have 

used different incentives, and interact with the national social 

security systems in different ways. In addition, we studied 401(k) 

plans and other voluntary accounts in the United States. For both the 

foreign and domestic cases, we interviewed officials and analysts in a 

variety of organizations, including government agencies, unions, 

advocacy groups, employer organizations, research and academic 

institutions, and financial service companies. We did not conduct a 

legal analysis of the relevant laws of the foreign countries. We 

conducted our review from January 2002 through March 2003 in accordance 

with generally accepted government auditing standards.



Results in Brief:



The design features of voluntary individual account plans can affect 

whether individuals participate in the accounts and what retirement 

incomes they will receive. For example, some voluntary plans, such as 

those in all three countries we studied, offer people the ability to 

opt in and opt out of the account periodically; most U.S. proposals 

have not explicitly considered whether people would face a one-time 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. Also, 

voluntary plans generally offer incentives to participate, while 

mandatory plans do not need them. In addition to increasing 

participation, incentives generally add to the value of the accounts 

and, therefore, ultimately to retirement income. Each of the three 

countries we studied offered incentives such as government 

contributions and tax advantages.



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. All 3 

countries we studied used a centralized government authority to track 

participation and handle account contributions. In addition, incentive 

costs can be substantial. For example, Germany has dedicated roughly 

$10.6 billion over the next 6 years to pay for matching contributions 

and tax incentives. Moreover, the uncertainty of participation rates in 

turn creates uncertainty for a variety of costs associated with 

individual account plans. For example, in the United Kingdom, 

participation in the individual accounts was much greater than 

expected, which resulted in unexpectedly high incentive costs. In 

addition, in response to what has been called the “mis-selling 

scandal,” British companies that provide accounts have spent billions 

of dollars to compensate participants who signed up for accounts that 

were clearly not to their advantage, given their particular 

circumstances.



Significant education efforts may help individuals make informed 

participation decisions. Individuals face complex participation 

decisions in addition to the contribution, investment, and withdrawal 

decisions they might face in a mandatory plan. To make informed 

participation decisions, individuals need to understand the effects on 

their government retirement, disability, and survivor benefits and on 

their retirement income as a whole. For example, in the United Kingdom, 

workers who left their employer plan to participate in the voluntary 

accounts often reduced their future retirement income because they lost 

employer contributions.



Background:



According to the Social Security Trustees’ 2002 intermediate, or best-

estimate, assumptions, Social Security’s cash flow is expected to turn 

negative in 2017. 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 while 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 2030.



Reductions in promised benefits and/or increases in program revenues 

will be needed to restore the long-term solvency and sustainability of 

the program. Within the program’s current structure, possible benefit 

changes might include changes to the benefit formula or reductions in 

cost-of-living increases, among other options; revenue increases might 

include increases in payroll taxes or transfers from the Treasury’s 

general fund. Also, some proposals would change the structure of the 

program to incorporate a system of individual retirement savings 

accounts. Many such proposals would reduce benefits under the current 

system and make up for those reductions to some degree with income from 

the individual accounts. Individual account proposals 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.



Three key distinctions help to identify the differences between Social 

Security’s current structure and one that would use 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” pension while individual accounts would 

provide a “defined-contribution” 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 1]

:



* 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 2] 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 are fully funded by 

definition. Both mandatory and voluntary individual account plans would 

reflect all of these distinctions. Both types of plans also have a 

variety of other features and design issues in common, which can be 

organized in four groups.

:



* Supplement versus substitute. Individual accounts can either 

supplement an existing national pension benefit[Footnote 3] or 

substitute for all or part of it.[Footnote 4] With supplemental 

accounts, the account and contributions to it have no effect on the 

national pension benefit. With substitute accounts, the national 

pension benefit is reduced (or “offset”) in some way to account for 

contributions that have been diverted from the national 

program.[Footnote 5]

:



* 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 up to a certain dollar amount. Also, contributions might 

be collected and deposited by the government in a centralized process 

or by employers or account providers in a decentralized process.

:



* Accumulation. An individual account plan can address the accumulation 

of interest and other investment earnings in a variety of ways. A plan 

might give participants a wide range of investment options through 

virtually any qualified investment manager or may limit them to a few 

mutual funds through a single administrator or specifically authorized 

managers. Such design features determine in part how much investment 

risk individuals are allowed to take and how much choice they have in 

managing their money. Moreover, plans might offer some degree of 

investor education, depending on the complexity of the choices they 

face.

:



* Withdrawal. An individual account plan can offer a variety of ways to 

withdraw money. A plan may require individuals to purchase an annuity 

when they retire.[Footnote 6] Alternatively, an individual account plan 

may also allow individuals to withdraw their funds according to a 

specified schedule. Such a “phased withdrawal” leaves ownership of the 

funds with the individual as well as much of the financial and 

insurance risk. Some individual account plans, such as most 401(k) 

plans, also allow individuals to take their entire account at 

retirement as a lump sum and spend it as they wish. The question of 

withdrawal options ultimately reflects a decision concerning how much 

choice to give individuals versus how far to go to ensure that assets 

are preserved for retirement income.



Several countries around the world have implemented national individual 

account plans as part of their retirement income policies. Many 

countries with individual account plans have made them mandatory. Some, 

such as Chile, have given current workers a choice but made the 

accounts mandatory for new workers. Still others have made the accounts 

voluntary for all workers.



All three of the countries we studied--the Czech Republic, Germany, and 

the United Kingdom--have reduced the growth of benefits in their public 

pay-as-you-go retirement systems in the face of demographic challenges. 

In all three cases, the decision to make the accounts voluntary related 

to either historical precedents, political realities, or both, rather 

than to a specific policy objective that a mandatory approach would not 

accomplish. Since 1961 employers in the United Kingdom have had the 

ability to opt their employees out of part of the national system to 

participate in employer-provided defined-benefit pension plans. The 

introduction of individual accounts in 1988 allowed workers, instead of 

employers, to make decisions about whether or not to opt out of part of 

the national pension system. Further, individual accounts enabled 

workers without access to employer-provided pensions to opt out of part 

of the national pension system. In the Czech Republic, the accounts 

were intended to help workers make up for reductions in the national 

pension benefit while also helping spur growth in the capital market of 

the previously communist economy. In Germany, the accounts were also 

intended in part to make up for reductions in the national pension 

benefit. (See apps. I, II, and III for details on each country.):



In the United States, many employers offer defined-contribution pension 

plans, which take the form of voluntary retirement savings accounts, 

such as 401(k) plans for private sector employees and the Thrift 

Savings Plan (TSP) for federal employees. In recent years, the number 

of defined-contribution plans has been growing and becoming a 

relatively more common way for employers to offer pension plans than 

defined-benefit plans. In fact, some employers who had only defined-

benefit plans now offer plans that include defined-contribution 

accounts, including the federal government and the state of Florida, to 

cite two examples.



While defined-contribution pensions and Individual Retirement Accounts 

(IRAs) are not directly comparable to individual accounts that are part 

of a national social security system, they do have similar features and 

raise similar issues. For example, many defined-contribution pension 

plans include incentives in the form of employer matching 

contributions. They also require administrative processes for 

collecting and distributing account contributions. They enjoy tax 

advantages and provide a range of investment and withdrawal options, as 

IRAs also do. Employer-sponsored plans typically provide some form of 

participant education. Moreover, in the Social Security reform debate, 

TSP has often been raised as an example of how a Social Security 

account plan might work, especially in terms of its centralized 

administration, relatively low administrative costs, independent 

oversight board, and passively managed investment options. Still, some 

have noted its limitations as an example, pointing especially to the 

fact that all its participants work for a single employer.



Design of Voluntary Plans Can Affect Individuals’ Participation and 

Retirement Incomes:



Through a variety of design features, voluntary individual account 

plans can affect whether individuals participate in the accounts and 

what retirement incomes they will receive. Using a voluntary approach 

to individual accounts adds considerable complexity due to the way 

choice and participation interact with the plan’s design features. In 

particular, design features relating to the participation decision 

include the ability to opt in and out of the plan and the use of 

incentives. Also, under some designs, accounts supplement national 

pension benefits while, under other designs, the accounts substitute 

for such benefits to some degree. Other design features relate to the 

accumulation and withdrawal phases of the accounts. (See table 1 for a 

summary of design features that can affect individuals’ participation 

and retirement incomes.) Finally, the effects of voluntary accounts on 

individuals will vary by market and demographic factors. Some groups of 

individuals may be more likely to participate in voluntary accounts 

than others.



Table 1: Design Features That Can Influence Voluntary Account 

Participation and Individual Retirement Incomes:



Design feature categories: Supplemental versus substitute accounts; 

[Empty]; Examples: Additional versus diverted contributions; Benefit 

offsets, especially potential for “adverse selection”[A].



Design feature categories: Participation decision and contribution 

phase; [Empty]; Examples: Participation decision features; 

Flexibility, such as opt-in/opt-out; Automatic enrollment; 

Administrative costs; Incentives; Government or employer 

contributions; Tax advantages.



Design feature categories: Accumulation phase; [Empty]; Examples: 

Investment options (and how they are regulated); Guarantees; Tax 

advantages.



Design feature categories: Withdrawal phase; [Empty]; Examples: Pre-

retirement loans; Withdrawal options: annuities, installment payments, 

and lump-sum distributions; Tax advantages.



Design feature categories: Other design considerations; [Empty]; 

Examples: Plan complexity; Public education.



Source: GAO.



[A] Adverse selection occurs when certain groups of individuals (e.g., 

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. (See section below on substitute versus 

supplemental accounts for further discussion.):



[End of table]



Participation Decision Features and Contribution Features Can Affect 

Incomes as Well as Participation:



Design features related to the participation decision include the 

flexibility of the decision, automatic enrollment provisions, and 

administrative costs borne by the participants. Additionally, 

participation incentives generally include government contributions 

and tax advantages. These features can affect not only individuals’ 

participation but also their eventual retirement incomes. Many of these 

features arise only under a voluntary approach and, therefore, result 

in added complexity of voluntary plans.



Participation Decisions:



Some voluntary plans, such as those in all three countries we studied, 

offer people the ability to opt in and opt out of the account 

periodically; most U.S. proposals have not explicitly considered 

whether people would face a one-time or a periodic decision to 

participate. The need to track individuals’ participation decisions 

requires additional administrative tasks and complexity, especially in 

the case of substitute account plans with benefit offsets that reflect 

those decisions. Individuals may consider the extent of flexibility in 

opting in and out when deciding whether to participate in the accounts. 

In the United Kingdom, workers can opt out of or opt back into part of 

the national pension at any time. Ultimately, the national pension 

benefit calculation adjusts by reflecting any periods of time that a 

person has opted out. In the case of supplemental accounts, it is less 

complicated to opt in and out. In the Czech Republic, individuals can 

stop making contributions to their accounts after 3 years and resume 

them when they wish. Government contributions to the accounts reflect 

any such changes in participation because they are based on reports 

from the pension funds about the individuals’ contributions. In 

Germany, individuals can participate in accounts through their employer 

or approved financial service companies. The ability to opt-in and opt-

out of would depend on the plan in which they participate.



In contrast to opting in and out, plans can also give participants the 

ability, to varying degrees, to cancel their accounts and get a refund 

of their past contributions. Generally, penalties are associated with 

canceling accounts, and government contributions are taken back from 

the participants’ accounts. The ability to cancel accounts may 

encourage participation by giving individuals the ability to reverse 

their decision. At the same time, individuals who cancel their accounts 

may be diminishing their eventual retirement incomes, especially 

because of any penalties and forfeited government contributions.



The flexibility of participation also varies according to how much 

latitude participants have with the size of their contributions. Some 

individual account plans allow participants to contribute at various 

rates while other plans specify one contribution rate for everyone. 

Also, some plans set a dollar limit on account contributions per year. 

In some cases, minimum and maximum contributions primarily relate to 

eligibility for government contributions or tax advantages. (See 

discussion of government contributions and tax advantages below.) U.S. 

proposals have ranged widely in the size of the contributions they 

would allow. Some proposals set contribution rates at 2 percent of 

taxable earnings, while another varies contribution rates by income 

level. Still another allows a range of contributions up to $1,500. In 

the United Kingdom, one type of pension account permits contributions 

of as little as $32[Footnote 7] at various intervals and limits 

contributions depending upon an individual’s circumstances. In the 

Czech Republic, participants can contribute as little as $3 per month. 

In Germany, participants will be able to contribute from 1 to 4 percent 

of their annual salaries that is subject to social security tax. The 

flexibility of contribution rates may encourage participation. 

Individual retirement incomes will clearly depend on the contributions 

individuals actually make.



In contrast to providing flexibility of participation, some plans use 

an administrative process to facilitate participation. In both the 

United Kingdom and the United States, employers can use automatic 

enrollment to place employees in voluntary company pension plans as a 

default option, while still allowing employees the choice not to 

enroll. According to one U.K. provider association, companies with 

automatic enrollment have employee participation rates around 

90 percent compared with 70 to 80 percent for companies without it. 

Similarly, a U.S. study found that after automatic enrollment 

provisions were enacted in 3 companies, employee participation rates in 

401(k) plans increased dramatically to more than 85 percen[Footnote 

8]t.:



In addition, the size of administrative costs and who bears them could 

influence participation decisions and retirement incomes. The costs of 

administering individual accounts can be substantial, especially for 

small accounts. If individuals directly bear such costs, the costs 

could substantially diminish the account balances and the retirement 

incomes received from them. In the United Kingdom, for example, 

administrative costs for one type of individual pension account are 

deducted from the accounts up front. According to one study, such costs 

have diminished the account balances by 40 to 45 percent on 

average[Footnote 9]. However, under another type of account, 

administrative charges are limited to 1 percent of the account balance 

per year. In the United States, estimates of the administrative costs 

for individual accounts have ranged from one-tenth of a percent to 

3 percent per year, depending on how the accounts are 

administere[Footnote 10]d. In addition to basic costs for administering 

the accounts, individuals may also pay fees or penalties for a variety 

of activities, including early withdrawal or termination, investment 

changes, and purchasing annuities.



Government and Employer Contributions:



Government and/or employer contributions can provide a major financial 

incentive for individuals to participate in accounts and are one of the 

most powerful, according to some U.S. pension providers. To encourage 

participation, many U.S. employers provide matching contributions, 

including the federal government in its TSP for workers under the 

Federal Employees Retirement System. Germany and the Czech Republic 

also provide matching contributions to encourage participation. Such 

contributions clearly increase account balances, which will generally 

increase retirement incomes in turn. Such contributions can also be 

designed to help redistribute income.[Footnote 11]



In Germany, workers contributing a specified percent of their pay into 

an individually arranged pension plan may receive a government 

contribution.[Footnote 12] This approach encourages participation in a 

way that rewards lower earners proportionally more than higher earners. 

