FROM THE OFFICE OF PUBLIC AFFAIRS
February 18, 2005
JS-2265
Remarks of Treasury Assistant Secretary Mark J. Warshawsky on Social Security
at the Securities Industry Association Savings & Retirement Symposium Fort
Lauderdale, Florida
In his State of the Union address the President said, "One of
He was of course referring to Social Security.
The President's willingness to fix Social Security shows his political courage. Our children's retirement security is more important than partisan politics and one of the tests of leadership is to confront problems before they become a crisis. President Bush came to
At the outset, let me reiterate what the President has said to those in or near retirement: Social Security will not be changed for those 55 or older. Today, more than 45 million Americans receive Social Security benefits and millions more are nearing retirement. For these Americans, Social Security benefits are secure and will not change in any way. This is only fair.
The inevitable demographics confronting Social Security mean that we have fewer workers to support our retirees. People are living longer and having fewer children. As a result we have seen a dramatic change in the number of workers supporting each retiree's benefits.
When today's young workers begin to retire in 2042, the system will be exhausted and bankrupt. Today's 30-year-olds can expect a 27 percent benefit cut from the current system when they reach retirement age. And without action, these benefit cuts will only get worse. The President believes we should fix Social Security once and for all. And, in doing so, we should make Social Security a better deal for our children and grandchildren.
The President supports Social Security reform that increases the power of the individual, does not increase the tax burden, and provides economic opportunity for more Americans. One important component of reform is the introduction of personal retirement accounts (PRAs). PRAs provide individual control, ownership, and are an effective vehicle for pre-funding more of our Social Security benefits. PRAs also offer individuals the opportunity to build a nest-egg that the government cannot take away. They allow individuals to partake in the benefits of investing in the financial markets. Individual control and ownership means that people would be free to pass any unused portion of accounts to their heirs.
Today I'll briefly discuss the Administration's proposals for how PRAs will be phased in, how they interact with the traditional Social Security benefits, and then I'll discuss the administrative structure, the investment choices, and the distribution options in more detail.
Let me make two critical points up front. First, the system needs to be reformed to make it permanently sustainable. The President is committed to doing this while maintaining the progressivity of the system. The second critical point is that personal retirement accounts will be voluntary. At any time a worker can "opt in" by making a one-time election to put a portion of his or her payroll taxes into a personal retirement account. A worker who chooses not to opt in will receive traditional Social Security benefits, reformed to be permanently sustainable.
To ease the transition to a personal retirement account system, participation will be phased in according to the age of the worker. In the first year of implementation, 2009, workers currently between the age of 40 and 54 (born between 1950 and 1965) would have the option of establishing personal retirement accounts. In the second year, 2010, workers currently between the age of 26 and 54 (born between 1950 and 1978) would be given the option and by the end of the third year, 2011, all workers born in 1950 or later who want to participate in personal retirement accounts would be able to do so.
Even after the initial implementation, personal retirement accounts will start gradually. Although all participants will eventually be allowed to contribute 4 percentage points of their payroll taxes to a personal account, the annual contributions to personal retirement accounts initially would be capped at $1,000 per year. The cap would rise gradually over time, growing $100 per year, plus growth in average wages. Starting with the full 4 percentage point PRA contribution ensures that low-income workers can get appreciable gains from the accounts. If we started out with a lower percentage contribution, the potential dollar gains for low-income workers would be much more limited.
There has been a great deal of discussion about how PRAs will interact with the traditional Social Security benefit. The PRA structure that the President has proposed is a "carve out" or "offset" PRA. An offset PRA simply means that workers who choose to contribute payroll taxes to a PRA will have their defined Social Security benefit adjusted by an actuarially fair amount. The government borrowing rate is the appropriate and fair offset rate or assumed rate of return.
As proposed by the President, PRAs are designed to hold down administrative costs, encourage careful and cautious investing, and provide a reliable income for the full length of retirement.
Centralized administration and limited choice will hold down administrative costs. The PRA administration and investment options will be modeled on the Thrift Savings Plan (TSP). TSP is a voluntary retirement savings plan offered to federal employees, including members of Congress. TSP offers comparable benefits and features to those available to private sector employees in 401(k) retirement plans. The Social Security Administration's actuaries project that the ongoing administrative costs for a TSP-style personal account structure would be roughly 30 basis points or 0.3 percentage points.
The PRAs will limit the risk of investments with low-risk, low-cost options like the broad index funds available to federal employees in TSP. Similarly to TSP, the index funds could include, for instance, a government securities fund; an investment-grade corporate bond index fund; a small-cap stock index fund; a large-cap stock index fund; and an international stock index fund. In addition to these TSP-type funds, workers could choose a Treasury Inflation-Protected Securities fund.
Workers will also be able to choose a "life cycle portfolio" that would automatically adjust the level of risk of the investments as the worker aged. As the individual neared retirement age, the life cycle fund automatically and gradually shifts the allocation of investment funds so that it is weighted more heavily toward bonds. The President's plan includes a mechanism that will protect near-retirees from sudden market swings on the eve of retirement. PRA balances would be automatically invested in the "life cycle portfolio" when a worker reaches age 47, unless the worker and his or her spouse specifically opted out by signing a waiver form stating they are aware of the risks involved.
Because these are specifically designed as retirement accounts, PRAs would not be accessible prior to retirement. Workers who choose personal retirement accounts would not be allowed to make withdrawals from, take loans from, or borrow against their accounts prior to retirement.
