Social Security Reform: Implementation Issues for Individual Accounts
(Letter Report, 06/18/1999, GAO/HEHS-99-122).

Social Security is one of the nation's most important and visible
programs. Although individual accounts offer the possibility of a better
rate of return on individual contributions, a flawed or failed system of
accounts could have devastating effects on retirees and undermine public
confidence in government. GAO believes that the following three critical
questions need to be addressed in designing and implementing a system of
individual accounts: Who would assume new administrative and
record-keeping responsibilities? How much choice would individuals have
in selecting and controlling their investment options? How much
flexibility would workers have when they retire and begin to draw on
their accounts? This report discusses the fundamental choices associated
with each question and several options that could be considered.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  HEHS-99-122
     TITLE:  Social Security Reform: Implementation Issues for
	     Individual Accounts
      DATE:  06/18/1999
   SUBJECT:  Investment planning
	     Federal social security programs
	     Financial analysis
	     Financial management
	     Future budget projections
	     Retirement benefits
	     Social security benefits
IDENTIFIER:  Social Security Program
	     Social Security Trust Fund
	     SSA Individual Account Program

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    United States General Accounting Office GAO                Report
    to the Chairman, Committee on Ways and Means, House of
    Representatives June 1999          SOCIAL SECURITY REFORM
    Implementation Issues for Individual Accounts GAO/HEHS-99-122 GAO
    United States General Accounting Office Washington, D.C. 20548
    Health, Education, and Human Services Division B-281329 June 18,
    1999 The Honorable Bill Archer Chairman, Committee on Ways and
    Means House of Representatives Dear Mr. Chairman: Social Security
    forms the foundation for our retirement income system. In 1998, it
    provided approximately $265 billion in annual benefits to 31
    million workers and their dependents. However, the Social Security
    program is facing significant future financial challenges as a
    result of profound demographic changes, including the aging of the
    baby boom generation and increased life expectancy. A wide variety
    of proposals to reform the program is currently being discussed-
    from more traditional approaches, such as reducing benefits and
    raising taxes, to more fundamental changes, such as creating a
    system of individual accounts. As policymakers decide whether and
    how to create a system of individual accounts, they must consider
    a range of difficult concerns. These concerns include broad
    macroeconomic issues, such as how to finance the accounts and how
    the accounts would affect the economy and program solvency, as
    well as program benefit issues, such as how to balance
    opportunities for improved individual investment returns with the
    need to maintain an adequate income for those who rely on Social
    Security the most. No less important is the need to consider how
    readily individual accounts could be implemented and
    administered.1 Under a system of individual accounts, workers
    would manage their own accounts to varying degrees. This would
    expose workers to a greater degree of risk in return for both
    greater individual choice in retirement investments and, according
    to proponents, the possibility of a higher rate of return on
    contributions than available under current law.2 Depending on the
    proposal, these accounts would replace all or part of the Social
    Security program, or they would supplement Social Security
    benefits. Moreover, some proposals would require that all workers
    participate, while others would allow workers to opt in or out.
    Yet not all individual account proposals clearly delineate how the
    accounts would be managed 1In testimony earlier this year, we
    discussed how these three issues could be used as criteria for
    evaluating reform proposals. See Social Security: Criteria for
    Evaluating Social Security Reform Proposals (GAO/T-HEHS-99-94,
    Mar. 25, 1999). 2Others, however, believe that returns on
    contributions are not the only goal of Social Security and that
    individual accounts are not the only way to increase rates of
    return. We will address the complex rate of return issue in a
    forthcoming report. Page 1
    GAO/HEHS-99-122 Implementing Individual Accounts B-281329 and
    administered, and administrative feasibility is vital to the
    success of any individual account proposal. A system of individual
    accounts covering 148 million workers would constitute a
    fundamental change to Social Security and would be significantly
    larger than any existing retirement investment program. If
    practical issues such as administrative barriers and challenges
    are not adequately considered before reform decisions are made,
    implementation of any proposal could be delayed or even derailed.
    Therefore, as you requested, this report focuses on issues to
    consider regarding the design and implementation of an individual
    account system. We performed our work from October 1998 to May
    1999 in accordance with generally accepted government auditing
    standards. Appendix II contains a detailed discussion of our
    objectives, scope, and methodology. Results    The Social Security
    system is one of our nation's most important and visible programs.
    While individual accounts offer the possibility of an improved
    rate of return on individual contributions, a flawed or failed
    system of individual accounts could have devastating effects on
    individuals' retirement security and on public confidence in
    government overall. In this context, we believe that three
    critical questions would need to be addressed in designing and
    implementing a system of individual accounts. All of the decisions
    made regarding these three critical questions would affect the
    design and structure of such a system, as well as who would bear
    any additional administrative responsibilities and costs. Who
    would assume new administrative and record-keeping
    responsibilities? While proposals for individual accounts vary,
    certain key administrative functions would need to be performed
    under any system of individual accounts, just as under any other
    defined contribution pension plan.3 Worker contributions would
    need to be collected, and records on these individual
    contributions maintained; contributions would have to be invested,
    typically according to worker preferences; and benefits would need
    to be paid. Depending on system design, the employer, the worker,
    private sector service providers, and the government could all be
    affected to varying degrees. Section 1 addresses this question in
    detail. How much choice would individuals have in selecting and
    controlling their investment options? The design of the investment
    structure, including how much discretion individuals would have in
    selecting who would invest the 3In defined contribution pension
    plans, contributions are allocated to individual accounts by a
    predetermined formula, and benefits depend on contribution levels
    and returns on investment of these contributions. Page 2
    GAO/HEHS-99-122 Implementing Individual Accounts B-281329
    contributions as well as the possible range of investment choices,
    would need to be considered before implementation. These factors
    would affect the cost and administrative complexity of the system.
    Section 2 outlines the key issues and trade-offs associated with
    various options. How much flexibility would workers have when they
    retire and begin to draw on their accounts? A number of options
    are available for providing payments to workers upon retirement.
    The variety and types of payments offered are important to a
    system's design. For example, if annuities were required,
    decisions would need to be made about who provided them and how
    they would be structured. A discussion of payment options and
    related issues is provided in section 3. Table 1 summarizes the
    fundamental choices associated with each question and a number of
    options that could be considered. Table 1: Key Design and
    Administration Issues      Critical questions and
    Possible options to decisions                        Fundamental
    choices           consider Who would assume new
    Centralize or decentralize    - Build on current Social
    administrative and               account administration and
    Security tax and payroll record-keeping                   record
    keeping.               reporting structure. responsibilities?
    - Build on employer-based 401(k) structure. - Build on
    individually controlled individual retirement account structure.
    How much choice would            Maximize individual choice -
    Offer a broad range of individuals have in selecting    or offer
    fewer choices.       investment options. and controlling their
    - Offer a small set of index investment options?
    funds. - Combine the two options by requiring a minimum account
    balance before a broader range of options is available. How much
    flexibility would       Maximize individual choice - Make
    annuities voluntary workers have when they           or ensure
    preservation of     and permit lump sum and retire and begin to
    draw on      retirement benefits.          gradual account their
    accounts?
    withdrawals. - Require lifetime annuities. - Combine the two
    options by requiring annuitization to ensure at least a minimum
    retirement income, with added flexibility for the remainder of the
    account. Page 3                                  GAO/HEHS-99-122
    Implementing Individual Accounts B-281329 Essentially, these
    decisions amount to trade-offs between simplicity and
    standardization on the one hand and heightened individual choice
    and flexibility on the other. Simpler, more standardized systems
    could limit individual choice by offering only a few investment
    options and requiring that retirees annuitize their accounts.
    These simplified systems minimize the risk that individuals will
    not choose a diversified portfolio or will simply make a bad
    choice. Conversely, when a system offers more choice, either in
    investment options or in how accumulated savings are distributed
    upon retirement, individuals have more opportunity to tailor their
    financial situation to their own tastes and preferences. This
    increased choice is accompanied by increased risk for the
    individual. Decisions about system design would also affect the
    costs of administering the program. As systems become more
    complex, and more services are offered, administrative costs rise.
    Finally, any system of individual accounts would probably
    necessitate a change in current federal roles and
    responsibilities. Some proposals call for the government to assume
    a new administrative role, while others would require an increased
    government oversight role. Each proposed alternative offers new
    administrative and operational challenges. When designing a system
    of individual accounts, the options that are available for each of
    the three critical decisions could be combined in a number of
    ways. For example, one proposal combines a centralized record-
    keeping system with a broad choice among preapproved investment
    options and mandatory annuitization. Another proposal would
    combine centralized account administration with few investment
    choices, and a portion of the account accumulation would be
    annuitized to provide an income comfortably above the poverty
    level. All of the various combinations would have associated
    trade-offs, costs, and other issues. It is important to note that
    individual accounts are one of a number of provisions in Social
    Security reform packages being considered. Many of these broader
    initiatives contain a variety of provisions for addressing Social
    Security Trust Fund solvency. While individual accounts offer the
    potential for increased investment returns, they cannot by
    themselves restore Social Security's solvency without additional
    changes to the current system. Moreover, higher returns can be
    achieved through other approaches to reform-for example, from
    increasing the buildup of the Social Security Trust Fund and
    providing opportunities to diversify investments. Higher returns
    can also be achieved through such means as investing the Trust
    Fund in equities, as some have proposed. Page 4
    GAO/HEHS-99-122 Implementing Individual Accounts B-281329 Today,
    we are issuing another report that provides additional information
    on individual accounts as a component of Social Security reform.
