Testimony Before the Subcommittee on 

Social Security, Committee on Ways and 

Means, House of Representatives

United States Government Accountability Office

GAO

For Release on Delivery 

Expected at 10:00 a.m. EDT 

Thursday, June 23, 2005 SOCIAL SECURITY 

REFORM 

Considerations for 

Individual Account Design 

Statement of Barbara D. Bovbjerg, Director, 

Education, Workforce, and Income Security 

GAO-05-847T 
What GAO Found

United States Government Accountability Office

Why GAO Did This Study

Highlights

Accountability Integrity Reliability

www.gao.gov/cgi-bin/getrpt?GAO-05-847T.

To view the full product, including the scope 

and methodology, click on the link above. 

For more information, contact Barbara D. 

Bovbjerg at (202) 512-7215 or 

bovbjergb@gao.gov. 

Highlights of GAO-05-847T, a testimony 

before the Subcommittee on Social 

Security, Committee on Ways and Means, 

House of Representatives 

June 23, 2005

SOCIAL SECURITY REFORM 

Considerations for Individual Account 

Design 

Because Social Security is so deeply woven into the fabric of our nation, any 

proposed reform should be considered as a package and with respect to all 

of the major elements of the Social security program (e.g., retirement, 

disability, and survivors). Individual accounts can be a part of that reform, 

and in fact, many proposals include individual accounts. However, any 

proposed reform must consider the program in its entirety, rather than one 

aspect alone. Likewise, an individual account system must address key 

design issues associated with the phases of a retirement savings vehicle. 

Contribution phase: Designing the contributions for individual accounts 

requires making choices about the role that contributions play with respect 

to the current Social Security system. These choices include determining 

the size of the contribution rate, how the contributions are collected, 

whether the funds come from existing revenue sources, and whether 

participation is voluntary or not. 

Accumulation phase: Once contributions have been made, the accumulation 

phase requires making decisions about what to do with the funds to make 

them grow. These decisions include how much choice 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. 

Distribution phase: Distributing the accumulated earnings in individual 

accounts needs to focus on how these funds would be preserved for 

retirement. This includes making choices about when individuals can gain 

access to their funds, how much money they receive, and in what form they 

receive the funds. Other considerations that arise include the tax treatment 

of distributions and whether there will be a guarantee of a specified level of 

benefits. 

Overall, when designing individual accounts, it is important to keep in mind 

that more features tend to increase costs. For example, more investment 

choices can result in more administrative fees. Administering the accounts 

and educating the public about a system of individual accounts requires 

choices and trade-offs. However, any related administrative, management, 

and data systems must be developed and tested before the accounts become 

available to workers in order to maintain confidence in the system. 

Individual accounts could also be designed to include some progressive 

features, which would mirror the redistributive effects of the current Social 

Security program. However, it is important to distinguish between 

progressivity and benefit adequacy. Greater progressivity is not the same 

thing as greater adequacy and may result in less equity. 

Social Security forms the 

foundation for our retirement 

income system, providing critical 

benefits to millions of Americans. 

However, the Social Security 

program is facing significant future 

financial challenges as a result of 

profound demographic changes. A 

wide variety of proposals to reform 

the program are currently being 

discussed, including restructuring 

the program to incorporate 

individual accounts. When 

designing a system with individual 

accounts, there are many options 

and issues to consider. The choices 

that have to be made will affect not 

only participation in the accounts, 

but also the amount of savings 

accumulated in the accounts, and 

the benefit received from the 

individual accounts. 

The Subcommittee asked GAO to 

discuss options for the 

administration of individual 

accounts, including the major 

design issues that are raised within 

the contribution, accumulation, and 

distribution phases of a retirement 

savings vehicle. 
Page 1 GAO-05-847T 

Mr. Chairman and Members of the Subcommittee: 

I am pleased to be here today to discuss options for designing a system of 

individual accounts within the Social Security program. Social Security 

forms the foundation for our retirement income system and, in so doing, 

provides critical benefits to millions of Americans. However, the Social 

Security program is facing significant future financial challenges as a 

result of profound demographic changes. A wide variety of proposals to 

reform the program are currently being discussed, including restructuring 

the program to incorporate individual accounts. When designing a system 

with individual accounts, there are many options and issues to consider, 

such as whether the accounts should be voluntary or mandatory, the 

amount of choice individuals have over their investments, and how and 

when the funds are withdrawn from the accounts. The choices that have to 

be made will affect not only participation in the accounts, but also the 

amount of savings accumulated in the accounts and the benefit received 

from the account. 

