oversight

Social Security Reform: Information on Using a Voluntary Approach to Individual Accounts

Published by the Government Accountability Office on 2003-03-10.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

             United States General Accounting Office

GAO          Report to the Ranking Minority
             Member, Special Committee on Aging,
             U.S. Senate


March 2003
             SOCIAL SECURITY
             REFORM
             Information on Using
             a Voluntary Approach
             to Individual Accounts




GAO-03-309
                                               March 2003


                                               SOCIAL SECURITY REFORM

                                               Information on Using a Voluntary
Highlights of GAO-03-309, a report to the      Approach to Individual Accounts
Ranking Minority Member of the Senate
Special Committee on Aging




Many proposals have been offered               If policymakers decide to restructure Social Security to include individual
to restructure the U.S. Social                 accounts, making participation voluntary has significant implications for
Security system to include                     designing and administering the plan. While offering the choice to
individual retirement savings                  participate may be desirable, doing so substantially increases the complexity
accounts. However, some key                    of an individual account plan and potentially its total costs. A variety of
proposals would make
participation in the accounts
                                               voluntary plan design features have potentially significant effects on
voluntary rather than mandatory.               individuals and total system costs.
While any individual account plan
can offer a variety of choices                 The design features of voluntary individual account plans can affect whether
regarding contributions,                       individuals participate in the accounts and what retirement incomes they
investments, and withdrawals, the              will receive. For example, some voluntary plans, such as those in the three
choice of whether or not to                    countries we studied—the United Kingdom, the Czech Republic, and
participate is fundamental to a                Germany, offer people the ability to opt in and opt out of the account
voluntary approach. That choice                periodically. Individuals may consider the extent of such flexibility in
could have significant effects on              deciding whether to participate in the accounts. Also, voluntary plans
individual retirement incomes and              generally offer incentives to participate, while mandatory plans do not need
on the costs to the government as
well.
                                               them. In addition to increasing participation, incentives generally add to the
                                               value of the accounts and, therefore, ultimately to the retirement income the
GAO was asked to report on the                 accounts will provide. The three countries we studied offered incentives
implications of using a voluntary              such as government contributions and tax advantages.
approach to individual accounts.
Accordingly, GAO’s reporting on                Voluntary individual account plans can also affect the total system costs to
(1) how voluntary plans can affect             the government, providers, employers, or participants, depending on design.
individuals, (2) how they could                In some cases, offering choice involves additional administrative, incentive,
affect the total costs of the                  and educational costs related to individuals’ participation decisions. In
retirement system, and (3) the role            particular, tracking individuals’ participation decisions would require
of educational efforts relating to             administrative processes that do not arise in mandatory plans. All three
the participation decision.
Throughout this report, GAO
                                               countries we studied used a centralized government authority to track
focuses on the issues that pertain             participation and handle account contributions. Moreover, the uncertainty
specifically to a voluntary approach           of participation rates in turn creates uncertainty for a variety of costs
as distinct from a mandatory                   associated with individual account plans. For example, in the United
approach.                                      Kingdom, participation in the individual accounts was much greater than
                                               expected, which resulted in unexpectedly high incentive costs. In addition,
GAO studied three countries that               costs would arise from the need to educate individuals to help them make
have enacted voluntary individual              informed decisions about participating in voluntary accounts.
account plans—the Czech
Republic, Germany, and the United              Significant education efforts may help individuals make informed
Kingdom.                                       participation decisions. Individuals face complex participation decisions in
                                               addition to the contribution, investment, and withdrawal decisions they
                                               might face in a mandatory plan. To make informed participation decisions,
                                               individuals need to understand the effects on their government retirement,
                                               disability, and survivor benefits and on their retirement income as a whole.
www.gao.gov/cgi-bin/getrpt?GAO-03-309.

