Order Code RL32756
Social Security Individual Accounts and
February 3, 2005
Specialist in Social Legislation
Domestic Social Policy Division
Social Security Individual Accounts and
The President’s 2001 Commission to Strengthen Social Security recommended
that Social Security be modified to include voluntary individual accounts. The
commission acknowledged that establishing and maintaining a system of individual
accounts (IAs) could impose new costs on employers, particularly small employers.
The commission’s final report urged that in designing and implementing a system
of IAs, policymakers should attempt to minimize the cost to employers while
maintaining the features of IAs that would make them attractive to workers.
Pension analysts generally agree that designing individual accounts would
require trade-offs between individual choice and efficient management. A relatively
“high-cost” approach would create a system of IAs in which contributions to the
accounts are deposited quickly, participants have substantial control over their
accounts and have many investment choices, but in which employers must take on
substantial new administrative duties. A “low cost” option would deposit
contributions several months after they have been deducted from employees’ pay,
give participants less control over their accounts and provide few investment choices,
but would minimize the administrative tasks required of employers. The low-cost
approach to implementing Social Security individual accounts would avoid imposing
significant new expenses on small businesses, but the result would be a system that
would have few of the investment features common to modern §401(k) plans.
The ability of an employer to absorb new administrative costs associated with
Social Security individual accounts would depend in part on its size and whether it
already sponsors a retirement plan for its employees. Large employers would be able
to spread the fixed costs of administering the accounts over more workers, thereby
reducing average costs. Employers that already offer their employees a retirement
plan have an administrative infrastructure in place to perform any new tasks that
might be required to maintain a system of individual accounts. Most employers in
the United States are small employers with fewer than 20 employees, and most small
employers do not sponsor a retirement plan for their workers.
Employers could seek to offset cost increases that arise from administering
individual accounts by reducing or restructuring the benefits they currently offer to
their employees. For example, employers who must absorb new costs to help
administer IAs might reduce contributions to their §401(k) plans or otherwise reduce
their existing pension benefits. Social Security IAs also could affect employees’
contributions to §401(k) plans. With more of their future retirement income
dependent on investment returns, some workers might invest their §401(k)
contributions more conservatively. Alternatively, exposure to greater investment risk
could encourage some employees to increase their contributions to §401(k) plans in
an attempt to offset some of this risk. As they gain experience with the accounts,
some workers might develop a “taste for saving” that would persuade them to save
more through other savings vehicles such as Individual Retirement Accounts (IRAs).
This report will not be updated.
Introduction: The President’s Commission . . . . . . . . . . . . . . . . . . . . . . . . . 1
Overview of Employer-sponsored Retirement Plans . . . . . . . . . . . . . . . . . . . 2
Large and Small Firms Employ Different Kinds of Workers . . . . . . . . 4
Administrative Tasks and Individual Accounts . . . . . . . . . . . . . . . . . . . . . . . 6
Centralized vs. Decentralized Administration . . . . . . . . . . . . . . . . . . . . 6
Promptness and Accuracy of Record-Keeping . . . . . . . . . . . . . . . . . . . 7
Remitting Income and Payroll Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
Frequency of Remitting Taxes and Contributions . . . . . . . . . . . . . . . . . 7
Reconciling Errors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Distributing Funds from Accounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Educating the Public . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
Other Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
Social Security IAs and Pension Integration . . . . . . . . . . . . . . . . . . . . 11
Employers’ Fiduciary Responsibilities . . . . . . . . . . . . . . . . . . . . . . . . 12
Possible Employer Responses to Increased Costs . . . . . . . . . . . . . . . . 13
Possible Employee Responses to Individual Accounts . . . . . . . . . . . . 13
The Thrift Savings Plan: A Model for Individual Accounts? . . . . . . . . . . . 15
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
List of Tables
Table 1. Firms and Establishments by Employment Size in 2000 . . . . . . . . . . . . . 3
Table 2. Employee Characteristics by Employer Retirement Plan
Sponsorship, 2003 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Social Security Individual Accounts and
Introduction: The President’s Commission
In December 2001, the President’s Commission to Strengthen Social Security
issued its final report. The report concluded that “Social Security will be
strengthened if modernized to include a system of voluntary personal accounts.”1
The commission acknowledged that establishing and maintaining a system of
individual accounts (IAs) could impose new costs on employers, particularly small
employers. They urged that in designing and implementing a system of IAs,
policymakers should attempt to minimize the cost to employers while maintaining
the features of IAs that would make them attractive to workers. Because small
employers would have more difficulty absorbing new costs than large employers, the
commission cautioned that “personal account administration should not add any
burden to small employers.”2 This CRS report describes employers in the United
States in terms of their size, sponsorship of employee benefits, and other
characteristics that might influence the extent to which implementing and
administering IAs could add to employers’ operating costs. It discusses the features
of IAs that are most likely to affect their administrative costs and how the policies
and procedures that might minimize those costs could also affect the extent to which
participants would be able to exercise control over their individual accounts.