    This report provides details on administrative costs, which could
    have a direct effect on the amount of savings accumulated in
    individual accounts over time.4 Agency Comments    We provided
    draft copies of this report to the Social Security Administration
    (SSA), the Internal Revenue Service (IRS), the Securities and
    Exchange Commission, the Department of Labor's Pension and Welfare
    Benefits Administration, the Department of the Treasury, and the
    Federal Retirement Thrift Investment Board, as well as other
    external reviewers who are experts in Social Security reform. In
    commenting on our report, the reviewers generally agreed with our
    characterization of the possible options and issues to consider
    under a system of individual accounts. They provided comments to
    us, either in oral or written form. These comments were primarily
    technical and clarifying in nature. In addition to technical
    comments, SSA stated that we should devote a portion of the report
    to the challenges of ensuring compliance under an individual
    account system. While we do not discuss compliance in a separate
    section, we did expand our discussion of this issue throughout the
    report. SSA also stated that we should discuss in more detail the
    shifting roles of agencies under such a system. We expanded this
    discussion as well. SSA further suggested that we discuss the
    impact of individual accounts on capital markets; however, this
    issue will be discussed in detail in a forthcoming report. We have
    incorporated these and other comments where appropriate. The
    written comments we received are included in appendixes III and
    IV. We are sending copies of this report to the Honorable Charles
    B. Rangel, Ranking Minority Member, House Ways and Means
    Committee; other interested congressional committees; the
    Honorable Kenneth S. Apfel, Commissioner of Social Security; the
    Honorable Alexis M. Herman, Secretary of Labor; the Honorable
    Robert E. Rubin, Secretary of the Treasury; the Honorable Arthur
    Levitt, Chairman of the Securities and Exchange Commission; and
    the Honorable Roger W. Mehle, Executive 4Social Security Reform:
    Administrative Costs for Individual Accounts Depend on System
    Design (GAO/HEHS-99-131, June 18, 1999). Page 5
    GAO/HEHS-99-122 Implementing Individual Accounts B-281329 Director
    of the Federal Retirement Thrift Investment Board. We will also
    make copies available to others on request. If you have any
    questions concerning this report, please contact me on (202) 512-
    7215. Other GAO contacts and key contributors to this report are
    listed in appendix V. Sincerely yours, Cynthia M. Fagnoni
    Director, Education, Workforce, and Income Security Issues Page 6
    GAO/HEHS-99-122 Implementing Individual Accounts Page 7
    GAO/HEHS-99-122 Implementing Individual Accounts Contents Letter
    1 Section 1
    12 Who Would Assume         Options for Account Administration and
    Record Keeping                       12 Issues and Trade-offs to
    Consider When Choosing Among                       14 New
    Administrative          Options and Record-Keeping       A System
    of Individual Accounts Would Face Record-Keeping
    20 Responsibilities?           Challenges Start-Up Issues: System
    Design and Development Would Take                   21 Time
    Section 2
    24 How Much Choice          Options for Management Structure and
    Investment Choice                      24 Issues and Trade-offs to
    Consider When Choosing Among                       27 Would
    Individuals           Options Have in Selecting and    Start-Up
    Issues: Developing an Investment Structure Would Take
    34 Controlling                 Time Investments? Section 3
    36 How Much Flexibility     Options for Payment of Retirement
    Benefits                                  36 Issues and Trade-offs
    to Consider When Choosing Among                       38 Would Be
    Granted in         Options Paying Retirement        Start-Up
    Issues: Need for Payout Structure Before
    42 Benefits?                   Implementation of Individual
    Accounts Appendix I
    44 Flowchart of Current Earnings Process Appendix II
    46 Objectives, Scope, and Methodology Page 8
    GAO/HEHS-99-122 Implementing Individual Accounts Contents Appendix
    III
    47 Comments From the Social Security Administration Appendix IV
    50 Comments From the Federal Retirement Thrift Investment Board
    Appendix V
    52 GAO Contacts and Staff Acknowledgments Bibliography
    53 Related GAO Products
    56 Tables                  Table 1: Key Design and Administration
    Issues                                 3 Table 1.1: Trade-offs
    Between Centralized and Decentralized                  14
    Administration and Record Keeping Table 1.2: Characteristics of
    U.S. Businesses and Workforce Pose             20 Challenges for a
    System of Individual Accounts Table 2.1: Trade-offs Between
    Limited Investment Choice and                  28 Greater Choice
    Table 3.1: Trade-offs for Paying Retirement Benefits
    38 Figures                 Figure 1.1: Options for Account
    Administration and Record                    13 Keeping Figure
    2.1: Options for Management Structure and Investment
    25 Choice Figure 3.1: Options for Payment of Retirement Benefits
    37 Page 9                          GAO/HEHS-99-122 Implementing
    Individual Accounts Contents Abbreviations ERISA        Employee
    Retirement Income Security Act of 1974 FERSA        Federal
    Employees' Retirement System Act of 1986 FICA         Federal
    Insurance Contributions Act IRA          individual retirement
    account IRS          Internal Revenue Service PWBA         Pension
    and Welfare Benefits Administration SSA          Social Security
    Administration TSP          Thrift Savings Plan Page 10
    GAO/HEHS-99-122 Implementing Individual Accounts Page 11
    GAO/HEHS-99-122 Implementing Individual Accounts Section 1 Who
    Would Assume New Administrative and Record-Keeping
    Responsibilities? A new system of individual accounts would entail
    additional administrative and record-keeping activities. Decisions
    about where and how the information for each individual's
    contributions would be recorded and managed, as well as how the
    money itself would be invested, would determine the administrative
    structure of a system of individual accounts. There are several
    options for how such a system could be structured, and each option
    offers advantages and challenges that must be considered.
    Moreover, decisions about structure would affect the related
    federal role and responsibilities. Depending on the system
    structure, the government could be taking on a new role or
    expanding its current role. Finally, designing a new system of
    individual accounts would take time. Options for Account    The
    basic options for account administration and record keeping span a
    Administration and     continuum ranging from a centralized
    record-keeping system operated by the government to a completely
    decentralized system managed by Record Keeping         individuals
    or various entities in the private sector (see figure 1.1). Under
    a centralized structure, which would build on the current payroll
    reporting and tax collection system, a federal agency, such as
    SSA, would assume record-keeping responsibilities. Alternatively,
    a new centralized government clearinghouse could assume
    responsibility for centralized record keeping, similar to the
    structure for the federal Thrift Savings Plan (TSP). A
    decentralized structure could build on the system that has grown
    up around employer-sponsored 401(k) plans or individually managed
    individual retirement accounts (IRA).5 Under 401(k) plans,
    individual records are maintained by either the employer or a
    separate entity hired to manage the plan, or both. Under an IRA,
    the record-keeping responsibility rests with the individual
    investor and the financial institution where the funds are
    invested. 5A 401(k) pension plan is an employer-sponsored defined
    contribution plan that allows participants to contribute, before
    taxes, a portion of their salary to a qualified retirement
    account. An IRA is a personal, tax-deferred retirement account.
    Page 12                                       GAO/HEHS-99-122
    Implementing Individual Accounts Section 1 Who Would Assume New
    Administrative and Record-Keeping Responsibilities? Figure 1.1:
    Options for Account Administration and Record Keeping Page 13
    GAO/HEHS-99-122 Implementing Individual Accounts Section 1 Who
    Would Assume New Administrative and Record-Keeping
    Responsibilities? Some proposals to create individual accounts
    include provisions for a tax credit to finance all or part of a
    worker's individual account. Under these proposals, contributions
    would be transferred from the Treasury to an individual's
    account.6 Moreover, some proposals call for replacing all or part
    of the current Social Security program or supplementing Social
    Security benefits. Regardless, accounts could still be maintained
    centrally or could be decentralized. Issues and Trade-offs
    While each of the options depicted above is based on an existing
    program to Consider When                     or model, none of the
    models could accommodate a nationwide system of individual
    accounts without significant change. Depending on the option
    Choosing Among                       selected, these changes could
    place additional costs, burdens, or Options
    responsibilities on government agencies, employers, individual
    workers, or private sector providers. Therefore, selecting an
    option would involve carefully weighing the associated trade-offs.
    For example, a centralized system is an option because it would
    build on an already existing centralized record-keeping system,
    could achieve economies of scale, and would maintain employers'
    responsibilities. Yet, it could raise concerns about increased
    government involvement, responsibilities, and contingent
    liabilities. In contrast, using a decentralized system would
    minimize direct government involvement yet still affect government
    workloads. However, economies of scale could be more difficult to
    achieve and responsibilities of and costs to employers,
    individuals, or both would likely increase. Table 1.1 summarizes
    issues to consider when weighing the merits of centralized and
    decentralized account administration and record keeping. Table
    1.1: Trade-offs Between Centralized and Decentralized
    Centralized administration and record               Decentralized
    administration and record Administration and Record Keeping
    keeping                                             keeping Would
    build upon existing government                Would require an
    expanded infrastructure, system, but would still require
    significant         especially for 401(k) model changes Would take
    advantage of economies of scale Would make economies of scale more
    difficult to achieve Would increase government role in
    Would minimize government role in managing individual account
    system                  managing individual account system, but an
    increased oversight role would need to be considered Would likely
    maintain employer role or              Could increase employer
    role, individual minimize additional employer responsibilities
    responsibility, or both 6The funds from the Treasury could
    originate either from the unified budget surplus or from general
    revenues. Page 14                                    GAO/HEHS-99-
    122 Implementing Individual Accounts Section 1 Who Would Assume
    New Administrative and Record-Keeping Responsibilities?
    Centralized Administration    The current centralized Social
    Security record-keeping system was not and Record-Keeping
    designed to maintain records on individual accounts that are owned
    and Structure                     managed by individual workers.
    SSA records annual earnings and calculates benefits on the basis
    of these earnings; the agency does not maintain individual
    contribution records nor does it base benefits on the payroll
    taxes paid into the system.7 As a result, aspects of the existing
    system would probably have to change to accommodate the
    introduction of individual accounts, or workers would have to
    accept certain limitations built into the system. For example, the
    system is not designed to record contributions, earnings, or
    losses to individual account records in a timely manner. This
    delay does not affect Social Security benefits, but it could
    affect benefits based on an individual's earnings on investments
    in the equities market. Under the current centralized system, SSA
    and the IRS work together to record each worker's earnings and
    collect taxes owed. Currently, both employers and employees pay
    Federal Insurance Contributions Act (FICA) taxes, which are used
    primarily for Social Security. Employers withhold FICA taxes from
    employees' pay and then regularly deposit both employers' and
    employees' shares of the taxes to a designated Federal Reserve
    bank or other authorized depository. Employers submit reports
    summarizing these deposits to the IRS at least quarterly. These
    reports indicate the aggregate amount of taxes withheld from
    workers' paychecks; they do not link the taxes paid to a
    particular individual. Once a year, usually at the beginning of a
    calendar year, employers submit an IRS W-2 form to SSA for each
    worker, showing the individual's earnings for the previous year.
    SSA then begins the process of checking this information and
    posting it to the earnings files it maintains for individual
    workers. Only when these W-2s were posted to earnings records
    would SSA know how much would be available for investment on
    behalf of an individual. Appendix I contains a detailed time line
    for the responsibilities of the employer, IRS, and SSA under the
    current system. Relying on the current record-keeping system would
    present several challenges under an individual account system.
