CONGRESS OF THE UNITED STATES

CONGRESSIONAL BUDGET OFFICE

A

STUDY

MARCH 2004

Administrative 

Costs of Private 

Accounts in

Social Security

CBO

© Image Ideas

The Congress of the United States O Congressional Budget Office

CBO

Administrative Costs of

Private Accounts in Social Security

March 2004

A

STUDY

Preface

A number of proposals for modifying Social Security call for the creation of a system of 

private retirement accounts. One important consideration, among many, in evaluating such 

proposals is the cost of administering the system. The operation of any system of accounts 

involves a number of administrative tasks whose costs will ultimately affect a retiree’s account 

balance. To assess the range of possible administrative costs that a system of private accounts 

might generate, this Congressional Budget Office (CBO) study—prepared in response to a 

request from the Ranking Member of the House Ways and Means Committee and the Ranking Member of the Subcommittee on Social Security—examines the costs of four systems 

used to fund retirement in the United States: Social Security, the federal government’s Thrift 

Savings Plan, retail mutual funds, and private defined-contribution pension plans. 

Ben Page of CBO’s Macroeconomic Analysis Division wrote this study under the direction of 

Douglas Hamilton and Robert Dennis. Paul Cullinan, Peter Diamond, Randall Mariger, 

Olivia Mitchell, David Moore, Noah Myerson, James Roosevelt, Ralph Smith, and Jan Walliser provided valuable comments.

Juyne Linger edited the study, and Christian Spoor proofread it. Maureen Costantino produced the cover and figure and prepared the study for publication, and Annette Kalicki prepared the electronic versions for CBO’s Web site (www.cbo.gov). 

Douglas Holtz-Eakin

Director

March 2004

1 Summary and Introduction 1

2 Administrative Tasks in a Pension System 3

Collection and Processing 3

Asset Management 3

Calculation and Payment of Benefits 4

Enforcement and Oversight 5

Marketing and Sales 5

3 Administrative Costs in Existing Systems 7

Social Security 7

The Thrift Savings Plan 11

Mutual Funds 12

Private Defined-Contribution Plans 14

Annuities 14

4 The Administrative Costs of a Personal Account System:

Identifying the Trade-Offs 17

Collection and Processing 17

Asset Management 17

Calculation and Payment of Benefits 18

Enforcement and Oversight 19

CONTENTS
vi ADMINISTRATIVE COSTS OF PRIVATE ACCOUNTS IN SOCIAL SECURITY

Tables

1-1. Estimated Administrative Costs of Pension Systems

and Their Effect on Assets at Retirement 2

Figures

2-1. Administrative Tasks in a Pension System 4

Boxes

3-1. CBO’s Methodology for Comparing Administrative Costs 8
1

Summary and Introduction

Many proposals for reforming Social Security 

call for the creation of a system of private retirement accounts. Although proposals for private accounts differ in 

significant ways, they share a common feature: the assets 

in a worker’s account at retirement would depend on the 

payments made into that account and the rate of return 

on the account’s assets during the person’s working life. 

Many types of accounts are possible, and their effects on 

retirement income would vary widely.1

A key consideration in evaluating proposals for establishing a system of private accounts is the cost of administering the system. The operation of any system of accounts 

involves basic administrative tasks such as collecting and 

processing contributions, managing assets, and paying 

benefits—all of which require recordkeeping. Each of 

those tasks carries costs, which will ultimately affect a retiree’s account balance.

This study examines the administrative costs of four systems for funding retirement in the United States: Social 

Security, the federal government’s Thrift Savings Plan, 

retail mutual funds, and private defined-contribution 

plans.2 The study also reviews the administrative cost of 

annuities, which might be used by some or all participants in a system of private accounts to convert asset balances into regular payments. 

The costs of administering the systems vary, in large part 

because of differences in the level of services and range of 

asset choices the systems provide. The current Social Security system, for example, restricts participants to one 

“asset”—promised benefits—and provides, on an annual 

basis, limited information about expected benefits. By 

contrast, most mutual funds offer a wide variety of services, including a broad range of asset choices and daily 

updates on account balances. 

Another important factor that can affect administrative 

costs is the degree to which a system is centralized. For 

example, a centralized system such as the federal government’s Thrift Savings Plan may generate few or no costs 

for marketing and sales. In a decentralized system that 

operates at the retail level, such as mutual funds, the cost 

of those tasks may be substantial. Decentralized systems, 

however, also allow for competition, which can lead to 

better services and more efficient operation over time. 

CHAPTER

1. For a review of the possible effects of private accounts, see Congressional Budget Office, Social Security: A Primer (September 

2001).

2. For a review of systems of accounts in several foreign countries, 

see Congressional Budget Office, Social Security Privatization: 

Experiences Abroad (January 1999). Other reviews of the issues 

surrounding administrative costs include Olivia S. Mitchell, 

“Administrative Costs in Public and Private Retirement Systems,” 

in Martin Feldstein, ed., Privatizing Social Security (Chicago: University of Chicago Press, 1998); Kelly A. Olsen and Dallas L. Salisbury, Individual Social Security Accounts: Issues in Assessing 

Administrative Feasibility and Costs, Issue Brief No. 203 (Washington, D.C.: Employee Benefit Research Institute, November 

1998); General Accounting Office, Social Security Reform: Administrative Costs for Individual Accounts Depend on System Design, 

GAO/HEHS-99-131 (June 1999); John B. Shoven, ed., Administrative Aspects of Investment-Based Social Security Reform (Chicago 

and London: University of Chicago Press, 2000); and Lawrence E. 

Hart and others, SSA’s Estimates of Administrative Costs Under a 

Centralized System of Private Accounts (Social Security Administration, January 2001).
2 ADMINISTRATIVE COSTS OF PRIVATE ACCOUNTS IN SOCIAL SECURITY

Table 1-1.

Estimated Administrative Costs of Pension Systems

and Their Effect on Assets at Retirement

Source: Congressional Budget Office estimates based on data from the Social Security System, the federal government’s Thrift Savings Plan, 

Pension Dynamics Corporation, the Internal Revenue Service, and the General Accounting Office.

Note: Calculations are for retirees contributing 2 percent of earnings to a retirement account for 40 years.

Evidence from the systems that the Congressional Budget 

Office (CBO) examined, combined with cost estimates 

that other researchers have calculated, suggests that administrative costs in a system of private retirement accounts would likewise vary according to the design of the 

system and the services that it provided—in particular, 

the degree of asset choice permitted and whether assets 

would be purchased centrally or by individuals at the retail level. 

To provide a consistent basis to compare the costs of various systems, CBO estimated how those costs would affect 

balances in a benchmark private account that received 

contributions of 2 percent of earnings (similar to the percentage called for in many proposals). The systems that 

CBO reviewed have administrative costs that, if charged 

to account holders, would reduce account balances at retirement by as little as 2 percent or as much as 30 percent, 

depending largely on the level of service provided (see Table 1-1). 

The size of the account is crucial in determining the percentage impact of administrative costs on account balances. Because large accounts are unlikely to cost much 

more to administer than small accounts, administrative 

costs would affect their balances proportionately less. For 

example, balances in accounts receiving 4 percent of taxable earnings would probably be affected by administrative costs only half as much, in percentage terms, as accounts receiving 2 percent of taxable earnings.

Evidence from existing systems, whose size and mix of 

participants differ from those of a nationwide system of 

private accounts, is of course only suggestive—not predictive—of the actual costs of administering a system of 

private retirement accounts. Forecasting the impact of 

those costs many years into the future, moreover, involves 

even greater uncertainty about their impact on a participant’s retirement income. Retirement accounts would be 

held for several decades, and costs could vary in response 

to factors such as changes in technology and wage rates 

during that time. 