Over the past several years, a number of retirement policy analysts have
considered the technical and administrative issues that would need to be addressed
if individual accounts were to be added to the Social Security program. There has
been general agreement among policy analysts that either of two approaches could
be taken in designing and implementing a system of Social Security IAs. One
approach would create a system of IAs in which contributions to the accounts are
deposited quickly, participants have substantial control over their accounts and have
many investment choices, but in which employers must take on substantial new
administrative duties to assure that these goals are achieved. For employers, this
would be a relatively “high cost” option. A “low cost” system would deposit
contributions to the accounts several months after they have been deducted from
employees’ pay, give participants relatively little control over their accounts and
provide few investment choices, but would minimize the administrative tasks
required of employers.
President’s Commission to Strengthen Social Security, Strengthening Social Security and
Creating Personal Wealth for All Americans, December 2001, p. 11.
President’s Commission, p. 47.
One pension analyst has described the design and implementation of individual
accounts as requiring inevitable “trade-offs between free choice and efficient
management,”3 while another has observed that “the central issues in designing
personal accounts involve tradeoffs between relatively standardized low-cost options
with constrained individual choice and limited risk on the one hand and more flexible
higher-cost options with enhanced opportunities for individual control and greater
risk on the other.”4 One implication of the tradeoff between individual choice and
administrative efficiency is that while it would be possible to design a system of
individual accounts that would keep administrative costs low and avoid imposing
significant new expenses on small businesses, “that system would likely bear little
or no resemblance to a modern 401(k) plan.”5 For IA participants, “keeping the
system as simple and inexpensive as possible would mean limiting the choices that
make IAs attractive in the first place.”6
Overview of Employer-sponsored Retirement Plans
Two characteristics of employers that would affect their ability to absorb
administrative costs associated with Social Security individual accounts are their size
and whether they already sponsor a retirement plan for their employees. Large
employers can spread the fixed costs of administering accounts over more workers,
thereby reducing average costs. Employers that offer their employees a retirement
plan already have an administrative infrastructure in place to perform new tasks that
might be required to maintain a system of individual accounts. For these reasons, it
is important to note that (1) most employers in the United States are small employers
with fewer than 20 employees; and, (2) most small employers do not sponsor a
retirement plan for their workers and therefore do not have an existing administrative
infrastructure to handle any new administrative tasks associated with individual
accounts. Because of the limited resources they have available to deal with new
administrative tasks, “small businesses may be particularly affected by reforms that
add individual accounts to Social Security.”7 The Government Accountability Office
(GAO) has observed, that “while large employers appear to be better able to handle
the costs and administrative demands of an individual account system, smaller
employers may face greater difficulties, such as reduced profitability, that could
reduce their willingness to provide pensions.”8
Although more than half of all workers in the United States are employed at
firms with 100 or more employees, most employers in the U.S. are small firms. For
example, of the 5.7 million private-sector firms in the United States in 2000, 3.4
million (60%) had fewer than five employees, and 5.0 million (88%) had fewer then
20 employees. (See Table 1.) Most small employers do not offer a retirement plan
Schreitmueller, p. 11.
Burke and McCouch, p. 1328.
EBRI, 2001, p. 4.
EBRI, March 1999, p. 2.
EBRI, April 1999, p. 3.
GAO, 00-187, p. 30.
to their employees. According to the Census Bureau’s Current Population Survey
(CPS), of the 66.9 million people who worked at firms with fewer than 100
employees in 2003, just 19.7 million (29.5%) worked for an employer that offered
a retirement plan to its employees. In other words, seven out of ten workers at small
firms worked for employers who did not offer either a pension or §401(k)-type plan
to their employees in 2003. Employers would not be able avoid incurring any new
administrative costs associated with IAs by declining to participate in the system,
because even if the accounts are voluntary for employees they would be mandatory
for employers. All employers would have to accommodate the wishes of employees
who wanted to establish Social Security individual accounts.
New administrative costs would not necessarily be limited to employers that do
not now offer their employees a retirement plan. Some employees who work for
employers that sponsor retirement plans are ineligible to participate in those plans.
The Employee Retirement Income Security Act (ERISA, P.L. 93-406) allows
employers to exclude from their retirement plans workers who are under 21 years old,
who work fewer than 1,000 hours per year, or who have worked for the employer for
less than one year. These exclusions reduce employers’ administrative costs and thus
encourage employers to sponsor plans.9 Employers who already offer retirement
plans to their employees could face higher administrative expenses if, as the
President’s Commission recommended, all workers who now participate in Social
Security would be eligible to establish a Social Security individual account.
Table 1. Firms and Establishments by Employment Size in 2000
Number of employees
Under 5 employees
5 to 9 employees
10 to 19 employees
20 to 99 employees
100 to 499 employees
500 or more employees
Under 5 employees
5 to 9 employees
10 to 19 employees
20 to 99 employees
100 to 499 employees
500 or more employees
Source: U.S. Small Business Administration, Office of Advocacy, March 2003.