To view the full report, including the scope
and methodology, click on the link above.
For more information, contact
Barbara D. Bovbjerg at (202) 512-7215 or
bovbjergb@gao.gov.
Contents


Letter                                                                                       1
               Results in Brief                                                              2
               Background                                                                    3
               Design of Voluntary Plans Can Affect Individuals’ Participation and
                  Retirement Incomes                                                         8
               Giving Choice of Participation Could Affect Total Costs and
                  Increase Uncertainty                                                     21
               Significant Education Efforts May Help Individuals Make Informed
                  Participation Decisions                                                  27
               Concluding Observations                                                     33
               Agency Comments and Our Evaluation                                          34

Appendix I     Summary of the United Kingdom’s Retirement System 35
               Description of Current System                                               35
               Key Design Features of Voluntary Individual Accounts in the
                 United Kingdom                                                            44

Appendix II    Summary of the Czech Republic’s Retirement System                           46
               Description of Current System                                               46
               Key Design Features of Voluntary Individual Accounts in the Czech
                 Republic                                                                  53

Appendix III   Summary of Germany’s Retirement System                                      55
               Description of Current System                                               55
               Key Design Features of Voluntary Individual Accounts in Germany             62

Appendix IV    Comments from the Social Security Administration                            64




               Page i                            GAO-03-309 Social Security Voluntary Accounts
Tables
          Table 1: Design FeaturesThat Can Influence Voluntary Account
                   Participation and Individual Retirement Incomes                      8
          Table 2: Key Design Features of Voluntary Individual Accounts in
                   the United Kingdom                                                 45
          Table 3: Schedule of Government Matching Contributions for
                   Czech Voluntary Supplementary Insurance                            49
          Table 4: Average Inflation-Adjusted Rate of Return for Czech
                   Pension Funds, 1995-2001                                           53
          Table 5: Key Design Features of Voluntary Individual Accounts in
                   the Czech Republic                                                 54
          Table 6: Key Design Features of Voluntary Individual Accounts in
                   Germany                                                            63


Figures
          Figure 1: Overview of the United Kingdom’s Retirement Income
                   Sources                                                            36
          Figure 2: Overview of Czech Retirement Income Sources                       46
          Figure 3: Average Monthly Participant Contribution and Average
                   Government Contribution to Czech Voluntary
                   Supplementary Pension Insurance, 1994-2001                         50
          Figure 4: Number of Pension Funds Providing Czech Voluntary
                   Supplementary Pension Insurance, 1994-2001                         52
          Figure 5: Overview of German Retirement Income Sources                      56




          Page ii                           GAO-03-309 Social Security Voluntary Accounts
Abbreviations

CSSS              Commission to Strengthen Social Security
DWP               Department for Work and Pensions
IRA               Individual Retirement Account
MIG               Minimum Income Guarantee
NIC               National Insurance Contributions
SERPS             State Earnings-Related Pension Scheme
S2P               State Second Pension
SSA               Social Security Administration
TSP               Thrift Savings Plan




This is a work of the U.S. Government and is not subject to copyright protection in the
United States. It may be reproduced and distributed in its entirety without further
permission from GAO. It may contain copyrighted graphics, images or other materials.
Permission from the copyright holder may be necessary should you wish to reproduce
copyrighted materials separately from GAO’s product.




Page iii                                  GAO-03-309 Social Security Voluntary Accounts
United States General Accounting Office
Washington, DC 20548




                                   March 10, 2003

                                   The Honorable John Breaux
                                   Ranking Minority Member
                                   Special Committee on Aging
                                   United States Senate

                                   Dear Senator Breaux:

                                   Many proposals have been offered to restructure the U.S. Social Security
                                   program to include individual retirement savings accounts. However,
                                   some key proposals would make participation in the accounts voluntary
                                   rather than mandatory. Under a mandatory approach, all covered workers
                                   would typically have individual retirement savings accounts, and some
                                   portion of their Social Security contributions would automatically be
                                   deposited in the accounts. Under a voluntary approach, all covered
                                   workers would have a choice whether or not to have such an account as
                                   part of their Social Security package. While any individual account plan
                                   can offer a variety of choices regarding contributions, investments, and
                                   withdrawals, the choice of whether or not to participate is fundamental to
                                   a voluntary approach. That choice could have significant effects on
                                   individual retirement incomes and on the costs to the government as well.

                                   You asked us to report on the implications of using a voluntary approach
                                   to individual accounts. Accordingly, we are reporting on (1) how voluntary
                                   plans can affect individuals, (2) how they could affect the total costs of the
                                   retirement system, and (3) the role of educational efforts relating to the
                                   participation decision. Throughout this report, we focus on the issues that
                                   pertain specifically to a voluntary approach as distinct from a mandatory
                                   approach.