Pension System

Annual

Administrative Cost

Percentage Reduction

in Assets at Retirement

Social Security $11 per participant 2

Federal Thrift Savings Plan $25 per participant 5

Mutual Funds (Average) 1.09 percent of assets 23

Private Defined-Contribution Funds, by Analyst

Pension Dynamics Corporation (Large plan) $24 per account plus 21

0.8 percent of assets 

Pension Dynamics Corporation (Small plan) $60 per account plus 30

1 percent of assets

IRS Form 5500 Tabulation $49 per account 9

General Accounting Office $103 per account 19
2

Administrative Tasks in a Pension System

The administration of any pension system involves a 

number of essential tasks. Identifying those tasks is crucial to any comparison of the costs of different systems. 

The requisite administrative tasks typically consist of the 

collection and processing of contributions; asset management; the calculation and payment of benefits; enforcement and oversight; and, in some cases, marketing and 

sales (see Figure 2-1). Because each system may assign a 

task to a different agency or individual, it is also important to determine who is responsible for performing each 

task. Some proposals would shift the administrative burdens to employers or spread them among different government agencies; a comparison of costs that focused on 

only one level of administration could therefore be misleading. 

Furthermore, any comparison of systems has to acknowledge differences in the level and quality of services. Some 

systems may provide additional value for workers by 

keeping them informed about expected benefits, for example, or by giving them a range of investment choices. 

To the extent that workers desire and are willing to pay 

for those services, participants may be better off even 

though their retirement resources are likely to be reduced. 

Collection and Processing

Any pension system must collect contributions in some 

form. In many systems, those contributions, as well as information that will ultimately determine benefits, must 

then be transmitted to institutions that either invest the 

contributions in some sort of assets (in a funded system 

such as a private pension) or pay them out directly as 

benefits (in a pay-as-you-go system such as Social Security). Theoretically, individuals could be required to 

make their contributions after they received each paycheck. In practice, however, most systems impose the task 

of collection on employers by requiring them to withhold 

the contribution from the paycheck. That arrangement 

has the advantage of reducing noncompliance.

The administrative burden of collecting and processing 

the contributions depends partly on the amount of information that must be gathered under a given system. In a 

simple system, the amount of each worker’s contributions 

is the only information required. However, matters can 

be more complicated—and administrative costs higher—

in a defined-contribution system with multiple investment funds. In that case, the collector must also convey 

the worker’s choice of funds. More frequent collection 

and transmission will also tend to increase costs.

The time required to collect and transmit contributions 

and information may be more important in a definedcontribution system than in a defined-benefit system. In 

a defined-benefit system, errors in transmitted information can be corrected at any time up to (or even after) retirement simply by changing the recorded earnings history. In a defined-contribution system, however, delays 

in transmitting workers’ choices of assets could lead to 

lost returns. If a system suffers from delays in transmission of information about asset choices, administrators 

may have to designate a default investment for contributions that have not been allocated. 

Asset Management

In a funded system, additional costs arise from managing 

retirement assets. If the contributions are invested in a 

mutual fund, for example, some payment must go to the 

fund managers for researching and choosing investments 

and making trades. Management fees depend heavily on 

how actively the fund is managed and the type of assets in 

the fund. More actively managed funds tend to be more 

expensive because the investment manager devotes more 

CHAPTER
4 ADMINISTRATIVE COSTS OF PRIVATE ACCOUNTS IN SOCIAL SECURITY

Figure 2-1.

Administrative Tasks in a Pension System

Source: Congressional Budget Office.

resources to making asset choices, and the fund’s assets 

have higher turnover. By contrast, funds that seek to 

match the assets in a published index of stock values 

(such as the Dow Jones Industrial Average or the S&P 

500) do not require research into particular investments 

and have lower turnover of assets. (Those funds may, 

however, miss investment opportunities.) Funds holding 

assets that require more extensive research, such as international funds, also tend to have higher costs. Note, 

though, that the cost of research tends to be largely 

fixed—additional participants or total assets are likely to 

have little impact on the costs of research.

In a defined-contribution system with a choice of assets, 

recordkeepers must also track contributions, returns, and 

balances for each type of asset, including transfers between asset types. All of that information must be recorded and processed—a task that becomes more costly 

as more asset types are allowed and more frequent contributions and transfers are permitted. A defined-contribution system with a choice of assets could involve multiple 

recordkeepers: if workers can simultaneously invest in 

funds from different providers, records for the same 

worker could be held by several providers.

Calculation and Payment of Benefits

Once workers become eligible to receive their pension, 

the accrued benefits must be calculated and benefit payments initiated. Because retired workers often rely heavily 

on their pension income, speedy calculation and timely 

payment of benefits are considered essential to a wellfunctioning pension system. 

To calculate benefits, some entity must maintain records 

of the variables that affect benefit levels. The complexity 

of the task depends on the design of the system. For example, in a defined-contribution system, benefits are simply based on accumulated wealth. If good records on account balances have been maintained, no further 

calculation is necessary. In a defined-benefit system, the 

benefits are generally determined by a variety of factors, 

including the number of years of contributions and previous earnings. Benefits also may change over time because 

of altered circumstances. In the current Social Security 

system, for example, benefits may change as a result of 

events such as the death of a spouse or reentry into the 

workforce. 

The speed and expense of calculating benefits also depends in part on the quality of recordkeeping. With 
CHAPTER TWO ADMINISTRATIVE TASKS IN A PENSION SYSTEM 5

timely, high-quality records, initial benefits can be determined quickly and without much additional cost. However, if records are poorly kept and information is lost, 

applying benefit formulas may require a costly cleanup of 

records. This process can also be time-consuming. Furthermore, the information required to calculate benefits 

may not be recorded immediately, causing further delays.

Additional costs may arise in a defined-contribution plan 

if the accumulated wealth is converted into an annuity—

a stream of payments lasting for the life of the recipient.1

To achieve the same protection against outliving resources that is offered by Social Security, workers in a defined-contribution system would have to purchase an inflation-indexed annuity with their retirement savings. 

However, purchase of an annuity can decrease retirement 

income in two ways. First, the firms offering the annuities generate their own administrative costs, including 

for marketing and sales. Second, if the system allows people to choose freely whether to purchase the annuities, 

their price will increase. In a phenomenon known as adverse selection, people who expect to have a long life span 

are more likely to purchase annuities than people without 

such expectations. As a result, annuities cost more than 

they would if all purchasers had average life expectancy. 

That increased cost prevents some people from purchasing annuities that they would otherwise want to buy if 

the annuities were priced on the basis of average life expectancy. Adverse selection does not occur, however, if all 

participants are required to annuitize their account balances.

Enforcement and Oversight

Some resources must also be spent on monitoring and 

enforcing a pension system to prevent improper activities, 

such as the misuse of contributions. Enforcement costs 

depend largely on the structure of the pension system. As 

indicated earlier, enforcement in a system in which the 

employer withholds contributions from paychecks is 

likely to be much less costly and intrusive than in a system in which the individual worker must make the contributions. To the extent that account contributions 

flowed through the existing system of employer withholding, there would be little or no additional cost for enforcement or oversight.