The government also provides contributions to reflect marital status 

and the number of children. Some individuals may participate in 

individual account plans through their employers. Such plans do not 

receive direct government contributions but do qualify for tax 

advantages. Employer contributions to such accounts depend on the 

specific arrangements for those plans.



The Czech Republic makes matching contributions to encourage 

participation. For the lowest worker contribution allowed, participants 

receive a 50-percent matching contribution. As contributions rise, the 

matching rate gradually declines to 0.[Footnote 13] The Czech Republic 

also allows employers to contribute to their workers’ accounts, 

although such contributions do not receive government matches.



In the United States, some individual account proposals would provide 

for government contributions, and some would redistribute income in the 

process. The Clinton Administration’s Universal Savings Account 

proposal would have provided account contributions only for those with 

incomes below certain levels. Also, under one of the proposals of the 

Commission to Strengthen Social Security (CSSS), account participants 

would contribute 1 percent of taxable earnings to their accounts (in 

addition to the 2.5 percent diverted from their payroll taxes), which 

the government would subsidize with a refundable tax credit that phases 

out as participant incomes rise.[Footnote 14]



Tax Advantages:



Favorable tax policies also provide incentives for individuals to 

participate in voluntary accounts. In the United States, such tax 

advantages encourage participation in employer-sponsored defined-

contribution plans and IRAs. Proposals to add individual accounts to 

Social Security would extend such tax advantages to those accounts to 

varying degrees.



All three countries we studied also make some portion of the individual 

account contributions tax exempt. In Germany, individuals are allowed 

to deduct government subsidies along with personal contributions from 

their income taxes.[Footnote 15] In the Czech Republic, contributions 

exceeding the government matching level are tax-deductible up to a 

limit. Czech analysts we interviewed explained that tax advantages are 

more attractive to higher earners for whom the government contributions 

are relatively small. For lower earners, who pay little or no tax, tax 

advantages offer little benefit. They believe that offering both tax 

advantages and government contributions provides a balanced approach 

that gives effective incentives across a range of income levels.



Also, in contrast to government contributions, which actually increase 

account balances, tax advantages generally have the effect of making 

participant contributions cost less out-of-pocket. For example, 

individuals making deductible IRA contributions will pay less income 

tax than if they did not, and they do not have to deposit those income 

tax savings into the IRAs.



Initially, to encourage workers to join individual account plans, the 

United Kingdom offered additional tax incentives in the form of reduced 

social security taxes. The government offered an “incentive bonus” 

which was an additional rebate of 2 percent of payroll taxes from 1988 

to 1993. A smaller incentive bonus of 1 percent was offered from 1993 

to 1996 to individuals over age 30. The government also encouraged 

people to join individual account plans by making a special, one-time 

offer when the law became effective in July 1988. The government 

credited individuals’ accounts with rebates, tax incentives, and 

incentive bonuses in a single lump sum for both the years 1987 

(retroactively) and 1988.



Substitute and Supplemental Accounts Have Different Effects on 

Participation and Retirement Incomes:



Individual accounts that supplement national pension benefits affect 

participation and retirement incomes differently than accounts that 

substitute for some portion of them. Participation in supplemental 

accounts does not affect national pension benefits, and such accounts 

do not draw on revenues of that national system. As a result, 

supplemental accounts normally require additional out-of-pocket 

contributions from the individual and thus a higher total contribution 

rate. The higher contribution rate offers the prospect of higher 

retirement incomes than participants would receive from the national 

pension alone. Both Germany and the Czech Republic employ supplemental 

accounts.



In contrast, substitute accounts do draw on revenues of the national 

pension system and have benefit offsets to adjust for contributions 

diverted from that system. Typically, a substitute plan does not affect 

the total contribution rate. Any potential for higher retirement 

incomes thus results primarily from the opportunity to earn potentially 

higher returns on plan contributions through investment in the private 

market. The United Kingdom employs substitute accounts, though some of 

its accounts can also be used as supplemental accounts.[Footnote 16] 

Some U.S. account proposals employ substitute accounts, some employ 

supplemental accounts, and some use a combination approach.



In deciding whether to participate in voluntary accounts, individuals 

may be sensitive to whether the accounts supplement or substitute for 

the national pension benefit and also to the amount of that benefit 

individuals expect to receive. In the case of supplemental plans, their 

willingness to make additional out-of-pocket contributions may depend 

on how adequate they expect their retirement income to be without the 

account. In the case of substitute accounts, their decision might 

depend more on the investment returns on the accounts they expect to 

receive. In either case, any reductions in the national pension benefit 

that are enacted (or expected to be enacted) to maintain program 

solvency could also affect their participation decision.



Benefit offsets under substitute accounts may have built-in incentive 

effects that favor some individuals over others, and these effects and 

the offsets generally may be confusing and poorly understood by the 

public. In a substitute plan, retirement benefits would generally come 

partly from the national pension benefit and partly from the account 

assets. Offsets could be applied to the retirement benefits from either 

the national pension or the accounts, and the incentive effects could 

depend on which of the two is subject to the offset.



For example, if the offset reduced monthly Social Security benefits for 

life, it might be calculated using life-expectancy assumptions for the 

population at large. Individuals who do not live as long as assumed 

would be subject to this benefit reduction for fewer years, so the 

offset could cost them less, in effect, than those who live longer. In 

such a situation, individuals who do not expect to live long in 

retirement, perhaps due to known health issues or family histories, 

could have more to gain by participating in the accounts than 

individuals who expect to live longer.



In contrast, hypothetically, if the benefit offset took a lump-sum at 

retirement from the individuals’ account balances, all participants 

would be subject to the full offset no matter how long they lived. For 

participants purchasing an annuity, it would reduce the monthly annuity 

income they could receive from their accounts. For everyone else, it 

would reduce the account balances they could either spend during their 

remaining lifetimes or leave to their heirs. Under this approach, 

monthly national pension benefits would be unaffected. In this case, 

the lump-sum offset might also be calculated using life-expectancy 

assumptions for the population at large. Those individuals who live 

shorter than the assumed life expectancy would be subject to the same 

total benefit offset as those who live longer even though they would 

collect benefits over fewer years. In effect, this lump-sum offset 

approach would transfer income from people who live shorter lives to 

those who live longer lives, just as life annuities do.



If individuals accurately perceive any built-in incentives in the 

benefit offsets, given their personal circumstances, and make their 

participation decisions accordingly, then “adverse selection” could 

result, which 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. (See section on total cost effects 

below.):



Other Design Features Could Also Affect Participation:



A range of other design features have the potential to affect whether 

individuals participate in a voluntary account plan. Design features 

relating to the accumulation and withdrawal phases could affect the 

appeal of participation. In addition, complexity of individual account 

plans might discourage participation while educational efforts might 

encourage participation by helping participants understand and be more 

comfortable with their decisions.



Investment Choices:



Under both voluntary and mandatory approaches, individual account plans 

have provisions regarding the range of investment choices participants 

have. Such choices affect earnings on account balances during the 

accumulation phase, and retirement incomes will depend on how 

participants exercise those choices. However, under a voluntary 

approach, the appeal of participating will depend on whether 

individuals are satisfied with those options. Individuals might 

consider how high expected returns are, how much risk is associated 

with those returns, and how much flexibility they have to adjust their 

investment choices. Regulation of the investment choices, as well as 

their design, affects the rates of return individuals might receive and 

the risks they face. In the Czech Republic, pension fund investments 

are strictly regulated in order to minimize risk; accordingly, returns 

on those funds have been relatively modest. One analyst we spoke with 

does not participate because the returns are too low from his 

perspective, even after accounting for the government match and tax 

advantages.



To address concerns individuals may have about risk, several individual 

account plans offer guarantees that benefits will reach a certain 

level. Under a voluntary approach, such guarantees are intended to 

encourage participation by reducing risk to the individuals. However, 

even some mandatory plans have offered guarantees. Guarantees can take 

a variety of forms. For example, some proposals would guarantee that 

Social Security beneficiaries would receive total benefits at least as 

high as those promised under current law. Germany requires that account 

providers return to participants on withdrawal an amount at least equal 

to the contributions participants made to their accounts.



Tax Advantages:



Under many individual account plans, investment earnings on account 

balances are not taxed during the accumulation phase. Both the United 

Kingdom and Germany allow most or all investment earnings to accrue to 

the accounts tax-free. In the Czech Republic, investment earnings also 

accrue tax-free for individuals; however, pension funds are required to 

pay taxes on the investment earnings. In the United States, investment 

earnings on retirement savings also generally accrue tax-free during 

the accumulation phase.



Individual account plans also have provisions for tax treatment during 

the withdrawal phase. In Germany and the United States,[Footnote 17] 

withdrawals from individual accounts are fully taxable, but marginal 

tax rates are often lower for individuals during retirement when their 

incomes are lower. In the United Kingdom, part of an individual’s 

benefit can be paid as a tax-free lump sum upon retirement or death.



Loans:



Some individual account plans allow participants to take out loans from 

their accounts before retirement, often for specified purposes such as 

buying a home or educational or medical expenses. Such provisions 

encourage participation by assuring participants that they can still 

use their money if they really need it. However, loans can reduce 

retirement incomes if they are not repaid, incur penalties, or miss out 

on periods of high investment returns. According to our 1997 study, in 

401(k) plans that allow borrowing, participants contribute 35 percent 

more than those in plans that do not.[Footnote 18] Also, the effects of 

account borrowing provisions on retirement income may affect certain 

participants more than others. Borrowers from 401(k) plans, on average, 

have less family income, lower net worth, and more nonhousing debt than 

nonborrowers.



None of the countries we studied allow loans on accounts. The Czech 

Republic allows participants to withdraw their own contributions after 

1 year, though they cannot collect any government matches or subsidies. 

In the United Kingdom, officials explained that doing so would not be 

consistent with the purpose of government expenditures on the accounts, 

which is to provide for retirement income. Additionally, one expert 

said that the United Kingdom prohibits loans from individual accounts 

as a way to preserve retirement income and keep individuals from 

claiming means-tested benefits.



Withdrawal Options:



Individual account plans can provide for withdrawals during retirement 

through lump-sum distributions, annuities, and installment payments. 

Individual accounts that offer only one type of withdrawal option may 

discourage participation among those interested in other withdrawal 

options. In addition, plans typically set an age at which participants 

can withdraw all their funds and apply penalties for any withdrawals 

before that age. Such age provisions help ensure that the assets are 

preserved for retirement. Neither the Czech Republic nor Germany allows 

full withdrawal before age 60. In the United Kingdom, individuals may 

retire early at age 50 (due to be raised to age 55) or due to ill 

health and start to draw on their accounts at that time.



Lump-sum withdrawals give participants flexibility in using their 

accounts’ funds.[Footnote 19] However, lump-sum withdrawals also pose 

the risk that participants might outlive those funds. Only the Czech 

Republic allows participants the option to withdraw the entire 

voluntary account as a lump sum. Still, lump-sum withdrawal can help 

avoid prohibitively high administrative or annuity costs for relatively 

small accounts.



Lifetime annuities provide a guaranteed income for life and protect 

individuals from the financial and longevity risks of outliving their 

assets. However, annuity providers charge to assume that risk and cover 

their administrative and other costs. In addition, “adverse selection” 

can occur when consumers who expect to live a long time are more likely 

to purchase an annuity than those who do not. As a result, annuity 

prices can be as much as 14 percent higher than they would be if every 

retiree purchased an annuity, according to one study.[Footnote 20]



Making annuities mandatory could mitigate the effect of adverse 

selection. It could also help ensure that account assets provide life-

long income. However, making annuities mandatory transfers income from 

those who do not live very long to those who do. It could also 

discourage participation in voluntary accounts, especially for those 

who do not expect to live long, perhaps due to known health problems or 

family history. Moreover, depending on the annuity provisions, 

prospective participants may be concerned that they would be forced to 

annuitize at a time when market conditions are unfavorable, either with 

respect to the value of the account balance or prevailing annuity 

prices, which depend significantly on interest rates.



Whether mandatory or not, annuities can have a variety of features that 

may make them either more or less attractive and, as a result, 

influence individual participation in the accounts. For example, a cash 

refund feature such as death benefits might be incorporated to 

accommodate those with an especially short life expectancy at 

retirement. Annuities could also account for family risk by 

incorporating a survivor feature.



Some individual account plans, such as IRAs and some 401(k) plans, also 

offer a phased withdrawal option, under which individuals receive 

installment payments on a schedule that attempts to ensure that the 

funds last until death. Such a phased withdrawal is not an annuity and 

does not provide insurance because it leaves the financial and 

longevity risk with the individual. Still, it would avoid the issue of 

adverse selection and some of the costs and other issues associated 

with annuities, though phased withdrawals also involve some 

administrative costs. Providing a phased withdrawal option may 

encourage participation by those who would object to mandatory 

annuitization.



Germany allows for different account draw-down options. One option is a 

lifelong annuity. Another allows a draw down of assets until age 85 

when the participant would have to purchase a life annuity. The United 

Kingdom requires annuitization of 75 percent of the voluntary account 

balance by age 75. The other 25 percent may be taken in a lump-sum 

payment. Some U.S. account proposals would require annuitization while 

others offer more withdrawal options.



Complexity and Public Education:



Under both voluntary and mandatory approaches, individual account plans 

can be very confusing to participants given the wide range of design 

features and other considerations they face. However, under a voluntary 

approach, such confusion may have the effect of reducing participation. 

Moreover, voluntary plans may have additional sources of confusion and 

complexity that do not arise in mandatory plans, such as how the 

incentives work and, in the case of substitute accounts, how national 

pension benefits are affected. Public education efforts can play a 

major role in helping participants understand both voluntary and 

mandatory individual account plans. However, their effectiveness can 

also influence participation in voluntary plans. In all three countries 

we visited, officials reported that individuals experienced substantial 

confusion over the complexity of the individual account plans. Some 

experts in Germany believe participation is lower than expected because 

the tax subsidies are too complicated for the general public to 

understand. In all three countries, officials underscored the 

importance of educational efforts.



Market and Demographic Factors Can Also Affect Participation:



Market factors can affect the investment returns individual accounts 

earn in both voluntary and mandatory plans. In voluntary plans, 

consumer confidence in the market can also affect participation. For 

example, in Florida, which recently added individual accounts to the 

state retirement system, participation has been lower than expected 

with just 5 percent of employees opting in.[Footnote 21] Officials cite 

the accounting scandals at a number of major corporations, a slowing 

economy, and the generally weak condition of the financial markets as 

possible reasons for the low participation.