                                   To provide this information, we studied the experiences of selected
                                   nations, experiences with U.S. retirement savings accounts, and proposals
                                   to add individual accounts to the U.S. Social Security program. We
                                   conducted an extensive review of the relevant literature and interviewed
                                   researchers in the field and officials at multinational organizations, such as
                                   the World Bank, and at U.S. government agencies. On the basis of this
                                   preliminary research, we identified 3 countries with voluntary individual
                                   account plans that illustrate a variety of circumstances and key design
                                   features—the Czech Republic, Germany, and the United Kingdom. For
                                   example, the individual account plans of these countries have been in


                                   Page 1                              GAO-03-309 Social Security Voluntary Accounts
                   operation for different lengths of time, have used different incentives, and
                   interact with the national social security systems in different ways. In
                   addition, we studied 401(k) plans and other voluntary accounts in the
                   United States. For both the foreign and domestic cases, we interviewed
                   officials and analysts in a variety of organizations, including government
                   agencies, unions, advocacy groups, employer organizations, research and
                   academic institutions, and financial service companies. We did not
                   conduct a legal analysis of the relevant laws of the foreign countries. We
                   conducted our review from January 2002 through March 2003 in
                   accordance with generally accepted government auditing standards.


                   The design features of voluntary individual account plans can affect
Results in Brief   whether individuals participate in the accounts and what retirement
                   incomes they will receive. For example, some voluntary plans, such as
                   those in all three countries we studied, offer people the ability to opt in
                   and opt out of the account periodically; most U.S. proposals have not
                   explicitly considered whether people would face a one-time or a periodic
                   decision to participate. Individuals may consider the extent of such
                   flexibility in deciding whether to participate in the accounts. Moreover,
                   the need to track individuals’ participation decisions requires additional
                   administrative tasks and complexity. Also, voluntary plans generally offer
                   incentives to participate, while mandatory plans do not need them. In
                   addition to increasing participation, incentives generally add to the value
                   of the accounts and, therefore, ultimately to retirement income. Each of
                   the three countries we studied offered incentives such as government
                   contributions and tax advantages.

                   Voluntary individual account plans can also affect the total system costs to
                   the government, providers, employers, or participants, depending on
                   design. In some cases, offering choice involves additional administrative,
                   incentive, and educational costs. In particular, tracking individuals’
                   participation decisions would require administrative processes that do not
                   arise in mandatory plans. All 3 countries we studied used a centralized
                   government authority to track participation and handle account
                   contributions. In addition, incentive costs can be substantial. For example,
                   Germany has dedicated roughly $10.6 billion over the next 6 years to pay
                   for matching contributions and tax incentives. Moreover, the uncertainty
                   of participation rates in turn creates uncertainty for a variety of costs
                   associated with individual account plans. For example, in the United
                   Kingdom, participation in the individual accounts was much greater than
                   expected, which resulted in unexpectedly high incentive costs. In addition,
                   in response to what has been called the “mis-selling scandal,” British


                   Page 2                             GAO-03-309 Social Security Voluntary Accounts
                 companies that provide accounts have spent billions of dollars to
                 compensate participants who signed up for accounts that were clearly not
                 to their advantage, given their particular circumstances.

                 Significant education efforts may help individuals make informed
                 participation decisions. Individuals face complex participation decisions
                 in addition to the contribution, investment, and withdrawal decisions they
                 might face in a mandatory plan. To make informed participation decisions,
                 individuals need to understand the effects on their government retirement,
                 disability, and survivor benefits and on their retirement income as a whole.
                 For example, in the United Kingdom, workers who left their employer plan
                 to participate in the voluntary accounts often reduced their future
                 retirement income because they lost employer contributions.


                 According to the Social Security Trustees’ 2002 intermediate, or best-
Background       estimate, assumptions, Social Security’s cash flow is expected to turn
                 negative in 2017. In addition, all of the accumulated Treasury obligations
                 held by the trust funds are expected to be exhausted by 2041. Social
                 Security’s long-term financing shortfall stems primarily from the fact that
                 people are living longer while having fewer children. As a result, the
                 number of workers paying into the system for each beneficiary has been
                 falling and is projected to decline from 3.3 today to about 2 by 2030.