In addition, enforcement may be less costly with more 

centralized recordkeeping. In today’s defined-benefit Social Security system, a single recordkeeping agency maintains earnings records. That makes it easier to compare 

those records with tax data or employers’ accounts. (The 

Social Security Administration and the Internal Revenue 

Service share responsibility for enforcement in the current system.) A defined-contribution system with multiple investment choices could have many recordkeepers, 

making it more difficult to track the flow of payments. 

In a funded system, government oversight is necessary to 

avoid pension fraud and underfunding regardless of 

whether the pension is a defined-benefit or a definedcontribution plan. In a fully funded defined-benefit system, the assets of the pension fund are projected to meet 

its liabilities from an actuarial perspective.2

 In a definedcontribution system, government oversight must ensure 

that records for each contributor are properly kept, that 

assets are actually invested on a worker’s behalf, and that 

the investments conform to any government restrictions.

Additional costs may arise from establishing and enforcing other regulations governing the system. For example, 

in a decentralized system, financial firms providing investment services might be required to disclose their costs 

in a certain way and to refrain from fraudulent claims. 

Marketing and Sales

If a pension system relies on a worker’s choice of pension 

funds and annuity companies, additional costs arise because the companies must communicate and sell their 

products to customers. Those costs include advertising 

expenses as well as sales commissions. Though marketing 

and sales carry a cost, they can be a service to investors to 

the extent that they convey useful information.

1. For a discussion of market imperfections and the regulatory issues 

involved in the annuitization of retirement savings, see Congressional Budget Office, Social Security Privatization and the Annuities Market (February 1998).

2. In the United States, employer-sponsored defined-benefit plans 

are subject to the requirements of the 1974 Employee Retirement 

Income Security Act (ERISA). ERISA regulations regarding contributions help reduce the risk that plans will fall short of full 

funding. In addition, defined-benefit plans are insured by the 

Pension Benefit Guaranty Corporation, which was established to 

provide benefits for workers whose pension plan failed.

3

Administrative Costs in Existing Systems

The United States has extensive experience administering different types of pension systems, including Social 

Security, employer-sponsored pension plans (including 

those of the federal government), and individual retirement accounts. The costs of those systems differ in part 

because they provide different levels of services and, to 

some degree, involve different sets of administrative tasks. 

For example, the Social Security system has relatively low 

administrative costs and does not incur transaction costs 

from investing in private assets, but it offers relatively few 

services compared with other systems. 

In an effort to provide a sense of potential administrative 

costs of private accounts with various design characteristics, this chapter reviews the administrative costs of four 

different systems—Social Security, the Thrift Savings 

Plan (TSP) for federal government employees, mutual 

funds, and private defined-contribution plans. The costs 

are presented on a consistent basis to facilitate comparison (see Box 3-1 for an explanation of the Congressional 

Budget Office’s methodology). Private accounts with 

characteristics similar to those of lower-cost systems are 

likely to have relatively lower costs, whereas accounts 

with characteristics similar to those of higher-cost systems 

are likely to have higher costs. 

It is important to note that these examples provide evidence on costs at a specific point in time. The future path 

of costs is uncertain. Falling prices for computers and 

software might contribute to lower costs. At present, 

most administrative costs go to pay wages for people who 

perform tasks such as entering and checking data, rather 

than for electronic equipment. For example, almost 

three-fourths of the administrative costs of the Social Security Administration in 2003 (excluding payments to 

state agencies) went to pay salaries and benefits. However, 

technological changes that allow advances in administrative processes, such as submission of records via the Internet rather than on paper, could reduce costs substantially. 

Because the future path of costs is uncertain, this analysis 

focuses on current costs.1

Social Security

Social Security—the federal government’s largest entitlement program—provides retirement, survivor, and disability benefits. It covers almost all workers in the United 

States.2 In 2002, about 153 million workers (including 

the self-employed) were covered by Social Security. More 

than 46 million individuals received payments from the 

Old Age and Survivors Insurance (OASI) and Disability 

Insurance (DI) trust funds in the form of retirement income, spousal and family benefits, survivor benefits, and 

disability benefits.3

Social Security is a defined-benefit system, with benefits 

calculated using a formula based largely on previous qualified earnings. That implies that beneficiaries have no 

choice of different types of assets within the system; the 

CHAPTER

1. Historical evidence on the evolution of costs is mixed. For example, since 1990, administrative costs per participant in Social 

Security’s Old Age and Survivors Insurance program have grown 

about 1.3 percent per year, less than the average rate of inflation. 

During the same period, costs per participant in the Thrift Savings Plan have grown by 6.4 percent per year. The TSP increased 

the level of services it provides during that time, however. 

2. A few categories of workers, including federal civilian workers 

under the old Civil Service Retirement System and some state and 

local employees, are not covered by Social Security.

3. Social Security Administration, 2003 Annual Report of the Board of 

Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds (March 17, 2003), p. 2, available at 

www.ssa.gov/OACT/TR/TR03.
8 ADMINISTRATIVE COSTS OF PRIVATE ACCOUNTS IN SOCIAL SECURITY

Box 3-1.

CBO’s Methodology for Comparing Administrative Costs

The costs of administering pension systems are measured in a variety of ways: per participant, per dollar 

of contributions, or per dollar of assets, among other 

methods. To provide a consistent basis for comparing the administrative costs of different pension systems, the Congressional Budget Office (CBO) estimates their impact as a percentage of the assets in a 

worker’s account at retirement. Specifically, CBO 

calculates the effect of those costs on the account balance of a retiring worker who has earned average income and contributed 2 percent of his or her taxable 

earnings to the account (about the level of contributions called for in many proposals). The average taxable earnings of covered workers in 2001 were 

$27,350, so a 2 percent account would receive contributions averaging about $547 per year.1

The size of the account is crucial in determining the 

percentage impact of administrative costs on account 

balances. Because large accounts are unlikely to cost 

much more to administer than small accounts, administrative costs would affect their balances proportionately less. For example, balances in accounts receiving 4 percent of taxable earnings would probably 

be affected by administrative costs only half as much, 

in percentage terms, as accounts receiving 2 percent 

of taxable earnings. 

In the case of Social Security, where no explicit administrative costs are charged to participants, CBO 

divides estimated total annual administrative costs 

by the number of participants to determine the cost 

per account. CBO then divides that cost by 2 percent of the average taxable payroll to establish the 

percentage effect on an account receiving 2 percent 

of earnings. Assuming that percentage remains constant over time, retirement assets will be affected by 

the same percentage. 

Some other types of accounts, such as mutual funds, 

carry explicit charges, often calculated at least in part 

as a percentage of assets. In those cases, the effect on 

account balances is calculated by applying the percentage of assets charged annually to a simulated account.2

Most administrative costs are incurred on a peraccount basis, but the cost to participants need not 

be distributed that way. If all accounts were charged 

the same flat fee, administrative costs would reduce 

the returns on small accounts by more than they 

would on large accounts. For that reason, policymakers may wish to restrict fees to a flat percentage of either contributions or accumulated assets. Of course, 

such a restriction would imply that small accounts 

would be charged less than the costs they generated, 

and large accounts charged more. In a system in 

which workers had wide latitude to choose among financial firms, that could lead firms to compete for 

the large accounts held by high-earners by offering 

better service or other inducements.

1. Social Security Administration, Annual Statistical Supplement, 2002 (December 2002), Table 4.B1, p. 153. Taxable 

earnings do not include earnings above the cap on payroll 

taxes ($87,000 in 2003). The account of a worker with average (mean) earnings is used in this calculation because if 

total administrative costs are distributed in proportion to 

contributions, the percentage effect of costs on the balances 

in that account will be the same as the effect on all other 

accounts.