Moreover, if the market offers attractive, alternative investment 

opportunities, individuals may choose those instead of participating in 

the accounts. For example, advanced financial markets, like that in the 

United States, offer workers the ability to participate in employer-

sponsored pensions and IRAs. In the case of supplemental accounts, such 

alternatives could compete for the workers’ contributions. In Germany, 

for example, improvements in employer-sponsored pension plans may be 

responsible for lower than expected participation in government-

sponsored voluntary accounts, according to government officials. In the 

Czech Republic, “building savings” accounts that help individuals save 

for purchasing a house may compete with the voluntary retirement 

accounts, especially since they receive a more generous government 

subsidy. According to one U.S. pension provider, it is difficult to 

predict whether new Social Security accounts would diminish 

participation in employer-provided pension accounts, even in the case 

of substitute accounts. The ability of individuals to alter their 

savings and even consumption behavior in other areas when they have 

Social Security accounts makes it especially difficult to predict how 

such accounts will ultimately affect retirement incomes.



Demographic factors could play a role in investment choices for either 

voluntary or mandatory accounts. Some groups such as lower income 

groups and women appear to be more conservative in their investment 

choices on average; over the long term, on average, such choices can 

result in lower retirement incomes. At the same time, a lower tolerance 

for risk may be quite understandable under their circumstances. Under a 

voluntary approach, such characteristics could also correlate to 

participation patterns. Participation patterns appear to vary by 

demographic factors in other countries as well as in the U.S. private 

pension market. In the United Kingdom, for example, individual accounts 

were initially popular with younger workers and workers with higher 

earnings. In the Czech Republic participation in individual accounts 

steadily increases with age until age 60, and the average age of 

participants is about 48 years, 10 years higher than the population 

average.



The design of individual account plans can attempt to compensate for 

the effect of both market and demographic factors. In the case of 

market factors, the investment choices and the companies who manage 

them can be selected to promote consumer confidence. In the case of 

demographic factors, government subsidies and other incentives and 

withdrawal options can be designed with particular groups in mind. For 

example, the German government developed individual accounts with 

subsidies designed to benefit those with low or average income as well 

as families with children. In the United Kingdom, older workers are 

given higher payroll tax rebates than younger workers to encourage 

their participation in the individual accounts.



Giving Choice of Participation Could Affect Total Costs and Increase 

Uncertainty:



Under a voluntary approach to individual accounts, a variety of design 

features can have implications for the total costs to the government, 

providers, employers, or participants. In some cases, giving choice can 

involve additional administrative, incentive, regulatory, and 

educational costs. In many cases, the uncertainty of participation 

rates in turn creates uncertainty for total cost[Footnote 22]s. Such 

costs include those associated with the participation decision and 

contribution phase. In addition, plans using substitute accounts pose 

transition costs and costs related to benefit adjustments that do not 

arise with supplemental accounts. Also, costs associated with the 

accumulation and withdrawal phases of the account and interaction 

effects with other government programs might also depend on 

participation rates.



Participation Decisions Create Unique Costs and Add Uncertainty:



The participation decision available to individuals in voluntary plans 

increases complexity and creates costs that do not arise in mandatory 

plans. Such costs include tracking the participation decisions 

themselves, some startup costs, incentive costs, and education costs. 

The extent of such costs is uncertain because they depend partly on 

participation rates.



Costs Related to Participation Decisions:



In voluntary individual account plans, tracking individuals’ 

participation decisions requires administrative processes that do not 

arise in mandatory plans. Under a substitute plan, such tracking might 

also be needed for computing benefit offsets. The tracking process 

depends partly on how account contributions are collected and deposited 

into the accounts. If individuals have a one-time choice to 

participate, the tracking process could become even more critical. 

Using a centralized administrative structure could help address 

tracking and related issues. Moreover, centralized administration 

offers the opportunity for economies of scale. However, in a voluntary 

plan, low participation rates could diminish opportunities to take 

advantage of economies of scale that centralized administration could 

offer.



All three countries we studied used a central government authority to 

handle account contributions. In the United Kingdom, voluntary account 

providers present the government revenue authority with a request for 

the account rebates. However, it takes about a year for rebated 

contributions to arrive to providers to allow for reconciliation. 

Officials described the delay as a price individuals pay for having the 

ability to opt out. In Germany, the tax authority largely manages 

government administration of the individual accounts via tax returns. 

In the Czech Republic, pension funds administer the accounts and 

reconcile funds with the Ministry of Finance to obtain the government 

matching contribution.



Also, administrative costs are generally relatively higher for smaller 

accounts because of the fixed costs associated with maintaining 

accounts. As a result, account providers may have an incentive to focus 

marketing efforts on individuals who are likely to have higher account 

balances. On the other hand, one U.S. provider speculated that many low 

earning individuals would chose to not participate under a voluntary 

account approach, which would reduce the number of smaller accounts.



In addition to costs for administering the accounts on an ongoing 

basis, startup costs would be incurred for creating new systems for a 

variety of administrative functions, including recording individual 

investment decisions, collecting account contributions, transmitting 

contributions to investment managers, recording account value changes, 

and sending periodic statements. Under a voluntary approach, such 

functions would also include recording participation decisions. Some of 

these administrative functions would need to be developed before actual 

participation rates were known. Such costs would need to be paid for by 

the government, account providers, program participants, or some 

combination thereof, and the cost per participant would depend on 

participation rates.



Incentive Costs:



Many voluntary individual account plans include participation 

incentives, as noted earlier. Incentive costs can be significant, 

depending on their design and on participation rates. For example, 

Germany offers tax incentives and government subsidies to participants. 

Germany has allocated $10.6 billion for incentives through 2008, but 

actual costs will depend on participation.



In the United Kingdom, soon after accounts were introduced in 1988, 

participation was much higher than predicted, and as a result so were 

incentive costs. An expert on the UK’s pension system asserts that the 

reasons for the high rates included overly generous rebates and tax 

incentives. In fact, in 1997, the UK Department of Social Security 

estimated that the net present value of savings resulting from opted-

out voluntary individual accounts was $11.6 billion for the period from 

1987-88 to 1994-95. During the same period, contribution rebates and 

incentives paid to voluntary account participants totaled $35.1 billion 

at net present value. Thus, the total government revenue foregone as a 

result of opted-out voluntary individual accounts was about three times 

the expenditure savings[Footnote 23]. However, since 1997 the 

government has moved to a rebate that is estimated to equal the 

actuarial value of the forgone benefits.



Education Costs Related to the Participation Decision:



Under a voluntary approach, individuals would face the decision of 

whether to participate, which they would not face under a mandatory 

approach. Helping them make an informed decision would entail costs for 

education, financial advice, and marketing efforts that would go beyond 

what mandatory plans would require. Such efforts and their costs could 

be the responsibility of the government, employers, account providers, 

or individuals, depending on the plan’s design. If employers or account 

providers were given the responsibility, the government might still 

incur costs for regulating those efforts. All of the countries we 

studied emphasized the need for significant educational efforts to 

explain the voluntary system, but none identified any concrete 

expenditures.



Substitute Accounts Can Have Special Consequences for Total Costs:



A voluntary plan using substitute accounts raises potential costs that 

do not arise with supplemental accounts and which depend on 

participation rates. Such costs include costs associated with moving 

from pay-as-you-go to advanced funding. Also, substitute accounts 

adjust benefits to reflect the diversion of social security 

contributions to individual accounts. Such benefit adjustments can 

affect system costs, depending both on their design and participation 

patterns.



Transition Costs:



Under a substitute individual account plan, some Social Security 

contributions would be diverted to the accounts. However, under Social 

Security’s pay-as-you-go financing, some of those contributions would 

also be needed to pay for current benefits. Making account deposits 

while also meeting current benefit costs requires additional revenue, 

which we refer to as “transition costs.”[Footnote 24]



For example, according to one study, contribution rates to the national 

pension system in the United Kingdom were an estimated 2.5 percent to 

3.0 percent higher in 1999 to 2000 than they would need to be without 

opted-out voluntary accounts.[Footnote 25]



While such transition costs would also arise under a mandatory 

approach, they would vary with participation rates under a voluntary 

approach and, therefore, would be smaller with less than 100 percent 

participation. Under a supplemental account plan, transition costs 

would not be an issue because no resources are diverted away from 

paying current benefits, though such plans do require additional 

contributions.



Adjustment Costs:



Substitute account plans adjust participants’ contributions or benefits 

in some manner to reflect that they are replacing some portion of their 

national pension benefit with an individual account. Under some U.S. 

proposals, a specified percentage of Social Security contributions 

would be deposited in the accounts, and a benefit offset would be 

calculated to reflect those diverted contributions. In contrast, in the 

United Kingdom, the account contributions, or “rebates,” are calculated 

to reflect the value of the national pension benefit that participants 

forego. In either case, the adjustment calculations can implicitly 

provide an incentive to participate, as they did initially in the 

United Kingdom, as previously discussed. In addition, the calculations 

depend on assumptions that, if incorrect, could either cost the 

government or participants money, on average. Under either situation, 

the costs arising from such adjustments depend on participation. 

Moreover, under any benefit offset, the potential for adverse selection 

exists, resulting in costs to the government. In short, the total 

actuarial value of the benefit offsets could differ from the total 

value of the diverted contributions, depending on the interaction of 

the benefit offset design and participation patterns. In that case, a 

subsidy either from or to the government could occur.



In the United States, some proposals would calculate the benefit offset 

as the annuitized value of the diverted contributions, assuming they 

earned a rate of interest specified by the proposal; in effect, the 

specified interest rate is applied to a “hypothetical account.” For 

example, under the three alternative options offered in 2001 by the 

President’s Commission on Strengthening Social Security (CSSS), three 

distinct interest rates are specified for the offsets, but only one 

rate would yield an offset with an actuarial value equal to the 

diverted contributions, even assuming that participation patterns are 

predicted with perfect accuracy. Implicitly, any other rate would 

represent either a subsidy or cost to the government. Under a voluntary 

approach, the total cost of (or revenue from) any such subsidies 

depends on the level of participation.



The benefit offsets under the CSSS and similar proposals would also 

make a variety of actuarial assumptions in converting the hypothetical 

account balances into an annuitized monthly amount. Such assumptions 

include mortality rates and the interest rates that insurers would use 

to set annuity prices (in contrast to the interest the accounts earn 

during the accumulation phase). To the extent that actual experience 

differs from these assumptions, the offsets will be either higher or 

lower than they would have been with perfect foresight, and there will 

be either a net loss or gain to the government fund; such effects will 

depend on the level of participation.



Still, even with perfect foresight of actuarial assumptions, the 

potential for adverse selection exists. The characteristics of those 

who participate in the accounts may not reflect the actuarial 

assumptions used in calculating the offsets. For example, offset 

calculations might assume that men and women participate at the same 

rate. If they do not, the rebates could pose a net loss or gain to the 

government fund because women live longer than men on average and 

therefore would collect benefits longer. Varying participation patterns 

by earnings level and household type could also result in adverse 

selection because U.S. Social Security benefits also depend on these 

factors. In fact, according to a recent report by the American Academy 

of Actuaries, adverse selection is inherent in any system involving 

voluntary participation.[Footnote 26]



Participation also Makes Other Costs Uncertain:



Under either a voluntary or a mandatory approach, the total costs of an 

individual account plan include costs associated with the accumulation 

and withdrawal phases of the accounts. During the accumulation phase, 

they may include administration, investment management, investor 

education, and tax deferrals. During the withdrawal phase, they may 

include administration of account withdrawals or annuitization costs. 

However, under a voluntary approach, participation rates can affect all 

these costs. In particular, participation rates can affect economies of 

scale, account size, the total cost of tax deferrals, and the 

contingent costs of benefit guarantees.



Under either a voluntary or a mandatory approach, individual accounts 

could also affect the costs of other government programs. For example, 

if income from substitute accounts leaves particular individuals with 

less retirement income than if they had not participated, some may 

qualify for other government programs such as Supplemental Security 

Income in the case of the United States, which provides income 

supplements to aged, blind, and disabled individuals with low incomes. 

On the other hand, to the extent that the accounts increase retirement 

incomes, costs for such programs may fall. Under a voluntary approach, 

such effects could depend partly on the rate of participation.



Significant Education Efforts May Help Individuals Make Informed 

Participation Decisions:



Under a voluntary approach to individual accounts, individuals face a 

complex participation decision in addition to the contribution, 

investment, and withdrawal decisions they might face in a mandatory 

plan. Individuals could benefit from both education and financial 

advice in making informed decisions, but the liability associated with 

providing advice can be an obstacle to providing education. Still, 

public education campaigns can offer a variety of tools to help with 

their decisions.



Individuals Face Complex Choices:



To make informed decisions about participating in voluntary accounts, 

individuals need to understand the social security system, the role of 

the accounts, and how much income they will need in retirement. For 

example, a German study shows that one of the reasons participation in 

individual accounts has been lower than expected is because the public 

believes they will have adequate income in retirement without the new 

accounts.



Furthermore, to make informed participation decisions, individuals need 

to understand who should participate in the accounts. Voluntary 

accounts can be designed to provide benefits to a broad range of people 

or select groups of people. In the United Kingdom, for example, 

voluntary accounts were initially designed to allow individuals without 

access to employer-sponsored pension plans the ability to opt out of 

part of the national pension system. However, strong incentives 

encouraged workers who had employer-sponsored pensions to leave their 

pension plan for an individual account. As a result, workers often 

reduced their future retirement income because they lost employer 

contributions in their employer plans.



Individuals should also understand the implications of individual 

accounts that interact with national pension benefits. For example, in 

the United Kingdom, individuals can opt out of part of the national 

social security system to participate in an employer-sponsored pension 

plan or an individual account. One government survey showed a quarter 

of public and private sector workers did not know whether they were 

participating in the national system or whether they were participating 

in an opted-out plan. Furthermore, government research conducted in 

1997 with a small group of people showed that although the principle of 

opting out was fairly well-known, they had difficulty understanding the 

implications. Recently, the government in the United Kingdom announced 

a number of initiatives designed to improve financial education and 

awareness.[Footnote 27] In the United States, some proposals would 

reduce (or offset) an individual’s Social Security benefit to reflect 

the diversion of program contributions into an individual account. 

According to one expert, it could be difficult to explain these Social 

Security benefit reductions to the public because the offset 

calculations can be complex.



Individuals could also make more informed choices if they received 

education about the effects of individual accounts on their family if 

they become disabled or die. Under some U.S. proposals, benefit offsets 

would reduce disability and/or survivors’ benefits as well as 

retirement benefits. On the other hand, individual account balances 

could provide income in cases of disability and death, though the 

balances may not be very large for younger workers.



Individuals have varying levels of financial interest, which can 

further complicate the educational efforts associated with a voluntary 

approach to individual accounts. In particular, one survey in the 

United Kingdom highlighted individuals’ lack of interest in financial 

matters, including pensions. Overall, it found that 60 percent of 

respondents thought about financial matters when it was absolutely 

necessary and that 10 percent didn’t think about financial matters at 

all. The same survey also found that older individuals have a more 

pronounced interest in financial matters than younger individuals.