                 Reductions in promised benefits and/or increases in program revenues will
                 be needed to restore the long-term solvency and sustainability of the
                 program. Within the program’s current structure, possible benefit changes
                 might include changes to the benefit formula or reductions in cost-of-living
                 increases, among other options; revenue increases might include increases
                 in payroll taxes or transfers from the Treasury’s general fund. Also, some
                 proposals would change the structure of the program to incorporate a
                 system of individual retirement savings accounts. Many such proposals
                 would reduce benefits under the current system and make up for those
                 reductions to some degree with income from the individual accounts.
                 Individual account proposals also try to increase revenues, in effect, by
                 providing the potential for higher rates of return on account investments
                 than the trust funds would earn under the current system.

                 Three key distinctions help to identify the differences between Social
                 Security’s current structure and one that would use individual accounts.

             •   Insurance versus savings. Social Security is a form of insurance while
                 individual accounts would be a form of savings. As social insurance, Social


                 Page 3                             GAO-03-309 Social Security Voluntary Accounts
    Security protects workers and their dependents against a variety of risks
    such as the inability to earn income due to death, disability, or old age. In
    contrast, a savings account provides income only from individuals’
    contributions and any interest on them; in effect, individuals insure
    themselves under a savings approach.

•   Defined-benefit versus defined-contribution. Social Security provides
    a “defined-benefit” pension while individual accounts would provide a
    “defined-contribution” pension. Defined-benefit pensions typically
    determine benefit amounts using a formula that takes into account
    individuals’ earnings and years of earnings. The provider assumes the
    financial and insurance risk associated with funding those promised
    benefit levels. Defined-contribution pensions, such as 401(k) plans,
    determine benefit amounts based on the contributions made to the
    accounts and any earnings on those contributions. As a result, the
    individual bears the financial and insurance risks under a defined-
    contribution plan until retirement.1

•   Pay-as-you-go versus full funding. Social Security is financed largely on
    a “pay-as-you-go” basis while individual accounts would be “fully funded.”
    In a pay-as-you-go system, contributions that workers make in a given year
    fund the payments to beneficiaries in that same year, and the system’s
    trust funds are kept to a relatively small contingency reserve.2 In contrast,
    in a fully funded system, contributions for a given year are put aside to pay
    for future benefits. The investment earnings on these funds contribute
    considerable revenues and reduce the size of contributions that would
    otherwise be required to pay for the benefits. Defined contribution
    pensions and individual retirement savings are fully funded by definition.
    Both mandatory and voluntary individual account plans would reflect all



    1
     At retirement, individuals do have the option of purchasing an annuity with their defined-
    contribution accounts, which then transfers the financial and insurance risk to the annuity
    provider. Before retirement, individuals may also have the option of purchasing deferred
    annuities.
    2
     Social Security is now temporarily deviating from pure pay-as-you-go financing by building
    up substantial trust fund reserves. Social Security is collecting more in revenues than it
    pays in benefits each year partly because the baby-boom generation makes the size of the
    workforce larger relative to the beneficiary population. In 2017, shortly after the baby
    boomers start to retire, the benefit payments are expected to exceed revenues, and the
    trust fund reserves and the interest they earn will help pay the baby boomers’ retirement
    benefits. For more detail about this temporary trust fund buildup and how it interacts with
    the federal budget, see U.S. General Accounting Office, Social Security Reform:
    Demographic Trends Underlie Long-Term Financing Shortage, GAO/T-HEHS-98-43
    (Washington, D.C.: Nov. 20, 1997).




    Page 4                                    GAO-03-309 Social Security Voluntary Accounts
    of these distinctions. Both types of plans also have a variety of other
    features and design issues in common, which can be organized in four
    groups.

•   Supplement versus substitute. Individual accounts can either
    supplement an existing national pension benefit3 or substitute for all or
    part of it.4 With supplemental accounts, the account and contributions to it
    have no effect on the national pension benefit. With substitute accounts,
    the national pension benefit is reduced (or “offset”) in some way to
    account for contributions that have been diverted from the national
    program.5

•   Contributions. An individual account plan can provide for contributions
    in a variety of ways. For example, a plan might set contributions at a fixed
    rate, such as 2 percent of pay, or allow a range of rates up to a certain
    dollar amount. Also, contributions might be collected and deposited by the
    government in a centralized process or by employers or account providers
    in a decentralized process.