2. In simulating the growth of account balances, CBO makes 

the following assumptions: a constant portion of wages is 

contributed over a continuous working life of 40 years, real 

wages grow at 1 percent per year, and the assets in an 

account earn a real rate of return of 5 percent in each year. 

Under those assumptions, for example, an annual charge of 

1 percent of assets reduces balances at retirement by about 

20 percent. The calculation is not highly sensitive to the rate 

of return or wage growth, but it is sensitive to the length of 

working life and the continuity of work. A longer working 

life increases the impact of a given percentage-of-assets 

charge (because there are more years of charges when 

account balances are large). Interruptions in the working life 

also increase the impact of a given percentage-of-assets 

charge compared with the same number of years of work 

with no interruptions. 
CHAPTER THREE ADMINISTRATIVE COSTS IN EXISTING SYSTEMS 9

only “asset” that participants hold is the promise of future 

benefits. That restriction simplifies administration. 

Proper calculation of the initial benefit requires the 

worker’s entire earnings history, aggregate wage growth 

over that period, and (in some cases) the earnings records 

of a current or former spouse. Given that information, it 

is relatively easy to compute the initial benefit. Benefits 

are adjusted for inflation each year thereafter.

Social Security benefits are financed mostly by taxes on 

current workers—that is, on a pay-as-you-go basis—

rather than by assets and returns from past contributions. 

The level of contributions is fixed at a total of 12.4 percent for most people, with 6.2 percent coming from the 

employee and 6.2 percent from the employer (the selfemployed pay the full amount). The absence of a choice 

of contribution level also simplifies administration. 

In 2002, the OASI trust fund received income of $468.1 

billion from payroll taxes (net of refunds) and the taxation of Social Security benefits, and $71.2 billion from 

interest on assets. In the same year, the trust fund made 

benefit payments of $388.1 billion and spent $2.1 billion 

on administration.4

The different administrative tasks of the Social Security 

system are performed by employers, the Internal Revenue 

Service (IRS), the Treasury’s Financial Management Service (FMS), and the Social Security Administration 

(SSA). 

Employers’ Responsibilities. Employers bear the burden 

of the collection costs. They collect payroll taxes from 

employees and transfer them to the IRS together with 

other withheld income taxes. Most employers with 

$50,000 or less in total income and payroll tax payments 

during a four-quarter look-back period must deposit the 

taxes withheld from wages within a month after the 

wages are paid. Employers with more than $50,000 in tax 

payments during that period must deposit their taxes 

semiweekly. Any employer who accrues a total liability of 

$100,000 in one day must deposit all withheld taxes by 

the following day. The deposits can be made either at a 

Federal Reserve Bank branch or at a financial institution 

that is authorized by the IRS. The IRS determines the tax 

payments for the trust funds from the information provided by employers on Form 941. Moreover, tax payments on Social Security benefits are transferred to the 

trust funds according to the information on individual 

tax returns. 

Employers are also responsible for transmitting substantial amounts of information to the SSA and the IRS. Employers must report the wages subject to Social Security 

taxes annually to the SSA. The SSA receives a copy of 

each W-2 form that is issued to employees for tax-filing 

purposes at the beginning of the year, detailing earnings 

and payroll taxes withheld during the previous calendar 

year. Moreover, employers must file form W-3, which 

summarizes aggregate tax withholdings, with the SSA. 

The IRS receives similar aggregate tax information from 

employers each quarter on Form 941. 

The self-employed do not file their earnings reports directly with the SSA. Instead, they calculate and report 

their Social Security tax (also called a self-employment 

tax) on schedule SE of the income tax return. After processing the tax form, the IRS furnishes the information 

about taxable earnings of the self-employed to the SSA.

SSA’s Responsibilities. The SSA’s first administrative task 

is to keep accurate earnings data. For that purpose, the 

SSA must issue Social Security numbers (SSNs) to all 

workers. Workers can apply for those numbers at one of 

the field offices that the SSA maintains. After processing 

the personal data, the SSA issues a Social Security card 

and stores the worker’s data. 

The SSA processes, stores, and verifies earnings records. 

Each year, the information contained on all W-2 and

W-3 forms is transferred to electronic records. The SSNs 

and names that are provided on the W-2 forms are 

checked against an SSA master file of all people with 

SSNs. When SSNs and names do not match the master 

file, the SSA contacts employers and employees. In some 

cases, the problem can be rectified, and the earnings 

records can be posted correctly. However, about 9 million 

of the approximately 250 million earnings records that 

the SSA processes each year cannot be reconciled with the 

master file.5

In addition, the earnings data that the SSA collects are 

compared to quarterly tax data from the IRS. When the 

figures do not match, the SSA and IRS share responsibil- 4. Social Security Administration, 2003 Annual Report of the Board of 

Trustees, p. 4. This analysis concentrates on the OASI program 

because the DI system faces costs of determining disability, which 

would not be present in a system of private retirement accounts.

5. Social Security Administration, Performance and Accountability 

Report for Fiscal Year 2003 (November 2003), p. 23.
10 ADMINISTRATIVE COSTS OF PRIVATE ACCOUNTS IN SOCIAL SECURITY

ity for contacting employers and obtaining consistent information.6

 Together, the two agencies contact almost a 

million employers each year.

The SSA posts earnings records with some delay after the 

end of the tax year. Not including the self-employed, in 

fiscal year 1999, 84 percent of earnings records were 

posted within the six months of the close of the tax year, 

and 95 percent were posted within nine months. Because 

the SSA must retrieve the Social Security earnings of the 

self-employed from income tax returns, only 93 percent 

of earnings of the self-employed are posted within nine 

months.7 The use of electronic filing may increase over 

time, particularly if opportunities for Internet filing increase. However, many small employers are likely to continue to file on paper in the foreseeable future. 

The SSA’s second major task is to determine an applicant’s eligibility for benefits, calculate the amount of benefits to be paid, and initiate payments. People may be eligible for benefits for several reasons. Those who worked 

in covered jobs for at least 10 years can apply for retirement benefits as early as age 62. People with sufficiently 

low earnings histories may qualify for spousal benefits 

based on their spouse’s primary insurance amount if their 

current or former spouse is an eligible retiree. Survivors of 

insured workers are also eligible to receive payments. 

Moreover, people who are unable to continue working 

because of severe impairments may receive disability benefits. Determining eligibility, therefore, can require 

checking the insurance status and age of an applicant, his 

or her marital status, the relationship to a deceased insured worker, and the gravity of a disability. 

After eligibility has been established, the SSA calculates 

benefits and initiates the payments. The SSA supervises 

those payments, but the Treasury issues the Social Security checks through its Financial Management Service. 

The SSA also must maintain current addresses for beneficiaries and assist participants with questions. Because 

tasks such as processing claims, determining eligibility, 

maintaining rolls of beneficiaries, and answering phone 

calls tend to be labor-intensive, those beneficiary services 

account for the bulk of the administrative costs in the Social Security system.

The IRS enforces Social Security payroll tax payments 

and the SSA monitors continuing eligibility for benefits. 

If an employer fails to withhold payroll taxes or does not 

pay the tax bills, or if a self-employed individual does not 

pay self-employment taxes, the IRS is responsible for collecting those taxes.8 The SSA also recalculates benefit levels. For example, additional earnings after retirement may 

affect benefits.

Unlike products that are purchased at the retail level—

mutual funds, for example—Social Security does not incur marketing or sales costs but still faces a substantial 

burden of serving workers and beneficiaries. Although 

the SSA does not need to sell its product to workers and 

beneficiaries, it assists workers and beneficiaries with their 

questions through its field offices and toll-free numbers. 