    Several important decisions would need to be made if a centralized
    structure was chosen. How Much Additional           While SSA
    maintains information on workers' earnings and work histories,
    Information on Individual     more information would need to be
    obtained and maintained for an Workers Would Be Needed?
    individual account system. For example, SSA does not keep personal
    7To determine a worker's monthly benefit, SSA applies a formula to
    reported lifetime earnings. This approach, therefore, holds the
    worker harmless when the employer does not remit the accurate
    Social Security tax payment to the IRS. Page 15
    GAO/HEHS-99-122 Implementing Individual Accounts Section 1 Who
    Would Assume New Administrative and Record-Keeping
    Responsibilities? information such as addresses on an ongoing
    basis, and IRS keeps only addresses that are submitted annually on
    individual tax returns. If individual accounts were to be
    considered the personal property of the individual, current
    information on such things as addresses would become important,
    especially when assets must be allocated or distributed in
    response to life events such as death or divorce. What New
    Administrative        The current reporting and tax collection
    system does not include other Functions Would Need to Be
    administrative activities that would need to occur under an
    individual Included, and Who Would Be     account system, such as
    creating systems to collect and record individual Responsible for
    Them?          investment choices, transmitting contributions to
    investment managers, recording account value changes, sending
    periodic account statements,8 and providing payout entities with
    necessary account information. While the investment manager could
    perform some of these activities, under a centralized system,
    government agencies would likely assume many of these
    responsibilities.9 Would the Current Reporting    Each year SSA
    receives a large number of incorrect W-2 forms from Error
    Threshold Change?        employers. Under a system of individual
    accounts, these errors could result in lost investment returns.
    For example, of the 235 million W-2s received for tax year 1996,
    about 19 million, or 1 in 12, had errors.10 Following internal
    corrections, SSA was able to resolve inconsistencies for about 15
    million of the W-2s, leaving about 4 million uncorrectable without
    contacting the employers. SSA does not contact all of the
    employers whose reports include these errors, however, because
    contacting employers can be time-consuming and expensive for both
    SSA and the employer. Therefore, SSA sets a tolerance threshold
    for errors and does not pursue errors with dollar amounts that
    fall below the threshold. According to SSA, if these tolerances
    were eliminated, its workload would at least double. Under a
    system of individual accounts, in which the account is considered
    to be personal property, it would be necessary to determine if
    such a threshold for error could be tolerated and whether the
    worker would be held harmless for employer error. 8Beginning in
    fiscal year 2000, SSA will be required by law to send Personal
    Earnings and Benefit Estimate Statements to almost every U.S.
    worker. However, if these statements were to be used for
    individual accounts as well, they would need substantial revision.
    9See National Academy of Social Insurance, "Report of the Panel on
    Privatization of Social Security" (Washington, D.C.: National
    Academy of Social Insurance, Nov. 1998), which contains a detailed
    discussion of administrative activities under individual accounts.
    10These errors or inconsistencies include mismatches between
    individual names and Social Security numbers, errors in FICA
    calculations, and inconsistencies between aggregate reports
    submitted to the IRS and the W-2 reports. Page 16
    GAO/HEHS-99-122 Implementing Individual Accounts Section 1 Who
    Would Assume New Administrative and Record-Keeping
    Responsibilities? Would Changes in the Current      Under a
    centralized system, the federal role would be mostly Regulation
    and Oversight          administrative in nature. However, if a
    centralized clearinghouse was Structure Be Needed?
    established, the oversight role would increase (especially if
    individuals were allowed to opt in or out of the system). Striking
    a balance between the need for additional personal information and
    the need to maintain individuals' privacy and limit access to this
    information would be an important oversight consideration. In
    addition, the government would need to ensure that workers'
    contributions were made promptly and accurately, as well as
    prevent fraud and abuse in the system. Would Posting Delays Be
    If the current system of employers' reporting individual earnings
    on an Tolerated?                        annual basis continued, it
    would result in a considerable lag-as much as 7 to 22 months-
    between the time taxes were deducted from an individual's earnings
    and the time funds were credited to the individual's name.
    Depending on the performance of an individual's selected
    investments, these lags could result in lost account
    accumulations. However, changing to a system that recorded
    earnings more frequently would place additional reporting burdens
    on employers and the government as well as increase administrative
    costs. The delays in posting contributions or earnings information
    to individual accounts are viewed by some as a significant barrier
    to a centralized system. However, there are several options for
    mitigating the effects of a time lag, each of which poses new
    record-keeping challenges. The record keeper, working together
    with the designated investment manager, could do one of the
    following: * Pool the aggregate funds into a safe investment
    vehicle, such as a money market account, until they are allocated
    to individual accounts. The earnings could then be credited to
    individual accounts along with actual contributions at a later
    date, and all workers would earn the same return during the lag
    period. * Permit workers to select personal investment options
    annually; group these individual selections by investment option;
    and invest incoming, pooled funds accordingly. * Project future
    contributions (perhaps on the basis of prior earnings history) and
    credit the accounts according to individual investment choices
    until actual cash contributions are deposited into accounts.11
    11These options were developed by the Employee Benefit Research
    Institute and are discussed in more detail in Kelly A. Olsen and
    Dallas L. Salisbury, Individual Social Security Accounts: Issues
    in Assessing Administrative Feasibility and Costs, special report
    of the Employee Benefit Research Institute (Washington, D.C.: Nov.
    1998). Page 17                                      GAO/HEHS-99-
    122 Implementing Individual Accounts Section 1 Who Would Assume
    New Administrative and Record-Keeping Responsibilities? Under a
    centralized system of individual accounts, it is likely that the
    agencies involved would require additional time and resources to
    address the above issues. However, at the same time, building on
    the current system and keeping records centrally could achieve
    economies of scale and minimize additional burdens and costs for
    employers and individuals. Decentralized
    Alternatively, individual account record keeping and
    administration could Administration and             be based on a
    model similar to either the current 401(k) or IRA system. Record-
    Keeping Structure       While minimizing government involvement in
    the administration of the system, either approach would probably
    be accompanied by additional responsibilities and costs for
    employers, workers, or both. Moreover, for both of these options,
    the appropriate government oversight role would have to be
    considered. Under a 401(k) defined contribution pension plan,
    individual employers sponsor a retirement plan for their
    employees. Employees are able to contribute pretax dollars to a
    qualified tax-deferred retirement plan. Under such plans, employee
    contributions can be invested in several options and, depending on
    the plan, employees may control how the assets are allocated among
    the various choices; the employer, a designated fund manager, or
    both, maintain records. Although the number of 401(k) plans has
    risen dramatically, employers are not required to provide such a
    retirement plan. If this model was chosen, several important
    questions would need to be addressed. What Changes Would Be
    Not all employers offer employee retirement plans-about 50 percent
    of Required to Ensure That All    full-time private sector workers
    are covered by any type of Workers Could Be Covered
    employer-provided retirement plan; about 25 million people
    participate in Under Such a System?           a 401(k) plan. Under
    a 401(k) model, employers, especially those that currently do not
    provide any retirement plan, would bear the additional cost and
    responsibility of creating an infrastructure to quickly deposit
    contributions and provide employees with links to and choices
    among funds. However, recent employer surveys and our interviews
    with employers' groups showed that most employers oppose any
    additional paperwork burden or costs. What Would Be the Potential
    401(k) plans differ in both the services they offer and the
    diversity of Outcomes of Building on the    available investment
    options. These differences would raise questions of Current
    System?                fairness if the system became the
    foundation for a universal system of Page 18
    GAO/HEHS-99-122 Implementing Individual Accounts Section 1 Who
    Would Assume New Administrative and Record-Keeping
    Responsibilities? individual accounts. In addition, requiring
    uniformity across the different plans would need to be considered.
    What Would Be the Possible      If employers were asked to bear
    additional costs and responsibilities, they Effect of Placing
    Additional    might decide to change or reduce the benefit
    packages they currently Requirements on Employers?      offer,
    thus possibly undermining the overall goal of pension plans and
    individual accounts: improved retirement security. In addition, it
    is not clear how current contributions to 401(k) plans would be
    handled. For example, policymakers would need to decide whether or
    not individual account contributions would be separate and
    distinct from 401(k) contributions. If these contributions were
    not considered separately, then individual accounts could replace
    401(k) savings. Would Changes in the Current    Under this
    decentralized system, government oversight and regulatory
    Regulation and Oversight        responsibilities would likely
    increase; the more complex a system of Structure Be Needed?
    individual accounts, the more challenging and costly oversight and
    compliance activities could be. Currently, the Department of
    Labor's Pension and Welfare Benefits Administration (PWBA) has
    responsibility for overseeing and regulating the 401(k) system.
    The Department of the Treasury and IRS have responsibility for
    drafting and enforcing rules regarding 401(k) plans' qualified tax
    status. With the Pension Benefit Guaranty Corporation and IRS,
    PWBA also enforces compliance with the Employee Retirement Income
    Security Act of 1974 (ERISA). Under ERISA, these agencies are
    expected to protect employee benefit plans and their participants
    and beneficiaries should employers go out of business, fail to
    remit payments, and so on. ERISA requires, among other things,
    that participants receive annual reports, that assets be held in
    trust, and that there be a fiduciary responsible for acting solely
    in the interests of the plans' participants and beneficiaries. The
    role of ERISA-or some other entity or mechanism to safeguard
    individual account accumulations-would need to be carefully
    considered. An IRA is a specific retirement account purchased by
    an individual worker, usually through a bank or another financial
    institution, that can be invested in almost any kind of investment
    vehicle. Under current law, IRAs are subject to a contribution
    limit. Several questions would need to be considered if individual
    accounts were managed under a decentralized structure, similar to
    today's IRA system. How Would the Individual        Individual
    workers would be responsible for selecting an investment Worker Be
    Affected?             manager or managers to invest their
    contributions. Workers would be expected to keep track of
    investments, understand the system as a whole, Page 19
    GAO/HEHS-99-122 Implementing Individual Accounts Section 1 Who
    Would Assume New Administrative and Record-Keeping
    Responsibilities? pursue error corrections, and generally ensure
    that contributions were made according to applicable rules and
    that tax obligations were properly met. Workers might benefit,
    however, because this approach could minimize lag time between
    depositing contributions and beginning to earn returns on those
    contributions. Would Changes Be Needed in               IRAs that
    are not provided through employee benefit plans are exempt from
    How the Market Was                       ERISA; yet various
    entities have oversight responsibility for the range of Regulated?
    vehicles available under IRAs. For example, the IRS sets the rules
    for IRA tax qualification, and the Securities and Exchange
    Commission has broad responsibility over the securities markets.