Today I will discuss options for the design of individual accounts 

specifically corresponding to the phases of a pension or similar retirement 

savings vehicle: the contribution phase, the accumulation phase, and the 

distribution phase. GAO has conducted several studies related to the 

design, implementation, and administration of individual accounts. My 

statement is largely based on that work.1

In summary, the creation of an individual account system faces key design 

decisions in each of the phases that comprise the dynamics of a retirement 

savings vehicle. For example, regarding contributions, the size of the 

contribution and whether the accounts will be mandatory or voluntary 

must be decided. This decision will be shaped to some degree by the 

implicit relationship of the accounts to the current Social Security 

program. In the accumulation phase, individual account design must 

negotiate a number of trade-offs in setting, for example, the amount of 

choice in investment options and the level of customer service provided. 

Finally, individual accounts, like current defined contribution (DC) plans 

and individual retirement accounts (IRAs), must distribute accumulated 

account balances to individuals. A system of individual accounts covering 

over 156 million workers would constitute a fundamental change to Social 

Security and would be significantly larger than any existing retirement 

 1

 See the list of related GAO products at the end of this statement. 
Page 2 GAO-05-847T 

investment program. Affected individuals need to know about and 

understand the features of such a new system to make informed life 

decisions about work, savings, and retirement. 

According to the Social Security Trustees’ 2005 intermediate, or bestestimate, assumptions, Social Security’s cash surplus begins to decline in 

2009, and in 2017 cash flow is expected to turn negative. In addition, all of 

the accumulated Treasury obligations held by the trust funds are expected 

to be exhausted by 2041. Social Security’s long-term financing shortfall 

stems primarily from the fact that people are living longer and having 

fewer children. As a result, the number of workers paying into the system 

for each beneficiary has been falling and is projected to decline from 3.3 

today to about 2 by 2040. 

A common feature of many Social Security reform proposals is the 

creation of a system of individual accounts. Individual accounts would 

generally not by themselves achieve solvency for the Social Security 

system. Achieving solvency requires more revenue, lower benefits, or 

both. Many proposals that incorporate a system of individual accounts into 

the current program would reduce benefits under the current system and 

make up for those reductions to some degree with income from the 

individual accounts. Individual accounts also try to increase revenues, in 

effect, by providing the potential for higher rates of return on account 

investments than the trust funds would earn under the current system, but 

this exposes workers to a greater degree of risk. 

Three key distinctions help to identify the differences between Social 

Security’s current structure and one that would create individual accounts. 

Insurance versus savings. Social Security is a form of insurance, while 

individual accounts would be a form of savings. As social insurance, Social 

Security protects workers and their dependents against a variety of risks 

such as the inability to earn income due to death, disability, or old age. In 

contrast, a savings account provides income only from individuals’ 

contributions and any interest on them; in effect, individuals insure 

themselves under a savings approach. 

Defined benefit versus defined contribution. Social Security provides 

a defined benefit (DB) pension while individual accounts would provide a 

defined contribution (DC) pension. Defined benefit pensions typically 

determine benefit amounts using a formula that takes into account 

individuals’ earnings and years of earnings. The provider assumes the 

Background 
Page 3 GAO-05-847T 

financial and insurance risk associated with funding those promised 

benefit levels. Defined contribution pensions, such as 401(k) plans, 

determine benefit amounts based on the contributions made to the 

accounts and any earnings on those contributions. As a result, the 

individual bears the financial and insurance risks under a defined 

contribution plan until retirement.2

Pay-as-you-go versus full funding. Social Security is financed largely on 

a pay-as-you-go basis, while individual accounts would be fully funded. In 

a pay-as-you-go system, contributions that workers make in a given year 

fund the payments to beneficiaries in that same year, and the system’s 

trust funds are kept to a relatively small contingency reserve.3

 In contrast, 

in a fully funded system, contributions for a given year are put aside to pay 

for future benefits. The investment earnings on these funds contribute 

considerable revenues and reduce the size of contributions that would 

otherwise be required to pay for the benefits. Defined contribution 

pensions and individual retirement savings accounts are fully funded by 

definition. Both mandatory and voluntary individual account plans would 

reflect all of these distinctions. 