The Social Security program includes workers from all levels of income, 

those who currently invest in equity and bond markets and those who do 

not. It is unlikely that a “one size fits all” educational effort would 

be appropriate for an individual account program. Investor education is 

especially important for individuals who are unfamiliar with making 

investment choices, including low-income and less well-educated 

individuals who may have limited investing experience. Specifically, 

one provider said that different communication strategies should be 

developed for low-income workers and high-income workers. Additionally, 

the provider noted that a simple plan design with few investment 

choices would make it easier to educate low-income workers, in 

particular. According to another pension provider, the workers who have 

not participated in employer-sponsored defined contribution pension 

plans will need more education about individual accounts than those who 

have. One pension professional said that inequality would exist in a 

voluntary system if workers were unable to develop financial planning 

skills.



Financial Education versus Advice:



A critical tension exists between financial education and financial 

advice. Government agencies, employers, account providers and others 

who might provide financial education may be reluctant to do so because 

those educational efforts might be construed as advice. Providers of 

advice can be held responsible for the outcomes of decisions based on 

that advice. Although this tension would arise under any approach to 

individual accounts regarding individual investment decisions, it would 

arise under a voluntary approach also regarding participation 

decisions. This distinction becomes even more relevant in a substitute 

system where individuals give up a portion of their Social Security 

benefit to participate in an individual account. In this instance, a 

provider of advice could be held liable for wrongly advising people to 

participate in an individual account when they would have been better 

off by not doing so.



For example, in the United Kingdom, financial service industry 

salespeople advised people to participate in individual accounts 

instead of the social security system or employer-sponsored pensions, 

where many of them would have been better off, given their particular 

circumstances. As a result, the government ordered the financial 

service industry to reimburse the individuals who were mis-sold 

individual accounts.



Governments often try to define the roles and responsibilities of those 

who would educate and advise the public in individual account plans. In 

the U.S. private pension market, the tension between investment 

education and investment advice led the Department of Labor to issue 

guidance to investment advisers and employers. In particular, the 

guidance shows how advisers and employers can provide educational 

investment information and analysis to participants without becoming a 

fiduciary under the Employee Retirement Income Security Act.[Footnote 

28] In the United Kingdom, employers are allowed to provide individuals 

with education, but not advice. However, employers are wary of 

providing education, fearing it will be misinterpreted as advice. 

Additionally, many workers do not seek financial advice because 

advisors are expensive. Similarly, in Germany, employers are allowed to 

inform employees about individual accounts; however, employers could be 

held liable if they provided employees with bad information.



Public Education Campaigns Involve Variety of Educational Tools:



Pension systems in the United States and other countries have used a 

variety of educational tools to inform the public about pension 

options, including electronic tools. For example, Florida recently gave 

state and local employees the option of participating in the state’s 

defined benefit pension plan or in an individual account. To educate 

employees about participation decisions, Florida used a variety of 

communication mediums that included printed materials, Web sites, 

workshops, and a toll-free telephone line. Focus groups revealed that 

individuals had a strong preference for printed materials. To 

accommodate that preference, information kits were mailed directly to 

individuals’ homes.



Educating the public about a voluntary approach to individual accounts 

would have associated costs. For example, in 2000, approximately 

153 million people worked in employment or self-employment covered by 

the Social Security program. The majority of these individuals paid 

Social Security payroll taxes on their earnings. According to SSA 

staff, information on changes to the program would most likely be sent 

to every working individual through the mail. As we reported 

previously, SSA estimated the minimum mailing cost would be $0.50 per 

letter, which totals more than $70 million per mailing.[Footnote 29]



Florida also experienced associated costs to educate workers about 

their pension choices. For example, the state budgeted roughly 

$42 million over 2 fiscal years to educate 617,000 employees that 

worked for 800 separate employers. The budget was designed to provide 

comprehensive education through a variety of communication mediums. 

Additionally, the state expects that a number of the education assets 

provided by the budget will be in place for the long-term. Furthermore, 

the state points out that the $23 million budgeted for education costs 

in the first fiscal year represents 0.10 percent of the annual payroll 

of Florida Retirement System employers and 0.03 percent of the amount 

of assets invested in the system’s trust fund.



A variety of tools can be used to inform individuals about 

participation decisions. Other governments have used a number of tools, 

such as customized statements, decisions trees, and financial education 

classes and workshops to inform the public.



Customized Statements:



Customized statements provide information on a personalized basis. In 

the United States, an example of a customized statement is the Social 

Security Statement. This statement is mailed annually to workers and 

provides estimates of Social Security benefits based on their own 

earnings histories. Florida also provides state and local employees 

with a customized statement, known as a personalized Benefit Comparison 

Statement. The statement compares projected benefits in the defined 

benefit plan with benefits from the individual account, using one set 

of assumptions. The statement is directly mailed to the employee’s home 

as part of a Retirement Choice Kit. Furthermore, workers can use an 

Internet-based service to forecast their future benefits under both 

plans, using a variety of different assumptions. According to state 

experts, approximately 20 to 25 percent of employees used the Internet-

based service to forecast future benefits.[Footnote 30]



The United Kingdom is also using customized statements to educate the 

public about social security issues. For a number of years, the United 

Kingdom has offered national pension forecasts upon request. These 

forecasts show individuals what they can expect to receive in 

retirement from their national pension. Recently, the government 

announced that it plans to automatically provide national pension 

forecasts to the working-age population. Additionally, the government 

is providing individuals with a combined pension forecast that shows 

what they can expect to receive in retirement from both their national 

pension and their employer-sponsored or private pension plan. 

Dissemination of the combined pension forecasts will rely on the 

voluntary participation of employers and pension providers.



Decision Trees:



In the United Kingdom, individuals must decide whether they should 

participate in the national social security system, their employer-

sponsored pension plan, or an individual account. The Financial 

Services Agency publishes decision trees on its Web site.[Footnote 31] 

Decision trees in the United Kingdom ask basic questions about pension 

arrangements to help individuals make their own choices.



Government officials said that usually individuals need more 

individualized attention than the decision trees can provide. 

Additionally, the decision trees are not very helpful for individuals 

with little financial planning skill. Some individuals may find the 

decision trees too complicated to understand, especially given the 

United Kingdom’s complicated pension system. While decision trees are 

designed to help individuals make informed choices, they are not 

intended to provide financial or professional advice. Further, the 

trees recommend that individuals in need of additional assistance 

consult with their financial advisor or pension provider.



Classes and Workshops:



Classes and workshops provide ways to educate adults on financial 

matters. In Florida, the state conducted 3,000 workshops to educate 

state and local employees about their pension choices. A number of 

local governments have required their employees to attend the 

workshops. The workshops lasted approximately 2 hours and provided 

employees with the opportunity to ask questions. The workshops were 

conducted by a nationally known financial services firm and were well 

received by the employees, according to state officials.



Some educational efforts have explored trying to promote financial 

education in the schools and prepare students for future choices 

concerning their retirement. For example, the United Kingdom introduced 

personal financial education as a nonstatutory part of the national 

curriculum in England. Additionally, Scotland, Wales, and Northern 

Ireland are also developing ways to improve personal financial 

education.



Concluding Observations:



If policymakers decide to restructure Social Security to include 

individual accounts, making participation voluntary has significant 

implications for designing the plan. Giving individuals the ability to 

participate or not is the most fundamental type of choice an individual 

account plan can offer.



While offering the choice to participate may be desirable to some 

policymakers, doing so creates additional administrative tasks, 

substantially increases the complexity of an individual account plan, 

and potentially increases its total costs. The full range of design 

features found in individual account plans can influence whether people 

participate or not. In turn, design and participation can interact to 

have significant effects on both the individual retirement incomes 

people enjoy and the plan’s total costs, whether borne by the 

government, employers, providers, or participants. In particular, in 

any substitute voluntary account plan, care should be taken to 

anticipate and minimize the potential for adverse selection. As a 

result, policymakers would be wise to consider the design of a 

voluntary plan with careful attention to the effects on participation 

and its consequences. Moreover, as we have said in the past, reform 

proposals should be evaluated as packages that strike a balance among 

various objectives, including achieving sustainable solvency, 

balancing benefit adequacy and equity, and ensuring the feasibility of 

implementing and administering the reforms. While using a voluntary 

approach has the potential to cost more than a mandatory approach, such 

costs should be weighed as part of a total package that could contain 

offsetting savings.



The role of incentives deserves particular attention in a voluntary 

plan. Early on, policymakers should make a deliberate decision about 

whether they intend to actively promote participation or simply to 

offer another retirement planning choice. Actively promoting 

participation generally requires offering costly incentives that should 

be weighed against the costs of other approaches to restoring Social 

Security’s long-term solvency. If incentives are offered, they will 

have the desired effect only if the public understands them.



In addition, individuals will need education and advice to help them 

make their participation decisions as well as the many other decisions 

associated with their accounts. Otherwise, confusion about their 

decisions may discourage participation or lead them to choices that 

could make them worse off than if they did not participate. In 

particular, any plan should offer a variety of educational tools that 

allow individuals to examine their specific circumstances given their 

own level of financial knowledge and experience. Achieving a high 

degree of transparency in how the account plan works would help ensure 

that people make choices that are in their best interest. Also, clearly 

articulating the reason for reform would promote system understanding 

and encourage participation.



If policymakers decide to create individual accounts as part of Social 

Security, using a voluntary approach is a fundamental decision with 

implications that flow through to many other design features. While the 

decision is ultimately a policy choice, successful plans would require 

clear objectives as well as design features that are consistent with 

those objectives.



Agency Comments and Our Evaluation:



We provided SSA an opportunity to comment on a draft report of this 

report. The agency provided us with written comments, which appear in 

appendix IV. SSA also provided technical comments, which we have 

incorporated where appropriate.



As arranged with your office, unless you publicly announce its contents 

earlier, we plan no further distribution of this report until 30 days 

from its issue date. At that time, we will send copies of this report 

to appropriate congressional committees and other interested parties. 

Copies will also be made available to others upon request. In addition, 

the report will be available at no charge on GAO’s Web site at http://

www.gao.gov. Please contact me at (202) 512-7215, Charles Jeszeck at 

(202) 512-7036, or Ken Stockbridge at (202) 512-7264, if you have any 

questions about this report. Other major contributors include Charles 

Ford and Ali Bonebrake.



Sincerely yours,



Barbara D. Bovbjerg

Director, Education, Workforce

 and Income Security Issues:



Signed by Barbara D. Bovbjerg:



[End of section]



Appendix I: Summary of the United Kingdom’s Retirement System:



Description of Current System:



In the United Kingdom, retirement income comes from a variety of 

sources, which can be organized in three levels--base, earnings-

related, and additional. (See fig. 1.) The country’s social security 

system provides both base level and earnings-related benefits.[Footnote 

32] The base level consists of the Basic State Pension (BSP) and means-

tested benefits for pensioners with low income. The earnings-related 

level consists of the government-run State Second Pension (S2P) and 

opted-out arrangements. Workers can choose to participate in S2P, 

employer pension plans, or individual pension accounts. Individuals can 

also set aside additional private savings for retirement on a voluntary 

basis. A variety of voluntary savings instruments enjoy tax-relief to 

encourage workers to save for their retirement.



Figure 1: Overview of the United Kingdom’s Retirement Income Sources:



[See PDF for image]



Notes: “Base” income sources include flat-rate or means-tested 

government benefits. “Earnings-related” income sources relate to 

earnings levels either through DB benefit formulas or DC contribution 

levels. “Additional” income sources consist of voluntary individual 

savings that are not directly related to earnings.



[A] Some individuals may use personal or stakeholder pensions as 

additional rather than earnings-related sources of retirement income.



[B] Can either substitute for (when “contracted-out,” or opted-out, of) 

or supplement (when “contracted-in,” or opted into) S2P benefits.



[C] Individuals may also make additional contributions to these 

accounts.



[D] Can either be arranged individually or through employer.



[End of figure]



The Base Level: The Basic State Pension and 

Means-Tested Benefits:



The Basic State Pension:



The U.K. social security system began in 1908 with the enactment of the 

Old-Age Pensions Act. At that time, the system provided flat-rate, 

means-tested benefits for individuals over age 70. In the 1940s, 

economist Sir William Beveridge advocated major changes to the 

country’s social security system. In a report, he proposed a universal 

social security system that would provide a minimum benefit to all 

individuals funded by worker contributions. Eventually, the Beveridge 

report led to the passage of the National Insurance Act of 1946, which 

created the basis for the current social security program.



BSP is the foundation of the country’s social security system. BSP 

benefits are paid to over 10 million people, which is nearly 

100 percent of the country’s pensioners. BSP provides a flat benefit 

based on the number of “qualifying years” that individuals contribute 

to the system. Individuals make contributions to the BSP and a variety 

of other benefits through payroll taxes known as National Insurance 

Contributions (NICs).[Footnote 33] To receive full benefits, men are 

required to have 44 qualifying years; whereas, the number of qualifying 

years for women will gradually increase from 39 to 44 between 2010 and 

2020. Individuals with fewer qualifying years will receive less than 

the full benefit amount; however, they may be able to earn credits 

towards the full BSP for periods of unemployment due to caregiving, 

disability, and certain other circumstances.



Workers are eligible for BSP benefits at the normal retirement age, 

which is 65 for men and will gradually increase from age 60 to age 65 

for women between 2010 and 2020. Currently, full BSP provides a benefit 

of $122[Footnote 34] per week for a single person.[Footnote 35] 

Relative to average wages, the benefit provided from BSP has declined 

since the 1980s. This decline in benefit levels, relative to average 

wages, reflects a 1980 change to benefit indexing. Prior to 1980, 

annual increases to BSP were linked to inflation or real wage growth, 

whichever was higher, but after 1980 annual increases were linked only 

to inflation. In December 2002, the government announced that it would 

increase BSP benefits in future years by at least 2.5 percent per year, 

even if this amount were larger than the increase in inflation.



Means-Tested Benefits:



The Minimum Income Guarantee:



The Minimum Income Guarantee (MIG) was introduced April 1999. It is a 

means-tested entitlement that provides extra financial support to poor 

pensioners. MIG is available to pensioners who are aged 60 and older, 

have savings under $19,392, and work less than 16 hours per week (or 

less than 24 hours per week if they have a partner).



MIG provides poor pensioners with a minimum income that is higher than 

BSP. Currently, poor pensioners can receive weekly MIG entitlements 

that top up their income to $159 for a single person or $242 for a 

couple.[Footnote 36] Individuals receive different MIG entitlement 

amounts, based on whether they have a full-or reduced-rate BSP, their 

amount of savings, and their income. Additionally, individuals can 

receive higher weekly MIG entitlements for certain circumstances, 

including disability and caregiving.



Some experts were concerned that MIG provides poor pensioners with a 

disincentive to work and save money for retirement. This is because MIG 

entitlement amount is reduced £1 per £1 based on income an individual 

receives from an occupational, personal, or stakeholder pension. Under 

MIG, some pensioners with modest savings would be no better off than 

pensioners without any savings. This concern, among others, led the 

government to reform MIG with the Pension Credit, which will be 

introduced in 2003.



