02-07-2005, 06:44 AM
Restricted ownership Private Soc. Sec. accounts offer limited control, require key choices
By Andrea Coombes] (http://www.marketwatch.com/news/mailto.asp?siteid=mktw&x=97+99+111+111+109+98+101+ 115&y=Andrea%20Coombes&guid=%7B9C1EDF29%2DF124%2D4 277%2DA015%2D7FD023270286%7D), MarketWatch Last Update: 5:00 PM ET Feb. 4, 2005
SAN FRANCISCO (MarketWatch) -- The surprising thing about the private investment accounts proposed as a Social Security reform and considered a hallmark of an ownership society is that they'll likely leave account owners with little direct control.
Workers will be offered few investment choices, won't be able to access the money until retirement, and some will be forced to annuitize their account funds when they retire, according to details released by the Bush administration on Thursday.
Plus, the opportunity to re-allocate money among the different fund options will likely be limited to one or two times per year.
Despite these restrictions, proponents hail the fundamental shift from government control to a system where workers own at least a portion of their benefits.
"What's most important is the ownership. They own this money," said Michael Tanner, a scholar at the Cato Institute, a libertarian think tank.
"The government can do whatever it wants to your Social Security benefits, but the government can't touch the money in your account," he said. "It's also part of your savings. If you die early, that money is passed on to your heirs."
Private-account advocates agree that workers will have far fewer choices to make with these accounts than under the investment accounts many Americans are used to.
These accounts "won't have a lot of the bells and whistles of a traditional 401(k) plan," said Matt Moore, senior policy analyst with the National Center for Policy Analysis, a Dallas-based conservative think-tank and advocate of private accounts.
"Unlike a traditional 401(k) plan, people probably will not have the opportunity to withdraw funds for other expenses, to borrow against their account (nor) to exchange funds whenever they want," he said.
The accounts will likely offer about six investment choices, according to the Bush administration's announcement.
Those choices include three stock funds (a large-cap, a small-cap and an international stock fund), a corporate bond fund, a Treasury bond fund, and a life cycle fund that automatically allocates money among the funds depending on your age -- the older you are, the more money goes to the less risky bond funds.
Limiting investment choices would seem an appropriate safety measure, given many Americans' lack of success adequately managing their 401(k) plans. See full story. (http://www.marketwatch.com/news/story.asp?guid=%7B17849DE5%2D0A26%2D4311%2D8813%2D 3B384433B314%7D&siteid=mktw)
First choice: To play or not to play
The first question that will likely face workers in 2009 -- the year the Bush administration suggests the plans be rolled out -- is whether to participate. Workers born before 1950 are spared this decision, as they won't be offered access to the private accounts.
Some estimates peg about two-thirds of workers opting for private accounts.
"The estimate is that most people will participate," said Teresa Ghilarducci, an associate professor of economics at Notre Dame University. "That might be one of the easiest decisions to make because you'll be on a bandwagon."
Workers facing that choice will have to remember the accounts aren't without risk.
Participants would be able to divert up to 4 percent of their payroll earnings to the account, to a cap of $1,000 each year (with that cap rising annually).
To end up ahead of the traditional system of the monthly Social Security check coming from the government, a worker's account would have to return 3 percent above inflation. The core rate of inflation was 2.2 percent last year.
Here's how it would work:
Upon retirement, the government will reduce its guaranteed monthly Social Security payment to the worker by the dollar amount in the personal account plus 3 percent above inflation. The account's real rate of return above 3 percent goes to the worker as an added benefit.
If the account earns exactly 3 percent above inflation, the worker's check from the government and the payout from the private account would amount to what she would have gotten under the traditional system.
But if the account earns less than 3 percent plus inflation, the worker with the private account is worse off than one who stuck with the traditional plan.
Some private-account proposals include a minimum benefit under which no one can fall, thus helping to protect lower-income workers from investment losses.
And, advocates say, a 3 percent return is easy to beat, meaning that opting for a private account entails little risk.
"Three percent is the government bond rate," Tanner said. "It would be relatively difficult not to beat that given a long investment horizon and a broadly diversified portfolio."
Others aren't so sure.