In addition to these key distinctions, options for the design of individual 

accounts can be grouped in three categories corresponding to the different 

phases of a retirement savings vehicle: 

• contribution phase: who should contribute, how much, and with what 

funds; 

• accumulation phase: how are funds invested to make them grow; and 

• distribution phase: how much of a benefit is received, when is it received, 

and in what form is it received. 

 2

At retirement, individuals have the option of purchasing an annuity with their defined 

contribution accounts, which then transfers the financial and insurance risk to the annuity 

provider. Before retirement, individuals may also have the option of purchasing deferred 

annuities. 

3

Social Security is now temporarily deviating from pure pay-as-you-go financing by building 

up substantial trust fund reserves. Social Security is collecting more in revenues than it 

pays in benefits each year partly because the baby boom generation makes the size of the 

workforce larger relative to the beneficiary population. In 2017, shortly after the baby 

boomers start to retire, the benefit payments are expected to exceed revenues, and the 

trust fund reserves and the interest they earn will help pay the baby boomers’ retirement 

benefits. For more detail about this temporary trust fund buildup and how it interacts with 

the federal budget, see GAO, Social Security Reform: Demographic Trends Underlie 

Long-Term Financing Shortage, GAO/T-HEHS-98-43 (Washington, D.C.: Nov. 20, 1997). 
Page 4 GAO-05-847T 

As we have reported previously with respect to Social Security reform as a 

whole, as policy makers decide whether and how to create a system of 

individual accounts, they must balance 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, administered, and explained to the 

public. An essential challenge would be to help people understand the 

relationship between their individual accounts and traditional Social 

Security benefits, thereby avoiding any gap in expectations about current 

or future benefits. Individuals would also need to be informed enough to 

make prudent investment decisions, which would require investor 

education, especially if individual accounts were mandatory. This would 

be especially important for individuals who are unfamiliar with making 

investment choices. 

Determining how contributions to an individual account will be made 

requires choices about the role these contributions play vis-à-vis the 

current Social Security system. These choices include determining the size 

and role of contributions, management of contributions, whether the 

account is a substitute or a supplement, and whether participation in the 

accounts should be voluntary or mandatory. 

An individual account plan can provide for contributions in a variety of 

ways. For example, a plan might set contributions at a fixed rate, such as 2 

percent of pay, or allow a range of rates with, possibly, a certain dollar 

limit. Some proposals provide for greater average contribution rates for 

lower earners than for higher earners. Individual accounts could be 

designed to include some progressive features, which could mirror the 

redistributive effects of the current Social Security program. For example, 

contribution rates may go down gradually as earnings rise, or alternatively, 

all workers might pay a fixed percentage but have a dollar cap on 

contribution amounts. 

Ultimately the size of the individual account contribution rate determines 

the relative role of the DC aspect of the account versus the DB portion of 

the Social Security program. As a result, depending on their design, 

Design 

Considerations In the 

Contribution Phase 

Size and Role of 

Contributions 
Page 5 GAO-05-847T 

individual accounts will have a varying effect on the adequacy of benefits 

for certain subgroups of beneficiaries. For instance, disabled beneficiaries 

leave the workforce sooner than retired workers. With fewer years to 

make contributions (and accrue interest), disabled beneficiaries will likely 

have smaller account balances. At the same time, reform provisions that 

disfavor subgroups of earners can be offset by other provisions that favor 

them. As a result, any evaluations of reform proposals should not focus 

solely on individual account proposals but should consider both the DC 

and DB aspect of a proposal’s provisions as a whole. 