The Pension Credit:



In response to concerns regarding MIG, in October 2003 the Pension 

Credit will become the major form of means-tested social assistance to 

individuals with modest incomes over the national pension age. The 

Department for Work and Pensions (DWP) believes that the Pension Credit 

will reward pensioners for their retirement savings efforts. DWP 

estimates that over 5.3 million pensioners (about half of all pensioner 

households) will be better off from the introduction of the Pension 

Credit. The government expects that the Pension Credit will entitle 

nearly half of all pensioner households to gain an average of $646 a 

year.



The Pension Credit consists of two elements: (1) a guarantee credit and 

(2) a savings credit. The guarantee credit tops up the income for a 

single pensioner to $165 a week and for a pensioner couple to $252 a 

week.[Footnote 37] The savings credit provides a “reward” element, so 

that those with savings, second pensions, or earnings that fall between 

the amount of BSP and $218 a week ($323 for couples) will receive a 

credit.[Footnote 38] The savings credit is designed to taper away as an 

individual’s income rises. For example, income between BSP and the 

guarantee credit is entitled to a 60-percent savings credit, whereas, 

additional income (up to $218 a week) is entitled to a 40-percent 

savings credit.



The Earnings-Related Level: The State Second Pension and Contracted-Out 

Arrangements:



To provide more adequate retirement income, the U.K. government created 

the second tier to the national pension system in 1959. This tier was a 

supplemental earnings-related plan called the graduated pension. The 

government allowed employers to “contract out” their employees, that 

is, opt them out, of the national graduated pension plan if they 

offered comparable benefits in occupational pensions. The U.K. history 

with contracting-out continued with the Social Security Pensions Act of 

1975. This act created the State Earnings-Related Pension Scheme 

(SERPS) to provide more substantial benefits and to further help those 

without employer pensions. In 1986, SERPS was further reformed to 

provide workers themselves with the option of contracting out of SERPS 

for participation in an employer-sponsored, defined contribution plan 

or a personal pension.



In July 2000, the U.K. government enacted reforms that called for 

replacing SERPS with S2P. In April 2002, the government implemented S2P 

to provide a more generous national pension plan than SERPS would have 

provided to individuals with low and moderate incomes. In addition, S2P 

provides more generous benefits to individuals caring for young 

children or a disabled person and individuals with long-term 

disabilities who have intermittent work records.



Although workers are required to participate in the second tier of the 

U.K. social security system, they have a range of participation 

choices. For example, workers can either participate in S2P, their 

employer’s pension plan, a personal pension, or a stakeholder pension. 

Additionally, workers can choose to participate in S2P while 

simultaneously participating in their employer’s pension plan and a 

personal pension or stakeholder pension plan.



State Second Pension:



On April 6, 2002, the government introduced S2P to replace SERPS, the 

second tier national social security system that existed from 1978 to 

2002. While SERPS provided individuals with earnings related benefits, 

S2P provides more generous redistributive benefits targeted to low 

earners, disabled individuals, and caregivers. The government intends 

to convert S2P into a flat rate benefit once stakeholder pensions have 

become established. It is the belief of the government that stakeholder 

pensions will provide an incentive for moderate earners to opt out of 

the national system.



S2P provides individuals earning up to $39,753 annually (in 2002/03 

terms) a larger pension than they would have received under SERPS. 

Individuals build entitlements to S2P by earning at least $6,302 in 

income per year.[Footnote 39] In 2002/03, individuals earning more than 

$6,302 but less than $17,453 annually will be treated for S2P purposes 

as if they had earned $17,453. Low and low-to-middle income individuals 

are also better off in S2P because the accrual rate (the rate at which 

the pension builds up) is more generous than it was in SERPS.[Footnote 

40]



Similar to BSP, contributions are made to S2P through payroll taxes 

(NICs). Currently, employees who remain in S2P pay NICs on 10 percent 

of weekly earnings between the primary threshold ($144) and the upper 

earnings limit ($945). Employers are also required to pay NICs on 

11.8 percent of earnings above $144 per week.[Footnote 41] Also, like 

BSP, individuals can build entitlements to S2P during periods when they 

cannot work due to long-term illness or disability or when they are 

providing certain types of care. These individuals will be able to 

build up about a $1.62 per week in S2P for each year they are eligible.



When S2P was introduced in 2002, the government estimated that 

approximately 18 million people would begin accruing entitlements from 

the program. Individuals accruing entitlements from S2P include 

4.5 million low earners (less than $15,352 a year), 9.5 million 

moderate earners (between $15,352 and $34,905), 2 million caregivers, 

and 2 million individuals with long-term disabilities.



Contracted-Out Arrangements:



Individuals may choose to contract out of S2P to participate in 

employer pensions, personal pensions or stakeholder pensions. However, 

individuals may also choose to participate in these arrangements while 

remaining in the national system. Those choosing to contract out of the 

national system will either pay reduced NICs or will receive government 

rebates. In particular, individuals choosing to participate in an 

employer-sponsored pension plans pay reduced NICs on a portion of their 

weekly earnings[Footnote 42]. Whereas, those participating in personal 

pensions and stakeholder pensions pay full-rate NICs but receive a 

rebate from the government paid directly into their private pension 

account. Individuals participating in an employer-sponsored defined 

contribution pension plan will receive a rebate from the government in 

addition to paying reduced NICs. The amount of rebate an individual 

receives depends on their age and the amount of their earnings. The 

age-related rebate allows individuals to receive a larger rebate amount 

as they grow older. For personal pensions and stakeholder pensions, 

there is currently a 1-year delay between when NICs are paid and when 

the rebates are paid to the pension provider. However, rebates may be 

paid more quickly to individuals participating in an employer-sponsored 

defined contribution plan.



Employer Pension Plans:



There is no statutory obligation for employers to establish, or for 

employees to join, employer-sponsored pension plans. Rather, it is up 

to the employer (or group of employers) to establish the pension plan 

and decide upon the rules and benefits of the plan. Approximately 

50 percent of the working population is covered by an employer-

sponsored pension.



Many employers offer defined benefit or defined contribution pension 

plans. A defined benefit plan promises to provide a benefit that is 

generally based on an employee’s salary and years of service. Whereas, 

a defined contribution plan provides a benefit based on the 

contributions to and investment returns (gains and losses) on 

individual accounts. Similar to the United States, a number of 

employers in the United Kingdom have begun offering defined 

contribution plans instead of defined benefit plans.



Personal Pensions:



Personal pensions are tax-deferred, defined-contribution individual 

pension accounts that were created by the 1986 Social Security Act and 

implemented in 1988. The original purpose of personal pensions was to 

allow individuals without access to employer-sponsored pensions the 

ability to contract out of the second tier government-run social 

security system. A variety of financial service providers, such as, 

banks, mortgage companies, investment trusts, and other financial 

institutions offer personal pensions. Individuals are subject to 

contribution limits depending upon certain circumstances. For example, 

those participating in an employer-sponsored plan or those with 

nontaxable or minimal earnings can contribute up to $5,818 in a 

personal pension each year. Otherwise, individuals can contribute up to 

a certain percentage of their taxable earnings. The maximum percentage 

individuals can contribute increases with age. These contributions can 

be made by the individual, the employer, and from tax relief received 

from Inland Revenue.



Administrative charges vary based on the type of personal pension an 

individual chooses. Additionally, the government provides few 

regulations concerning the administrative costs and fees that personal 

pension providers can charge. In personal pension plans, providers can 

front-load the administrative charges, thereby charging a high amount 

of fees in the beginning stage of an individual account. These charges 

can consume a substantial amount of an account balance, particularly 

for individuals that may not have the means to make sizeable 

contributions or cannot make contributions for a prolonged period of 

time. For example, one study found that on average, various 

administrative costs in the United Kingdom have historically consumed 

between 40 and 45 percent of an individual account’s value[Footnote 

43].:



When personal pensions were first introduced, hundreds of thousands of 

individuals were convinced to opt out of their employer-sponsored 

pension into a personal pension when it was disadvantageous to them. 

These individuals found themselves with lower benefits than they would 

have had if they remained in their employer-sponsored pensions. This 

became known as the “mis-selling scandal.” The insurance industry was 

held responsible and required to compensate individuals that were mis-

sold pension products. It is expected that payments in compensation to 

those mis-sold pension products will reach $19.4 billion.



Stakeholder Pensions:



According to U.K. experts, stakeholder pensions were created to address 

the tarnished image of personal pensions after the mis-selling scandal. 

Stakeholder pensions were introduced in April 2001 and provide 

additional pension coverage to the self-employed and to employees with 

low to moderate incomes.[Footnote 44] Like personal pensions, 

stakeholder pensions provide individuals with the option of contracting 

out of the national second tier social security system to participate 

in the tax-relieved defined contribution individual pension accounts.



Stakeholder pensions were designed to meet a number of standards 

concerning administrative costs, flexibility, and security. 

Specifically, stakeholder pensions differ from personal pensions in the 

following ways:



* Administrative charges are capped at 1 percent of the account’s total 

value.

:



* Individuals are not penalized for breaks in contributions or for 

transferring to another pension plan.

:



* Individuals can contribute as little as $32, which can be paid 

weekly, monthly, or at less regular intervals.

:



* Trustees and stakeholder managers are required to make investment 

decisions for individuals that do not want to make such decisions.



Employers that do not provide an employee pension plan and have five or 

more employees are required to provide their employees with access to a 

stakeholder pension. However, employers are not required to make any 

contributions to the stakeholder pension. Stakeholder pensions are 

subject to the same contribution limits as personal pensions. These 

contributions can be made by the individual, the employer, and from tax 

relief received from Inland Revenue.



The Additional Level: Individual Voluntary Savings:



The additional level to the U.K. pension system consists of individual 

forms of voluntary savings. For example, individuals can make 

additional voluntary contributions into their employer-sponsored 

pension plan. Individuals can also save money for retirement by 

participating in a personal or stakeholder pension while they are 

simultaneously participating in S2P or an employer-sponsored pension. 

Individuals can receive tax relief for these additional contributions, 

up to a ceiling. Furthermore, individuals can also choose to make 

contributions to a variety of other tax-relieved instruments, such as, 

annuities and life insurance.



Key Design Features of Voluntary Individual Accounts in the United 

Kingdom:



Voluntary individual accounts represent an integral part of the 

retirement system in the Untied Kingdom. Table 2 describes the key 

design features of voluntary individual accounts in four areas: (1) the 

interaction with national pension benefits, (2) the contribution phase, 

(3) the accumulation phase, and (4) the withdrawal phase.



Table 2: Key Design Features of Voluntary Individual Accounts in the 

United Kingdom:



Interaction with national pension benefits (social security):



Substitute or supplement: The United Kingdom has a system of substitute 

accounts. This is because individuals give up their benefits from S2P 

when they are participating in a voluntary individual account that 

qualifies for either a reduction payroll taxes or a government rebate.



Contribution phase:



Who can participate: Anyone who is eligible to participate in S2P can 

choose to 

opt out of S2P to participate in an individual account. (Individuals 

earning at least $6,302 a year--the lower earnings limit in 2002/03--

are eligible to participate in S2P.).



Opt-in/opt-out ability: Individuals can decide to opt in and opt out 

of accounts at any time.



How much individuals can contribute: Individuals are subject to 

contribution 

limits depending upon certain circumstances. For example, those 

participating in an employer-sponsored plan or those with nontaxable 

or minimal earnings can contribute up to $5,818 in a personal pension 

each year. Otherwise, individuals can contribute up to a certain 

percentage 

of their taxable earnings. The maximum percentage individuals can 

contribute increases with age.



Government or employer contributions: Once a year, the government 

contributes a 

rebate into individual account plans known as personal pensions 

and 

stakeholder pensions. The amount of the rebate an individual 

receive 

depends on their age and the amount of their earnings. Employers 

are 

not required to make contributions to their employees’ individual 

accounts.



Automatic enrollment: Employers can automatically enroll their 

employees 

into an employer-sponsored pension plan. However, employees have 

the 

right not to participate in such a plan.



Tax advantages: Individuals and employers receive tax relief for 

the 

contributions they make to individual accounts. Additionally, 

individuals are not taxed on any contributions that employers may 

make 

to their account.



Accumulation phase:



Regulation of investment options: Financial service companies 

offer 

individual account investment options that provide varying degrees 

of 

risk.



Regulation of administrative charges: One type of individual account, 

the 

stakeholder pension, limits the administrative charges to 1 percent of 

the value of the account each year. Whereas, another type of individual 

account, provides few regulations regarding administrative charges.



Tax advantages: Individual accounts are exempt from the tax on capital 

gains and most of the investment returns accruing to the account are 

also tax exempt.



Withdrawal phase:



Preretirement loans: Individuals cannot take preretirement loans from 

their 

individual accounts.



Withdrawal options--annuity, installment payments, and lump-sum 

distributions: Between the ages of 60 and 75, individuals must 
annuitize 

the portion of their account that was funded by tax rebates. 

Individuals have more flexibility with the portion of the account 

funded by their additional contributions. They are still required to 

purchase an annuity between the ages of 50 and 75. However, they can 

choose to take up to 25 percent of the account balance as a lump sum 

provided that they purchase an annuity or take income withdrawals at 

the same time.



Rate of return or minimum benefit guarantees: Individual accounts are 
not 

required to provide specified rates of return or minimum benefit 

guarantees.



Tax advantages: Individuals can receive some benefits from an 
individual 

account free of income tax. Specifically, the benefits an individual 

receives as a lump sum are not subject to income tax.



[End of table]



Source: GAO.



[End of section]



Appendix II: Summary of the Czech Republic’s Retirement System:



The Czech Republic has a pay-as-you-go social security system with old-

age benefits that provide individuals with base-level and earnings-

related benefits in retirement. (See fig. 2.) The base benefit consists 

of a basic, flat-rate amount and an earnings related pension. 

Additional retirement income comes from voluntary accounts. These 

voluntary accounts are fully funded and encourage participation through 

government matching, tax-deferred interest accruals, and tax preferred 

participant and employer contributions.



Figure 2: Overview of Czech Retirement Income Sources:



[See PDF for image]



[End of figure]



Notes: “Base” income sources include flat-rate or means-tested 

government benefits. “Earnings-related” income sources relate to 

earnings levels either through DB benefit formulas or DC contribution 

levels. “Additional” income sources consist of voluntary individual 

savings that are not directly related to earnings.



