The Costs of Individual Accounts

1. The Costs of Individual Accounts Christian E. Weller Senior Economist Center for American Progress

2. Social Security Privatization • Social Security privatization replaces part of a social insurance system with a system of individual accounts. • This process privatizes the risks associated with saving for retirement. • Greater risks are also reflected in greater costs.

3. Administrative Fees • Privatization will establish a large number of comparatively small accounts. • Without economies of scale, management fees will likely be on the high end. • Costs for individual accounts range from 0.8% to 1.3%, depending on investment options and plan size, among other things. • This can reduce total savings by 20-30% over a lifetime.

4. Insurance Premiums: Annuities • Social Security offers guaranteed lifetime, inflation adjusted benefits upon retirement. • To mirror this benefit, workers will have to purchase annuities from insurance companies. • The costs of annuities amount to 4-6% of savings, which reduces monthly benefits 15-20%.

5. Insurance Premiums: Rate of Return Guarantee • Social Security’s benefits are a defined benefit, dependent only on one’s earnings. • To mirror this benefit, workers would have to purchase investment guarantees from insurance companies. • Over a 40-year period, the insurance premium would cost 16.1% of contributions.

6. Transition Costs • Privatization diverts funds currently used to pay for benefits away from Social Security. • To honor already made promises, the government needs to transfer money to Social Security. • The transfer would equal 1.2% of payroll for the next 75 years or a net present value of about $2 trillion.

7. Labor Market Risks: The Logic • The labor market and the stock market move together. • Stock prices are low, when unemployment is high and earnings are low, i.e. workers struggle financially, when it is most opportune to buy stocks. • This is even more true for women and minorities than for men and whites.

8. Labor Market Risks: Women and Minorities • Women tend to have similar unemployment rates as men, but lower earnings than men, which also fluctuate more than those of men. • Minorities have higher unemployment rates and lower earnings than whites, although their earnings fluctuate as much as those of whites. • Earnings and unemployment rates fluctuate with the stock market. • The result is that women and minorities earn less than their counterparts, while they have a more tenuous attachment to the labor market during business cycles.

9. Labor Market Risks: Adding Insult to Injury • Women and minorities would have saved less due to lower earnings. From 1979 to 2002, women would have saved 58% of what men would have saved, and African-Americans would have saved 75% of what whites would have saved. • Labor market risks reduce the savings of African-Americans by 3 cents for each dollar invested, by 6 cents for women, by 5 cents for African-American women and by 7 cents for white women. • The costs from labor market risks can come close to the costs of turning savings into lifetime benefits by buying annuities.

10. Social Security’s Added Insurance Value • Social Security compensates for the adverse labor market outcomes. • Its progressive formula generates higher replacement rates for lower lifetime earners. • Its benefits do not depend on the performance of the stock market and thus eliminate labor market risks.