In managing individual accounts, contributions might be collected and 

deposited by the government in a centralized process or by employers or 

account providers in a decentralized process. Under a centralized process, 

which would build on the current payroll reporting and tax collection 

system, a federal agency, such as the Social Security Administration, 

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. A decentralized structure could build on the system that has 

grown up around employer-sponsored 401(k) plans or individually 

managed IRAs. 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. 

Individual accounts can either supplement current Social Security 

contributions or substitute for all or part of them. With supplemental 

accounts, sometimes referred to as add-ons, the individual account and 

contributions to it have no effect on existing Social Security benefits. The 

supplemental account approach effectively leaves the entire current 12.4 

percent payroll tax contribution available to finance the program while 

dedicating additional revenues for individual accounts. With substitute 

accounts, or carve-outs, the existing Social Security benefit is reduced (or 

offset) in some way to account for contributions that have been diverted 

Management of 

Contributions 

Substitute versus 

Supplementary 

Contributions 
Page 6 GAO-05-847T 

from the program.4 The obvious effect is that less revenue is available to 

finance the current benefit structure, which creates a problem of 

transition costs. Absent any other reforms, these transition costs increase 

in proportion to the individual account contribution rate. This means that 

either benefits must be reduced or additional resources must be devoted 

to the defined benefit portion of the Social Security program in the near 

term. The trade-off to incurring transition costs is that the expected higher 

rate of return on the individual accounts may permit somewhat higher 

benefits to be paid, although with increased risk. 

Another important design feature to consider with respect to the 

contribution phase is whether the individual account is voluntary or 

mandatory. As we have previously reported, voluntary individual accounts 

require additional design considerations that mandatory accounts do not.5

For instance a voluntary account could offer participants the ability to opt 

in and opt out of the account periodically; most U.S. proposals for 

voluntary accounts have not explicitly considered whether people would 

face a onetime or a periodic decision to participate. Individuals may 

consider the extent of such flexibility in deciding whether to participate in 

the accounts. Moreover, the need to track individuals’ participation 

decisions requires additional administrative tasks and complexity. 

Educational efforts would be needed to inform individuals if their 

participation in an individual account would be advantageous or not, 

especially if the account substitutes for existing Social Security benefits. 

Voluntary individual account plans may also require incentives to induce 

participation, while mandatory plans do not. In addition to increasing 

participation, incentives generally add to the value of the accounts and, 

 4

In GAO’s work to date, we have used the term “add-on” accounts to refer to accounts that 

would have no effect on Social Security benefits, would supplement those benefits, and 

would draw contributions from new revenue streams. In contrast, we have used the term 

“carve-out” accounts to refer to accounts that would result in some reduction or offset to 

Social Security benefits because contributions to those accounts would draw on existing 

Social Security revenues. Others have used these terms in different manners. For example, 

some have used “add-ons” in connection with new individual accounts funded from new 

revenue sources that result in a reduction or offset to some or all Social Security benefits. 

In the final analysis, there are two key dimensions: first, whether individual accounts are 

funded from existing or new revenue sources; second, whether individual accounts result 

in some reduction or offset to Social Security benefits. 

5

 See GAO, Social Security Reform: Information on Using a Voluntary Approach to 

Individual Accounts, GAO-03-309, (Washington, D.C.: March 10, 2003). 

Voluntary Contributions 

Require Additional 

Considerations 
Page 7 GAO-05-847T 

therefore, ultimately to retirement income. Government contributions and 

tax advantages are just a few of the potential incentives for voluntary 

individual accounts. The costs of incentives can be difficult to estimate 

and can be substantial. Further, in certain circumstances, the net effect of 

voluntary individual account incentives may not result in improving 

overall retirement income. For example, if the voluntary account was also 

supplementary, then it might be difficult to determine whether a voluntary 

account adds to total retirement income, as it might merely substitute for 

other forms of saving. On the other hand, if the individual accounts truly 

add to total retirement income, they allow workers the opportunity and 

choice to build up additional savings to meet both income and health care 

cost needs in retirement. 