Description of Current System:



The National Old-Age Pension:



The Czech Republic first introduced laws relating to old-age, 

disability and death benefits in 1906. The current system described 

below was enacted in 1995. The national pension system covers all 

employees, members of assimilated groups, including certain groups of 

students, farmers, artists, the unemployed, caregivers, military 

personnel, and the self-employed. Employees, employers, and the 

government all contribute to the system’s funding. Employees pay taxes 

of 6.5 percent of earnings, employers pay 19.5 percent of payroll, and 

the government pays for any cash flow deficits incurred by the 

system.[Footnote 45] To qualify for old-age benefits, one must have 

25 years of insurance coverage[Footnote 46] and be within 3 years of 

retirement age. The current retirement age is 61 years and 4 months for 

men. For women the retirement age is between age 55 and 8 months or age 

59 and 8 months.[Footnote 47] The retirement age will continue to 

increase by 2 months per year for men and 4 months per year for women 

until they reach their target level in 2007 of age 62 for men and age 

57 to 61 for women. The expected old-age replacement rate is on average 

53 percent. However the replacement rate varies across earnings levels 

as it falls from 81 percent for those with the lowest wage to less than 

30 percent for those with double the average wage.



The old-age benefit is composed of a basic benefit and an earnings-

related benefit. The basic benefit is a flat-rate benefit that is 

currently $43.84 per month.[Footnote 48] The second part of a 

participant’s national pension consists of an earnings-related pension. 

The earnings included are indexed earnings, that is, earnings are 

adjusted to reflect the average wage.[Footnote 49] Monthly earnings of 

up to $247.62 receive 100 percent inclusion into the earnings 

calculation. Monthly earnings amounts between $247.62 and $598.98 

receive 30 percent inclusion. Monthly earnings amounts over $598.98 

receive 10 percent inclusion into the earnings calculation. The 

earnings-related benefit is derived from a calculation base that varies 

by type of pension. For old-age (and full disability) pensions, 

1.5 percent of the calculation base is multiplied by the number of 

insured years. The minimum earnings-related pension is $25.77 per 

month, which combines with the base pension for a total minimum of 

$69.60 per month. The average old-age benefit in 2002 was $228.92 per 

month. Old-age benefits at or above $4,015.49 a year are subject to 

income taxation.



In addition to old-age benefits the Czech system provides for full 

disability, partial disability, survivors, widows or widowers, and 

orphans. Partial disability benefits are paid using the same flat 

benefit of $43.84 per month and using half of the accrual rate 

(0.75 percent of the base multiplied by the number of insured years). 

Widows and widowers receive that flat benefit of $43.84 plus half of 

the deceased spouses earnings related pension. This benefit is paid at 

any age for one year immediately following the loss of the spouse, and 

thereafter paid to widows age 55 or older and widowers age 58 or older. 

Benefits are payable at any age if the widow or widowers is disabled, 

caring for dependent or disabled child or for disabled parent.



Additional Retirement Sources: Voluntary Supplementary Pension 

Insurance:



In 1994 the Czech Republic introduced supplementary pension 

insurance.[Footnote 50] The supplementary pension insurance system is 

not integrated with the government-provided base or earnings related 

old-age benefits. The system is characterized by voluntary 

participation and is largely administered by private pension funds with 

government supervision performed by the Czech Ministry of Finance and 

the Czech Securities Commission. Participants may contribute as little 

as $3.34 per month. For participant contributions in the $3.34 to 

$16.73 per month range, the government contributes a match related to 

the amount contributed by the participant. (See table 3.) Contributions 

between $200.77 and $602.32 per year are tax deductible. Participants 

may contribute more than $602.32 per year, but they do not receive any 

additional government contributions or tax advantages.



Table 3: Schedule of Government Matching Contributions for Czech 

Voluntary Supplementary Insurance:



Amounts shown in U.S. dollars: Planholder’s monthly contribution: $3.34 

to $6.66; Government contribution: $1.67 + 40% of the amount over 

$3.34.



Amounts shown in U.S. dollars: Planholder’s monthly contribution: $6.69 

- $10.01; Government contribution: $3.01 + 30% of the amount over 

$6.69.



Amounts shown in U.S. dollars: Planholder’s monthly contribution: 

$10.04 - $13.35; Government contribution: $4.02 + 20% of the amount 

over $10.04.



Amounts shown in U.S. dollars: Planholder’s monthly contribution: 

$13.38 - $16.70; Government contribution: $4.68 + 10% of the amount 

over $13.38.



Amounts shown in U.S. dollars: Planholder’s monthly contribution: 

$16.73 and more; Government contribution: $5.02.



Source: State-Contributory Supplementary Pension Insurance Act (http:/

/www.mpsv.cz/files/clanky/1140/No_42_1994.pdf).



Note: Contribution amounts are not continuous as they reflect whole 

Czech koruna amounts (approximately $0.03). Amounts converted by GAO 

using a conversion rate of 29.88 CZK per U.S. dollar.



[End of table]



The supplementary system has 2.5 million participants that account for 

roughly 25 percent of the population and 50 percent of the labor force. 

In 2001 the average contribution was $11.54 per month and the average 

government contribution was $3.11 per month. (See fig. 3.) In 2000 a 

provision was introduced to allow participants to receive employer 

contributions to their supplementary pension. The employer 

contributions are not matched by government contributions, but 

employers and employees receive tax advantages for employer 

contributions up to a limit. (See table 5 for more detail on tax 

advantages.) About 25 percent of participants receive employer 

contributions.



Figure 3: Average Monthly Participant Contribution and Average 

Government Contribution to Czech Voluntary Supplementary Pension 

Insurance, 1994-2001:



[See PDF for image]



Note: “State Supervision in Pension Funds: Annual Report 2000.” Data 

for 1994 reflects only one fiscal quarter and data for 2001 reflects 

only the first two fiscal quarters of data.



[End of figure]



Plan holders are eligible to receive both their own contributions and 

the government contributions after they have contributed for at least 

5 years and have attained age 60. The current eligibility thresholds 

are higher than 3 contribution years and attainment of the age 50 that 

applied to supplementary pensions from 1994 to 1999. The age was 

raised, as it appeared that accounts were used as short-term savings 

vehicles just prior to retirement rather than long-term retirement 

savings. However, since the increase in contribution years and 

eligibility age, the average age of plan holders has remained around 

age 48, about 10 years higher than the population average age of 38.



Some flexibility exists regarding plan holders access to account funds 

prior to retirement. Plan holders may also adjust the amount of monthly 

contributions, though they may be required to wait up to 3 months by 

the fund to change their contribution amount. Contributions to the 

accounts may be suspended without penalty after a period of 3 years. In 

addition, plan holders may terminate their accounts after 1 year and 

receive both their own contributions as well as accrued interest. In 

the event of termination, the matching contribution is returned to the 

government. If the plan holders terminate their accounts but transfer 

the accounts to a new pension fund provider, the plan holders maintain 

both their own contributions and government matching contributions.



Plan holders may choose the form of payout (annuity or lump sum) and 

there are provisions for payout in the event of death (i.e., survivors) 

or disability. At the present, it appears that lump sum payouts are a 

popular form of payout. A representative of the pension funds estimated 

that only 5 percent of plan holders take benefit payouts in the form of 

an annuity.



Just a year after the Czech voluntary supplementary pension insurance 

system began, there were 44 pension funds, yet by 2001 the number of 

pension funds declined to 14. (See fig. 4.) The drop in funds is mainly 

due to the consolidation of funds and the imposition of capitalization 

requirements after early failures of some of the smaller funds. Some of 

these failures resulted in liquidation and various degrees of accounts 

losses for about 46,000 plan holders.[Footnote 51]



Figure 4: Number of Pension Funds Providing Czech Voluntary 

Supplementary Pension Insurance, 1994-2001:



[See PDF for image]



Note: June 12, 2002 Presentation, “The Czech Pension Reform.”



[End of figure]



The Czech Republic’s Ministry of Finance regulates the funds, which 

must have at least $1.7 million in registered capital. Funds are joint 

stockholding companies. This means that funds are independent legal 

entities formed by solely for capital financing as a pension fund. Both 

national and foreign legal entities or individuals may establish a 

pension fund and be a shareholder in it. One criticism of this 

arrangement is that operating costs and distribution of profits between 

plan holders and shareholders are not very transparent. Funds are 

allowed to make no more than 10 percent profit or return distributions, 

with the remainder put in reserve (at least 5 percent) or to the 

benefit of the participant. Average rates of return accruing to 

accounts have been fairly low. (See table 4.) In 1998 and 2001, the 

average inflation-adjusted rate of return was negative. The portfolio 

of the funds is fairly conservative. Most investments are in low risk 

vehicles as laws regulate both the type of investment vehicle as well 

as the portfolio composition of pension funds.[Footnote 52] As of 

December 31, 2001, about 83 percent of the total funds were invested in 

bonds or treasury bills.



Table 4: Average Inflation-Adjusted Rate of Return for Czech Pension 

Funds, 1995-2001:



Amounts shown in percent.



Average nominal rate of return; 1995: 11.0; 1996: 9.9; 1997: 9.2; 1998: 

8.2; 1999: 5.6; 2000: 4.0; 2001: 3.9.



Annual inflation rate; 1995: 9.1; 1996: 8.8; 1997: 8.5; 1998: 10.7; 

1999: 2.1; 2000: 3.9; 2001: 4.7.



Average inflation-adjusted rate of return; 1995: 1.7; 1996: 1.0; 1997: 

0.6; 1998: -2.3; 1999: 3.4; 2000: 0.1; 2001: -0.7.



Source: Czech Ministry of Finance, Office of the State Supervision In 

Insurance and Pension Funds and Czech Ministry of Labor and Social 

Affairs.



Note: “State Supervision in Pension Funds: Annual Report 2000.”



[End of table]



Key Design Features of Voluntary Individual Accounts in the Czech 

Republic:



Voluntary individual accounts are a part of the retirement system in 

the Czech Republic. Table 5 describes the key design features of 

voluntary individual accounts in four areas: (1) the interaction with 

national pension benefits, (2) the contribution phase, (3) the 

accumulation phase, and 

(4) the withdrawal phase.



Table 5: Key Design Features of Voluntary Individual Accounts in the 

Czech Republic:



Interaction with national pension benefits (social security).



Substitute or supplement: The Czech Republic has a system of 
supplemental 

accounts.



Contribution phase:



Who can participate: Any permanent resident of the Czech Republic over 

18 years 

of age that signs a contract for supplementary pension insurance with a 

pension fund.



Opt-in/Opt-out ability: Can opt in at any time. Cancellation is also 

possible at any time though government contributions must be returned 

to the government and penalties may be due.



How much can individuals contribute: To qualify for government 

contributions, 

individuals must contribute at least $3.35 per month.



Government or employer contributions: Plan holder contributions between 

$3.35 and 

$16.73 per month are eligible for government contributions between 

$1.67 and $5.02 per month. (See table 3 for complete schedule of 

government contributions.) Employers may make contributions of any 

amount, but tax advantages to the employer and employee are limited. 

(See below).



Automatic enrollment: There is no automatic enrollment.



Tax advantages: Employer contributions and individual plan holder 

contributions enjoy tax advantages up to a limit. Plan holder 

contributions between $200.77 per year up to $602.32 per year are tax 

deductible. An employer may receive tax deductions for contributions up 

to 3 percent of an employee’s earnings subject to social security tax. 

Further the employee is exempt from income tax on employer 

contributions up to 5 percent of the employee’s earnings subject to 

social security tax.



Accumulation phase: 



Regulation of investment options: To qualify as a pension fund, fund 

must 

adhere to certain investment choices including approved financial 

vehicles. Account holders may change pension fund provider at no 

penalty at any time.



Regulation of administrative charges: The pension fund may keep no 

more than 

10 percent of distributed profits.



Tax advantages: Investment returns accruing to the account is tax 

exempt.



Withdrawal phase:



Pre-retirement loans: No. However, account may be terminated after 

1 year. 

Termination returns all individual contributions and accruals.



Withdrawal options - annuity, installment payments, and lump sum 

distributions: Individuals may take full distributions in the form 

of an 

annuity or lump-sum after contributing for 5 years and attaining 

age 

60.



Rate of return or minimum benefit guarantees: None.



Tax advantages: Non-interest income is subject to a preferential 

tax rate.



Source: GAO.



[End of table]



[End of section]



Appendix III: Summary of Germany’s Retirement System:



Description of Current System:



In Germany, retirement income comes from a variety of sources, which 

can be organized in three levels--base, earnings-related, and 

additional. (See fig. 5.) At the base level, Germany provides means-

tested social assistance benefits, which are not formally part of the 

social security system.[Footnote 53] The country’s social security 

system provides pension insurance benefits that are primarily earnings-

related. Also, employer-sponsored pensions offer earnings-related 

benefits but only to a small portion of retirees. A system of voluntary 

individual accounts, known as “Riester Pensions,” has recently been 

introduced, which will provide earnings-related retirement income and 

which can be arranged either individually or through employers. 

Finally, individuals can also set aside additional private savings for 

retirement on a voluntary basis through a variety of savings vehicles, 

such as, bank accounts, stocks and bonds, and particularly life 

insurance contracts.



Figure 5: Overview of German Retirement Income Sources:



[See PDF for image]



Notes: “Base” income sources include flat-rate or means-tested 

government benefits. “Earnings-related” income sources relate to 

earnings levels either through DB benefit formulas or DC contribution 

levels. “Additional” income sources consist of voluntary individual 

savings that are not directly related to earnings.



[A] Employer-sponsored pensions account for less than 5 percent of 

total retirement income.



[End of figure]



The Base Level: Means-Tested Social Assistance for the Elderly:



Germany has a means-tested, social assistance program that provides 

benefits for those needing assistance towards living expenses. Germany 

also provides assistance for special circumstances, such as, illness, 

disability, or old age. Social assistance can come in the form of 

personal assistance, cash benefit payments, or payments in kind. 

However, before individuals are eligible to receive social assistance, 

they must draw upon any personal assets.[Footnote 54] The amount an 

individual receives from social assistance is dependent on their need.



In 2003, the government reformed social assistance for the elderly 

(those over age 65) and the disabled. The reform is designed to 

encourage elderly individuals to claim the social assistance that they 

are entitled to. In the past, elderly individuals have not claimed 

social assistance because German family law holds relatives liable for 

social assistance payments.[Footnote 55] The new reform encourages 

elderly individuals to claim social assistance by removing the 

obligation that their relatives pay for it. Specifically, relatives 

with an annual income of less than $106,154[Footnote 56] will not be 

required to pay social assistance. The government believes that this 

reform will make it easier for elderly individuals to enforce their 

rightful claims to social assistance, thereby improve their living 

conditions.



The Earnings-Related Level: National Pension Insurance, Employer-

Sponsored Pensions, and Riester Pensions:



The earnings-related level of the German retirement system consists of 

national pension insurance, employer-sponsored pension plans and 

Riester pensions. Individuals are compelled to participate in the 

national pension insurance system; however, they can choose whether or 

not to participate in employer-sponsored pension plans and Riester 

pensions.



