Offsetting the Principal in the New Social Security Accounts
Posted: 20 Apr 2005
The President's Commission to Strengthen Social Security suggests three plans for reforming Social Security. These plans divert various amounts of the payroll tax to a personal account if the worker chooses to participate in the account. In return, Social Security benefits are offset using accounts with real returns ranging from 2% to 3.5%.
When personal accounts are mentioned, most people think of accounts that are in some sense separate and shielded from the uncertainties of the Social Security System. That is not the case for the personal accounts proposed by the Commission. Participating in the account does not shield the individual from the political risk of being in the Social Security System. Because of the way the benefit offset is structured, if in the future Social Security benefits are further reduced, the basic benefit will be reduced by the same dollar amount whether one has chosen to participate in the individual account or not. The offset to the plan essentially taxes away the principal in the account, but leaves intact the full Social Security benefit, so that any change in retirement income due to the account reflects the difference in interest earned on the portfolio beyond a stated real rate of interest offset. Thus our analysis describes the account as a financial instrument equivalent to a bet that the real return will exceed the level of offset specified in the plan, ranging from 2 percent to 3.5 percent real. As a result, the reduction in political risk fostered by the Commission's proposals comes mainly from the improvement in the financial status of the system fostered by other provisions of the recommended plans.
Keywords: personal accounts, retirement. social security
JEL Classification: H55, J26, J14, D31, I3
Suggested Citation: Suggested Citation