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Ten Points Concerning Carve-Out Social Security Individual Accounts


Social Security provides social insurance to workers and their families (see Figure 1). Unlike many savings plans, it is not, nor was it designed to be, an investment. It was designed to provide a foundation of income upon which workers can build retirement income security by adding their personal savings and pension accumulations.

Most vitally, Social Security is an expression of community. Through Social Security, the nation provides a base of economic welfare for retired and disabled workers and their families, widows and surviving children, and low-wage earners who may be without pensions and lack any substantial savings. If some part of current payroll taxes were diverted away from Social Security to finance individual accounts, known as "carve-out" accounts, Social Security's ability to provide these fundamental protections would be reduced.

Figure 1 - Percent of Social Security Beneficiaries by Benefit Category, 2002

1. Diverting current payroll taxes from Social Security to create carve-out individual accounts without other revenues to make up the difference means that guaranteed benefits would have to be cut substantially.

According to experts, a policy of diverting two percent of current-law payroll taxes to individual accounts would make it necessary to cut by 50 percent the guaranteed benefit of workers 30 and under. Even when the income from individual accounts is added to the guaranteed benefit, these workers' retirement income would average 20 percent below current-law levels, and the cut in total benefits would be even larger for some workers.

2. Carve-out individual accounts would increase the risk faced by participants.

Carve-out individual accounts would replace some of Social Security's current guaranteed benefit with a benefit that depends on the performance of the stock market. The stock market's recent travails raise concerns about whether or for how long future returns will continue negative, remain stagnant, or grow. Moreover, many analysts make the mistake of forecasting individual account performance based on a single rate of return that reflects the average stock market performance over several decades, without taking into account large swings in the rate of return from year to year. For this reason, estimates of future stock market returns should be adjusted downward to reflect the additional risk. As a result of stock market price swings, privatization could make it difficult to plan for retirement, and cause large differences in the rates of return received by different age groups.

3. For many workers, carve-out accounts would be too small to make a significant contribution to retirement income.

For the average salary of $30,000, a contribution of two percent to an individual account amounts to only $600 per year. Given the steep cuts in benefits that would be necessary to restore solvency to the guaranteed part of the system, if revenue is diverted to individual accounts, it could be difficult for lower-income people to make up the difference from individual accounts. In contrast, higher-income people would contribute larger amounts to two-percent individual accounts. Inevitably, there will be pressures to withdraw account balances before retirement for medical emergencies, education, home buying, or other purposes, and this could significantly reduce account balances.

4. Carve-outs would replace part of Social Security's progressive benefit with a proportional one, hurting low-income workers.

Social Security provides progressive benefits. Low-income workers have a greater percentage of their pre-retirement wages replaced than high-income workers. This redistribution helps to keep roughly 40 percent of older Americans out of poverty. Redistribution would be difficult to accomplish in a system of carve-out individual accounts belonging to account owners and their heirs. At the same time, carving out Social Security's revenues for individual accounts would leave fewer resources for redistribution.

5. Carve-outs would hurt women.

Ninety percent of all women age 65 and older receive Social Security benefits. For non-married women over age 65, Social Security comprises over half of their income. Because, on average, women live longer, earn less, and are far more likely than men to take time out of the labor force for care giving, Social Security's inflation-adjusted, defined-benefit, lifelong guarantee is particularly important for them. To carve out from this lifetime guarantee might well push more women into poverty.

6. Carve-outs would hurt minorities.

Social Security is indispensable to the income security of minorities. African Americans and Hispanics make up a disproportionately large segment of workers earning low and moderate wages. Older African Americans and Hispanics are less likely to have private pensions and assets (see Table 1). Although African Americans represent 12 percent of the U.S. population, they comprise almost 18 percent of workers receiving disability benefits. African Americans comprise 23 percent of children and 17 percent of widows receiving survivor benefits. For these reasons, carve-out accounts, which jeopardize the stability of retirement, survivor, and disability benefits, would be particularly detrimental to minority groups.