    In 1992, about 9.6 million individuals contributed to an IRA.12
    Overseeing the large number of accounts, ensuring compliance, and
    preventing fraud would be significant issues to consider under
    this model. A System of Individual Regardless of the type of
    administration and record-keeping structure Accounts Would Face
    selected, additional challenges would need to be addressed under
    an individual account system. These challenges primarily center on
    the Record-Keeping                           nature of the ever-
    changing American workforce and its employers and Challenges
    can complicate keeping accurate and timely records on earnings or
    account contributions. Table 1.2 details these challenges. Table
    1.2: Characteristics of U.S. Businesses and Workforce Pose
    Characteristic                                     Challenge
    Challenges for a System of Individual    Employer turnover
    About 650,000 employers go out of Accounts
    business or start new businesses each year (about a 10-percent
    turnover rate). This turnover could create particular challenges
    in ensuring that contributions were made and credited to
    individual accounts. Once an employer went out of business, making
    corrections to individual accounts would be difficult, if not
    impossible. Employer record keeping
    About 4 million employers have 10 or fewer employees. These small
    businesses tend to have particular record-keeping problems, and
    their records are often error-prone. According to SSA, about 85
    percent of the nation's 6.5 million employers still submit forms
    on paper, requiring additional administrative steps to check and
    record the data. (continued) 12This number includes individuals
    who contributed to an IRA through their employer. Page 20
    GAO/HEHS-99-122 Implementing Individual Accounts Section 1 Who
    Would Assume New Administrative and Record-Keeping
    Responsibilities? Characteristic
    Challenge Workers with more than one employer            Many
    workers in the United States have more than one job at any given
    time or work for more than one employer during the year.
    Specifically, about 58 million workers (about 40 percent of the
    total workforce) have annual earnings reported to SSA from more
    than one employer. This could pose special problems for
    administering and monitoring compliance with individual account
    requirements unless a mechanism was created to consolidate the
    records, especially at retirement. Unique reporting structure used
    by             In 1998, the United States had self-employed
    approximately 12 to 15 million self-employed individuals. The
    self-employed have their own wage reporting system-they do not
    file W-2s directly with SSA but rather provide information to only
    the IRS through their annual tax filings. The IRS then forwards
    this information to SSA at a later date. Further complicating
    their record-keeping status, about one-half of the self-employed
    also work for employers that send W-2s to SSA. Because of similar
    problems, some of the countries whose pension systems we reviewed
    for this work either do not include the self-employed in their
    pension systems or offer coverage as an option rather than a
    requirement. Ensuring the compliance of the self-employed under a
    system of individual accounts would need to be considered. Start-
    Up Issues:     Estimates of how long an individual account
    system's design and System Design and    development would take
    would depend upon how quickly the proposal moved through the
    legislative process and how complex the proposed Development Would
    system was. Some reform proponents have cited the federal TSP as
    an Take Time            example of quick implementation. Ten
    months after passage of the Federal Employees' Retirement System
    Act of 1986 (FERSA), the federal TSP began investing participants'
    contributions in the government securities fund, and the TSP began
    investing contributions in the stock and bond index funds 8 months
    later. Moreover, the TSP plans to add two additional funds in May
    2000. While this example illustrates how a system can begin with
    one simple investment fund and add more over time, the challenges
    of establishing the TSP differ in certain ways from those of
    setting up a Page 21                                 GAO/HEHS-99-
    122 Implementing Individual Accounts Section 1 Who Would Assume
    New Administrative and Record-Keeping Responsibilities? national
    system of individual accounts. The federal workforce, as well as
    the federal government as a single employer, differs substantially
    from the workforce that would be covered under a nationwide
    system. For example, the federal workforce experiences less job
    turnover, tends to be older, and has higher average earnings than
    the general workforce. In addition, federal agencies experience
    greater stability and have greater access to automation for
    payroll and record-keeping functions than the employer population
    at large. These characteristics helped expedite the implementation
    of the TSP, since an infrastructure for implementing the system
    already existed and could be built upon. Issues to consider before
    selecting a system would include * computer system design,
    development, and testing needs; * year 2000 systems design issues;
* the contract procurement process (requests for proposals, the
    bidding process, and contractor selection); * regulation
    development and promulgation; * hiring and training new staff; *
    the possible need to set up individual accounts for those who do
    not have earnings; and * the need for employer and public
    education. Regardless of the type of individual account management
    system selected, the length of time needed to develop the system
    would need to be considered-especially since no system exists that
    has demonstrated the capacity to handle a national system of
    individual accounts without significant changes. Creating a
    centralized system that would build on the existing computer
    capacity of federal agencies such as SSA and the IRS could pose
    special challenges in the near term. Officials from various
    federal agencies told us their computer systems staff have been
    working to ensure that their systems are ready for the year 2000,
    and as a result, other needed systems changes have been deferred
    until that challenge has been met. Moreover, systems staff may
    need to continue working on year 2000 issues even after 2000
    arrives, thus affecting their ability to take on any additional
    requirements. If the new system design involved any contracting
    out for services, then lead time would need to be considered for
    such things as issuing requests for proposals, qualifying bidders,
    and carrying out other activities required by law and regulation.
    These requirements would need to be incorporated Page 22
    GAO/HEHS-99-122 Implementing Individual Accounts Section 1 Who
    Would Assume New Administrative and Record-Keeping
    Responsibilities? into any implementation time frame. Moreover,
    regardless of the account management system chosen, the time
    needed for regulation development and promulgation would need to
    be considered. For example, the ERISA construct is a well-
    developed body of law on employee benefits; however, the ERISA
    framework has been developed over a number of years. In fact, some
    regulations alone have taken years to be promulgated. Hiring and
    training qualified staff would also take time. Depending on the
    structure of the new design, staff might be expected to be able to
    answer any number of technical questions about system design,
    requirements for employers and individuals, and investment and
    payout options. Even if these services could be contracted out,
    lead time would also need to be considered if this option was
    chosen. In addition, measures to prevent employee fraud and to
    protect account holders' personal information would need to be
    considered. Moreover, some proposals call for establishing
    accounts for individuals who do not have any earnings. One such
    approach might be to allow a spouse without earnings to set up an
    account that was based on the other spouse's earnings.
    Accommodating such accounts would be important in considering
    system design. Finally, educating employers and the public on the
    essentials of the new system would be important to its
    administration and implementation. It would take time to develop
    and implement an education campaign for both employers and workers
    to ensure that the public understood the new system and how it
    would affect their retirement income security. Many proposals do
    not specify what entity would be responsible for public education
    or what would be involved, but, as an example, SSA officials told
    us that it currently takes about 1 year and costs about $1 million
    to develop a specific public service announcement campaign. Page
    23                                 GAO/HEHS-99-122 Implementing
    Individual Accounts Section 2 How Much Choice Would Individuals
    Have in Selecting and Controlling Investments? A system of
    individual accounts would provide workers with opportunities to
    assert greater control over their retirement savings and possibly
    receive a greater rate of return than is available under current
    law. When designing a system, critical decisions would need to be
    made about how much choice or discretion individuals would have in
    selecting funds, who would invest their funds, and what the range
    of their investment choices would be. These decisions, in part,
    would determine the cost and complexity of the system and the
    degree of public education needed. Moreover, offering the level of
    customer service found in the private sector, such as frequent
    deposits and accessibility of account information, would add costs
    and administrative complexity to a system. Options for
    Alternatives for designing the investment structure of a system of
    Management           individual accounts range from offering the
    individual a limited number of preselected funds, such as those
    offered by the federal TSP, to offering a Structure and
    broad array of private market choices, such as those available
    through Investment Choice    IRAs. As with record keeping, options
    for managing these investment choices could vary from a
    centralized, government-managed system to a decentralized,
    privately managed system. Figure 2.1 shows the basic options that
    represent both ends of the spectrum; however, numerous variations
    fall in between. Page 24                          GAO/HEHS-99-122
    Implementing Individual Accounts Section 2 How Much Choice Would
    Individuals Have in Selecting and Controlling Investments? Figure
    2.1: Options for Management Structure and Investment Choice
    Examples of some of the existing investment management options and
    the choices they offer are discussed below. The federal TSP and
    the system of individual accounts developed in Chile illustrate
    different approaches to limiting choice. Thrift Savings Plan
    The TSP currently offers three investment fund choices to
    contributors. The first, a government securities fund, is managed
    by the independent Federal Retirement Thrift Investment Board. The
    other two funds, a fixed income (or bond) fund and a common stock
    fund, are managed under competitively awarded contracts, currently
    with Barclays Global Investors. Barclays has no responsibility for
    record keeping or reporting requirements at the individual TSP
    participant level. Instead the Thrift Investment Board, through an
    agreement with the Department of Agriculture's National Finance
    Center, maintains individual records. Page 25
    GAO/HEHS-99-122 Implementing Individual Accounts Section 2 How
    Much Choice Would Individuals Have in Selecting and Controlling
    Investments? Individuals may invest their contributions in any of
    the funds in any combination they choose. Chile
    In Chile, workers may select from over 12 qualified private
    pension funds. Each fund was created solely for the country's
    retirement program. Fund administrators are responsible for
    maintaining records, as well as investing contributions, which are
    sent directly to the private fund from the employers. The
    government sets minimum and maximum rates of return for the
    participating funds. Under this system, workers must invest their
    contributions with only one fund; if they decide to change funds
    they must move their entire balance. At the other end of the
    continuum, offering greater investment choices, IRAs illustrate
    the flexibility individuals can experience when investing in
    privately managed individual accounts. The systems developed in
    the United Kingdom and Sweden demonstrate still other approaches
    that also offer greater individual choice for investments.