Note: Excludes government employees, railroad employees, and self-employed workers. A firm is
a business under a single management. It may include one or more establishments.
The “Minimum Universal Pension System” (MUPS) proposed by the Carter
Administration in 1980 would have allowed employers to restrict participation to workers
between the ages of 25 and 65 with more 1,000 hours of service per year.
Large and Small Firms Employ Different Kinds of Workers. The
administrative costs of individual accounts relative to the account balances would
depend in part on the characteristics of the employees who participate in the system
of IAs. Relative to account balances, administrative costs will tend to be lower for
employees who remain with an employer for longer periods of time, who work fulltime, and who have higher annual earnings. These characteristics are more common
among employees of large firms than those of small firms. The data displayed in
Table 2 show that workers whose employers currently offer retirement plans differ
in several respects from workers whose employers do not offer such plans. In
general, workers whose employers do not offer retirement plans are younger (and
therefore change jobs more frequently), work fewer hours, earn lower wages, and
work for smaller firms than workers whose employers offer retirement plans. For
many such workers, annual contributions to an IA would be small and administrative
expenses would be large relative to their account balances. Among the 152 million
workers in the United States in 2003:
23.6 million were under 25 years of age and 15.8 million (67%) of
those under age 25 worked for employers who did not offer a
28.9 million had earnings of less than $10,000 and 21.3 million
(74%) of those with earnings under $10,000 worked for employers
who did not offer a retirement plan;
10.3 million typically worked fewer than 20 hours per week and 7.5
million (73%) of those who worked fewer than 20 hours per week
worked for employers who did not offer a retirement plan;
47.4 million were employed at firms with fewer than 25 employees
and 37.3 million (79%) of those who worked at firms with fewer
than 25 employees worked for employers who did not offer a
Table 2. Employee Characteristics by Employer Retirement
Plan Sponsorship, 2003
(number of workers, in thousands)
15 to 19
20 to 24
25 to 34
35 to 44
45 to 54
55 to 64
65 and up
Earnings in 2003
$5,000 - $9,999
$50,000 and up
Hours usually worked per week
Fewer than 10 hours
10 to 19 hours
20 to 29 hours
30 hours or more
Firm size (# of workers)
Fewer than 10
10 to 24
25 to 99
100 to 499
500 to 999
1,000 or more
Employer sponsors a
Employer does not
sponsor a plan
Workers Percent Workers
Source: CRS analysis of the March 2004 Current Population Survey.
Administrative Tasks and Individual Accounts
Social Security IAs could increase employers’ operating costs both directly and
indirectly.10 Employers’ costs would be affected directly to the extent that they
would be required to help administer the accounts. Some administrative tasks may
be performed by the Social Security Administration (SSA) or another governmental
agency, and some may be performed by private sector financial institutions (such as
mutual fund providers), but responsibility for other administrative tasks could fall to
employers. Whether these costs would be borne fully by the account owners, or
would be shared among the account owners, employers, financial service providers,
and the government would depend on the specific features of the IAs and the manner
in which the accounts are set up, administered, and regulated.
For employers, administrative tasks associated with individual accounts could
informing each employee of the option to participate in a voluntary
enrolling interested employees in the system;
establishing and maintaining a record for each account;
sending individual account contributions to the central administrator
or other entity;
correcting errors in the amounts contributed or the fund in which
contributions were invested; and
tracking employees’ marital status so that account balances can be
divided in the event of divorce.11
Centralized vs. Decentralized Administration. Costs to employers of
administering IAs would depend in part on whether the administrative and recordkeeping functions would be centralized or decentralized. A centralized system could
build on the existing tax collection and record-keeping systems of the SSA and the
IRS. A centralized system that allowed employers to continue using their current
procedures for reconciling tax payments would be more likely to maintain the current
level of employer costs and administrative responsibilities, but it would result in
significant delays in crediting contributions to participants’ accounts because many
small employers continue to file wage reports on paper once a year. A decentralized
system would require employers to reconcile tax collections and individual
contributions more frequently, to transmit contributions to a greater number of public
and private entities, and might require all employers to submit both contributions and
financial reports electronically. A decentralized system would provide a higher level
of service to participants, but would increase costs for many employers. Higher costs
for IAs might inadvertently cause some employers to reduce or eliminate the
retirement benefits they offer to their employees.
Under current law, both the employer and employee contribute an amount equal to 6.2%
of pay to the Social Security trust fund for benefits under Old Age, Survivors, and Disability
Insurance (OASDI), more commonly known as Social Security.
EBRI, 2001, p. 9.