National Pension Insurance:



Chancellor Bismarck introduced Germany’s first social security system 

in 1889. Initially, the system was designed to provide disability 

insurance to a limited segment of the workforce. However, over time the 

social security system began to provide pension insurance and to 

increasingly larger segments of the workforce. The current system of 

pension insurance has been in place since 1957. The objective of the 

German system is to provide a comfortable retirement income to workers 

based on the standard of living they achieved during their working 

years. As a result of this objective, the German pension insurance 

system, unlike the Social Security system in the United States, 

incorporates only a few redistributive properties.



In Germany, national pension insurance benefits provide the major 

source of income for workers in retirement. Most workers, with the 

exception of self-employed workers, are required to contribute to the 

social security system.[Footnote 57] The German system provides 

generous benefits that currently replace approximately 69 percent of 

pre-retirement income for an illustrative worker with average 

earnings.[Footnote 58] In the future, the system will replace a 

slightly lower proportion of a worker’s pre-retirement income. By 2030, 

the government expects social security to replace between 67 and 

68 percent of pre-retirement income.[Footnote 59] Furthermore, workers 

receive annual increases in their social security benefits based on 

changes in net wages.



The system is financed from equal contributions paid by employees and 

employers plus a subsidy from tax funds to cover the gap between the 

system’s income and payments. It is difficult to estimate the exact 

amount of contributions that finance old age pensions because the 

German system simultaneously collects contributions to finance 

disability benefits and some health prevention plans. One expert 

estimates that approximately two-thirds of the entire contributions 

collected finance old-age pensions. Due to recent reforms, the 

government has specified total contribution rates from 2002 to 2030 

ranging from 18.3 percent in 2010 to 21.8 percent in 2030.[Footnote 60]



Within the social security system, workers can choose among several 

types of old-age pensions: (1) standard old-age pension; (2) long 

service pensions; (3) old-age pension after unemployment or partial 

retirement; (4) old-age pension for women; (5) severe disability 

pension; and (6) miner’s long service pension. Benefit eligibility and 

years of contributions varies among the different types of pensions. 

However, most workers are eligible for social security benefits at 

standard retirement age, which is 65 for men and is gradually 

increasing for women in monthly steps from age 60 to age 65 between 

2000 and 2004.[Footnote 61] Workers can choose to delay their 

retirement beyond the age of 65 and, in return, receive a bonus that 

increases their pension by 0.5 percent. Conversely, workers can choose 

to retire before age 65 and receive pensions that are reduced by 

0.3 percent for each month of early retirement. The average age of 

retirement in Germany is about 60.



Employer-Sponsored Pensions:



Employer-sponsored pensions account for less than 5 percent of total 

retirement income among elderly households. While overall employer-

sponsored pension coverage is low, it varies significantly from 

industry to industry. For example, many more employees in the 

manufacturing industry are covered by employer-sponsored pension plans 

than employees in the wholesale and retail industries. Approximately 

66 percent of employees in the manufacturing industry are covered by an 

employer-sponsored pension; whereas, only 25 percent of employees are 

covered in the wholesale and retail industry.



A number of reasons explain the slow development of employer-sponsored 

pensions in Germany. For example, the ability of the national pension 

insurance system to provide generous benefits has reduced the need for 

individuals to have employer-sponsored pensions. Additionally, 

employers have been offering pension plans at declining rates due to 

the rise in unemployment, the establishment of specific indexation 

rules, unfavorable changes in taxation, and complicated legal rules.



Germany has five different types of employer-sponsored pension plans: 

“direct promises,” “support funds,” “pension assurance associations,” 

“direct insurances,” and “pension funds.” Various supervisory 

authorities and taxation rules regulates each type of plan. Direct 

promises and support funds have traditionally been organized as defined 

benefit pension plans. Increasingly, companies in Germany are moving 

away from these types of plans because of the financial risks, 

administrative costs, inflated balance sheets, and the lack of 

comparability of financial ratios between German and foreign companies. 

The government recently introduced pension funds as a way to promote 

occupational pensions while helping companies improve both their 

balance sheets and their standing in international capital markets. 

This new type of employer-sponsored pension provides minimum benefit 

guarantees and allows for more flexibility of investment.



Recently, a number of reforms to the German social security system were 

designed to strengthen employer-sponsored pension plans. One such 

reform legally entitles employees to an employer-sponsored pension by 

waiving certain parts of their income, such as, holiday pay or overtime 

to be directly deposited into their employer-sponsored plan. Another 

reform reduced the general statutory time limits for becoming vested in 

an employer-sponsored pension from 10 years to 5 years.



Riester Pensions: Voluntary Individual Accounts:



In May 2001, the German parliament passed reforms that were designed to 

make the social security system more financially sustainable and better 

able to handle demographic challenges. One major part of the reform 

created special incentives for workers to participate in voluntary 

individual accounts, known as Riester pensions.[Footnote 62] 

Individuals have been able to participate in a Riester pension since 

January 1, 2002. Individuals can receive the special incentives 

associated with Riester pensions by participating in either employer-

sponsored pension plans or individual pension plans. However, only 

certain types of employer-sponsored pension plans are eligible to 

receive the special incentives.[Footnote 63] Due to recent reforms, 

collective agreements will play a larger role in establishing employer-

sponsored pension plans and such agreements could take advantage of the 

Riester incentives. Agreements have already been created in the 

construction industry, the metal industry, the chemical industry, and 

the civil service. Those participating in Riester pensions on an 

individual basis may also receive special incentives for a variety of 

approved individual pension plans, including: private pension 

insurances, investment funds, and bank deposit plans.



Riester pensions are composed of personal contributions, government 

subsidies, and tax-free allowances. The government subsidies provide 

direct payments to individual accounts and are designed to benefit 

individuals with lower income and families with children[Footnote 64]. 

To obtain the full government subsidy, individuals must pay a certain 

proportion of their annual salary that is subject to social security 

contributions into the Riester pension. Individuals contributing 

1 percent as of 2002, 2 percent as of 2004, 3 percent as of 2006, and 

finally 4 percent as of 2008 of their salaries will receive the 

respective maximum subsidy. Individuals contributing less than the 

recommended amount receive correspondingly lower payments from the 

government. As the contribution rate grows between 2002 and 2008, the 

government subsidy also becomes larger. For example, the subsidy for 

single individuals grows from $40 annually in 2002 to $163 in 2008 and 

the subsidy for married couples grows from $81 in 2002 to $327 in 2008. 

Instead of receiving the direct payments from the government, 

individuals can choose to deduct their personal contributions along 

with the amount of the government subsidy from their income taxes. Tax 

deductions may only be claimed up to a specified amount that increases 

between 2002 and 200[Footnote 65]8. The tax office will automatically 

check whether individuals will benefit from the tax deduction.



To receive the subsidies and tax relief associated with Riester 

pensions, individual account plans have to be certified by the Federal 

Insurance Supervisory Office.[Footnote 66] This certification verifies 

that Riester pensions meet certain legal requirements. For example, to 

receive certification the individual account plan must not allow 

individuals to withdrawal benefits until they reach age 60 or until 

they begin to receive pension insurance benefits. Individuals 

withdrawing money before age 60 must repay the government subsidies and 

tax relief they received. Furthermore, Riester pensions must provide 

permanent and guaranteed benefits. Individuals can have benefits paid 

in the form of a life annuity that provides payments of equal or rising 

amounts. Additionally, individuals can take a portion of their account 

as a lump sum or installment payment, provided that the account balance 

meets certain criteria and provided that account will revert to a life 

annuity at age 85. Riester pensions must also provide a nominal capital 

guarantee; that is, individuals are guaranteed total payments that are 

at least equal to the actual amount they paid into the account, without 

an adjustment for inflation. In addition to these requirements, Riester 

pensions are also subject to administrative, documentary, and 

transparency requirements. For instance, contracting fees must be 

spread equally over a period of 10 years or more.



The Additional Level: Private Savings:



The additional level of the German retirement system consists of 

various forms of private saving. Many Germans save in bequeathable 

vehicles, such as, bank accounts, stocks and bonds, and life insurance 

contracts. Life insurance is particularly popular among Germans with 

approximately 50 percent of individuals in West Germany and 64 percent 

of individuals in East Germany covered by life insurance contracts.



Key Design Features of Voluntary Individual Accounts in Germany:



Voluntary individual accounts, known as Riester pensions, have been 

part of the German retirement system since January 2002. Table 6 below 

describes the key design features of voluntary individual accounts in 

four areas: (1) the interaction with national pension benefits, (2) the 

contribution phase, (3) the accumulation phase, and (4) the withdrawal 

phase.



Table 6: Key Design Features of Voluntary Individual Accounts in 

Germany:



Interaction with national pension benefits (social security).



Substitute or supplement: Germany has a supplemental system of 
voluntary 

individual accounts. Participation in voluntary individual accounts 

does not affect the benefit an individual receives from the national 

pension insurance system.



Contribution phase: 



Who can participate: Individuals can participate in the voluntary 

individual 

accounts if they are covered by the national pension insurance 

system. 

Those not covered by the national pension insurance system can 

participate in a voluntary individual account if they are disabled and 

working in workshops, insured during creditable child-raising periods, 

providing care, or are in military or civilian replacement duty.



Opt-in/opt-out ability: Individuals can terminate their voluntary 

individual 

account at any time and immediately receive the money they paid into 

the account. However, the government subsidies must be paid back and 

individuals will be taxed on the appreciation and returns to the 

account.



How much individuals can contribute: Currently, individuals can 

contribute 

1 percent of their annual salary that is subject to social security 

contributions into an individual account. This amount gradually 

increases to 4 percent in 2008.



Government or employer contributions: The government provides direct 

payments to 

individual accounts. These payments are designed to benefit 

individuals 

with lower income and families with children The amount of direct 

payments from the government increases between 2002 and 2008. Instead 

of receiving the direct payments, individuals can choose to receive 

tax 

relief.



Tax advantages: Instead of receiving the direct payments from the 

government, individuals can choose to deduct their personal 

contributions along with the amount of the government subsidy from 

their income taxes. Tax deductions may only be claimed up to a 

specified amount that increases between 2002 and 2008.



Accumulation phase:



Regulation of investment options: Individuals can choose among 

various types 

of individual accounts based on their willingness to take risks. 

For 

example, bank savings plans and private pension insurance represent 

low-risk individual accounts; whereas, investment funds have more 

risk 

but may yield higher returns. Although each of these individual 

account 

plans must undergo government certification, there is no guarantee 

as 

to how much profit an account will make.



Regulation of administrative charges: Individual accounts are 

subject to 

administrative requirements. For instance, contracting fees must 

be 

spread equally over a period of 10 years or more.



Tax advantages: Individual accounts can accrue capital gains and 

investment 

returns tax-free.



Withdrawal phase: 



Preretirement loans: Individuals withdrawing money from their 

individual account 

before age 60 must repay the government subsidies and tax relief 

they 

received.



Withdrawal options--annuity, installment payments, and lump sum 

distributions: Individuals can have benefits paid in the form of 

a life 

annuity that provides payments of equal or rising amounts. 

Additionally, individuals can take a portion of their account as 

a lump 

sum or installment payment, provided that the account balance 

meets 

certain criteria and provided that account will revert to a life 

annuity at age 85.



Rate of return or minimum benefit guarantees: Individual accounts 

must provide a 

nominal capital guarantee; that is, individuals are guaranteed 

total 

payments that are at least equal to the nominal amount they paid 

into 

the account.



Tax advantages: Individual accounts are fully taxable upon withdrawal.



Source: GAO.



[End of table]



[End of section]



Appendix IV: Comments from the Social Security Administration:



SOCIAL SECURITY:



The Comissioner:



March 5, 2003:



The Honorable David M. Walker, Comptroller General of the United 

States 

U.S. General Accounting Office Washington, D.C. 20548:



Dear Comptroller General:



Thank you for the opportunity to review and comment on the preliminary 

draft report “Social Security Reform: Information on Using a Voluntary 

Approach to Individual Accounts” (GAO-03-309). Social Security is one 

of the most important and successful government programs. The Trustees 

of Social Security and many others have said projected benefits as 

presently financed, are unsustainable over the long term. Potential 

solutions many observers have suggested include voluntary personal 

savings accounts. Therefore, your report is very timely.



GAO has done an excellent job covering many of the issues surrounding 

the creation of voluntary accounts. The report identifies a series of 

important design issues, some of which have not yet been the subject of 

much public debate. This delineation of the issues, their interaction, 

and the foreign experience will provide policy makers and analysts with 

important information as they consider individual account plans.



If your staff has questions about our comments, they may contact 

Patricia Vinkenes, Acting Deputy Associate Commissioner for Retirement 

Policy. Ms. Vinkenes can be reached by phone at (202) 358-6110 or by E-

mail at pat.vinkenes @ ssa.gov .



Sincerely,



Jo Anne B. Barnhart:



Signed by Jo Anne B. Barnhart:



Enclosure:



COMMENTS ON THE GENERAL ACCOUNTING OFFICE (GAO) REPORT “SOCIAL SECURITY 

REFORM: INFORMATION ON USING A VOLUNTARY APPROACH TO INDIVIDUAL 

ACCOUNTS” (GAO-03-309):



Administrative Issues. The draft report cites the Federal Thrift 

Savings Plan and private 401(k) and IRA plans as models for a national 

voluntary account system, but gives little information on how the TSP 

has achieved very low costs. Combining the contributions of much of the 

U.S. workforce into a single, limited-option system of individual 

accounts could achieve significant economies of scale. For example, the 

cost of developing a computer system to support individual accounts 

does not increase in proportion to the number of participants. Limiting 

the number of account features (such as the availability of loans) 

would also hold down costs. The use of index funds would keep 

investment fees to minimal levels.



Benchmarks. Although the draft states at one point that “reductions in 

benefits and/or increases in revenue will be needed to restore 

solvency” to Social Security, it generally seems to presume that the 

baseline benefit is that promised under current law. GAO has previously 

made clear that proposals that achieve sustainable solvency for Social 

Security should not be compared to benchmarks that are unsustainable at 

present tax rates. This report should emphasize that the projected 

level, at present tax rates, of defined Social Security benefits 

(including coverage in the event of death or disability) is likely to 

affect the rate of participation in voluntary individual accounts.



Benefit offsets. The discussion of substitute accounts should include a 

more thorough discussion of benefit offsets, including specific 

examples. The way in which participation in a voluntary individual 

account could affect a person’s total Social Security benefit, and the 

extent to which people understand the affect, will influence the rate 

of participation.



Participation Decision. The draft states that most proposals for 

voluntary individual accounts in the U.S. would not provide for an 

annual participation decision. In fact, most proposals have not 

explicitly considered whether participation would be an annual or a 

one-time decision. More public debate on this topic is needed.



[End of section]



FOOTNOTES



[1] At retirement, individuals do 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.



[2] 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 U.S. General Accounting Office, 

Social Security Reform: Demographic Trends Underlie Long-Term Financing 

Shortage, GAO/T-HEHS-98-43 (Washington, D.C.: Nov. 20, 1997).