In 2002, the SSA’s toll-free service responded to 51 million calls.9 Each year, SSA sends statements summarizing 

lifetime earnings and projected benefits to covered workers over age 25 who file income tax returns. Restricting 

calculation of those statements to once a year reduces 

costs relative to products such as mutual funds, which 

generally update balances daily. 

The SSA faces only small costs for asset management because of the simplicity of its investments and the relatively low level of assets held. Because the trust funds are 

restricted to invest in special government securities, asset 

management consists mostly of recording the number of 

securities owned by the trust funds, their maturity, and 

the interest earned. In addition, because the system is 

largely operated on a pay-as-you-go basis, the assets of 

about $1.4 trillion held by the trust funds at the end of 

fiscal year 2002 are small compared with future benefit 

obligations under current law. 

6. The SSA is responsible for contacting employers when tax returns 

received by the IRS show higher total wages than do earnings 

reports received by SSA; the IRS has responsibility when tax 

returns show lower wages.

7. Social Security Administration, Performance and Accountability 

Report for Fiscal Year 1999 (November 1999), p. 81.

8. Among self-employed workers, the self-employment tax is subject 

to substantial evasion because some individuals reclassify their 

income on their tax returns. See Joyce Manchester, “Compliance 

in Social Security Systems Around the World,” in Olivia S. Mitchell, Robert J. Myers, and Howard Young, eds., Prospects for Social 

Security Reform (Philadelphia: University of Pennsylvania Press, 

1999), pp. 295-312. The gains to people who evade payroll taxes 

by failing to declare earnings are partially offset because they ultimately receive lower benefits.

9. Social Security Administration, Performance and Accountability 

Report for Fiscal Year 2002 (November 2002), p. 27. 
CHAPTER THREE ADMINISTRATIVE COSTS IN EXISTING SYSTEMS 11

Governmental Administrative Costs. Data on administrative costs in Social Security are available, but they can be 

difficult to interpret. The SSA can explicitly calculate its 

total administrative costs. However, although the SSA attempts to divide those costs between OASI and DI, the 

retirement and disability portions of Social Security, 

many costs contribute to more than one portion, making 

the allocation difficult. 

Similarly, although the Treasury charges the trust funds 

for services performed by the IRS and the FMS (net of 

some services the SSA provides to the Treasury), it is difficult to separate the cost of the different administrative 

services of the SSA, IRS, and FMS. For example, the IRS 

incurs administrative costs in processing both income tax 

and payroll tax payments that often arrive simultaneously. 

There is no clear way, even in theory, to separate the costs 

of processing the two types of taxes. In addition, the reported costs may be understated if the agencies do not 

pay the full economic cost of their activities—for example, if they do not properly account for the cost of using 

government-owned buildings.

The reported governmental administrative costs of the 

OASI system in 2002 were less than $11 per participant 

(that is, workers plus beneficiaries) in the system.10 One 

must be cautious in interpreting the implications of that 

cost for a system of private retirement accounts for several 

reasons. On the one hand, a system of accounts based on 

SSA procedures would not necessarily need to duplicate 

the entire administrative structure of the SSA, but it 

could instead take advantage of the existing structure. On 

the other hand, the SSA does not perform some roles that 

might be required in a system of accounts, such as investing in a mix of assets or crediting returns to individual 

workers. Nevertheless, the $11 charge represents about 2 

percent of the average contribution under a system of private accounts with contributions of 2 percent of payroll 

($547 in 2001); assuming that percentage remained constant over time, the costs would reduce assets in an account at retirement by an identical 2 percent.11

The administrative costs discussed above do not include 

the burden on the private sector. Costs to firms and individuals in the form of time and increased paperwork are 

probably substantial. However, it is difficult to assess the 

administrative burden for employers in dollar values because those costs depend on the individual circumstances 

of each employer (for example, their use of electronic reporting and the size of their workforce). Furthermore, it 

is difficult to separate the cost to employers of processing 

payroll tax contributions from other costs, such as remitting income taxes withheld from employees. For those 

reasons, this analysis makes no attempt to estimate the 

administrative burden on the private sector. Evidence 

about the operation of labor markets indicates that workers are likely to bear most of that burden in the long run. 

The Thrift Savings Plan

The TSP is a defined-contribution plan available to 

workers in the federal government. Like Social Security, 

the TSP is a large-scale, centrally organized system. It offers some choice in assets and contribution levels, however, and in that respect is similar to private account 

plans. Services are intentionally limited to hold down administrative costs. No toll-free number is maintained for 

inquiries, for example. Unlike actively managed funds, 

TSP limits investment choice to a few funds that track financial market indices. 

As of December 31, 2002, 3 million employees participated in the TSP, and the amount in all TSP accounts totaled more than $102 billion.12 Workers under the Federal Employees Retirement System may contribute up to 

14 percent of their wages (subject to a cap of $13,000 in 

2004) to the TSP. The employing agency contributes 1 

percent of wages and matches all employee contributions 

up to 3 percent of wages, and half of contributions be10. That calculation is based on administrative costs of $2.1 billion, 

divided by 153 million workers plus 46 million beneficiaries in 

the OASDI system (Social Security Administration, 2003 Annual 

Report of the Board of Trustees, pp. 2, 4) minus 6.9 million beneficiaries under DI (Social Security Administration, Annual Statistical Supplement, 2002, Table 5.A1, p. 170). Costs including 

administration of the Disability Insurance program are substantially higher because of the more complicated tasks related to verifying disability claims; however, private accounts are unlikely to 

require such costly tasks.

11. The assumption that costs will remain a constant percentage of 

contributions amounts to an assumption that costs will rise at the 

same rate as average taxable earnings. A reasonable alternative 

would be to assume that costs will rise only with inflation rather 

than with earnings. However, using that assumption does not substantially affect the results—the estimated effect on balances at 

retirement still rounds to 2 percent.

12. Ernst & Young, Financial Statements of the Thrift Savings Fund—

2002 and 2001 (McLean, Va: Ernst & Young, March 2003), available at www.tsp.gov/forms/financial-stmt.pdf.
12 ADMINISTRATIVE COSTS OF PRIVATE ACCOUNTS IN SOCIAL SECURITY

tween 3 percent and 5 percent of wages. (Employees under the older Civil Service Retirement System receive no 

matching contributions.) 

Workers can allocate their contributions among five investment funds: an equity fund that seeks to match the 

S&P 500 stock index (the C fund); an equity fund that 

seeks to match the Wilshire 4500 index of small-capitalization corporations (the S fund); an equity fund that 

seeks to match the EAFE index of 21 stock markets in 

foreign countries (the I fund); a bond fund that seeks to 

match the returns of a broad index of government and 

private fixed-income securities (the F fund); and a fund 

composed of nonmarketable government securities that 

pay the average market rate of return on marketable U.S. 

Treasury securities with four or more years to maturity 

(the G fund). 

TSP contributions and the returns on TSP assets are not 

taxable; however, withdrawals from TSP accounts are 

taxed as regular income. Funds can be withdrawn as a 

lump sum or in a series of monthly payments; alternatively, they can be used to purchase an annuity. 

The task of collecting and processing contributions is 

split between the agency employing a worker and the 

Federal Retirement Thrift Investment Board (FRTIB), 

which oversees the plan. The Department of Agriculture’s 

National Finance Center (NFC), under contract with the 

FRTIB, keeps the records of all TSP accounts. The personnel department in the employing agency reports the 

employer’s and employee’s contributions to the NFC. 