Promptness and Accuracy of Record-Keeping. The current Social
Security program is a defined benefit plan in which a worker’s retirement benefit is
based on a record of his or her past earnings. Although all workers who are covered
under Social Security (about 96% of the workforce) pay social security taxes, “an
individual’s benefit bears no direct relationship to his or her total contributions.”12
An individual’s Social Security benefit is based solely on the benefit formula written
into law by Congress, regardless of the amount of Social Security taxes previously
paid by each covered worker. In this system, small errors in employers’ reports of
employee earnings or delays in recording those earnings on each worker’s Social
Security record rarely affect the amount of the worker’s retirement benefit. In fact,
under the current system, “even in instances in which an employer fails to report
earnings, workers who can provide evidence of those earnings have them credited to
their record.”13 In contrast, in a defined contribution plan — such as Social Security
IAs — the worker’s benefit consists of the balance in the account at the time the
worker retires. The account balance is the sum of all past contributions, interest,
dividends, and capital gains minus any pre-retirement withdrawals and investment
losses. Defined contribution plans require “accurate and timely record keeping”14 so
that contributions can be invested promptly and begin to earn interest, dividends, and
Remitting Income and Payroll Taxes. Employers are responsible for
sending both Social Security payroll taxes and federal income taxes withheld from
employees’ pay to the federal government. The majority of employers today send
payroll taxes and federal income taxes in lump-sum payments to Federal Reserve
Banks or other authorized institutions. At least once each calendar quarter employers
must submit a report (IRS Form 941) that summarizes their total tax deposits. This
report indicates only the aggregate amount of taxes withheld from workers’ pay. It
does not indicate the amount of taxes paid by each worker, nor even how much of the
total represents payroll tax and how much is income tax. Reconciliation of gross tax
payments with individuals’ earnings is done just once each year on the Form W-2.
Small employers are permitted to file reports on paper, and most still do so. In 2003,
although 60% of workers’ W-2 forms were submitted to the Social Security
Administration electronically or on magnetic tape or cartridge, 72% of employer
reports to SSA (Form W-3) were submitted on paper, mostly by small employers.
According to SSA, “the reason for this is the vast amount of small and medium-sized
businesses (under 250 employees) that send SSA paper wage reports.”15
Frequency of Remitting Taxes and Contributions. The frequency with
which contributions must be transmitted to the IA central administrator or other
entity would directly affect the cost of administering IAs. The 2001 report of the
President’s Commission on Strengthening Social Security stated that “personal
account owners are entitled to have their contributions credited to their personal
Schreitmueller, p. 12.
SSA, 2001, p. 5.
American Academy of Actuaries, 2003, p. 2.
Personal communication with SSA Office of Legislation & Congressional Affairs,
January 5, 2005.
accounts in a timely and accurate fashion, but without imposing additional
compliance costs on employers.”16 The Commission recognized that imposing new
requirements on employers could also impose new costs, stating that “to prevent
compliance costs from increasing, employers must be allowed to continue to submit
contributions through the existing payroll tax system, which requires some
The two goals of depositing contributions quickly while imposing no new costs
on employers could be difficult to reconcile in practice. Using the existing payroll
tax system is widely regarded as the lowest-cost option for transmitting contributions
to IAs, but it would do so only with a considerable delay between the time the money
would be withheld from the worker’s pay and the date on which it would be
deposited to the investment account of his or her choice.18 The Social Security
Administration has estimated that in a low-cost system of IAs, “contributions would
be credited to specific individuals’ IAs within seven to 22 months after being
deducted from workers’ earnings.”19 The President’s Commission acknowledged
that “using the current payroll contribution system, it would take about 15 months on
average before payroll contributions are credited to personal accounts.”20 Because
it would be costly for small employers to transmit contributions more quickly, the
Commission recommended that IA funds should be invested in interest-bearing
government bonds during the period between the date that the contributions are
deducted from employees’ pay and the time at which they are allocated to each
Both the frequency and method of reporting information would be important
factors in determining the administrative costs associated with individual accounts.21
The delay between withholding Social Security taxes and posting earnings to
workers’ social security records occurs in part because the reporting system in place
today is designed to keep the demands on employers’ time and resources to a
minimum. Faster processing of contributions would require accelerating the
frequency of the wage-reporting process, and in that case, “employers’
President’s Commission, p. 44.
President’s Commission, p. 45.
EBRI has said that “making use of the current payroll system would be the most costeffective way to implement an IA system without adding administrative costs and burdens
to employers related to enrollment and contributions.” (EBRI, 2001, p. 17.) The GAO has
noted that “building on the current system and keeping records centrally could achieve
economies of scale and minimize additional burdens and costs for employers and
individuals.” (GAO, 99-122, p.18.) Likewise, the American Academy of Actuaries has
stated that IA proposals could “reduce administrative costs by taking advantage of the
current infrastructure for tax collection.” (American Academy of Actuaries, 1998, p.3.)
SSA, 2001, p. 6, SSA also estimates that “if SSA had additional resources, processing
the majority of reported W-2 earnings to earnings records could theoretically be performed
within two to 13 months of the date payroll taxes were withheld from a given paycheck.”
(SSA, 2001, p. 18, footnote.)
President’s Commission, p. 47.
