Social Security forms the foundation for our retirement income system. In 1998, it provided approximately $264 billion in annual benefits to 31 million workers and their dependents. However, the Social Security program is facing significant future financial challenges as a result of profound demographic changes, including the aging of the baby boom generation and increased life expectancy. In response, different groups and individuals have advanced numerous proposals that have called for the creation of some sort of mandatory or voluntary individual accounts. To better understand the potential implications of individual accounts, the Chairman of the House Committee on Ways and Means asked GAO to determine how individual accounts could affect private capital and annuities markets as well as national savings, the potential risks and returns to individuals, and the disclosure and educational information needed for public understanding and use of an individual account investment program. The Social Security program is not in long-term actuarial balance. That is, Social Security revenues are not expected to be sufficient to pay all benefit obligations from 1999 to 2073. Without a change in the current program, excess cash revenues from payroll and income taxes are expected to begin to decline substantially around 2008. Based on the Social Security Trustees latest “best estimate” projections, in 2014 the combined OASDI program will experience a negative cash flow that will accelerate in subsequent years. In addition, the combined OASDI trust funds are expected to be exhausted in 2034, and the estimated annual tax income will be enough to pay approximately 70 percent of benefits. Every year, Social Security’s Board of Trustees estimates the financial status of the program for the next 75 years using three sets of economic and demographic assumptions about the future. According to the Trustees’ intermediate set of these assumptions (or best estimate), the nation’s Social Security program will face both solvency and sustainability problems in the years ahead unless corrective actions are taken. Over the next 75 years, Social Security’s total shortfall is projected to be about $3 trillion in 1998 dollars. Social Security’s long-term financing problem is primarily caused by the aging of the U.S. population. As the baby boom generation retires, labor force growth is expected to slow dramatically. Beyond 2030, the overall population is expected to continue aging due to relatively low birth rates and increasing longevity. These demographic trends will require substantial changes in the Social Security benefits structure and/or revenues (i.e., taxes and/or investment returns). Without such changes, current Social Security tax revenues are expected to be insufficient to cover benefit payments in about 2014, less than 15 years from now. These trends in Social Security’s finances will place a significant burden on future workers and the economy. Without major policy changes, the relatively smaller workforce of tomorrow will bear the brunt of financing Social Security’s cash deficit. In addition, the future workforce also would likely be affected by any reduction in Social Security benefits or increased payroll taxes needed to resolve the program’s long-term financing shortfall. As a result, without timely actions, certain generations could face the twin blows of higher burdens and reduced benefits. Proposals have been advanced by different groups to reform Social Security through individual accounts. Such proposals basically also try to restore the Social Security program’s solvency and conserve its sustainability. In its report to the Social Security Commissioner, the 1994- 1996 Advisory Council on Social Security offered three alternative reform proposals, two of which would create individual accounts. The remaining proposal called for having the government invest the trust fund in financial assets, such as corporate equities. Numerous other proposals, also calling for individual accounts, have since been put forth by various organizations. Currently, therefore, there are a wide array of proposals that rely on some form of individual accounts. These proposals have in common the idea that to varying extents, individuals would manage their own individual accounts. The returns from these accounts would provide some or much of an individual’s future retirement income. Social Security is currently structured as a defined benefit program. The current Social Security program’s benefit structure is designed to address the twin goals of individual equity and income security—including retirement income adequacy. The basis of the benefit structure is that these twin goals, and the range of benefits Social Security provides, are currently combined within a single defined benefit formula. Under this defined benefit program, the worker’s retirement benefits are based on the lifetime record of earnings, not directly on the payroll tax he or she contributed. Alternatively, a number of individual account proposals introduce a defined contribution structure as an element of the Social Security program. A defined contribution approach to Social Security focuses on more directly linking a portion of the worker’s contributions to the retirement benefits that will be received. The worker’s contributions are invested in financial assets and earn market returns, and the accumulations in these accounts can then be used to provide income in retirement and an additional pre-retirement death benefit. One advantage of this approach is that the individual worker