Voluntary individual account plans can also affect the total system costs to 

the government, providers, employers, or participants, depending on 

design. In some cases, offering choice involves additional administrative, 

incentive, and educational costs. In particular, tracking individuals’ 

participation decisions would require administrative processes that do not 

arise in mandatory plans. Moreover, the uncertainty of participation rates 

in turn creates uncertainty for a variety of costs associated with voluntary 

individual account plans. For instance if individuals accurately perceive 

any built-in incentive in the benefit offsets, given their personal 

circumstances, and make their participation decision accordingly, then 

adverse selection could result. This occurs when certain groups of 

individuals (for example, those with longer life expectancies) are more (or 

less) likely to participate than others and when such participation patterns 

result in a net cost to the government. 

A system of individual accounts would provide workers with opportunities 

to assert greater control over their retirement savings. Therefore, when 

designing a system, critical decisions would need to be made about who 

will manage and invest funds and what investment choices will be offered. 

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. 

Alternatives for designing the investment structure of a system of 

individual accounts range from offering the individual a limited number of 

preselected funds, such as those offered by the federal Thrift Savings Plan 

Design 

Considerations in the 

Accumulation Phase 

Options for Investment 

Management 
Page 8 GAO-05-847T 

(TSP), to offering a broad array of private market choices, such as those 

available through IRAs. Options for managing these investment choices 

could vary from a centralized, government-managed system to a 

decentralized, privately managed system. A centralized system would take 

advantage of economies of scale, which is to say that the more accounts 

managed by a single entity, the lower the cost for each; thus such an 

approach could have lower administrative costs than a decentralized 

system. This is especially important when considering that a number of 

individuals may initially have small account balances. Depending on how 

administrative costs are assessed, administrative costs may eat into the 

accumulated savings of all accounts but could have a greater impact on 

the smaller accounts. 

There are trade-offs associated with the range of investment choices 

offered. When individuals have more investment choices, they have more 

opportunity to tailor their financial situation to their own tastes and 

preferences and assert greater control over their 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. As the range and variety of investment choices grow, so does the 

range of possible outcomes for individual account returns. This means that 

a number of individual accounts could perform very well, while others will 

not perform well at all. This results in increased risk to the government 

that individuals with inadequate income will turn to the government for 

support through other programs. In addition, a wider range of investment 

choices can also lead to higher administrative costs, which, if not offset by 

significantly higher returns, could undermine 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. 

Investment decisions become more complicated as the number of choices 

increase. If individuals do not make an investment choice, managers 

would need to decide how to invest the contributions for those 

individuals. Some have proposed placing these contributions in the lowest 

risk accounts. One such option would be to place these contributions in a 

limited number of funds and then weight individual portfolios differently 

Tradeoffs Between 

Investment Choices 
Page 9 GAO-05-847T 

depending on the age of the worker, similar to a life-cycle fund, so that 

workers increasingly assume less risk as they neared retirement. 

Public education about the choices available and the risks associated with 

each would be needed under any system. However, the need to educate 

the public about the consequences of using different investment strategies 

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. However, 

as the number of choices increases, the public would need a greater level 

of education to learn about the wider variety of investment options to 

understand and use the information disclosed to them, and to fully 

appreciate the consequences of investment choices. 

Frequent statements indicating the actual account value, daily or periodic 

valuation of account balances, and the ability to transfer funds between 

investment options are some of the different services that could be 

available with individual accounts. When more services and more 

flexibility are offered, the costs and administrative complexity of 

managing the investments increase. Moreover, if individuals consider the 

individual accounts as their personal property, they may expect options 

and service consistent with those often provided by private sector fund 

managers, such as frequent detailed account statements and allowing 

frequent interfund transfers. 

The final design element centers on how the accumulated earnings in 

individual accounts would be preserved for retirement. Ensuring that 

retirement income is available for the life of the retiree is a fundamental 

goal of Social Security. With respect to the distribution phase, individual 

account systems could use three basic ways to pay retirement benefits: 

annuitization, timed withdrawals, and lump sum payments. The 

appropriateness of additional distribution features such as loans or early 

withdrawals, which are common in 401(k) plans, would also need to be 

considered. While such features would enhance the account holder’s sense 

of ownership and control, loans or early withdrawals create a risk for 

leakage of account income that could diminish adequacy in retirement. 

