Is it time for Personal Retirement Accounts?
If properly designed, a system of optional Personal Retirement Accounts (PRAs) could give almost all retirees significantly better retirement benefits. For example, Plan No.1, in the 2001 report of the bi-partisan President's Commission to Strengthen Social Security, is a simple plan that would likely yield superior results for workers in various wage brackets. Under this proposal, the core Social Security system would not be changed in any way. However, a worker would have the option of redirecting up to 2% of his or her taxable payroll from traditional Social Security to a PRA.
Under the proposal, the worker who elected to redirect payroll tax to the PRA would have his or her traditional Social Security benefits reduced by the same amount, compounded at a real interest rate of 3.5% (That means if inflation is, say, 3%, he would be charged 6.5%). The participant would be allowed to invest his or her funds in one or more of a few diversified portfolios, with low administration costs.
The Commission estimated that workers at all income levels could expect superior retirement benefits, with the "medium earner" getting an increase of about 12%. Other advantages could include a boost in national savings (as we set aside money to fund the PRAs), and improved worker productivity. According to several economists, including Martin Feldstein, workers would be motivated to work harder and longer with a system of PRAs, because they would have tangible ownership of their retirement assets - assets which could be left to their heirs.
The charts below, from the Commission's report, show the projected benefits of this simple PRA system (Commission's Plan 1) for workers at 3 income levels.
In each case, benefits under the PRA proposal are superior to those of traditional Social Security, and the PRA advantage steadily increases throughout the projection period (i.e., through 2052). In other words, young workers and old workers, low-income workers, and affluent workers, could all expect to gain with a PRA system. Indeed, the results are so desirable, we should strongly consider allowing workers to divert more than 2% into PRAs.
Caveats
Although PRAs could be very beneficial, a system of PRAs must be designed with care. To minimize administration costs, a simple and centralized system such as that used in the federal Thrift Savings Plan should be available, as an option, to all participants. To minimize investment risk, PRA rules would have to impose some limitations on investment choices. And, to prevent the draining of resources from the traditional Social Security program, an appropriate reduction of traditional benefits would have to be imposed on all who elect the PRA option.
Finally, we must reject PRA proposals that involve additional wealth shifting gimmicks. For example, we should reject plans similar to Proposals 2 and 3, offered by the 2001 President's Commission. In those proposals, the benefits of the PRAs are more than offset by implicit tax increases, changes to the indexing, new benefits for certain married couples, and earnings caps that limit the benefits of the PRAs to low earners. Proposals such as these, we don't need.