The NFC records the contributions and their returns. In 

addition, the FRTIB provides annual updates on the status of TSP accounts and information about investment 

strategy. The equity and bond index funds are managed 

by a financial firm. The management fee and the other 

administrative costs not borne by the employing agencies 

are paid out of the earnings on accounts and account balances that are forfeited to the TSP when employees leave 

federal service before they are vested.13

In addition to their role in collection and processing, the 

employing agencies have primary responsibility for employee education. The TSP Web site advises employees, 

“While you are employed, your agency is your primary 

TSP contact.”14 All the costs incurred by the employing 

agency are paid by that agency. Much like employers’ 

costs of administering Social Security, those costs are difficult, if not impossible, to measure and are not included 

in published measures of the TSP’s administrative costs. 

Reported administrative and investment costs of the TSP 

totaled about $75 million in 2002 (excluding costs to the 

employing agencies). That translates to about $25 per 

participant.15 Most of those costs represent payments to 

the NFC for recordkeeping.16 The administrative costs of 

the TSP are held in check by several factors: investment 

choices are restricted; the system is quite large, and investments are bundled and made centrally; and all covered workers operate under the same payroll system, 

which simplifies recordkeeping. In addition, all records 

provided by the employing agencies are in electronic 

form. An annual cost of $25 would reduce the assets in 

an account receiving 2 percent of earnings by about 5 

percent at retirement. However, the administrative costs 

of a universal system that offered the same services as the 

TSP could be higher because a different set of employers 

and employees would be covered. For example, many employers provide Social Security with paper earnings 

records, which are more costly to process than electronic 

records.

Mutual Funds

Mutual funds are collections of assets, chosen and managed by professionals. Individuals can purchase shares in 

mutual funds directly or through employer-sponsored retirement plans. The value of the shares rises and falls with 

the value of the assets in the mutual fund, minus administrative fees. Assets invested in mutual funds totaled over 

$6.4 trillion in 2002.17

In addition to enabling individuals to invest easily in a diversified portfolio of assets, mutual funds tend to offer a 

wide range of services. According to the Investment 

13. Only the “agency automatic contribution” of 1 percent of pay, 

which is made by the employing agency, and the earnings on that 

contribution are ever forfeited. Employees are vested after two or 

three years, depending on the employing agency.

14. See www.tsp.gov/features/chapter01.html#sub3.

15. Ernst & Young, Financial Statements of the Thrift Savings Fund—

2002 and 2001.

16. Ibid. The NFC is a government agency. Therefore, as is the case 

with Social Security’s payments to the Treasury Department, it is 

not clear how closely the TSP’s payments to the NFC correspond 

to true costs. 

17. Investment Company Institute, 2003 Mutual Fund Fact Book 

(Washington, D.C.: ICI, May 2003), p. 7.
CHAPTER THREE ADMINISTRATIVE COSTS IN EXISTING SYSTEMS 13

Company Institute, an industry group, those services include “toll-free telephone service, 24-hour telephone access to account information and transaction processing, 

consolidated account statements, shareholder cost basis 

(tax) information, exchanges between funds, automatic 

investments, checkwriting privileges on money market 

and some bond funds, automatic reinvestment of fund 

dividends, and automatic withdrawals. Mutual funds also 

provide extensive investor education and other shareholder communications, including newsletters, brochures, retirement and other planning guides, and websites.”18

Those services, together with marketing costs associated 

with sales at the retail level, tend to have higher administrative costs than those of lower-service systems such as 

Social Security. The administrative costs of mutual funds 

may therefore provide a guide to possible costs in a decentralized system of private accounts with an extensive 

choice of assets and a high level of services, perhaps modeled after individual retirement accounts (IRAs).19 In 

that type of system, individuals make contributions, and 

financial management firms record and manage the accounts.

Analyzing mutual fund fees is complicated by the fact 

that they come in two varieties: shareholder fees and operating expenses. Shareholder fees, or loads, are primarily 

one-time fees paid when shares are purchased, sold, or 

shifted from one fund to another. Those fees generally finance commissions for investment advisers or salesmen. 

Shareholder fees may not exceed 8.5 percent by law, but 

few funds charge the maximum, and no-load funds levy 

no shareholder fee at all. Operating expenses are used to 

pay for the costs of running a fund and are generally 

charged as a percentage of the balance in an account. 

Averages of the fees in each category are not available, but 

analysts at the Investment Company Institute have converted all fees to a single annual percentage-of-assets 

charge for purposes of comparison. According to those 

calculations, the dollar-weighted average annual fee on 

retail equity mutual funds was 1.28 percent of account 

balances in 2001; the average fee on bond mutual funds 

was 0.90 percent; and the average fee on money market 

mutual funds was 0.36 percent.20 (The dollar-weighted 

measure accounts for the fact that less-expensive funds 

constitute a larger percentage of total investments.) 

Asset allocation in IRAs, 401(k) plans, and similar retirement accounts suggests how assets in private retirement 

accounts might be divided among the different types of 

mutual funds. In 2002, retirement assets invested 

through mutual funds included $1,334 billion in equity 

mutual funds, $288 billion in bond funds, and $283 billion in money market funds.21 Weighting the average fees 

on each type of mutual fund by those amounts yields an 

estimated average fee of 1.09 percent of assets per year. 

Because balances grow over time and the fee is charged 

against the total balance each year, a percentage-of-assets 

charge can have a surprisingly large effect on assets at retirement. Under moderate assumptions, a 1.09 percent 

annual fee would reduce assets at retirement by roughly 

23 percent for an account held over an entire working 

life. A General Accounting Office survey of expense ratios 

found lower fees—0.70 percent of account balances for 

equity funds and 0.54 percent for bond funds—than the 

Investment Company Institute calculated (1.28 and 0.90, 

respectively), but GAO’s estimates explicitly exclude 

shareholder fees.22

Overall industry averages mask significant differences in 

the average fees for various types of funds. Fees tend to be 

higher for funds that require more research. For example, 

the Investment Company Institute calculates that the average asset-weighted operating expense (not including 

shareholder fees) was 1 percent for international funds 

18. Ibid., p. 14.

19. Such a system would include additional costs for monitoring, 

enforcement, and education, among other things.

20. John D. Rea, Brian K. Reid, and Travis Lee, Total Shareholder Cost 

of Mutual Funds: An Update (Washington, D.C.: Investment 

Company Institute, September 2002). In that study, the loads 

were translated into annual charges based on the average holding 

period for mutual funds. If private accounts were held longer than 

the average mutual fund, the annual cost would be somewhat 

lower. The holding period would be likely to depend partly on 

regulation—if workers were allowed to switch assets between 

funds at will, the holding period would probably be similar to the 

current average. If switching was not allowed, the holding period 

would be significantly longer. In that case, however, charges would 

probably increase in the long run to make up for the revenue lost 

because of reduced turnover.

21. Investment Company Institute, 2003 Mutual Fund Fact Book,

p. 56. An additional $209 billion was held in hybrid funds containing both bonds and equities, but estimates of shareholder costs 

for those funds are not available. 

22. General Accounting Office, Mutual Funds: Information on Trends 

in Fees and Their Related Disclosure, GAO-03-551T (March 12, 

2003), p. 7.
14 ADMINISTRATIVE COSTS OF PRIVATE ACCOUNTS IN SOCIAL SECURITY

but only half that amount for growth and income 

funds.23

Private Defined-Contribution Plans 

Defined-contribution pension plans are employersponsored retirement accounts. They tend to offer services similar to those provided by mutual funds; indeed, 

most plans include at least some mutual funds among a 

limited menu of asset choices. Their administrative costs 

can be higher or lower than those of mutual funds. Some 

defined-contribution plans have an extra layer of recordkeeping and collection costs on top of normal fees for retail mutual funds. However, larger plans may be able to 

negotiate discounted fees or bypass mutual funds by contracting directly for investment services. 