[3] In other countries, “social security” refers to a wide range of 

social insurance programs, including health care, long-term care, 

workers’ compensation, unemployment insurance, etc. To generalize 

across countries, we use “national pension benefit” to refer to 

defined-benefit old-age pensions provided by the social security 

system. We use “Social Security” to refer to the U.S. Old-Age, 

Survivors, and Disability Insurance Program since that is how the 

program is commonly known.



[4] In the United States, the terms “add-ons” and “carve-outs” have 

also been used. However, using these terms to describe foreign programs 

could be misleading because of the different contexts in which accounts 

exist. Moreover, in the case of mandatory accounts, “carve-out” plans 

may reduce benefits while adding the accounts; however, since the 

accounts are mandatory, the benefit reductions need not be construed as 

being linked to the accounts. To avoid this ambiguity, we use 

“substitute” accounts for cases in which participation in the accounts 

is linked to compensating benefit offsets and “supplemental accounts” 

for cases in which participation is not so linked.



[5] In the United States, for example, the Clinton Administration’s 

Universal Savings Account proposal would have created supplemental 

accounts, while Model 2 of the Commission to Strengthen Social Security 

would create substitute accounts. See U.S. General Accounting Office, 

Social Security: The President’s Proposal, GAO/T-HEHS/AIMD-00-43 

(Washington, D.C.: Nov. 9, 1999) and 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).



[6] Annuities pay benefits on a fixed schedule for life or sometimes 

for a fixed period. Some annuities, called joint-and-survivor 

annuities, pay benefits to the annuity holders while they live and to 

their survivors after they have died. Annuities provide a way of 

managing a lump sum of money and transferring financial and insurance 

risk to the providers to ensure a steady stream of income for the 

annuitant.



[7] All currency values have been converted to U.S. dollars, using the 

following average exchange rates for the month of January 2003: 

U.S.$1=£0.61882; U.S.$1=29.88 Czech koruna (CZK); U.S.$1=€0.94203.



[8] Participation rates were initially 57 to 69 percent for employees 

that had over 3 years of tenure. Participation rates were initially 

26 to 43 percent for employees that had over 6 months of tenure but 

less than 3 years.



[9] Mamta Murthi, J. Michael Orszag, and Peter R. Orszag. 

“Administrative Costs under a Decentralized Approach to Individual 

Accounts: Lessons from the United Kingdom,” in Robert Hollzman and 

Joseph E. Stiglitz, New Ideas About Old Age Security: Toward 

Sustainable Pension Systems in the 21st Century. The World Bank 

(Washington, D.C.: 2001).



[10] U.S. General Accounting Office, Social Security Reform: 

Administrative Costs for Individual Accounts Depend on System Design, 

GAO/HEHS-99-131 (Washington, D.C.: 

June 18, 1999).



[11] Such account contributions are generally related to annual income 

rather than lifetime income. As a result, they could go to people who 

turn out to have relatively high lifetime incomes, such as students and 

people with irregular but not necessarily low annual earnings. Under 

national defined benefit pension plans, redistribution is generally 

based on lifetime incomes.



[12] In 2008 and thereafter, Germans contributing a recommended 4 

percent of their salary to an individual account will receive a direct 

payment of $163. Those contributing less will receive a smaller direct 

payment. Individual accounts are being implemented between 2002 and 

2008. Individuals investing 1 percent of their annual salary as of 

2002, 2 percent as of 2004, 3 percent as of 2006, and finally 4 percent 

as of 2008 will receive the respective maximum government subsidy.



[13] Note that in contrast to the German approach, the Czech matching 

schedule is not progressive with respect to income, only with respect 

to contributions. In effect, the Czech matches decline relative to 

contribution levels while the German matches decline relative to 

income, which is not the same. See appendix II for more details on the 

Czech Republic’s matching levels.



[14] GAO-03-310.



[15] Tax deductions may only be claimed up to a specified amount. In 

the assessment periods 2002 and 2003, individuals can deduct up to 

$557. In the assessment periods 2004 and 2005, individuals can deduct 

up to $1,115. In the assessment period 2006 and 2007, individuals can 

deduct up to $1,672. Finally, in the assessment period 2008 and 

thereafter annually, individuals can deduct up to $2,229.



[16] In the United Kingdom, for any or all years they work, workers can 

contract out of the State Second Pension (S2P), which provides a 

defined-benefit retirement pension that is related to earnings and 

years of service. When workers contract out to an individual account, 

they receive a rebate to deposit into the account, which represents the 

value of the benefits they give up, as calculated actuarially. In turn, 

any S2P benefit they ultimately receive is calculated to reflect any 

periods in which they have opted out. Still, other national benefits 

they receive, such as the Basic State Pension and disability benefits, 

are not affected. The Basic State Pension is a flat-rate benefit paid 

to all retirees worth roughly $122 per month in 2002.



[17] For one type of individual retirement account in the United 

States--the Roth IRA--withdrawals are not taxed though contributions 

are not tax-deductible.



[18] U.S. General Accounting Office, 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).



[19] In the case of U.S. employer-provided accounts, individuals can 

typically take their funds if they leave a plan prior to retirement. 

While this provides pension portability, it also creates the 

possibility that individuals will not preserve those lump sums for 

retirement.



[20] James M. Poterba and Mark J. Warshawsky, “The Costs of Annuitizing 

Retirement Payouts from Individual Accounts,” (Cambridge, Mass.: 

National Bureau of Economic Research, Jan. 1999).



[21] Since June 1, 2002, approximately 160,000 Florida State employees 

were given the option of participating in a new individual account 

plan. The first choice period was open from July 1, 2002, to September 

3, 2002. There will be three more choice periods when the remaining 

employees can decide whether or not to participate in the plan. The 

government initially predicted approximately 35 to 40 percent of state 

workers would participate in the new accounts. However, later the 

government revised its estimates and predicted approximately 

17 to 24 percent would participate. 



[22] A mandatory approach to individual accounts can also involve a 

variety of costs that depend on the plan’s design, even though 

participation rates are not at issue. See U.S. General Accounting 

Office, Social Security Reform: Administrative Costs for Individual 

Accounts Depend on System Design, GAO/HEHS-99-131 (Washington, D.C.: 

June 18, 1999) and Social Security Reform: Implementation Issues for 

Individual Accounts, GAO/HEHS-99-122 (Washington, D.C.: June 18, 1999).



[23] The ratio of expenditures to savings would be slightly higher if 

tax relief were included. For the years 1988-89 to 1995-96, the net 

present cost of income tax relief for contribution rebates to voluntary 

individual accounts amounted to $3.2 billion. For more information see 

Lillian Liu, “Retirement Income Security in the United Kingdom,” Social 

Security Bulletin, vol. 62, no. 1, 1999.



[24] In the United States, the amount necessary to pay the benefits 

already accrued by current workers and current beneficiaries is roughly 

$9 trillion, according to the Social Security Administration. Under the 

CSSS proposals, transition costs would be funded through general 

revenue transfers, which would be repaid in future years when 

decreasing benefit costs fall below payroll tax revenues.



[25] See Richard Disney, Carl Emmerson and Sarah Smith, “Pension Reform 

and Economic Performance in Britain in the 1980s and 1990s.” Discussion 

paper available at: http://www.nottingham.ac.uk/economics/staff/

details/papers/PensionReformEconomicPerformance.doc.



[26] American Academy of Actuaries, “Social Security Reform: Voluntary 

or Mandatory Individual Accounts.” September 2002 Issue Brief. 



[27] In December 2002, the government announced a number of proposals 

to help individuals access information about their retirement. These 

proposals include telephone and Web site information services, 

interactive financial planning tools, interactive digital television, 

retirement planning around life events, and an online retirement 

planner.



[28] The interpretive bulletin (29 C.F.R. 2509.96-1) by the Department 

of Labor provides examples of educational investment information and 

analysis, including: plan information, general financial and investment 

information, asset allocation models, and interactive investment 

materials.



[29] GAO/HEHS-99-131.



[30] Florida introduced individual accounts to state employees in 

different groups. In the first group eligible to participate in 

individual accounts, 20 to 25 percent of employees used the Internet-

based service. At the time of our interview, the state did not yet have 

statistics on the remaining groups.



[31] www.fsa.gov.uk/pubs/public/stakeholder.pdf.



[32] In the United Kingdom, the term “social security” refers to a dual 

social insurance and social assistance system that includes benefits 

for old-age, disability, survivors, sickness and maternity, work 

injury, unemployment, and family allowances. In this appendix, the term 

“social security” refers specifically to the government-run retirement 

income security programs: the Basic State Pension and the State Second 

Pension.



[33] Individuals earning more than $7,458 a year (in 2002/03) are 

required to pay NICs towards the BSP. However, individuals earning 

between $6,302 and $7,458 a year (in 2002/03) can still build 

entitlement to the BSP even though they do not pay NICs.



[34] In this appendix, all British pounds are converted into U.S. 

dollars using a conversion of 

0.61882 British pounds per U.S. dollar. This figure represents the 

monthly conversion average in January 2003.



[35] Beginning in April 2003, the full BSP will increase to $125 a week 

for a single pensioner.



[36] In April 2003, the MIG will increase so that poor pensioners can 

receive weekly entitlements that top up their income to $165 for a 

single person or $252 for a couple.



[37] The guarantee credit links benefit increases to changes in wages; 

whereas, BSP links benefit increases to changes in prices. As a result 

of the differences in benefit indexation, it is likely that in the 

future more pensioners will be entitled to means-tested benefits.



[38] In 2003, the maximum credit payable is $22 a week for single 

pensioners and $30 a week for pensioner couples.



[39] In 2002/03, the lower earnings limit was $6,302.



[40] SERPS had a 20-percent accrual rate; whereas, S2P has three 

different accrual rates related to annual earnings.



[41] From April 2003, NIC rates will increase by 1 percent for 

employers and employees on earnings above a threshold. Employees will 

also pay 1 percent of earnings above the earnings limit, and the 

earnings limit will be raised in line with inflation.



[42] Currently, employees that contract out of S2P to participate in an 

employer-sponsored pension receive a flat rate reduction of NICs at a 

rate of 1.6 percent. Similarly, employers also receive a flat rate 

reduction of NICs ranging from 1 percent to 3.5 percent.



[43] Mamta Murthi, J. Michael Orszag, and Peter R. Orszag. 

“Administrative Costs under a Decentralized Approach to Individual 

Accounts: Lessons from the United Kingdom,” in Robert Hollzman and 

Joseph E. Stiglitz, New Ideas About Old Age Security: Toward 

Sustainable Pension Systems in the 21st Century. The World Bank 

(Washington, D.C.: 2001).



[44] Stakeholder pensions are targeted to approximately 3.1 million 

employees who do not have pension coverage and earn between $16,160 and 

$32,320 per year. Stakeholder pensions are also targeted to about 

1.5 million self-employed individuals.



[45] Currently the income rate is 26 percent of payroll and the cost 

rate is about 28 percent of payroll with the government contributing 

the difference.



[46] One qualifies with 15 years of insurance if aged 65. 



[47] The reason for this variation is that women are given allowances 

for the number of children they raise. The current retirement ages are 

up from the retirement ages in 1995 of 60 for men and 53 or 57 for 

women.



[48] Under law, the government is authorized to increase this basic 

benefit. All Czech koruna (CZK) are converted into U.S. dollars using a 

conversion of 29.88 CZK per U.S. dollar. This figure represents the 

monthly conversion average in January 2003. The $43.84 amount per 

month, converted to a yearly amount, equals only about 1.5 percent of 

2001 per capita gross domestic product (GDP) in the United States 

($35,000 in 2001). However, the same benefit amount equals about 9.6 

percent of 2001 per capita GDP ($5,500 in 2001) in the Czech Republic. 

In part, this comparison reflects that about $120 worth of goods in the 

United States would be roughly equivalent to $43.84 worth of goods (or 

2.7 times as much) in the Czech Republic (on a purchasing power parity 

basis). 



[49] The annual coefficients determined by the Czech Statistical 

Office. 



[50] To review the act enabling the creation of supplementary pension 

insurance in English visit http://www.mpsv.cz/files/clanky/1140/

No_42_1994.pdf.



[51] Less than 2 percent of all current plan holders.



[52] This includes not allowing more than 10 percent of a fund’s 

portfolio to be composed of one security traded on the stock exchange, 

and no more than 25 percent of the total portfolio can be composed of 

shares traded on the stock exchange. Additionally the pension fund 

cannot own more than a 20 percent share of any one issuers stock.



[53] In Germany, the term “social security” refers to a social 

insurance program that includes benefits for old-age, disability, 

survivors, sickness and maternity, work injury, and unemployment. In 

this appendix, the term “social security” refers specifically to the 

old-age pension system. 



[54] There are some exceptions in drawing upon personal assets to be 

eligible for social assistance. For example, individuals do not have to 

draw upon assets consisting of smaller savings deposits or the house in 

which they are living.



[55] The social service office decides whether or not direct relatives 

will be required to pay social assistance. The office also decides the 

amount of such payments. Only first-degree relatives (parents and 

children) or spouses can be held liable for social assistance payments.



[56] In this appendix, all Eurodollars are converted into U.S. dollars 

using a conversion of .94203 Eurodollars per U.S. dollar. This figure 

represents the monthly conversion average in January 2003.



[57] In addition to the self-employed, workers with low earnings and 

workers in some professions that have their own mandatory retirement 

system (such as civil servants) are not covered by social security.



[58] These replacement rates apply to an illustrative worker with 45 

years of contributions who always earned exactly the average income per 

worker. Since workers work less than 45 years on average actual 

replacement rates tend to be lower than those cited here. Thus, these 

pension benefits are less generous than the replacement rate might 

suggest.



[59] Assuming participation in voluntary individual accounts, the 

government expects social security to replace 76 percent of 

preretirement income in 2030.



[60] Prior to reform, the contribution rate was 19.3 percent in 2000.



[61] For workers with a severe disability pension, the retirement age 

is increasing from age 60 to age 63 between January 2001 and December 

2003. Workers with a miner’s long service pension can retire at age 60.



[62] Named for Walter Riester, the Minister of Labor at the time of 

their adoption.



[63] Employer-sponsored pension plans consisting of pension assurance 

associations, direct insurances, and pension funds are eligible for the 

Riester incentives; whereas, the book reserve funds and support funds 

are not eligible.



[64] The maximum subsidy per child that can be claimed annually is $49 
in 

2002, $98 in 2004, $146 in 2006, and $196 in 2008.



[65] The maximum tax relief that can be claimed annually is $557 in 

2002, $1,115 in 2004, $1,672 in 2006, and $2,229 in 2008.



[66] Individual account plans require certification; whereas, 

certification is not required for employer-sponsored plans receiving 

the Riester subsidies and tax relief.



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