Further, administrative aspects of the distribution must be considered. 

These include any guarantees that may be offered as well as the tax 

treatment of the distributions. 

Customer Service 

Considerations 

Design 

Considerations in the 

Distribution Phase 
Page 10 GAO-05-847T 

Under a system of annuities, retirees would receive monthly payments for 

an agreed-upon length of time, and the size of those payments would 

depend on the total value of the individual accounts. Under individual 

account proposals, annuities would be obtained either through 

government agencies or the private market. Further, such annuitization 

could be mandatory, voluntary, or some hybrid of both. For example, 

some individual account proposals have suggested mandatory 

annuitization up to an amount necessary to avoid poverty, and then any 

remaining account monies could be distributed at the account holder’s 

discretion. 

Mandatory annuitization could help ensure that the accounts provided 

retirement income for the entire remaining lifetimes of participants. 

Mandatory annuitization of accounts could also minimize adverse 

selection. Adverse selection occurs, for example, when only healthy 

people buy annuities and on average live longer than nonbuyers, driving 

up the cost of annuities. According to one study, annuity prices in a 

voluntary environment can be as much as 14 percent higher than they 

would be if every retiree were required to purchase an annuity. However, 

mandatory annuitization also effectively transfers income from the 

shorter-lived to those that are longer-lived. 

Additional design considerations for annuities include the type of 

annuities that could be offered. For example, monthly income can be a 

fixed amount per month (fixed annuity); a steadily increasing amount 

based on an index, such as the Consumer Price Index (indexed annuity); 

or a variable amount based on returns from investing the premium 

(variable annuity). Under a single-life annuity, the annuitant receives a 

guaranteed stream of payments that end with the annuitant’s death. Under 

a joint and survivor annuity, the payments continue to be made, 

sometimes at a reduced rate, to a second annuitant, such as a spouse, on 

the death of the primary annuitant. For a term-certain annuity, payments 

are not contingent on the annuitant’s life; instead, they are guaranteed for 

a specified period of time, such as 5 or 10 years. With a variable annuity, 

the annuitant assumes some of the risk from the investment returns on the 

annuity. 

The current Social Security retirement benefit provides a fixed lifetime 

annuity that increases with inflation. In addition, Social Security provides 

auxiliary benefits to workers’ eligible spouses, children, and survivors 

without reducing the size of the worker’s own annuity. While annuity 

providers could potentially replicate some of the features of Social 

Security benefits, some important features would not likely be replicated. 

Annuities 
Page 11 GAO-05-847T 

Adding components such as inflation indexing or a joint and survivor 

annuity will require the primary annuitant to accept less monthly income 

than under a single-life annuity. Furthermore, individuals with small 

account balances at retirement could have difficulty purchasing annuities 

in the private sector insurance market. Insurers may find provision of 

annuities to be inefficient and costly for individuals with small accounts 

because of the relatively high cost of issuing monthly checks and other 

administrative costs. 

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. Both timed 

withdrawals and lump sums give the individual the most immediate 

control of their account. Such options also underscore that increased 

personal choice comes with increased personal responsibility if the 

retirement income is to be preserved for the long term. 

A unique distribution phase design feature of some proposals involves a 

guarantee of a certain benefit level at retirement. This guarantee could be 

provided in tandem with other benefit structure changes such that the 

worker would be guaranteed a minimum benefit. One such approach 

would guarantee the current Social Security defined benefit. If the 

individual account provided less than the current benefit, then the system 

would ensure that benefits were provided to fill the gap. Such an 

arrangement might be desirable from a benefit adequacy perspective but 

would require safeguards against the government becoming an insurer of 

excessive risk taking by individuals. This risk taking could occur if 

individuals assumed unwarranted investment risk knowing that the 

government would still guarantee a minimum benefit or rate of return. 