The distribution options for PRAs will include restrictions on withdrawals to discourage outliving ones assets. Procedures would be established to govern how account balances would be withdrawn at retirement. This would involve some combination of inflation indexed annuities to ensure a stream of monthly income over the worker's life expectancy, phased withdrawals indexed to life expectancy, and lump sum withdrawals. Individuals would not be permitted to withdraw funds from their personal retirement accounts as lump sums if doing so would result in their moving below the poverty line. Account balances in excess of the poverty-protection threshold requirement could be withdrawn as a lump sum for any purpose or left in the account to accumulate investment earnings.
Some have raised concerns about the public borrowing that might be needed to help finance PRA contributions. Such an increase in public borrowing is often referred to as a "transition cost," but I want to argue here that the term is a misnomer; the increased public borrowing does not represent an increase in the cost of paying retirement benefits and hence is not a cost in the sense that people would normally believe. PRAs increase public debt in the short term, but ultimately leave public debt unchanged when factoring in the outlay reductions deriving from the reduction in defined benefits. Because long-term public debt is unchanged, the policy is neutral with respect to the long-term cost of paying retirement benefits.
But is it a concern that the policy would increase public debt in the short term? The answer is no, at least not with respect to the size and type of accounts that the President has put forward. In the short term, the private sector has effectively swapped a promise of future defined benefits for explicit public debt of equal value. At all times, private sector wealth is unchanged, and the government's total liabilities are unchanged. It follows that the so-called transition costs of introducing PRAs are not added costs. I think financial markets understand that any transition debt is but a small fraction of what Social Security currently owes, and will respond favorably to a reform plan that responsibly addresses Social Security's long-term financial imbalance.
SINGLE EMPLOYER DEFINED-BENEFIT PENSION REFORM
I would also like to talk today about the Administration's proposal to reform the single-employer defined benefit pension system. The current defined benefit pension rules do not ensure that pension plans are adequately funded. Underfunded plan terminations are placing an increasing financial strain on the pension insurance system and, through that system, impose an increasing burden on healthy employers who sponsor well-funded pension plans, and ultimately potentially threaten taxpayers. The President's proposal focuses on three areas:
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Ensuring pension promises are kept by improving opportunities, incentives and requirements for funding plans adequately;
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Improving disclosure to workers, investors and regulators about pension plan status; and
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Adjusting the pension insurance premiums to better reflect each plan's risk and ensure the pension insurance system's financial solvency.
Today I want to focus on two important, but less frequently discussed aspects of the proposed reforms: the treatment of lump sums and the reforms that affect defined contribution plans.
Our lump-sum proposal would replace the use of 30-year Treasury rates for purposes of determining lump sum settlements under qualified plans with a yield curve approach. Current law use of the 30-year Treasury rate to determine the minimum lump sum amount often inflates the lump sums in comparison with the value of the annuity that the employee would otherwise receive. Under our proposal, lump sum settlements would be calculated using the same interest rates that are used in discounting pension liabilities: interest rates that are drawn from a zero-coupon corporate bond yield curve based on the interest rates for high quality corporate bonds. This reform will include a transition period, so that employees who are expecting to retire in the near future are not subject to an abrupt change in the amount of their lump sums as a result of changes in law. The new basis would not apply to distributions in 2005 and 2006 and would be phased in for distributions in 2007 and 2008, with full implementation beginning only in 2009.
We also want to make improvements to defined contribution retirement plans. Congress successfully passed two proposals originally set forth in the President's Retirement Security Plan with the enactment of the Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act (1) guarantees that workers will now receive notice 30 days prior to a pension plan blackout period and (2) prohibits corporate officers from selling their own company stock during blackout periods.
The other components of the President's reform plan are to:
- Improve choice by allowing participants to diversify their investments by selling their company stock after three years. The use of employer stock allows companies to be more generous with their matching contributions. Workers, however, should also have the right to choose how they want to invest their retirement savings. The President's plan would ensure that workers could sell company stock and diversify into other investment options after three years of participation in the plan.
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Enhance information by requiring quarterly benefit statements to be sent to participants. A meaningful ability to change investments also depends on workers receiving timely information about their 401(k) accounts. The President's plan would require companies to provide workers with quarterly benefit statements with information about their accounts including the value of their assets, their rights to diversify, and the importance of maintaining a diversified portfolio.
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Increase confidence by providing participants with increased access to professional investment advice. Current ERISA law raises barriers against employers and investment firms providing individual investment advice to workers. The President's plan would increase workers' access to professional investment advice. By relying on expert advisers who assume full fiduciary responsibility for their counsel and disclose relationships and fees associated with investment alternatives, American workers will have the information to make better retirement decisions.
In summary, I expect the coming months to be a busy and productive time at the Treasury Department. As I have discussed today, fixing Social Security is a critical and urgent issue. We must make the system permanently sustainable and I believe personal accounts are an integral part of the solution. The defined benefit pension system provides retirement income for 44 million Americans; therefore adopting reforms that improve plan funding and ensure the long-term solvency of the system and the PBGC are critical. Putting annuity and lump sum distributions on an even footing is an important aspect of these reforms. Similarly, we encourage Congress to pass the President's Plan for Retirement Security which will improve the diversification, information, and confidence of defined contribution pension participants.