SSA, 2001, p. 17.
responsibilities for sending and reporting payroll contributions would grow in
number and frequency.”22 Employers might, for example, be required to report W-2
information along with the quarterly wage and tax statements they submit to the IRS
on Form 941. This was the case prior to 1978, when Congress ended the requirement
for quarterly reporting of W-2 information to SSA. Inevitably, however, “employers
would incur additional administrative costs from having to report more frequently.”23
According to SSA, “the burden of more frequent periods of reporting would fall
disproportionately on the self-employed, small employers (over 80% of the employer
universe), and employers who prepare records manually.”24 The process of crediting
earnings to employee records (or allocating contributions into individual accounts)
also could be accelerated by requiring all employers to submit wage reports
electronically. The use of electronic filing has increased substantially in recent years;
however, the Congressional Budget Office (CBO) expects that “many small
employers are likely to continue to file on paper in the foreseeable future.”25
Employer costs of submitting taxes and reporting earnings could increase under
a system of IAs even if the frequency of reporting were not increased, because under
a defined contribution retirement system such as individual accounts, employer
reports would need to be held to a high standard of accuracy.26 Currently, if the
difference between wages reported and the payroll taxes submitted is less than one
Social Security wage credit ($920 in 2005), SSA takes no further action because
errors of less than one wage credit rarely affect an individual’s retirement benefit.27
Discrepancies much smaller than this amount probably would not be tolerated by
participants in a system of Social Security IAs. Consequently, the number of errors
that SSA and employers need to resolve would increase substantially.
Although maintaining the current system of submitting taxes and earnings
reports would minimize costs to employers, a time lag of seven to 22 months would
elapse between the date when IA contributions would be deducted from pay and
when these contributions would be allocated to individual workers’ accounts. This
lag, referred to as a “float period” could reduce workers’ future benefits by “reducing
the amount of time that contributions have to accrue investment earnings based on
workers’ individual fund choice(s).”28 Long delays in crediting deposits to individual
accounts are not permitted in §401(k) plans sponsored by employers in the private
sector. Federal law requires employers to deposit account contributions into
SSA, 2001, p. 6.
SSA, 2001, p. 19.
SSA, 2001, p. 19.
CBO, 2004, p. 10. According to the Social Security Administration, “although requiring
all employers to submit electronically may appear to be an optimistic assumption, it is
consistent with actions currently under way at the Internal Revenue Service to increase the
frequency of electronic reporting.” (SSA, 2001, p. 20, fn.)
SSA, 2001, p. 22.
If the taxes submitted are less than the amount owed, the IRS may take action to collect
the amount due, even if the discrepancy is less than the equivalent of one wage credit.
SSA, 2001, p.18.
employee accounts within 15 days of the beginning of the month after the
contribution is made. However, if this were required of Social Security individual
accounts, it “would dramatically increase administrative expenses for the millions of
employers that do not offer defined contribution plans, and therefore do not have the
administrative infrastructure already in place to assist in the administration of IAs.”29
Investment losses during the “float period” could be reduced by “investing
contributions on a pooled basis with investment earnings allocated at the same time
as contributions are posted.”30 The President’s Commission proposed “that the
aggregate pool of contributions be invested in government bonds until information
on contributions by individuals is reconciled with aggregate employer payments.”31
Reconciling Errors. In order to protect workers from errors made by their
employers in reporting earnings or submitting payroll taxes, the Social Security
Administration posts earnings credits to participants’ records even if the employer
has failed to send the attendant taxes, provided that the individual can provide proof
of earnings. Unless workers are “held harmless” in this way under an IA system,
some of them could lose substantial contributions and investment earnings because
of employers’ errors or noncompliance. However, being held harmless in a cashbased system like IAs “requires someone else (such as the government) to contribute
money to replace these lost funds.”32 In the event of an employer’s bankruptcy, lost
contributions may never be recovered. In those cases, the government may be the
only possible source of funds to make the workers’ accounts whole.
Errors in wage reporting to SSA are not uncommon, and some cannot be
resolved. The Congressional Budget Office reports that “about 9 million of the
approximately 250 million earnings records that the SSA processes each year cannot
be reconciled with the master file.”33 SSA notes that in a system of IAs, “unresolved
discrepancies could lead to appeals that would mean additional expenses for SSA and
employers.”34 The high rate of turnover among small businesses also would present
a challenge to administering a system of individual accounts for Social Security.
About 650,000 employers — more than 10% of the total — start up or go out of
business each year, possibly creating difficulties in ensuring that contributions are
collected and applied to individual accounts. After an employer goes out of business,
recovering lost or misplaced funds would be difficult.35
Distributing Funds from Accounts. Employers might have to consider
changes to their pension plans to coordinate them with the rules for taking
EBRI, 2001, p. 19.
EBRI, 2001, p.17.
President’s Commission, p. 47.
EBRI, 2001, p. 30.
CBO, 2004, p. 9.
SSA, 2001, p. 21.