•   Accumulation. An individual account plan can address the accumulation
    of interest and other investment earnings in a variety of ways. A plan might
    give participants a wide range of investment options through virtually any
    qualified investment manager or may limit them to a few mutual funds


    3
     In other countries, “social security” refers to a wide range of social insurance programs,
    including health care, long-term care, workers’ compensation, unemployment insurance,
    etc. To generalize across countries, we use “national pension benefit” to refer to defined-
    benefit old-age pensions provided by the social security system. We use “Social Security” to
    refer to the U.S. Old-Age, Survivors, and Disability Insurance Program since that is how the
    program is commonly known.
    4
     In the United States, the terms “add-ons” and “carve-outs” have also been used. However,
    using these terms to describe foreign programs could be misleading because of the
    different contexts in which accounts exist. Moreover, in the case of mandatory accounts,
    “carve-out” plans may reduce benefits while adding the accounts; however, since the
    accounts are mandatory, the benefit reductions need not be construed as being linked to
    the accounts. To avoid this ambiguity, we use “substitute” accounts for cases in which
    participation in the accounts is linked to compensating benefit offsets and “supplemental
    accounts” for cases in which participation is not so linked.
    5
     In the United States, for example, the Clinton Administration’s Universal Savings Account
    proposal would have created supplemental accounts, while Model 2 of the Commission to
    Strengthen Social Security would create substitute accounts. See U.S. General Accounting
    Office, Social Security: The President’s Proposal, GAO/T-HEHS/AIMD-00-43 (Washington,
    D.C.: Nov. 9, 1999) and Social Security Reform: Analysis of Reform Models Developed by
    the President’s Commission to Strengthen Social Security, GAO-03-310 (Washington, D.C.:
    Jan. 15, 2003).




    Page 5                                    GAO-03-309 Social Security Voluntary Accounts
    through a single administrator or specifically authorized managers. Such
    design features determine in part how much investment risk individuals
    are allowed to take and how much choice they have in managing their
    money. Moreover, plans might offer some degree of investor education,
    depending on the complexity of the choices they face.

•   Withdrawal. An individual account plan can offer a variety of ways to
    withdraw money. A plan may require individuals to purchase an annuity
    when they retire.6 Alternatively, an individual account plan may also allow
    individuals to withdraw their funds according to a specified schedule.
    Such a “phased withdrawal” leaves ownership of the funds with the
    individual as well as much of the financial and insurance risk. Some
    individual account plans, such as most 401(k) plans, also allow individuals
    to take their entire account at retirement as a lump sum and spend it as
    they wish. The question of withdrawal options ultimately reflects a
    decision concerning how much choice to give individuals versus how far
    to go to ensure that assets are preserved for retirement income.

    Several countries around the world have implemented national individual
    account plans as part of their retirement income policies. Many countries
    with individual account plans have made them mandatory. Some, such as
    Chile, have given current workers a choice but made the accounts
    mandatory for new workers. Still others have made the accounts voluntary
    for all workers.

    All three of the countries we studied—the Czech Republic, Germany, and
    the United Kingdom—have reduced the growth of benefits in their public
    pay-as-you-go retirement systems in the face of demographic challenges.
    In all three cases, the decision to make the accounts voluntary related to
    either historical precedents, political realities, or both, rather than to a
    specific policy objective that a mandatory approach would not
    accomplish. Since 1961 employers in the United Kingdom have had the
    ability to opt their employees out of part of the national system to
    participate in employer-provided defined-benefit pension plans. The
    introduction of individual accounts in 1988 allowed workers, instead of
    employers, to make decisions about whether or not to opt out of part of



    6
     Annuities pay benefits on a fixed schedule for life or sometimes for a fixed period. Some
    annuities, called joint-and-survivor annuities, pay benefits to the annuity holders while they
    live and to their survivors after they have died. Annuities provide a way of managing a lump
    sum of money and transferring financial and insurance risk to the providers to ensure a
    steady stream of income for the annuitant.




    Page 6                                     GAO-03-309 Social Security Voluntary Accounts
the national pension system. Further, individual accounts enabled
workers without access to employer-provided pensions to opt out of part
of the national pension system. In the Czech Republic, the accounts were
intended to help workers make up for reductions in the national pension
benefit while also helping spur growth in the capital market of the
previously communist economy. In Germany, the accounts were also
intended in part to make up for reductions in the national pension benefit.
(See apps. I, II, and III for details on each country.)