    Individual Retirement    Individuals with IRAs can manage accounts
    themselves or select their own Accounts                 private
    financial institution to do the record keeping and investment
    management. As previously stated, IRA contributions can be
    invested in almost any kind of investment vehicle. In general, the
    individual IRA owner is responsible for complying with the rules
    applicable to IRAs. United Kingdom           The United Kingdom
    system consists of a state-provided, flat-rate benefit based on
    work history and an earnings-related benefit. For the earnings-
    related benefit portion, individuals have a choice of
    participating in the state earnings-related benefit program,
    participating in their employer's pension plan (if available), or
    voluntarily opting out and choosing their own individual account
    through any private financial provider. As in the United States,
    employers withhold each individual's contributions and remit them
    to the government. After a reconciliation process, the government
    sends the contributions to the individual's financial provider for
    investment. This provider, like an IRA, maintains the records and
    manages the investment. In 1996, the United Kingdom's Personal
    Investment Authority regulated about 4,000 firms providing
    individual accounts. Page 26
    GAO/HEHS-99-122 Implementing Individual Accounts Section 2 How
    Much Choice Would Individuals Have in Selecting and Controlling
    Investments? Sweden                   Sweden has planned a system
    of individual accounts, but it is not yet in full operation. This
    system will include a basic state pension and an individual
    account benefit. Employers and individuals will contribute a total
    of 18.5 percent of an individual's earnings to the social security
    system; 2.5 percent of this contribution will be collectively
    invested on behalf of the individual in government bonds.13 When
    systems are in place, individuals will be able to direct their 2.5
    percent contributions into a registered fund of their choice. To
    register, a fund must be licensed to operate in Sweden and agree
    to certain reporting and fee requirements. In addition, all
    records will be maintained by the government pension agency, and,
    at retirement, the government agency provides the individual's
    annuity. Issues and Trade-offs    There are trade-offs associated
    with the range of investment choices to Consider When
    offered, as illustrated in table 2.1. When individuals have more
    investment choices, they have more opportunity to tailor their
    financial situation to Choosing Among           their own tastes
    and preferences and assert greater control over their Options
    personal property. However, with a greater variety of choices
    comes the possibility that individuals will not choose a
    diversified portfolio or will simply make a bad selection, thus
    lessening their retirement income from the individual account.14
    As the range and variety of investment choices grow, so does the
    risk that an individual's retirement income will not be adequate.
    This results in increased risk to the government that individuals
    with inadequate income will turn to the government for support
    from other programs. In addition, a wider range of investment
    choices also leads to higher administrative costs, which, if not
    offset by significantly higher returns, could undermine the
    retirement income for individuals. Limiting investment choice
    would help to minimize risk and administrative costs, but doing so
    could also limit the possible return on investments. Moreover,
    limiting choices raises concerns about the role of government in
    selecting the investment vehicles and the possibility of political
    influence over these selections. Essentially, the challenge
    becomes finding the right balance between individual choice and
    the related risks and costs to the individual and the government.
    13Currently, the individual's contribution is 6.95 percent and the
    employer's contribution is 6.4 percent of earnings, and 2.5
    percent of the total is invested in government bonds. As of 2000,
    the total contribution will amount to 18.5 percent: 9.25 from both
    employer and employee. 14Under some proposals for individual
    accounts, retirees would continue to receive Social Security
    benefits at some level, as well as the accumulated balance in
    their individual accounts. Page 27
    GAO/HEHS-99-122 Implementing Individual Accounts Section 2 How
    Much Choice Would Individuals Have in Selecting and Controlling
    Investments? Table 2.1: Trade-offs Between Limited Investment
    Choice and Greater Choice     Limited, but diversified, investment
    choice                                               Greater
    investment choice Minimizes individual risk, but may also limit
    Increases individual risk because of returns
    possibility of less diversification, but also provides opportunity
    to maximize returns for some Minimizes government risk
    Increases government risk Minimizes administrative costs
    Increases administrative costs Increases concern over political
    influence           Decreases concern over political influence
    Limited, but Diversified,                Several proposals suggest
    offering individual accounts with a limited set of Investment
    Choice                        investment options to minimize risk
    and administrative cost, while providing some degree of choice and
    the possibility of earning higher rates of return than are
    available under today's Social Security program. If participants
    were given limited investment choice, a number of issues would
    need to be resolved. Would There Be Ways to                   The
    federal TSP structure minimizes this risk by having a third party
    Mitigate the Concern Over                passively manage index
    funds.15 In addition, the law creating the TSP Political Influence
    of                   mandated an independent, five-person
    oversight board with specific Investment Choices?
    fiduciary responsibilities to the plan participants. The Thrift
    Investment Board must manage the funds solely for the benefit of
    the participants; if they fail to do so they can be civilly and
    criminally liable. In Chile, the use of private fund
    administrators helped to insulate investment policies from
    political influence, and the ability of individuals to change
    pension funds gave private administrators incentives to protect
    investors' interests. What If Individuals Did Not              As
    part of program design, it would be necessary to decide what
    should Make an Investment Choice?               happen to the
    contributions of those individuals who did not choose among the
    investments offered. Some have proposed placing these
    contributions in the lowest risk accounts. Another option would be
    to place these contributions in a few balanced funds, or life
    cycle accounts, that had portfolios with the same components but
    were weighted differently depending on the age of the worker-with
    less risk as workers neared retirement. How Much Public Education
    Public education about the choices available and the risks
    associated with Would Be Necessary Under a               each
    would be needed under any system. However, the need to educate
    System With Limited Choice?              the public about the
    consequences of using different investment strategies 15Index
    funds are a common form of passive investment management in which
    securities are held in proportion to their representation in
    certain stock or bond market indexes. Page 28
    GAO/HEHS-99-122 Implementing Individual Accounts Section 2 How
    Much Choice Would Individuals Have in Selecting and Controlling
    Investments? would be less under a system with limited choice than
    under a system with a broader range of choice. When the number of
    choices is limited, the degree of risk is more defined, and the
    program is less complex. What Would the Federal Role
    Because both choice and risk would be limited, the need for
    government Be in a Limited Choice             regulation and
    oversight of investment activities would be less complex
    Structure?                         under a TSP model than under a
    system offering wider choice; under the TSP model, individuals'
    accounts are pooled and invested collectively. The government's
    role would depend on whether the government invested in funds on
    behalf of participants, as Sweden plans to do, or individuals
    invested directly in the funds. The government's role would likely
    center around authorizing an independent infrastructure and
    monitoring the overall operations. However, the mechanisms used to
    minimize risk can have unintended consequences that should be
    considered. In Chile, because the government sets maximum and
    minimum rates of return for all participating funds and places
    restrictions on the composition of the fund portfolio, fund
    managers tend to hold portfolios of assets that are similar to the
    ones held by their competitors. Each fund, thus, earns a return
    that is close to the national average. While helping to lessen
    individual risk, this requirement has limited the variety of
    choice and earnings potential of the privately managed funds. What
    Protections Would             It would be necessary to determine
    the role of government if any of the Investors Have If Funds
    Failed?    available funds failed. While this would be an issue
    for scenarios with either limited or greater investment choices,
    it would have significance because of the role played by the
    government in selecting the available options. Greater Investment
    Choice          Some reform proposals would give individuals more
    discretion in selecting their investments. This greater discretion
    could be provided under a management structure similar to that of
    IRAs or the United Kingdom's plan, or under a centralized system
    such as Sweden's. If greater investment choice was offered,
    certain decisions would need to be made. What Options Would Be
    Experiences in Chile demonstrate that extensive competition among
    Available to Minimize              investment funds can lead to
    frequent and costly switching among funds. High-Pressure Sales
    Tactics,       To minimize this, Chile has reduced the number of
    times participants may Especially for Inexperienced       switch
    among funds from four to two times a year. In contrast, Sweden
    Investors?                         designed its program to protect
    its investors from high-pressure sales tactics. In Sweden,
    individual contributions will be amalgamated, and the government
    pension agency will execute buy orders in its name. As a Page 29
    GAO/HEHS-99-122 Implementing Individual Accounts Section 2 How
    Much Choice Would Individuals Have in Selecting and Controlling
    Investments? result, the identities of the individual account
    holders will be known only to the pension agency, not to the
    investment providers. How Much Public Education        Currently,
    the information that is required to be disclosed to investors is
    Would Be Necessary?              not uniform across different
    investment products. Under a system of individual accounts, this
    information would need to be presented in a more clear and simple
    format for the general public to understand. Moreover, the public
    would need a greater level of education to learn about the wider
    variety of investment options, understand and use the information
    disclosed to them, and fully appreciate the consequences of
    investment choices.16 The United Kingdom experienced substantial
    difficulties when it moved to individual accounts, in part, by
    providing too little public education and relying on its already
    existing regulatory system, which proved to be inadequate. In what
    has become known as the "mis-selling" controversy, high-pressure
    sales tactics were used to persuade individuals, especially older
    workers, to switch to unsuitable individual accounts that could
    not meet their retirement needs. What Should Be Done With
    Just as in the limited choice option, it would be necessary to
    decide what Contributions When the           should happen with
    the contributions of those individuals who neglected Individual
    Fails to Choose an    to choose among the investments offered.
    This decision could be more Investment?
    complicated if many investment options were offered. What Would
    the Federal Role      The government's regulatory and oversight
    role would be designed to Be in a System With Greater      protect
    investors from fraudulent and inappropriate sales practices. A
    lack Investment Choice?               of such oversight was a
    factor in the mis-selling controversy in the United Kingdom. In
    the United States, regulations and oversight mechanisms exist for
    the current IRA and 401(k) structures, as well as the securities
    market. It would be necessary to consider what special provisions
    should be included in a nationwide system of individual accounts.
    For example, requirements to disclose information to investors
    vary across different products or investment types, and more
    simplified information could be needed to ensure that
    inexperienced investors received information that was helpful to
    them. Should the Government            More investment choice
    increases the possibility that individuals will not Provide
    Guaranteed Minimum       choose diversified portfolios or will
    simply make bad selections, and thus Benefits?
    their retirement income may not be adequate. Some governments have
    explicitly accepted this risk by guaranteeing a minimum benefit.
    In Chile, the government sets a minimum rate of return that
    investment fund 16More information on this topic can be found in a
    forthcoming GAO report that discusses capital markets and
    educational issues related to individual accounts. Page 30
    GAO/HEHS-99-122 Implementing Individual Accounts Section 2 How
    Much Choice Would Individuals Have in Selecting and Controlling
    Investments? companies must provide. In addition, Chilean workers
    are guaranteed that they will receive at least a minimum monthly
    pension if they participate for at least 20 years in the system.
