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Social Security

Private Accounts or Carve Outs: What Do They Mean?

Q. Many elected officials say they want to protect Social Security. Do they all have the same position?

A. Listening to the current debate over Social Security reform can certainly be confusing. While just about every elected official says he or she wants to "strengthen Social Security," ideas about how to do that can be very different. And some plans to strengthen Social Security would actually jeopardize the program's guarantees.

Q. I hear a lot of officials accusing one another of wanting to “privatize” Social Security. What are they talking about?

A. “Privatization” is often used as shorthand for the idea of taking some of the money workers currently pay into the Social Security system and diverting it into individually owned accounts, where each worker would bear some risk for how his or her investments performed. These accounts would be "carved-out" of Social Security.

Diverting money away from Social Security and into individual accounts is risky and involves trading some of today's inflation protected, lifetime guaranteed benefit for an account subject to market risk and not guaranteed to last a lifetime or keep pace with inflation. Inflation, market turns or loss of employment can mean that your private account may not have enough money to provide an adequate benefit.

Unfortunately, there is a lot of debate on the semantics rather than the substance. Essentially it doesn't matter if you call the concept "privatization," "personalization," or anything else—diverting Social Security revenues into individual accounts shifts risk to the individual and hurts the financial status of Social Security itself.

Q. How exactly do "carve-out" accounts hurt Social Security's finances?

A. Diverting money out of Social Security into individual accounts worsens Social Security's long-term financial health. Since current payroll taxes are used to pay benefits to beneficiaries, transferring money into individual accounts means that less money will be available to pay promised benefits. To avoid major benefit cuts, younger workers would have to pay twice—once to fund the new account and again to meet Social Security's current obligations.

Q. But isn't Social Security in financial trouble anyway?

A. Not for a long time. Social Security is projected to have enough assets to pay 100% of benefits until 2041. Even then, incoming revenues will be enough to pay more than 75% of benefits for decades to come. This isn't enough— we need to strengthen the system so that it remains strong for our children and grandchildren. And doing this will involve some hard choices. After all, there is no such thing as a "free lunch."

Q. Wouldn't these accounts give me control over my own money?

A. Personal control can be appealing. In reality, your investment choices would likely be limited, at least initially. For example the President's Commission to Strengthen Social Security, which proposed carve-out accounts, structured them so that workers had just a handful of investment options. This was done to keep the administrative costs down.

Q. Wouldn't I end up with more money for retirement if I could put my Social Security money into an individual account?

A. Maybe, but maybe not. Personal accounts come with a host of risks. The stock market goes down as well as up—and sometimes it stays down for quite awhile. Not every individual or every fund earns a lot of money; many have returns well below the average return. Administrative and management costs, much higher for individual investment accounts than for Social Security, would also reduce your balances. What happens if you have to retire when the market is down or choose investments that perform poorly?

In addition to the market costs and risks, you also would run the risk of outliving your retirement funds or seeing them depleted over time. Social Security offers a reliable benefit that increases every year to help meet rising costs of living. It doesn't matter if you live to be 70 or 107, you can't outlive your Social Security benefits. The government–not you–bears the risk of ensuring that Social Security benefits get paid.

Q. Does this mean I shouldn't invest money for retirement in the stock market?

A. Not at all. Social Security was never intended to be your only source of retirement income—just the safe, reliable piece of a smart retirement plan. Ideally, you should build on Social Security's base with a pension, an IRA, a 401(k) or other investments. When added to Social Security, these kinds of private investments help provide a more adequate retirement income.

Q. I have heard some people talk about the idea of investing part of the Social Security trust funds in something other than Treasury bonds. Is this the same thing as individual accounts carved-out of Social Security?

A. No. By law, Social Security must invest only in government backed securities. Some have proposed the Social Security Administration hire money managers to invest part of the trust funds in other assets, such as stocks or bonds, just like private pensions plans do. The key difference with this approach compared to carve-out individual accounts is that benefits would still be guaranteed and individuals would not bear risk. There are pros and cons to this type of plan—and they should be debated fully before such a change in Social Security's investment policy is enacted.

Q. What should I look for in my elected officials' responses on Social Security?

A. Focus on substance, not semantics. It's not important whether you call individual accounts carved-out of Social Security "private accounts," personalization, or anything else. What really matters is the impact. You should ask the officials probing questions about how they want to strengthen Social Security. And be skeptical if they offer ideas that sound too good to be true.


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