While the above design features consider design options in the distribution 

phase at retirement, individual account design may also consider whether 

to allow preretirement access. For example, most 401(k) pension plans 

allow participants to borrow against their pension accounts at relatively 

low interest rates. In past work we have shown that preretirement access 

Timed Withdrawals and 

Lump Sums 

Guarantees 

Preretirement Access 
Page 12 GAO-05-847T 

improves participation in 401(k) pension plans and might also be an 

incentive for participation in a system of voluntary individual accounts.6

However, those plan participants who borrow from their accounts risk 

having substantially lower pension balances at retirement and, on average, 

may be less economically secure than nonborrowers. While some may 

argue that individuals should be allowed the freedom to access income 

through borrowing from their accounts before retirement, the added 

complexity and potential diminution of retirement income need to be 

given serious consideration. 

Any payout option, whether pre- or postretirement, would need to 

consider the tax treatment of the individual account distribution. Benefits 

from individual accounts could be taxed in a variety of ways. For example, 

individual account benefits could be taxed like current Social Security 

benefits. Persons who currently receive Social Security benefits and have 

income over a certain amount may have to pay taxes on their benefits.7

Generally, the higher one’s total income, the greater the taxable part of 

one’s benefits. Typically, up to 50 percent of one’s benefits will be taxable. 

However, up to 85 percent can be taxable if, for example, a person filed a 

federal tax return and one-half of his or her benefit and all other income 

exceeds $34,000. Alternatively, individual accounts could be taxed 

similarly to ordinary income. Individual accounts could also be treated like 

pension payments (such as DC pensions like 401k plans) or annuity 

payments from a qualified employer retirement plan, which may either be 

fully or partially taxable, depending on the type of retirement plan. 

Clearly, the wide range of possible options complicates the design of an 

individual account system. In general, our work shows that the features 

that provide additional flexibility and choice may increase system costs. 

Such features would include making participation voluntary, rather than 

 6

 Participants in plans that allow borrowing contribute, on average, 35 percent more to 

their pension accounts than participants in plans that do not allow borrowing. See GAO, 

401(k) Pension Plans: Loan Provisions Enhance Participation but May Affect Income 

Security for Some, GAO/HEHS-98-5, (Washington, D.C.: Oct. 1, 1997). 

7

Individual income tax filers pay this tax if their adjusted gross income plus tax-exempt 

interest income plus one-half their Social Security benefits exceeds $25,000. A married 

couple filing jointly will pay the tax if this income exceeds $32,000. These levels are not 

adjusted for inflation, so the percentage of beneficiaries paying tax on Social security 

benefits is expected to rise in the future. 

Tax Treatment 

Conclusions 
Page 13 GAO-05-847T 

mandatory, and expanding the number of investment options.8 Other key 

decisions also have cost implications. For example, the contribution 

phase, the accumulation phase, and the distribution phase could each be 

administered in a centralized or decentralized manner, and at various 

levels by the government or by private contractors. In general, costs of 

individual accounts will rise with increasing decentralization. 

No matter what sort of features individual accounts include, any related 

administrative, management, and data systems must be developed and 

tested before the individual accounts are made available to American 

workers. If reforms are implemented with haste and key administrative 

functions are neglected, the ensuing problems have the potential to 

undermine an otherwise well-designed accounts system. The federal Thrift 

Savings Plan has been suggested as a model for providing a limited 

amount of options that reduce risk and administrative costs while still 

providing some degree of choice. While using this existing model could 

mitigate administrative issues, a system of accounts that spans the entire 

national workforce and millions of employers would be significantly larger 

and more complex than the TSP. 

The choice to include individual accounts as part of broader reform could 

fundamentally alter the defined benefit aspect of current Social Security 

benefits. Under its current structure, Social Security redistributes benefits 

to lower-income workers. Mirroring the redistributive effects of the 

current Social Security program, individual accounts could be designed to 

include some progressive features. However, it is important to distinguish 

between progressivity and benefit adequacy. Greater progressivity is not 

the same thing as greater adequacy and may result in less equity. As a 

result, any evaluation of a Social Security reform proposal that includes 

individual accounts should consider not only the overall costs to the 

system but also, very importantly, the impact on individuals and families. 