    Some U.S. proposals would ensure that workers receive at least the
    benefits promised under the current Social Security system. This
    raises the possibility that some people might take greater risk
    with their investments if they knew that the government would
    provide a guarantee, thus creating a contingent liability for the
    government. System Design and       Decisions about the design of
    a system of individual accounts, including Administrative Costs
    the flexibility offered in making investment decisions, have a
    direct effect on administrative cost.17 In general, the more
    services offered to the investor and the more investment options
    provided, the higher the administrative costs. Much of these costs
    would probably be borne by individual account holders, which would
    directly affect their accumulations and, eventually, their
    benefits. Moreover, under almost any scenario, government agencies
    would require additional resources, either for new record-keeping
    and administrative duties or new oversight and monitoring
    responsibilities. Decisions would have to be made concerning who
    would bear the different costs associated with the accounts. There
    are, however, options that could help limit administrative costs
    while still offering a degree of choice in investment vehicles.
    Offering choices among investment funds that are passively managed
    or based on a broad market index could keep costs down. Indexing
    does not require research on individual companies or securities,
    and securities held in index funds are not bought and sold
    frequently.18 Both activities-market research and frequent
    trading-can increase investment costs. In the TSP, where costs per
    participant are kept low relative to other defined contribution
    plans, both the bond and equity funds are invested in index funds,
    and records are kept centrally. System design can also be used to
    keep administrative costs down, when offering a greater range of
    investment choices. In the United Kingdom, one study found
    administrative costs to be as high as 36 percent of an 17See
    GAO/HEHS-99-131, June 18, 1999. 18Index funds that require a
    specific ratio between stocks and bonds would require daily buying
    and selling to maintain the ratio. Page 31
    GAO/HEHS-99-122 Implementing Individual Accounts Section 2 How
    Much Choice Would Individuals Have in Selecting and Controlling
    Investments? account's value.19 The study attributed these high
    costs, in part, to the fact that these accounts are voluntary,
    decentralized, and do not take advantage of economies of scale. In
    contrast, in Sweden, a centralized mandatory system can take
    advantage of economies of scale. Sweden's system is in the early
    stages of implementation, and it is too early to know how well it
    will work. Preretirement Access to     Whether to allow
    individuals access to their account funds prior to Individual
    Account Funds    retirement would be both a policy and a cost
    consideration. Ensuring that retirement income is available for
    the life of the retiree is a fundamental goal of Social Security.
    However, with accounts viewed as the property of the contributor,
    there could be pressure for access to the funds before retirement
    age, including access to these accounts through divorce,
    disability, or loans. While some may argue that individuals should
    be allowed the freedom to optimize their lifetime income through
    borrowing from their accounts before retirement, the added
    complexity and potential diminution of retirement income and
    possible increased risk to the government should be given serious
    consideration. Most major proposals prohibit loans and other
    preretirement access to individual account balances. A number of
    issues would need to be addressed if loans were allowed under an
    individual account system. These issues include the following: for
    what purposes would loans be allowed; who would approve and
    service the loans; how would loan denials, if any, be appealed;
    who would enforce loan repayment; and what would happen if an
    individual defaulted on a loan? Under a 401(k) plan, employers may
    allow individuals early access before age 59 in certain
    circumstances (including death, disability, hardship situations,
    and separation from service), but individuals may be subject to a
    10-percent additional income tax for early withdrawal.
    Administrative costs would be affected by the treatment of each of
    these issues, and these costs could be significant. Customer
    Service            There would also be a range of customer service
    options that could be Considerations              considered in
    any system of individual accounts. When more services and more
    flexibility are offered, the costs and administrative complexity
    of 19This percentage includes costs attributed to fund
    accumulation (that is, management and administrative costs) and
    costs of switching from one financial provider to another or
    stopping contributions altogether; it does not include
    annuitization costs. If annuitization costs were included, the
    study estimated that total charges could be as high as 43 percent.
    See Mamta Murthi, J. Michael Orszag, and Peter R. Orszag, "The
    Charge Ratio on Individual Accounts: Lessons from the U.K.
    Experience," Birkbeck College Working Paper 99-2 (London:
    University of London, Mar. 1999). Page 32
    GAO/HEHS-99-122 Implementing Individual Accounts Section 2 How
    Much Choice Would Individuals Have in Selecting and Controlling
    Investments? managing the investments increase. Moreover, if
    individuals consider the individual accounts as their personal
    property, they may expect more options and better service than
    they would from a government program. Many of the services that
    could be considered in the design of an individual account system
    are discussed below. How Frequently Should            Statements
    provide individuals with information on the actual value of
    Statements Be Issued?            their account, and the frequency
    of such statements under current systems varies. Statements
    estimating future Social Security benefits will be provided to all
    U.S. workers once a year beginning in fiscal year 2000. Sweden
    will also require annual statements, while the TSP currently
    provides statements twice a year. Statements for private
    investments, such as brokerage accounts, however, are often
    provided on a quarterly or monthly basis. How Often Should
    Deposits Be     While making deposits more frequently could
    increase earnings potential, Credited to an Individual        it
    could also increase administrative costs and require additional
    reporting Account?                         and reconciling because
    of the likely increase in reporting errors. Shifting to more
    frequent deposits might not be costly for employers with
    electronic record keeping, but doing so could represent a
    significant cost for small businesses. Conversely, making deposits
    to accounts less frequently would raise the issue of how funds
    collected but not deposited would be treated and who would benefit
    from any earnings. Should Valuations Be             Valuation is
    the process by which investment gains or losses are reflected
    Performed on a Daily or          in account balances. If valuation
    is performed daily, then participants' Periodic Basis?
    accounts reflect daily changes in market performance. Because
    valuation is rather involved, daily valuation is more expensive
    than periodic valuation and raises the possibility that some
    participants might switch among funds more frequently. This in
    turn could lead to their having inadequate retirement income. How
    Often Should Individuals     The frequency of interfund transfers
    can affect the value of an individual's Be Allowed to Transfer
    Funds     account, depending on who incurs the cost of the
    transfer. The TSP Between Investment Options,      currently
    allows individuals to move their assets once a month, and there
    and Who Should Bear the Cost?    is no direct charge to the
    individual. At the end of each calendar year, individuals in the
    United Kingdom may transfer to a new provider. However, they are
    charged exit fees, and other provisions often make such changes
    financially unrewarding. Under Sweden's plan, individuals will be
    able to transfer their funds at any time and incur a cost of about
    $10 per transfer. Page 33                               GAO/HEHS-
    99-122 Implementing Individual Accounts Section 2 How Much Choice
    Would Individuals Have in Selecting and Controlling Investments?
    What Channels of Direct             A number of options, such as
    toll-free numbers, regional offices, the Communication Should Be
    Internet, and form inquiries, are available for interaction on
    account Established for Individuals to      information. For
    example, participants in the TSP can conduct Obtain Account
    Information?         transactions, such as changing their account
    allocations, through either a computer-assisted phone service or
    the Internet. As a general rule, more flexibility equals higher
    costs. However, higher costs could be associated with more
    customer service and, potentially, with higher investment returns;
    yet higher investment returns are not consistently correlated with
    higher administrative costs. Many actively managed investment
    options have not been able to generate higher returns than broad
    market indexes. Start-Up Issues:                    As with the
    start-up of any new system, considerations such as the Developing
    an                       following would need to be addressed
    prior to implementation: Investment Structure * establishing a
    link between the record keeper and investment manager for Would
    Take Time                     fund deposits, * phasing system
    changes gradually, and * addressing the challenges of small
    accounts. If the investment management function was contracted out
    from a centralized record-keeping entity, a mechanism would be
    needed to link the information on deposits with actual
    contributions and the individual's investment selection before
    crediting deposits to the individual's account. For instance, for
    an individual account system under the current structure, SSA
    would maintain an individual's record, IRS would receive
    contribution information from employers, and individual
    contributions would be sent to a Federal Reserve bank or other
    authorized repository. After reconciliation between SSA and IRS
    was completed, this information and the individual's contribution
    would need to be linked to the individual's investment choice and
    forwarded to the designated investment manager. Phasing the new
    system in gradually and limiting choices would have advantages.
    For example, the TSP started with one fund, then added two more
    funds, and, in May 2000, will add another two: a Small
    Capitalization Stock Index Fund and an International Stock Index
    Fund. This gradual phase-in allowed the TSP and federal agencies
    sufficient time to establish a record-keeping system, inform the
    participants of their investment options, and observe the
    investment patterns before expanding the choices offered. Sweden
    plans to collect and accumulate contributions Page 34
    GAO/HEHS-99-122 Implementing Individual Accounts Section 2 How
    Much Choice Would Individuals Have in Selecting and Controlling
    Investments? before crediting them to individual accounts; the
    phasing allows more time for investor education about the new
    system and more substantial accumulation of account balances
    before investment. Small accounts would pose challenges during
    both system start-up and full-scale implementation. Average
    taxable earnings for U.S. workers in 1997 were $22,383, so an
    annual contribution of 2 percent of earnings would equal an
    average contribution of about $448 per year. The level of
    administrative costs can have a significant effect on account
    accumulation: the higher the percentage charged, the greater the
    effect. Moreover, if individuals were charged a flat fee per
    account for administrative costs, accumulations in small accounts
    would be affected to a greater extent than if an annual percentage
    rate were charged.20 However, there are ways to mitigate the
    problems associated with small accounts. Suggestions from various
    pension experts include (1) designing an administrative fee
    structure that permits large accounts to cross-subsidize small
    accounts; (2) establishing a separate, privately managed defined
    benefit plan for low earners; and (3) pooling the contributions of
    small accounts and investing them until they reach a designated
    size and then moving the contributions and earnings into
    individual accounts.21 Another alternative would permit workers
    initially to select among a small set of passively managed funds.
    Then, after several years, when account assets had built up
    sufficiently, workers seeking more investment choice would be
    given the option of rolling their investment funds into any
    qualified retirement account. 20For more information on the
    effects of administrative costs, see GAO/HEHS-99-131, June 18,
    1999. 21State Street Corporation, among others, has raised this
    third option as a possible means to address small accounts. Page
    35                                     GAO/HEHS-99-122
    Implementing Individual Accounts Section 3 How Much Flexibility
    Would Be Granted in Paying Retirement Benefits? A third critical
    decision would involve how much flexibility in the choice of
    payout options to afford workers when they retire and begin to
    draw on their accounts. Several options are available for the
    payout of benefits upon retirement, and each option has issues and
    trade-offs associated with it. In essence, the desire to give
    retirees flexibility in drawing on their accumulated savings must
    be balanced with the goal of ensuring reliable income over a
    retiree's life span. While some may argue that the method for
    payout would not need to be addressed for some time, it is
    important to note that there are many issues related to payout
    that could affect the overall goals of the program. These issues
    would need to be explored and clarified before implementation.