GAO-99-122., p. 20
distributions from Social Security individual accounts. In 2005, full Social Security
benefits are available at age 65 and six months. Reduced benefits are available at
age 62, and this will continue to be the case after the full retirement age reaches 67
in 2022. Workers with §401(k) accounts may start to take distributions without
penalty at age 59½. Section 72(t) of the Internal Revenue Code allows penalty-free
distributions from individual retirement accounts (IRAs) and §401(k) plans before
age 59½ in certain instances, such as to purchase a primary residence or to meet
qualifying educational expenses, or if taken in a series of payments based on life
expectancy. The President’s Commission recommended that no such pre-retirement
distributions should be permitted from IAs.36 To minimize confusion among
participants and to ease administrative burdens on employers, Congress would need
to consider how the rules for taking distributions from Social Security individual
accounts would interact with those that now apply to Social Security and to
distributions from §401(k) plans and IRAs.
Educating the Public. Participants in a system of individual accounts would
need to be educated about the rules for participating in the plan, the available means
of taking money out of their account at retirement, and such essential financial
concepts as investment diversification, market risk, and the effects of compound
interest on account balances over long periods of time. Investor education would be
particularly important for people who are unfamiliar with making investment choices,
especially low-income workers, those with less formal education, and those for
whom English is a second language.37 It is likely that primary responsibility for this
ongoing educational effort would fall to the federal government because “employers
would be very unlikely to accept the burden of educating employees about the Social
Social Security IAs and Pension Integration. When designing their
pension plans, employers sometimes take into account the Social Security taxes they
pay and/or the benefits that Social Security provides. Pension plans that “explicitly
incorporate Social Security benefits or contributions into their plan design” are called
integrated plans.39 Adding individual accounts to Social Security could cause some
employers to change the type of pension integration they use or the type of retirement
plan they offer. In defined benefit plans, integration is usually related to the benefit
paid to participants, while in defined contribution plans it most often relates to the
contributions made by employers.40 In an integrated defined benefit plan, the amount
of the worker’s monthly pension is reduced or offset by a percentage of his or her
Social Security benefit. In an integrated defined contribution plan, the amount
“Pre-retirement access to funds in personal accounts should not be allowed.” (President’s
Commission, p. 55.)
GAO, 99-115, p. 56.
American Academy of Actuaries, 2002, p. 3.
GAO, 00-187, p. 4.
GAO, 00-187, p. 15.
contributed by the employer is higher for the portion of the employee’s salary that is
in excess of a specific amount, called the integration level. The most common
integration level is the maximum amount of annual income that is subject to Social
Security taxes ($90,000 in 2005). Federal law limits the extent to which an
employee’s defined benefit pension can be reduced under the “offset” method and the
permissible disparity in contributions between lower- and higher-income employees
under the “excess” method of integration.
Adding individual accounts to Social Security could induce some defined
benefit plan sponsors that integrate through the offset method to abandon pension
integration because this method requires that they estimate the participant’s Social
Security benefit to calculate the appropriate pension offset. With IAs, estimating the
benefit to determine the appropriate offset would be difficult. Some employers might
abandon defined benefit plans integrated through the offset method in favor of
defined contribution plans integrated through the excess method. In an integrated
defined contribution plan, the employer needs only to satisfy IRS regulations on the
permitted disparity between contributions for workers whose earnings are less than
the integration level (typically the annual Social Security taxable maximum) and
those whose earnings are above the integration level.
Reductions in traditional Social Security benefits could increase pension costs
for employers that sponsor integrated defined benefit pension plans because reducing
Social Security benefits would result in a smaller pension offset, and thus a bigger
pension payment. In response, employers “could redesign their plans to eliminate
that feature, absorb the costs, or take other actions.”41 Because the integration rules
for defined contribution plans are tied solely to employer contributions to Social
Security, they would not be affected by changes in promised benefits under the
traditional Social Security program. If, however, Social Security payroll taxes were
increased or if the cap on taxable earnings were raised, employers who integrate their
defined contribution plans through the excess method “might adjust upward the
integration level of plans, thus reducing the number of covered workers eligible for
higher contributions or accruals.”42
Employers’ Fiduciary Responsibilities. In a §401(k) plan, the employer
transmits contributions directly to the financial institution that manages the account
or to an administrator that forwards deposits to a number of such financial
institutions. In handling employees’ account contributions and performing other
activities, employers take on a fiduciary responsibility with respect to their
employees’ retirement accounts.43 In establishing a system of Social Security IAs,
it would be important for Congress to define the fiduciary responsibilities that
GAO, 00-187, p. 19.
GAO, 00-187, p. 20.
A fiduciary is a person or institution in a position of trust, confidence, or responsibility
with respect to the property of another. Federal law requires that anyone acting as a
fiduciary in a retirement plan must act solely in the best interest of the plan participants.
employers would have for managing their workers’ IA contributions.44 The
Employee Retirement Income Security Act requires, among other things, that in
managing their employees’ retirement funds, employers have a fiduciary
responsibility to act solely in the best interests of the plans’ participants and
beneficiaries. In establishing employer responsibilities for IA’s, “the role of ERISA
— or some other entity or mechanism to safeguard individual account accumulations
— would need to be carefully considered.”45 Legislation also might consider a need
to define the extent to which employers that offer investment advice or education for
IA participants would be taking on fiduciary responsibilities.