Administering the accounts and educating the public about a system of 

individual accounts requires difficult choices and trade-offs; and these 

choices will determine the degree and speed of public acceptance. 

Ultimately, what matters most is that we maintain a strong retirement 

security system for the millions of American workers and their families. 

 8

 See GAO, Social Security Reform: Information on Using a Voluntary Approach to 

Individual Accounts, GAO-03-309 (Washington, D.C.: Mar. 10, 2003), and GAO, Social 

Security Reform: Implementation Issues for Individual Accounts, GAO/HEHS-99-122

(Washington, D.C.: June 18, 1999). 
Page 14 GAO-05-847T 

Mr. Chairman and Members of the Subcommittee, this concludes my 

prepared statement. I would be happy to respond to any questions you or 

the other Members of the Subcommittee may have. 

For further information regarding this testimony, please contact 

Barbara D. Bovbjerg, Director, Education, Workforce, and Income 

Security Issues, on (202) 512-7215. Blake Ainsworth, Alicia Cackley, 

Charlie Jeszeck, Michael Collins, and Charles Ford also contributed to this 

statement. 

GAO Contacts and 

Staff 

Acknowledgments 
Page 15 GAO-05-847T 

Social Security Reform: Answers to Key Questions. GAO-05-193SP. 

Washington, D.C.: May 2005. 

Options for Social Security Reform. GAO-05-649R. Washington, D.C.: 

May 6, 2005. 

Social Security Reform: Early Action Would Be Prudent. GAO-05-397T. 

Washington, D.C.: Mar. 9, 2005. 

Social Security: Distribution of Benefits and Taxes Relative to Earnings 

Level. GAO-04-747. Washington, D.C.: June 15, 2004. 

Social Security Reform: Analysis of a Trust Fund Exhaustion Scenario. 

GAO-03-907. Washington, D.C.: July 29, 2003. 

Social Security and Minorities: Earnings, Disability Incidence, and 

Mortality Are Key Factors That Influence Taxes Paid and Benefits 

Received. GAO-03-387. Washington, D.C.: Apr. 23, 2003. 

Social Security Reform: Analysis of Reform Models Developed by the 

President’s Commission to Strengthen Social Security. GAO-03-310. 

Washington, D.C.: Jan. 15, 2003. 

Social Security Reform: Information on Using a Voluntary Approach to 

Individual Accounts. GAO-03-309. Washington, D.C.: Mar. 10, 2003. 

Social Security: Program’s Role in Helping Ensure Income Adequacy. 

GAO-02-62. Washington, D.C.: Nov. 30, 2001. 

Social Security Reform: Potential Effects on SSA’s Disability Programs 

and Beneficiaries. GAO-01-35. Washington, D.C.: Jan. 24, 2001. 

Social Security Reform: Information on the Archer-Shaw Proposal. 

GAO/AIMD/HEHS-00-56. Washington, D.C.: Jan. 18, 2000. 

Social Security: Evaluating Reform Proposals. GAO/AIMD/HEHS-00-29. 

Washington, D.C.: Nov. 4, 1999. 

Social Security: Issues in Comparing Rates of Return with Market 

Investments. GAO/HEHS-99-110. Washington, D.C.: Aug. 5, 1999. 

Social Security Reform: Implementation Issues for Individual Accounts. 

GAO/HEHS-99-122. Washington, D.C.: June 18, 1999. 

Related Products 
Page 16 GAO-05-847T 

Social Security: Criteria for Evaluating Social Security Reform 

Proposals. GAO/T-HEHS-99-94. Washington, D.C.: Mar. 25, 1999. 

Social Security: Different Approaches for Addressing Program Solvency. 

GAO/HEHS-98-33. Washington, D.C.: July 22, 1998. 

Social Security: Restoring Long-Term Solvency Will Require Difficult 

Choices. GAO/T-HEHS-98-95. Washington, D.C.: Feb. 10, 1998. 
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