One method of surveying administrative costs in definedcontribution plans is to solicit bids for hypothetical plans 

from firms that administer employer-sponsored pension 

plans. A survey by Pension Dynamics Corporation for 

Money magazine found that average fees for a large plan 

with 4,000 participants and $20 million in assets consisted of an administrative charge of $24 per participant 

and an investment fee of 0.8 percent of assets.24 Those 

fees would reduce account balances by about 21 percent 

in a 2 percent-of-earnings system. Fees for a smaller plan, 

with 100 participants and $2 million in assets, were considerably higher on average: an administrative charge of 

about $60 per participant, and an investment fee of 1 

percent of assets. Those fees would reduce account balances at retirement by about 30 percent. 

One criticism of the survey method is that pension providers are unlikely to reveal their best price at an early 

stage of negotiations. Employers who actually hire pension providers may get discounts. Also, it is unclear what 

assumptions the providers make about the likely length of 

the contract and the future path of assets in pricing their 

plans. 

Government data on pension plan costs avoid that problem, but they have other flaws. Some data on definedcontribution plan costs are included on Form 5500 and 

Form 5500 C/R, documents that all employers with pension plans must file with the IRS. The data from Form 

5500 have significant shortcomings, however. First, the 

costs do not include financial management fees deducted 

from workers’ accounts, which are often the largest category of fees. Second, firms may not always accurately separate the cost of pension administration from that of 

other administrative tasks; Form 5500 only details expenses explicitly charged to the plan, not those paid by 

the employer. For example, if a firm already has a personnel department with full-time employees, equipment, 

and office space, what portion of those costs should be ascribed to administering the pension plan? Third, published data on Form 5500 combine plans with very different features, making it difficult to interpret the 

implications of average costs for private plans with specific features. Finally, Form 5500 does not include the 

costs to the government agencies providing oversight and 

enforcement.

Tabulations of data from Form 5500 for 1998 show that 

defined-contribution plans reported spending an average 

of $49 per participant on administrative costs covered by 

the form.25 That cost would reduce the balances in a 2 

percent-of-payroll plan at retirement by about 9 percent. 

However, the average of $49 includes many plans that report no expenses—a finding that raises questions about 

the reliability of the data. The General Accounting Office 

used the same data source but excluded plans reporting 

zero costs. It found an average reported administrative 

cost of $103 per participant in 1993.26 That cost would 

reduce the balances in a 2 percent-of-payroll account by 

about 19 percent. The actual impact would be greater, 

however, because the accounts would also be subject to 

investment fees, which are not included in the Form 

5500 reports. Nonetheless, the evidence suggests that the 

results of the private surveys discussed earlier are unlikely 

to overestimate average costs.

Annuities

Investors in mutual funds and many private definedcontribution plans have a pool of assets at retirement. If 

they finance retirement expenses by withdrawing money 

23. Investment Company Institute, The Cost of Buying and Owning 

Mutual Funds (Washington, D.C.: ICI, February 2004), p. 21.

24. Penelope Wang, “Protect Yourself Against the Great Retirement 

Rip-Off,” Money (April 1997), pp. 96-101.

25. Department of Labor, Pension and Welfare Benefits Administration, Private Pension Plan Bulletin: Abstract of 1998 Form 5500 

Annual Reports (Winter 2001-2002).

26. General Accounting Office, Private Pensions: Most Employers That 

Offer Pensions Use Defined-Contribution Plans, GAO/GGD-97-1 

(October 1996).
CHAPTER THREE ADMINISTRATIVE COSTS IN EXISTING SYSTEMS 15

from that pool, they run the risk of running out of 

money before they die. For that reason, retirees may wish 

to convert some or all of their assets into a life annuity, a 

stream of payments that is guaranteed for the lifetime of 

the recipient (and, in the case of a joint life annuity, the 

recipient’s spouse). Some proposals for retirement accounts would make conversion to annuities a requirement. 

Annuities cost more than the value of the stream of payments they provide because financial firms must cover administrative costs, including marketing and sales. In addition, if the system allows people to choose whether to 

purchase them, the price of annuities will increase as a result of adverse selection: because longer-lived people are 

more likely to purchase annuities, the annuities cost more 

than they would if all purchasers had average life expectancy. That increased cost prevents some people from purchasing annuities even though they would choose to buy 

them if the price of the annuities was based on average 

life expectancy. 

The impact of those factors is substantial. For a 65-yearold with average life expectancy, private annuities currently pay out about 15 percent to 20 percent less than 

they would if there were no administrative costs or adverse selection.27 A person with average life expectancy 

who wishes to annuitize the balance in a mutual fund, for 

example, faces an additional burden of 15 percent to 20 

percent on top of the costs paid to maintain the account 

up to that point. Of that amount, between 7 percentage 

points and 9 percentage points represent administrative 

costs, with the remainder resulting from adverse selection 

(which would not occur if annuitization was mandatory).28

The impact on payouts could be lower still if the annuities were purchased on a group basis through a central 

clearinghouse. For example, annuities purchased by 65-

year-olds through the Thrift Savings Plan cost about 4 

percent to 6 percent less than those purchased by men on 

the open market and 12 percent to 13 percent less than 

those purchased by women.29 (Unlike most privately 

marketed annuities, the TSP annuities are offered at one 

price to both men and women. Because women live 

longer than men on average, annuities cost more for 

women when different prices are charged to men and 

women). 

TSP annuities are voluntary, however, and therefore still 

subject to adverse selection. If the purchase of the annuities was mandatory, costs would be even lower. The evidence from the TSP suggests that if they were purchased 

through large groups, mandatory annuities could cost at 

least 4 percent to 6 percent less than they would if purchased individually. Consequently, although administrative costs might reduce the payout of individually purchased mandatory annuities by 7 percent to 9 percent of 

assets, group purchase could lower that reduction to 1 

percent to 5 percent of assets. 27. See James M. Poterba and Mark J. Warshawsky, “The Costs of 

Annuitizing Retirement Payouts from Individual Accounts,” in 

John B. Shoven, ed., Administrative Aspects of Investment-Based 

Social Security Reform (Chicago and London: University of Chicago Press, 2000); Olivia Mitchell and others, “New Evidence on 

the Money’s Worth of Life Annuities,” American Economic Review, 

vol. 89, no. 5 (December 1999), pp. 1299-1318; and Congressional Budget Office, Social Security Privatization and the Annuities Market (February 1998). 

28. Mitchell and others, “New Evidence on the Money’s Worth of 

Life Annuities,” Table 3.

29. Poterba and Warshawsky, “The Costs of Annuitizing Retirement 

Payouts from Individual Accounts,” Tables 5.1 and 5.4,

pp. 177, 188.

4

The Administrative Costs of a Personal Account 

System: Identifying the Trade-Offs

The evidence on administrative costs presented in 

this study can be used to illustrate some of the basic 

trade-offs in designing a system of personal accounts. The 

way a personal account system accomplished each administrative task—collection and processing of contributions, 

asset management, calculation and payment of benefits, 

and enforcement and oversight—could have a significant 

impact on administrative costs. However, each task 

might involve trade-offs; lower costs often mean reduced 

services.