Possible Employer Responses to Increased Costs. Employers could
seek to offset any increases in costs that arise from administering individual accounts
by reducing or restructuring the benefits they currently offer to their employees. For
example, the American Academy of Actuaries has expressed concern that employers
who must absorb new costs to help administer IAs “might reduce contributions to
their pension and §401(k) plans.”46 Employee contributions to employer-sponsored
plans could be affected too, because if employers were to cut back on §401(k)
contributions in response to new costs from administering IAs, employee
contributions to §401(k) plans might decline. Similarly, the GAO has noted that
“employers might seek to offset any higher costs arising from individual accounts by
reducing or restructuring their existing pension plans.”47 The ERISA Industry
Committee (ERIC) has suggested that if administrative costs of IAs are significant,
they “could cause a shrinkage of pension sponsorship.”48
Possible Employee Responses to Individual Accounts. Workers may
find that Social Security individual accounts do not offer the same range of
investment choices or the amount of individual control over contributions that a
typical §401(k) plan offers. In a §401(k) plan, for example, contributions must be
deposited into employee accounts soon after the contribution is made. If, to prevent
Social Security IAs from imposing new costs on small employers the current method
of collecting Social Security payroll taxes is used to process IA contributions, there
would be a “float period” of roughly seven to 22 months between the time payroll
taxes are withheld from an employee’s pay and the date when those taxes are credited
to his or her IA investment account. During that period, the funds would probably
be held in U.S. Treasury bonds, as is the case with the Social Security trust fund
today. As another measure to prevent IAs from imposing new costs on employers,
the President’s Commission recommended that participants should be permitted to
re-direct their contributions among investment funds and re-allocate account balances
“The private sector faces many unresolved issues with individual accounts — such as the
fiduciary responsibility that employers would likely face for managing their workers’
contributions.” EBRI, March 1999, p. 3.
GAO, 99-122, p. 19.
American Academy of Actuaries, 1998, p. 4.
GAO, 00-187, p. 31.
EBRI, March 1999, p. 4.
among funds just once a year.49 Participants in §401(k) plans typically have the
opportunity to re-direct new contributions and re-allocate account balances at least
How the opportunity to participate in Social Security IAs might affect
employees’ participation in or contributions to employer-sponsored retirement plans
would depend on their perceptions of the potential for the accounts to increase their
retirement income, their expectations about the future benefits they will receive from
the traditional Social Security program, and their attitudes toward risk. Even if there
is no increase in the payroll tax, IAs could affect employees’ contributions to §401(k)
plans. If employees believe that a reduced Social Security benefit plus the IA balance
would provide adequate retirement income, some workers “may offset their
individual account saving by saving less elsewhere or borrowing more.”50 With more
of their future retirement income dependent on investment returns, some workers
might invest their §401(k) contributions more conservatively, seeking to reduce the
increased investment risk that would result from replacing part of Social Security
with IAs. Alternatively, greater exposure to investment risk could encourage some
employees to increase their contributions to §401(k) plans in an attempt to offset
some of this risk. Some workers who currently contribute little or nothing to §401(k)
plans might increase their contributions as they gain knowledge and experience as
investors. Given the opportunity to invest in financial markets, some workers might
develop a “taste for saving” that would persuade them to save more for retirement
through vehicles such as Individual Retirement Accounts (IRAs).
The possibility that some employees might see the introduction of IAs as an
opportunity to cut back on other retirement saving would need to be carefully
addressed in worker education efforts. For example, employees’ responses to IAs
also could affect employers if some workers perceive the IA as a substitute for their
employer-sponsored retirement savings plan rather than a complement to it. If some
workers reduce their contributions to their employer’s §401(k) plan, the employer
might find it more difficult to meet the “nondiscrimination” requirement of the tax
code, which prohibits contributions by highly-compensated employees in
employer-sponsored retirement plans from exceeding the contributions of lower-paid
employees by more than specific ratios. In some cases, this possibility might
persuade employers to adopt “safe harbor” 401(k) plans in which the employer makes
contributions for all eligible employees. Other employers might seek to satisfy the
nondiscrimination requirements by adopting automatic enrollment in their plans.
President’s Commission, p. 48.
GAO, 00-187, p. 32.
The Thrift Savings Plan: A Model for Individual Accounts?
Both the President’s Commission on Strengthening Social Security and
President Bush himself have referred to the Thrift Savings Plan (TSP) for federal
employees as a possible model for the structure of individual accounts under Social
Security.51 The TSP currently has more than 3 million participants and has assets of
more than $150 billion, making it the largest defined contribution plan in the United
States. The TSP offers participants five investment funds: one that invests in U.S.
