Social Security Individual Accounts

From time to time, Social Security’s long-term solvency challenges have been used to justify basic structural changes. Some propose replacing all or part of Social Security’s guaranteed benefit promise with individual accounts. Under these proposals, a portion of the payroll taxes that currently fund Social Security would be diverted into these individual accounts. The funds would then be invested in stocks and bonds. This is different from proposals to diversify the investments in the Social Security trust funds.

Proposals to use some revenue from payroll taxes to create private individual accounts separate from Social Security are problematic.

• Individual accounts erode the progressive nature of Social Security. Social Security is structured to provide a larger return to lower earners than to higher earners. In contrast, accumulations in individual accounts—and the resulting income in retirement—would be directly proportional to earnings.

• Individual accounts expose workers to risks in the financial markets. These risks include making poor investment choices, needing to retire at a time when the market is down, and deciding how to manage funds to make them last throughout retirement. The people who are most dependent on Social Security income in retirement are often less able to manage investments and tolerate market risks.
• Returns on these accounts could be lowered by substantial administrative costs. If the private sector managed individual private accounts, the administrative costs would be comparable to those for an equity mutual fund. Those average between 0.5 percent and 1 percent of account balances annually.
• Individual accounts could jeopardize Social Security’s disability protections. Young workers who become disabled could receive a smaller lifetime benefit because they would not have had enough time to build up their individual account and might not be able to contribute once they withdraw from the labor force.
• The current system’s spouse and survivor benefits would be at risk in a system with private accounts. Many individual accounts would be too small to provide meaningful benefits to surviving spouses and children, particularly if the worker dies at an early age.

Replacing part of Social Security with individual accounts would particularly disadvantage low-wage earners. These earners are predominantly women and people from racial and ethnic groups that have experienced discrimination. Social Security benefits represent a larger portion of their preretirement earnings than they do for average and high-wage earners.

Such proposals would also worsen the program’s solvency. Payroll taxes that are diverted into private accounts would no longer be available to pay current retirees. The trust funds would be depleted much sooner. Government borrowing would then be necessary to pay current beneficiaries.