Collection and Processing

The additional costs of collecting contributions could be 

reduced to the extent that the system of personal accounts adopted the procedures currently used by agencies 

such as the Social Security Administration and the Internal Revenue Service, and to the extent that choice of investments was limited. 

If the system used the same collection procedures now 

used for payroll taxes, there would be no additional costs 

for that task (assuming the private accounts were financed by payroll taxes at their current level; there could 

be some adjustment costs for employers and the SSA if 

the payroll tax rate changed). If a different administrative 

structure performed the collection task, additional 

costs—at least as high as those in the current system—

would probably be generated. Most proposals would 

maintain the current system for some portion of contributions, so the administrative costs of the new system 

would come on top of those of the old system. If the new 

system changed collection procedures to credit contributions to accounts more quickly, the costs would be higher 

because faster processing would require some combination of more employees, improved hardware, and more 

sophisticated software. 

In a defined-contribution system with asset choice, information on asset allocation would also have to be collected 

and processed. If the choice of assets was restricted, little 

additional information would be required, and the costs 

of collecting and processing it would be reduced. In the 

extreme, if the system permitted investing in only one asset, no additional information would be necessary. By 

contrast, if the system allowed unlimited choice of assets, 

much more information would be required, generating 

higher costs.

Minimizing the cost of collection would limit services, of 

course. If the existing collection procedures were used, 

the system could credit contributions to specific workers 

only after a delay, meaning that workers would not be 

able to allocate contributions to their chosen investments 

immediately and might lose some returns in the meantime. In addition, workers might desire a broad choice of 

assets to tailor their portfolio to their own preferences. 

Asset Management 

Asset management costs would most likely be lower if the 

system was more centralized, for two main reasons. First, 

a centralized system can bundle together contributions to 

different accounts and invest them all at once. That reduces the costs of processing and transferring money. 

Second, larger purchasers have a great deal of buying 

power, so they may be able to reduce the profit margins 

of investment firms. For both reasons, a system in which 

investments were made through large groups, such as employers, would be likely to face lower asset-management 

CHAPTER
18 ADMINISTRATIVE COSTS OF PRIVATE ACCOUNTS IN SOCIAL SECURITY

costs than a system in which investments were made directly by individual workers. A system in which all investments were made through one central clearinghouse 

would be likely to have still lower costs. 

A defined-contribution system must also maintain 

records on account balances. Tracking those balances requires the recording of contributions, allocation among 

asset types, returns on various assets, and loans and repayments (if allowed). The more choice that is permitted, 

and the more often contributions and balances can be 

shifted among assets, the more costly those tasks will be.

The cost of maintaining accounts could be reduced by 

limiting the transmission of account information to investors. For example, the system could provide infrequent 

statements or not offer a toll-free number for inquiries. 

Limiting the choice of assets and transfers between assets 

would also be likely to reduce the cost of providing account information because less-active accounts would 

probably generate less demand for information. 

A related cost is that of investor education. Many people 

have little or no experience making investments. For that 

reason, it might be desirable to give workers information 

to help them make wise investment decisions. However, 

an investor-education program would increase costs. 

In the absence of publicly provided information, workers 

would have to purchase investment advice or do their 

own research. Investment advice, such as that provided by 

a full-service broker or financial advisor, can be costly. 

Self-education could also require substantial time and effort, and might lead to more mistakes. Clearly, education 

would be more important if a greater range of investment 

choices was permitted. 

Calculation and Payment of Benefits

In a system of personal accounts, the costs of calculating 

benefits would probably be low if high-quality records 

were kept. In a defined-contribution system, for example, 

if reliable records on account balances have been maintained, little or no additional calculation is required. Similarly, in a defined-benefit system such as Social Security, 

it is simple to calculate benefits given well-maintained 

earnings records. However, if records are poorly kept, applying benefit formulas can involve a costly process of 

data reconstruction. Of course, high-quality recordkeeping also carries costs.

The cost of paying benefits would be lower if the benefit 

level was more stable and fewer types of distribution were 

allowed. The level of service offered in response to inquiries would also influence costs. In addition, if account balances were to be converted to an annuity upon retirement, costs would be lower if annuitization was 

mandatory and if a central institution converted the 

funds into an annuity or pooled the funds and purchased 

annuities from a private provider rather than allowing individuals to make the purchase themselves.

The cost of distributing benefits to beneficiaries would 

most likely to be low as well. For example, in 1994, the 

Social Security Administration calculated that it cost 

about $2 per year to pay retirement benefits to each beneficiary. However, costs for processing changes are 

higher; each change of address costs the SSA about $7.1

(That cost may fall as more payments are made electronically.) Similarly, costs would be higher if life events such 

as divorce or additional earnings after retirement altered 

the benefit level, requiring additional processing.

Costs would also be lower to the extent that services to 

beneficiaries are limited. For example, people might want 

advice about potential benefit levels or they might inquire 

about missed payments. Such information could be provided through face-to-face meetings at field offices, a tollfree telephone number, mailings, or a Web site or simply 

not be offered, in roughly descending order of expense. 

Payment costs would also be lower if benefits were distributed only once, as a lump sum. To the extent that individuals had a choice of payout options—lump sum, annuity, or phased withdrawal, for example—costs could 

increase because administration would be more complicated. If benefits were disbursed in a lump sum, however, 

individuals might still face additional costs in managing 

the money.

Lump-sum distribution could also mean that some retirees might exhaust their assets before death.2 Retirees 

could avoid that risk by converting their assets into an annuity. Buying annuities on an individual basis is expen1. Social Security Administration, SSA Selected Workload Unit Costs

(1994).

2. Asset exhaustion could impose not only personal but also governmental costs. Those who ran out of assets could be eligible for 

income-supplement programs such as Food Stamps and Supplemental Security Income, as well as medical care through Medicaid, depending on their income level. 
CHAPTER FOUR THE ADMINISTRATIVE COSTS OF A PERSONAL ACCOUNT SYSTEM: IDENTIFYING THE TRADE-OFFS 19

sive, though, in part for the same reasons that asset management is more expensive when accounts are purchased 

on an individual basis. The charges to accounts would 

most likely be somewhat lower if the annuities were purchased through a central clearinghouse or provided directly. In addition, if only some retirees purchased annuities, adverse selection would further raise the cost.

Adverse selection could be eliminated if the government 

made annuitization mandatory and put everyone in the 

same pool. In addition, mandatory annuitization could 

reduce expenditures on federal income-security programs 

such as Supplemental Security Income by ensuring that 

retirees did not spend their assets too quickly. With mandatory annuitization, all payments could be made along 

with traditional Social Security benefits; only one recalculation of benefits would be required. The conversion to 

an annuity could be done through contracts with private 

providers, or within the Social Security system, with taxpayers implicitly taking on the risk of unexpected changes 

in mortality and interest rates. 

The combination of mandatory annuitization and purchase through a central clearinghouse would be the

lowest-cost method of providing all retirees with an annuity, but that low cost would come at a price: some retirees would probably prefer to receive their benefits as a 

lump sum—either because they do not expect to live as 

long as the average person or because they would like to 

pass on some of their assets to their children. Furthermore, some workers would be forced to annuitize during 

temporary market downturns, which could significantly 

reduce their retirement resources. 

Enforcement and Oversight

 Enforcement and oversight costs would be lower to the 

extent that contributions were made through employers 

rather than individually. Monitoring contributions by individuals would be extremely difficult, and audits would 

not be cost-effective. By contrast, corporate employers are 

audited by outside accounting firms, with the results 

made public.