has more control over the account and more choice in how the account is invested. In essence, the defined contribution structure is similar to the current 401(k) or IRA systems. Some proposals combine defined contribution and defined benefit approaches into a two-tiered structure for Social Security. The aim is to maintain in some form the current existing system as a base tier and add an individual account component as a supplemental tier. Some proposals modify the existing benefit structure; and others propose features that provide guarantees of current law benefits or some other level, such as the poverty line. Other proposals have a more complicated formula including forms of matching. Thus, the relationship between contributions and benefits may be less direct. Under most of these proposals, individuals would receive part of their future benefits from a modified Social Security program and part from the accumulations from their individual account. Most of the individual account proposals seek to create investment accounts that to varying extents are managed by the participants themselves. However, the actual details of how to structure individual accounts vary by each proposal. Individual account proposals are usually framed by four characteristics: (1) carve-out versus add-on; (2) mandatory versus voluntary participation; (3) range of investment options offered; and (4) distribution options (e.g., required annuitization or lump-sum pay- out). The first characteristic pertains to whether to carve-out a portion of Social Security’s tax that is to be invested in financial assets or to add-on a percentage to the current tax that is to be invested in financial assets. OASDI has a payroll tax of 12.4 percent. A carve-out involves creating and funding individual accounts with a portion of the existing payroll tax. Thus, some portion of the 12.4 percent payroll tax, such as 2 percent, would be carved out of the existing Social Security cash flow and allocated to individual account investments. The resulting impact would be that revenues are taken out of Social Security and less is left to finance current benefits. Other proposals take a different approach and add-on individual accounts as a type of supplementary defined contribution tier. For instance, 2 percent would be added on to the current tax of 12.4 percent. The resulting effect of an add-on leaves the entire 12.4 percent payroll tax contribution available to finance the program while dedicating additional revenues for program financing either from higher payroll taxes and/or from general revenue. The second characteristic of individual account proposals concerns whether to make investments in individual accounts mandatory or voluntary. Mandatory participation in individual accounts would require that each individual invest some percentage of his or her payroll tax contribution in financial assets such as equities. Voluntary participation in individual accounts could allow individuals to opt in or opt out of investing any portion of their payroll tax contributions into financial assets. Individuals would rely on the existing Social Security if they chose to opt out of participating in individual accounts. Other voluntary approaches allow individuals to contribute with or without matching to a retirement account. Additionally, mandatory or voluntary can also refer to the pay- out an individual receives upon retirement, such as a pay-out in the form of a lump sum. The third characteristic has to do with the degree of choice and flexibility that individuals would have over investment options. Some proposals would allow unlimited investment choices, such as investments in corporate equities, bonds, or real estate. Other proposals would offer a more limited range of choices, such as equity or bond indexed funds. Thus, individual account investments offer individuals some range of choice over how to accumulate balances for their retirement. The final characteristic centers around how the accumulated earnings in individual accounts will be paid out. Preserving individual’s retirement income prior to pay-out by prohibiting pre-retirement distributions or loans is also a requirement of most proposals. However, upon pay-out, some proposals would permit requiring annuities--contracts that convert savings into income and provide periodic pay-outs for an agreed-upon span of time in return for a premium. Other proposals suggest allowing the individual to withdraw the account balance in lumpsum or through gradual pay-outs. Among the changes implementing individual accounts would make to the current Social Security program is to move away from a pay-as-you-go system in the direction of an advanced funded system. Social Security is currently financed largely on a pay-as-you-go basis. Under this type of financing structure, the payroll tax revenues collected from today’s workers are used to pay the benefits of today’s beneficiaries. Under a strict pay-as-you-go financing system, any excess of revenues over expenditures is credited to the program’s trust funds, which function as a contingency reserve. Advanced funding refers to building and maintaining total balances for Social Security, whether that is done through individual accounts or some other mechanism. Thus, although individual accounts are a form of advanced funding, the two terms are distinct. For instance, building up the balance in the Trust Funds is a form of advanced funding. The creation of individual accounts refers to a defined contribution system of accounts connected to Social Security and held in individuals’ names.