7. Carve-outs would hurt the disabled and/or survivors.

The Social Security system is more than just an "investment" because it also provides insurance against the retirement, disability, or death of a breadwinner. Social Security Disability Insurance protects younger women in the labor force and their families. Widows with children may be eligible for survivor benefits at any age when caring for a child who is under 16 or disabled and entitled to benefits. Unmarried children may receive survivor benefits based on a parent's record. Yet individual account proposals often do not address these important aspects of the Social Security system. If two percent of the payroll tax were diverted to individual accounts, it would be difficult for the system to maintain the same level of disability and survivors' insurance while addressing worsened solvency problems—an issue of particular importance to minority groups who disproportionately receive disability and survivor benefits. Moreover, proponents of carve-out accounts often compare apples to oranges when they exclude the value of disability and survivors' insurance from the calculations of Social Security's rate of return.

8. Returns to carve-outs would be lowered by substantial "transition costs."

The nation has to make good on the promises it has made to current beneficiaries, and to people who are so close to retirement that they cannot adjust their retirement savings plans. Yet if some of Social Security's revenue is carved out and diverted to individual accounts, the resulting revenue shortfall would have to be made up somewhere, and it would have to come from the same group of workers contributing to individual accounts in the first place, through the income tax, the budget surplus, or debt. In other words, they would pay twice. So, in a sense, the "carve out" is really an "add-on" for current workers-but instead of being up front and open, it is hidden. Moreover, many analyses that tout individual accounts employ an unfair comparison with Social Security. They claim rates of return on stocks assuming that there are no transition or administrative costs.

9. Returns to individual accounts would be lowered by substantial administrative costs.

If the private sector managed individual accounts, the administrative costs could be comparable to those for an equity mutual fund, which average about 150 basis points (1.5 percent of account balances) annually. These fees would go to Wall Street investment managers. Moreover, should annuitization of account balances be required in order to provide a retirement income stream, there would be additional administrative costs. Administrative costs could sharply diminish the benefit payments from individual accounts.

10. The current annuities market cannot replicate Social Security's inflation-indexed benefit.

Social Security benefits are inflation-adjusted. Many carve-out individual account proposals require that some or all of account balances be annuitized upon retirement, yet inflation-indexed annuities are almost non-existent in the private marketplace. At three percent inflation, a non-indexed annuity loses one-third of its value over 15 years.


  1. Peter R. Orszag, Richard Kogan, and Robert Greenstein, Social Security and the Tax Cut: The 75-Year Cost of the Tax Cut is More Than Twice as Large as the Long-Term Deficit in Social Security, Center on Budget and Policy Priorities, April 11, 2002. See also Henry J. Aaron, Alan S. Blinder, Alicia H. Munnell, and Peter R. Orszag, Governor Bush's Individual Account Proposal: Implications for Retirement Benefits, The Century Foundation and the Social Security Network, June 6, 2000.
  2. John Geanakoplos, Olivia S. Mitchell, and Stephen P. Zeldes, Social Security Money's Worth, NBER Working Paper Series, #6722, September, 1998.
  3. Kilolo Kijakazi, "Improving the Retirement Income of Low-Wage Earners," in The Future of Social Insurance, National Academy of Social Insurance, Washington, DC, 2001.
  4. Note that this row differs in concept from the next two rows. This line shows the proportion of total retirement income provided by Social Security.
  5. According to the Employee Benefit Research Institute, high administrative costs (200 basis points for managing the accounts and annuity loading costs of 15 percent of the account balance at retirement) can reduce benefit payments by 22 to 24 percent for people born in 1946, as compared to an assumption of low administrative costs (10 basis points for managing the accounts and annuity loading costs of 5 percent of the account balance). Workers born in 1976 would receive 40 to 42 percent lower benefits under high administrative cost assumptions than under low-cost assumptions. See Dallas Salisbury, editor, Beyond Ideology: Are Individual Social Security Accounts Feasible? Employee Benefits Research Institute, Washington, DC: 1999.

Written by Alison Shelton and Laurel Beedon, AARP Public Policy Institute
October 2002
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