Treasury bonds, one that invests in private-sector bonds, and three that invest mainly
in common stocks. The private-sector bond fund and the common stock funds are
passively managed “index funds” that track the performance of broad market indices.
Index funds have substantially lower administrative costs than actively managed
mutual funds. In its most recent annual report, the TSP reported administrative costs
of just six basis points, or six-hundredths of 1%. In other words, the administrative
expenses of the TSP are about 60 cents for each $1,000 invested. This is far lower
than the average administrative costs of §401(k) plans in the private sector, where
total administrative costs under 50 basis points are rare.
The Congressional Budget Office (CBO) recently observed that “the
administrative costs of a universal system that offered the same services as the TSP
could be higher because a different set of employers and employees would be
covered.”52 As the data displayed in Table 1 showed, most employers in the United
States are small firms with fewer than 20 employees. The majority of small
employers still submit wage reports to SSA on paper. Most do not have automated
payroll systems that could communicate wage data quickly and efficiently to a central
record keeping agency. The employees of small firms also differ markedly from the
federal workforce. As the GAO, reported in 1999, “the federal workforce, as well as
the federal government as a single employer, differs substantially from the workforce
that would be covered under a nationwide system [of IAs]. For example, the federal
workforce experiences less job turnover, tends to be older, and has higher average
earnings than the general workforce.”53
The low administrative costs of the TSP have been achieved in part because
other federal agencies provide substantial administrative support for their employees
who participate in the TSP. The administrative costs for the TSP do not include the
services that federal agencies provide for TSP participants.54 The agencies where
federal employees work are responsible for educating employees about the TSP,
enrolling them in the plan, and transmitting payroll information to the central TSP
record keeper. As a former executive director of the TSP has said, “the TSP relies
heavily on government agencies to provide these services through their human
“Bush Lauds TSP as Outline of Future Social Security,” Stephen Barr, The Washington
Post, December 19, 2004.
CBO, 2004, p. 12.
GAO, 99-122, p. 22.
GAO, 99-131, p. 17.
resources departments free of charge.”55 The TSP itself advises federal employees
that “while you are employed, your agency is your primary TSP contact.”56
In summary, a number of analysts have concluded that adapting the TSP model
to the private sector would be difficult because the nearly 6 million employers in the
United States and their 150 million employees differ in important ways from the
federal government and its workforce. One analyst has pointed out that “the TSP
functions well because it is essentially a single-employer plan with ready access to
centralized record keeping and services.”57 Another has asked how the TSP model
could be made to work in the private sector when most private employers submit
contribution information on paper once each year, “as opposed to the automated
payroll submissions now given to the TSP by federal agencies each payday.”58 While
the TSP is an efficient provider of retirement savings accounts to the federal
workforce, it is a model that would be difficult to duplicate among the numerous and
diverse employers in the private-sector.
American Academy of Actuaries, Issues Regarding Social Security Individual
Accounts, Issue Brief, winter 1998.
American Academy of Actuaries, Social Security Reform Voluntary or Mandatory
Individual Accounts? Issue Brief, September 2002.
American Academy of Actuaries, Social Security Individual Accounts: Design
Questions, Issue Brief, October 2003.
Karen C. Burke and Grayson McCouch.
“Privatizing Social Security:
Administration and Implementation,” Washington & Lee Law Review, 58(4)
Francis X. Cavanaugh, “Feasibility of Social Security Individual Accounts.” AARP
Public Policy Institute, #2002-14, 2002.
Congressional Budget Office, Administrative Costs of Private Accounts in Social
Security, March 2004.
Employee Benefit Research Institute, “Are Individual Social Security Accounts
Feasible?” EBRI Notes, 20(3) (March 1999).
Employee Benefit Research Institute, “Small Employer Survey on Individual Social
Security Account Administration,” EBRI Notes, 20(4) (April 1999).
Cavanaugh, p. 10.
CBO, 2004, p 12.
Burke and McCouch, p. 1334.
EBRI, 2001, p. 9.
Employee Benefit Research Institute, “Individual Social Security Accounts:
Administrative Issues.” EBRI Issue Brief # 236 (September 2001).
President’s Commission to Strengthen Social Security, Final Report: Strengthening
Social Security and Creating Personal Wealth for All Americans, December
Social Security Administration, SSA’s Estimates of Administrative Costs under a
Centralized Program of Individual Accounts,” January 2001.
Dick Schreitmueller, “Social Security Personal Accounts: How Would They Work?”
Journal of Pension Benefits, 10(4) (summer 2003).
U.S. Government Accountability Office, Social Security: Capital Markets and
Educational Associated with Individual Accounts, GAO-99-115, 1999.
U.S. Government Accountability Office, Social Security Reform: Implementation
Issues for Individual Accounts, GAO-99-122, 1999.
U.S. Government Accountability Office, Social Security Reform: Administrative
Costs for Individual Accounts Depend on System Design, GAO-99-131, 1999.
U.S. Government Accountability Office, Social Security Reform: Implications for
Private Pensions, GAO/HEHS-00-187, 2000.