    Options for Payment    There are three basic ways to pay
    retirement benefits under a system of of Retirement
    individual accounts: annuitization, timed withdrawals, and lump
    sum payments. Under a system of annuities, the retiree contracts
    with the Benefits               annuity provider, generally an
    insurance company, to provide income for an agreed-upon length of
    time. Individuals provide a mutually agreed upon dollar amount,
    called a premium, to the provider in return for their monthly
    benefit.22 The contract specifies the premium paid to the company,
    the monthly amount paid to the retiree, and the interest rate that
    will be calculated on the premium over the life of the annuity.
    Premiums can be paid either as a lump sum or as a series of annual
    payments. For example, $100,000 today (the average premium in
    today's annuity market) yields a monthly benefit of approximately
    $700 to $800 per month for a 65-year-old male for the rest of his
    life. Other options for the payout of accounts include timed
    withdrawals (also referred to as self-annuitization) and lump sum
    payments. In a timed withdrawal, retirees specify a withdrawal
    schedule with the investment manager or record keeper. Each month,
    they receive their predetermined amount, while the balance of the
    individual account remains invested. Under a lump sum payment
    option, individuals may liquidate their accounts through a single
    payment at retirement and choose to spend or save their money
    according to their needs or desires. A fundamental decision in
    paying retirement benefits to participants in individual accounts
    would be whether to require participants to annuitize the funds in
    their accounts. Figure 3.1 illustrates the options that would be
    available under a system in which individuals were required to
    annuitize 22In a forthcoming report, we will provide a more
    detailed discussion of the factors that affect the costs
    associated with purchasing an annuity and how this cost could
    factor into a system of individual accounts. Page 36
    GAO/HEHS-99-122 Implementing Individual Accounts Section 3 How
    Much Flexibility Would Be Granted in Paying Retirement Benefits?
    their funds as well as the options available if more flexibility
    was granted regarding the payout of funds. Figure 3.1: Options for
    Payment of Retirement Benefits There are at least two ways that
    annuities could be provided: the government could sponsor the
    annuities centrally or individuals could purchase their annuities
    from the private market. If the government sponsored annuities,
    the government could provide them, contract with a private
    provider, or create a new quasi-governmental agency to provide the
    annuities.23 23For example, the Pension Benefit Guaranty
    Corporation currently pays annuity benefits to participants in
    defined benefit pension plans that are terminated with
    insufficient assets to pay guaranteed benefits. Page 37
    GAO/HEHS-99-122 Implementing Individual Accounts Section 3 How
    Much Flexibility Would Be Granted in Paying Retirement Benefits?
    Issues and Trade-offs               Choosing between options such
    as making annuities mandatory and to Consider When
    allowing beneficiaries to select their own course would require
    carefully examining the significant trade-offs associated with
    each option. For Choosing Among                      example,
    requiring individuals to annuitize individual accounts would be
    Options                             one way to ensure that
    benefits were available for the entire life of the retiree,
    regardless of how long that might be. Yet annuitization would
    allow individuals less flexibility, especially those with shorter
    life expectancies. Timed withdrawals and lump sum payments also
    present issues to consider. For example, a worker who selected a
    timed withdrawal could live longer than expected and run out of
    money, or a worker who selected a lump sum could spend it quickly
    or invest it badly, leaving nothing for retirement. These
    possibilities increase the risk that some retirees would be left
    without adequate income and the government might be called upon to
    provide further income support; however, providing choice would
    enable individuals to pass on accumulated wealth. Table 3.1
    depicts the trade-offs that would need to be considered before
    deciding how the payout system would be structured under a system
    of individual accounts. Table 3.1: Trade-offs for Paying
    Retirement Benefits                 Mandatory annuitization
    Choice for beneficiaries Reduces range of individual choice
    Maximizes individual choice Ensures reliability of income over a
    lifetime,    Increases risk of elderly population with but may
    disadvantage those with shorter life inadequate retirement income
    expectancies Minimizes risk to government of need to
    Increases risk to government of need to provide further income
    support                    provide further income support Provides
    option to choose to ensure family        Provides opportunity to
    pass on benefits if annuitant dies
    accumulated wealth Can be less costly to administer
    Can be more costly to administer Deciding on payout options for a
    system of individual accounts would not be limited, however, to
    choosing between requiring annuities or permitting maximum choice.
    Partial annuitization is one way of coping with the trade-offs.
    Payout options could be combined to ensure minimum benefits while
    offering greater flexibility to the individual. In Chile, for
    example, individuals are required to purchase an annuity that
    represents 70 percent of the average worker's salary, but they can
    withdraw the funds that exceed this level. Mandatory Annuitization
    Some of the proposals for individual accounts require annuitizing
    account accumulations to ensure dependable retirement benefits.
    The Page 38                                 GAO/HEHS-99-122
    Implementing Individual Accounts Section 3 How Much Flexibility
    Would Be Granted in Paying Retirement Benefits? administrative
    functions would be performed by an annuity provider, which would
    both prepare the annuity contract and pay the benefits according
    to its terms. Once a provider was chosen, the investment manager
    would be released from its responsibilities. For example, under
    the TSP, MetLife is the current annuity provider; when
    participants leave federal employment and choose to annuitize
    their TSP accounts, they then deal only with MetLife. MetLife
    offers five different types of annuities, each with a variety of
    features from which to choose. It is up to individuals to select
    the annuity they want to purchase, and the TSP transfers the funds
    to cover the premium. Any individual account system would require
    that a mechanism for communication be established among the record
    keeper, the investment manager, and the annuity provider to share
    personal information and account balances to initiate the
    payments. This mechanism would take time to develop and should
    therefore be thought through prior to implementing individual
    accounts. In creating the TSP, the establishment of a payout
    system at the same time as the entire system was recognized and
    included in the initial FERSA legislation. Payout Structure
    Affects    Concerns over administrative costs raise important
    issues regarding Administrative Costs        system design. The
    administrative cost of purchasing an individual annuity in the
    current market is relatively high, averaging a one-time charge of
    about 5 percent of the premium.24 This cost is for maintaining
    records, making payments, and providing services to the annuitant
    as well as some profit margin for the annuity provider. These
    costs can significantly reduce the amount accumulated in a savings
    account and therefore reduce lifetime benefit amounts. Government-
    sponsored and centrally managed annuities are one way to lower
    administrative costs, in part by taking advantage of economies of
    scale. In addition, the current Social Security system has
    demonstrated that it has the capability of managing a large volume
    of benefit payments. In addition to these administrative costs,
    current retirees who purchase annuities in the private market pay
    additional costs because of the characteristics of the other
    individuals who buy annuities. This situation is known as "adverse
    selection." In the current private market, consumers who expect to
    live a long time are much more likely to purchase annuities than
    others are. As a result, annuity providers charge higher prices
    than they would if every retiree purchased an annuity. The cost of
    insuring 24James M. Poterba and Mark J. Warshawsky, "The Costs of
    Annuitizing Retirement Payouts from Individual Accounts"
    (Cambridge, Mass.: National Bureau of Economic Research, Jan.
    1999). Page 39                                   GAO/HEHS-99-122
    Implementing Individual Accounts Section 3 How Much Flexibility
    Would Be Granted in Paying Retirement Benefits? against adverse
    selection could be as high as 12 percent of the premium.25 Making
    annuities mandatory would help equalize the pool of applicants by
    including individuals with lower life expectancies, thus somewhat
    mitigating the need for these additional costs. Moreover, managing
    the annuities centrally could provide additional opportunity for
    reduced costs. Pooling individual annuitants would provide more
    certainty that those with longer life expectancies would be
    balanced out by those with shorter life expectancies. However,
    making annuities mandatory or managing them centrally limits
    individual choice and increases the role of government in the
    payout process. Other Implementation              In addition to
    the broad issues of payout structure and administrative Issues
    costs, there are a number of implementation issues that arise in
    relation to a discussion on mandatory annuities that should be
    addressed before making a decision on a method for paying
    retirement benefits. Would a Unisex Mortality Table    As a result
    of a Supreme Court decision, pension plans that provide group Be
    Used?                          annuities must use a unisex
    mortality table that pools together the risk factors for men and
    women, thereby ensuring that both sexes receive the same monthly
    benefit, although they have different mortality rates. In
    contrast, individual annuities are not required to use the unisex
    table. Under the current system, SSA pays the same benefit to
    women and men who have the same earnings record. If a unisex
    mortality table was required, there would be the possibility that
    insurance companies would market only to men. What Would Happen If
    a Person     This could affect the overall account accumulation
    and, therefore, the Retired When the Market Was       value of the
    annuity that a retiree would be able to purchase. Unlike a Down?
    lump sum, under an annuity an individual would no longer control
    the money and would not be able to move it in and out of the
    financial market. Additionally, the interest rates at the time of
    retirement affect the annuity payments. If, for example, the
    interest rates were low at retirement, then the monthly payments
    would be lower than at higher interest rates and would stay
    constant regardless of any change in interest rates. In the United
    Kingdom, an annuity purchase may be delayed until an individual
    reaches age 75. What If a Retiree Wanted          Once individuals
    contract with an annuity company, their only access to Access to
    His or Her Funds?       the funds is through the monthly payment;
    individuals needing extra money are not able to draw from their
    premium. Under a lump sum, 25Poterba and Warshawsky, "The Costs of
    Annuitizing Retirement Payouts from Individual Accounts." Page 40
    GAO/HEHS-99-122 Implementing Individual Accounts Section 3 How
    Much Flexibility Would Be Granted in Paying Retirement Benefits?
    however, the money would be accessible. This becomes an issue when
    people begin to consider their individual accounts to be personal
    property. It would be important to make sure individuals
    understood that agreeing to an annuity would deny them access to
    their accumulated account balance but would ensure them a lifetime
    of retirement benefits. An important consideration is that any
    early retirement provisions would affect the annuity payout. Would
    Annuity Payments Be       Currently, Social Security beneficiaries
    get a cost of living adjustment to Indexed to Inflation?
    their benefits. Most private annuities do not offer this option.