If "you were able to achieve a rate of return in excess of inflation plus 3 percent, then you could potentially be better off with the individual account than not doing the individual account," said Dallas Salisbury, president of the Employee Benefits Research Institute.
But "to put that number in perspective, currently on inflation-indexed bonds issued by the government they're paying 1.8 percent plus CPI, and the long-term rate of return on bonds has been about 2..5 percent plus CPI," he said.
Based on those numbers, Salisbury said, participants would have to be willing to bear stock-market risk. The bond-fund choices may not be enough to beat the payout offered by the traditional system.
Next choice: Where to put your money
Workers opting for a private plan must then figure out how to allocate their money among the funds offered, though the default will likely be the life-cycle fund, according to the administration.
Perhaps hardest for many Americans: In order to plan adequately for retirement, investors in private accounts would need to estimate a realistic rate of return.
"You'll have to decide how much money you'll have ... by estimating the rate of return throughout your lifetime of work, and the rate of return for the rest of your life," Ghilarducci said.
Every year, workers will have to re-assess their overall retirement plan, and decide how to re-allocate their private-account funds.
And that's where many novice investors fail, Salisbury said.
Often, "people end up market timing, and not market timing well," he said. "I'm not saying everybody would be stupid. There will obviously be a group ... that does focus on the long- term that would put the money in and let the money stay there and do better under the accounts," he said.
But "if you look at how people behave, when they can change investment options they tend to time in the opposite (direction) of what they should be doing."
The annuity rule
At retirement, beneficiaries must decide how to access their money, whether through a lump sum or by annuitizing, just like 401(k) holders do now.
But some lower-income private-account holders would be required to purchase annuities with their private account money.
The annuity from the private account must ensure a monthly benefit that, combined with the traditional benefit, keeps the worker above the poverty line.
One choice workers wouldn't have to make: How to choose among the various annuity products in the private market currently. The federal government would provide the annuity.
Still, that could change, some say.
"That's going to be 20 to 30 years down the road," Tanner, of the Cato Institute, said. "We'll have to see what that (annuity) market is at that time to see if that requirement stays."
Andrea Coombes is a reporter for MarketWatch in San Francisco.
By Andrea Coombes] (http://www.marketwatch.com/news/mailto.asp?siteid=mktw&x=97+99+111+111+109+98+101+ 115&y=Andrea%20Coombes&guid=%7B9C1EDF29%2DF124%2D4 277%2DA015%2D7FD023270286%7D), MarketWatch Last Update: 5:00 PM ET Feb. 4, 2005
SAN FRANCISCO (MarketWatch) -- The surprising thing about the private investment accounts proposed as a Social Security reform and considered a hallmark of an ownership society is that they'll likely leave account owners with little direct control.
Workers will be offered few investment choices, won't be able to access the money until retirement, and some will be forced to annuitize their account funds when they retire, according to details released by the Bush administration on Thursday.
Plus, the opportunity to re-allocate money among the different fund options will likely be limited to one or two times per year.
Despite these restrictions, proponents hail the fundamental shift from government control to a system where workers own at least a portion of their benefits.
"What's most important is the ownership. They own this money," said Michael Tanner, a scholar at the Cato Institute, a libertarian think tank.
"The government can do whatever it wants to your Social Security benefits, but the government can't touch the money in your account," he said. "It's also part of your savings. If you die early, that money is passed on to your heirs."
Private-account advocates agree that workers will have far fewer choices to make with these accounts than under the investment accounts many Americans are used to.
These accounts "won't have a lot of the bells and whistles of a traditional 401(k) plan," said Matt Moore, senior policy analyst with the National Center for Policy Analysis, a Dallas-based conservative think-tank and advocate of private accounts.
"Unlike a traditional 401(k) plan, people probably will not have the opportunity to withdraw funds for other expenses, to borrow against their account (nor) to exchange funds whenever they want," he said.
The accounts will likely offer about six investment choices, according to the Bush administration's announcement.
Those choices include three stock funds (a large-cap, a small-cap and an international stock fund), a corporate bond fund, a Treasury bond fund, and a life cycle fund that automatically allocates money among the funds depending on your age -- the older you are, the more money goes to the less risky bond funds.
