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Provisions Affecting Individual Accounts

Updated May 3, 2006  


The current Social Security program is a defined benefit social insurance program. Monthly benefits for a worker and his/her eligible dependents are determined based on a formula that takes into account the worker's earnings history. The program is financed on a pay-as-you-go basis. The contributions of all workers each month are used to provide these benefits to eligible retirees, disabled workers, and survivors in the same month. In contrast, individual accounts would provide benefits based solely on each worker's own contributions (plus contributions by the employer) made to the account plus investment earnings on these contributions. Individual accounts are thus funded on a wholly advance-funded basis.

Contributions to the individual accounts can be financed by the following means: (1) a redirection of some portion of Social Security payroll tax, (2) transfers from the General Fund of the Treasury, (3) additional contributions from workers (and/or the employers), or (4) some combination of the above. In addition, individual accounts can be mandatory or voluntary.

Many of the individual account provisions included in recent solvency proposals would redirect some portion of each participating worker's Social Security payroll tax to an individual account and later pay a reduced traditional monthly Social Security benefit. Some plans base the amount of reduction, or "benefit offset", on a hypothetical or shadow account balance accumulated to retirement (or to entitlement to disability benefits in some proposals). The rate of return at which hypothetical accounts accumulate is generally set at a level such that workers should have a good chance of doing better with their actual investments over a working lifetime. These "benefit offsets" are a source of savings to the Social Security trust funds. Individual account provisions of this type generally do not, in themselves, improve the solvency of the Social Security trust funds. As a result, some proposals often include some additional revenues (like General Fund transfers) for a period of years before the benefit offset provision has matured.

The size of the individual accounts (i.e., the percentage of taxable earnings invested in individual accounts), how the accounts are funded, and the specifications of any "benefit offset" provision can cause considerable variation in the long-range financial effect of individual accounts on the Social Security program. Several comprehensive solvency proposals provide examples of proposals that include individual accounts.

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