    Insurance companies have said that if payments were indexed to
    inflation they would charge more. Who Would Be Responsible for
    Insurers have told us that early on under a new system, account
    balances Small Accounts?                 would be small and that
    the government should hold and annuitize accounts because it would
    not be economical for insurers to do so. Monthly payment amounts
    are linked to the premium, which may be all or some portion of an
    individual account, and a premium of $10,000 might provide a
    monthly payment of only $60 to $80. Some argue that it would be
    especially important for these small accounts to be given every
    opportunity to face minimal administrative costs. How Would the
    Federal Role      If annuities were offered through the private
    market, there would need to Change Under a System of        be
    coordination between SSA and the investment manager. A system
    would Mandatory Annuities?            need to be created whereby
    the money in individual accounts for annuity payments to retirees
    would be sent to the annuity provider for benefit payments. If the
    payout structure was decentralized, additional oversight and
    regulation would be needed to prevent fraud in the system and to
    ensure that individuals received the money that was due to them.
    Similarly, a decision would need to be made about whether the
    government would guarantee annuities to the full amount.
    Currently, by law, each state is responsible for regulating the
    insurance industry, but if annuities became part of a national
    system of individual accounts, the role of the federal government
    would need to be revisited. Timed Withdrawals and           If
    annuities were not required, retirees could be permitted to assess
    their Lump Sum Payments               individual needs and make
    decisions based on their personal situations. Several questions
    would need to be answered before implementing timed withdrawals or
    lump sums as payout options for individual accounts. Page 41
    GAO/HEHS-99-122 Implementing Individual Accounts Section 3 How
    Much Flexibility Would Be Granted in Paying Retirement Benefits?
    Would Individuals Be Able to    Under the current Social Security
    system, retirees receive a reduced Choose These Options If They
    benefit if they retire early. A decision would have to be made
    regarding Retired Early?                  whether and when
    retirees could gain access to their funds prior to the
    predetermined normal retirement age. What Would Happen If an
    Individuals might calculate their monthly withdrawals on the basis
    of the Individual's Self-Determined    number of years they expect
    to live. It is possible, though, that an Periodic Payments or
    individual who selected a timed withdrawal could live longer than
    Withdrawals Failed to Cover     expected and run out of money. In
    addition, a worker who selects a lump His or Her Full Lifetime?
    sum could spend it quickly or invest it badly, leaving none for
    retirement. Would the Government Provide    A decision would have
    to be made about a government guarantee in the a Minimum Pension
    If Funds      event that retirement funds were outlived or
    depleted. In Chile, for Were Outlived or Exhausted?     example,
    for those who select a timed withdrawal option, the government
    guarantees a minimum pension if one's funds are depleted before
    his or her death. This again raises the possibility that some
    people would take greater risk with their investments if they knew
    that the government would provide a guarantee, thus creating a
    contingent liability for the government. Start-Up Issues: Need
    It would be important to look at how all the parts of a system of
    individual for Payout Structure            accounts would interact
    with each other and determine whether, as a whole, the system was
    structured to meet its preestablished goals-such Before
    as enhancing individual choice and paying retirement benefits.
    Therefore, Implementation of               the start-up time for
    creating a payout system should be considered within the broader
    context of the entire system. Whether annuities were Individual
    Accounts             mandatory or voluntary, the government's role
    would need to be redefined. If mandatory annuities were selected
    as the payout option, an oversight agency's responsibilities could
    include creating a system for processing annuities, developing a
    process for contracting out annuity services, or creating a system
    that regulated at least some of the activities of private
    insurance companies that offer annuities. Furthermore, the various
    types of annuities being offered would need to be considered,
    since the specific option selected could make a difference in
    retirement provisions. Regardless of the payout structure, the
    public would need to be educated to understand the payout options
    available to them. If annuities were mandatory, for example,
    individuals would need to be educated about the annuity options
    available to them, because differing features could make a
    difference in the amount of retirement income. In addition, the
    public Page 42                             GAO/HEHS-99-122
    Implementing Individual Accounts Section 3 How Much Flexibility
    Would Be Granted in Paying Retirement Benefits? would need to be
    educated about how the payout would occur, which agency would be
    responsible for processing the payout, and what the effects of
    each option available to them would be. Page 43
    GAO/HEHS-99-122 Implementing Individual Accounts Appendix I
    Flowchart of Current Earnings Process Page 44      GAO/HEHS-99-122
    Implementing Individual Accounts Appendix I Flowchart of Current
    Earnings Process Page 45
    GAO/HEHS-99-122 Implementing Individual Accounts Appendix II
    Objectives, Scope, and Methodology At your request, the objectives
    of this review were to explore the options under a system of
    individual accounts for (1) placement of new administrative
    responsibilities, (2) managing investment funds and determining
    the extent of investment choices, and (3) determining the degree
    of flexibility offered to individuals at payout. To accomplish
    this, we agreed to include in our analysis the federal role in
    administering or regulating both individual accounts and personal
    savings accounts as well as the role of large and small employers,
    including the self-employed and businesses that typically have no
    retirement plans. We met with officials from the federal agencies
    that would be affected by a system of individual accounts,
    including the Social Security Administration (SSA), the Internal
    Revenue Service (IRS), the Securities and Exchange Commission, the
    Department of Labor's Pension and Welfare Benefits Administration,
    the Pension Benefit Guaranty Corporation, and the Department of
    the Treasury. In addition, we met with experts in the areas of
    Social Security and pension reform, as well as employer
    representatives, payroll processors, investment managers, and
    annuity providers, to obtain a more detailed understanding of the
    tasks involved in each aspect of account management. We also
    reviewed the experiences of other countries related to the
    administration of individual accounts to determine what additional
    manpower or other resources would be required. We performed our
    work from October 1998 to May 1999 in Washington, D.C., and
    Sacramento, California, in accordance with generally accepted
    government auditing standards. We provided a draft copy of our
    report to SSA, IRS, the Securities and Exchange Commission, the
    Pension and Welfare Benefits Administration, and the Federal
    Retirement Thrift Investment Board for review and comment. SSA and
    the Federal Retirement Thrift Investment Board provided written
    comments, which are included in appendixes III and IV. We also
    provided draft copies of our report to experts in the field of
    Social Security and pension reform. Page 46
    GAO/HEHS-99-122 Implementing Individual Accounts Appendix III
    Comments From the Social Security Administration Page 47
    GAO/HEHS-99-122 Implementing Individual Accounts Appendix III
    Comments From the Social Security Administration Page 48
    GAO/HEHS-99-122 Implementing Individual Accounts Appendix III
    Comments From the Social Security Administration Page 49
    GAO/HEHS-99-122 Implementing Individual Accounts Appendix IV
    Comments From the Federal Retirement Thrift Investment Board This
    discussion was deleted. Page 50      GAO/HEHS-99-122 Implementing
    Individual Accounts Appendix IV Comments From the Federal
    Retirement Thrift Investment Board Page 51
    GAO/HEHS-99-122 Implementing Individual Accounts Appendix V GAO
    Contacts and Staff Acknowledgments GAO Contacts       Barbara D.
    Bovbjerg, (202) 512-7215 Kay E. Brown, (202) 512-3674 Staff
    In addition to those named above, the following team members made
    Acknowledgments    important contributions to this report: Valerie
    Rogers, Abbey Frank, Gerard Grant, Deborah Moberly, Elizabeth
    O'Toole, Roger Thomas, and Rodina Tungol. Page 52
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    Benefit Research Institute, Nov. 1998. Poterba, James M., and Mark
    J. Warshawsky. "The Costs of Annuitizing Retirement Payouts from
    Individual Accounts." National Bureau of Economic Research,
    Cambridge, Mass., Jan. 1999. Social Security Administration,
    Office of Research, Evaluation and Statistics. "Retirement Income
    Security in the United Kingdom." Washington, D.C.: SSA, Nov. 1998.
    State Street Corporation. Administrative Challenges Confronting
    Social Security Reform. Boston, Mass.: State Street Corporation,
    1999. Page 53                          GAO/HEHS-99-122
    Implementing Individual Accounts Bibliography Thompson, Lawrence
    H. "Administering Individual Accounts in Social Security: The Role
    of Values and Objectives in Shaping Options." Washington, D.C.:
    Urban Institute, Jan. 1999 Page 54
    GAO/HEHS-99-122 Implementing Individual Accounts Bibliography Page
    55         GAO/HEHS-99-122 Implementing Individual Accounts
    Related GAO Products Social Security Reform: Administrative Costs
    for Individual Accounts Depend on System Design (GAO/HEHS-99-131,
    June 18, 1999). Social Security: Criteria for Evaluating Social
    Security Reform Proposals (GAO/T-HEHS-99-94, Mar. 25, 1999).
    Social Security: Individual Accounts as an Element of Long-Term
    Financing Reform (GAO/T-HEHS-99-86, Mar. 16, 1999). Social
    Security Reform: Experiences of the Alternative Plans in Texas
    (GAO/HEHS-99-31, Feb. 26, 1999). Social Security and Surpluses:
    GAO's Perspective on the President's Proposals (GAO/T-AIMD/HEHS-
    99-96, Feb. 23, 1999). Social Security and Minorities: Current
    Benefits and Implications of Reform (GAO/T-HEHS-99-60, Feb. 10,
    1999). Social Security: What the President's Proposal Does and
    Does Not Do (GAO/T-AIMD/HEHS-99-76, Feb. 9, 1999). Social Security
    Reform: Implications for Women (GAO/T-HEHS-99-52, Feb. 3, 1999).
    Social Security: Different Approaches for Addressing Program
    Solvency (GAO/HEHS-98-33, July 22, 1998). Social Security
    Financing: Implications of Stock Investing for the Trust Fund, the
    Federal Budget, and the Economy (GAO/T-AIMD/HEHS-98-152, Apr. 22,
    1998). Social Security Financing: Implications of Government Stock
    Investing for the Trust Fund, the Federal Budget, and the Economy
    (GAO/HEHS-98-74, Apr. 22, 1998). 401(k) Pension Plans: Loan
    Provisions Enhance Participation but May Affect Income Security
    for Some (GAO/HEHS-98-5, Oct. 1, 1997). (207040)      Page 56
    GAO/HEHS-99-122 Implementing Individual Accounts Ordering
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