Limiting investment choices would seem an appropriate safety measure, given many Americans' lack of success adequately managing their 401(k) plans. See full story. (http://www.marketwatch.com/news/story.asp?guid=%7B17849DE5%2D0A26%2D4311%2D8813%2D 3B384433B314%7D&siteid=mktw)
First choice: To play or not to play
The first question that will likely face workers in 2009 -- the year the Bush administration suggests the plans be rolled out -- is whether to participate. Workers born before 1950 are spared this decision, as they won't be offered access to the private accounts.
Some estimates peg about two-thirds of workers opting for private accounts.
"The estimate is that most people will participate," said Teresa Ghilarducci, an associate professor of economics at Notre Dame University. "That might be one of the easiest decisions to make because you'll be on a bandwagon."
Workers facing that choice will have to remember the accounts aren't without risk.
Participants would be able to divert up to 4 percent of their payroll earnings to the account, to a cap of $1,000 each year (with that cap rising annually).
To end up ahead of the traditional system of the monthly Social Security check coming from the government, a worker's account would have to return 3 percent above inflation. The core rate of inflation was 2.2 percent last year.
Here's how it would work:
Upon retirement, the government will reduce its guaranteed monthly Social Security payment to the worker by the dollar amount in the personal account plus 3 percent above inflation. The account's real rate of return above 3 percent goes to the worker as an added benefit.
If the account earns exactly 3 percent above inflation, the worker's check from the government and the payout from the private account would amount to what she would have gotten under the traditional system.
But if the account earns less than 3 percent plus inflation, the worker with the private account is worse off than one who stuck with the traditional plan.
Some private-account proposals include a minimum benefit under which no one can fall, thus helping to protect lower-income workers from investment losses.
And, advocates say, a 3 percent return is easy to beat, meaning that opting for a private account entails little risk.
"Three percent is the government bond rate," Tanner said. "It would be relatively difficult not to beat that given a long investment horizon and a broadly diversified portfolio."
Others aren't so sure.
If "you were able to achieve a rate of return in excess of inflation plus 3 percent, then you could potentially be better off with the individual account than not doing the individual account," said Dallas Salisbury, president of the Employee Benefits Research Institute.
But "to put that number in perspective, currently on inflation-indexed bonds issued by the government they're paying 1.8 percent plus CPI, and the long-term rate of return on bonds has been about 2..5 percent plus CPI," he said.
Based on those numbers, Salisbury said, participants would have to be willing to bear stock-market risk. The bond-fund choices may not be enough to beat the payout offered by the traditional system.
Next choice: Where to put your money
Workers opting for a private plan must then figure out how to allocate their money among the funds offered, though the default will likely be the life-cycle fund, according to the administration.
Perhaps hardest for many Americans: In order to plan adequately for retirement, investors in private accounts would need to estimate a realistic rate of return.
"You'll have to decide how much money you'll have ... by estimating the rate of return throughout your lifetime of work, and the rate of return for the rest of your life," Ghilarducci said.
Every year, workers will have to re-assess their overall retirement plan, and decide how to re-allocate their private-account funds.
And that's where many novice investors fail, Salisbury said.
Often, "people end up market timing, and not market timing well," he said. "I'm not saying everybody would be stupid. There will obviously be a group ... that does focus on the long- term that would put the money in and let the money stay there and do better under the accounts," he said.
But "if you look at how people behave, when they can change investment options they tend to time in the opposite (direction) of what they should be doing."
The annuity rule
At retirement, beneficiaries must decide how to access their money, whether through a lump sum or by annuitizing, just like 401(k) holders do now.
But some lower-income private-account holders would be required to purchase annuities with their private account money.
The annuity from the private account must ensure a monthly benefit that, combined with the traditional benefit, keeps the worker above the poverty line.
One choice workers wouldn't have to make: How to choose among the various annuity products in the private market currently. The federal government would provide the annuity.
Still, that could change, some say.
"That's going to be 20 to 30 years down the road," Tanner, of the Cato Institute, said. "We'll have to see what that (annuity) market is at that time to see if that requirement stays."
Andrea Coombes is a reporter for MarketWatch in San Francisco.