In the United States, many employers offer defined-contribution pension
plans, which take the form of voluntary retirement savings accounts, such
as 401(k) plans for private sector employees and the Thrift Savings Plan
(TSP) for federal employees. In recent years, the number of defined-
contribution plans has been growing and becoming a relatively more
common way for employers to offer pension plans than defined-benefit
plans. In fact, some employers who had only defined-benefit plans now
offer plans that include defined-contribution accounts, including the
federal government and the state of Florida, to cite two examples.

While defined-contribution pensions and Individual Retirement Accounts
(IRAs) are not directly comparable to individual accounts that are part of a
national social security system, they do have similar features and raise
similar issues. For example, many defined-contribution pension plans
include incentives in the form of employer matching contributions. They
also require administrative processes for collecting and distributing
account contributions. They enjoy tax advantages and provide a range of
investment and withdrawal options, as IRAs also do. Employer-sponsored
plans typically provide some form of participant education. Moreover, in
the Social Security reform debate, TSP has often been raised as an
example of how a Social Security account plan might work, especially in
terms of its centralized administration, relatively low administrative costs,
independent oversight board, and passively managed investment options.
Still, some have noted its limitations as an example, pointing especially to
the fact that all its participants work for a single employer.




Page 7                             GAO-03-309 Social Security Voluntary Accounts
                      Through a variety of design features, voluntary individual account plans
Design of Voluntary   can affect whether individuals participate in the accounts and what
Plans Can Affect      retirement incomes they will receive. Using a voluntary approach to
                      individual accounts adds considerable complexity due to the way choice
Individuals’          and participation interact with the plan’s design features. In particular,
Participation and     design features relating to the participation decision include the ability to
                      opt in and out of the plan and the use of incentives. Also, under some
Retirement Incomes    designs, accounts supplement national pension benefits while, under other
                      designs, the accounts substitute for such benefits to some degree. Other
                      design features relate to the accumulation and withdrawal phases of the
                      accounts. (See table 1 for a summary of design features that can affect
                      individuals’ participation and retirement incomes.) Finally, the effects of
                      voluntary accounts on individuals will vary by market and demographic
                      factors. Some groups of individuals may be more likely to participate in
                      voluntary accounts than others.

                      Table 1: Design FeaturesThat Can Influence Voluntary Account Participation and
                      Individual Retirement Incomes

                          Design feature categories                Examples
                          Supplemental versus substitute                •   Additional versus diverted contributions
                          accounts                                      •   Benefit offsets, especially potential for
                                                                            “adverse selection”a
                          Participation decision and               Participation decision features
                          contribution phase                            •   Flexibility, such as opt-in/opt-out
                                                                        •   Automatic enrollment
                                                                        •   Administrative costs
                                                                   Incentives
                                                                        •   Government or employer contributions
                                                                        •   Tax advantages
                          Accumulation phase                            •   Investment options (and how they are
                                                                            regulated)
                                                                        •   Guarantees
                                                                        •   Tax advantages
                          Withdrawal phase                              •   Pre-retirement loans
                                                                        •   Withdrawal options: annuities,
                                                                            installment payments, and lump-sum
                                                                            distributions
                                                                        •   Tax advantages
                          Other design considerations                   •   Plan complexity
                                                                        •   Public education
                      Source: GAO.
                      a
                       Adverse selection occurs when certain groups of individuals (e.g., those with longer life
                      expectancies) are more (or less) likely to participate than others and when such participation patterns
                      result in a net cost to the government. (See section below on substitute versus supplemental
                      accounts for further discussion.)




                      Page 8                                          GAO-03-309 Social Security Voluntary Accounts
Participation Decision      Design features related to the participation decision include the flexibility
Features and Contribution   of the decision, automatic enrollment provisions, and administrative costs
Features Can Affect         borne by the participants. Additionally, participation incentives generally
                            include government contributions and tax advantages. These features can
Incomes as Well as          affect not only individuals’ participation but also their eventual retirement
Participation               incomes. Many of these features arise only under a voluntary approach
                            and, therefore, result in added complexity of voluntary plans.

Participation Decisions     Some voluntary plans, such as those in all three countries we studied,
                            offer people the ability to opt in and opt out of the account periodically;
                            most U.S. proposals have not explicitly considered whether people would
                            face a one-time or a periodic decision to participate. The need to track
                            individuals’ participation decisions requires additional administrative
                            tasks and complexity, especially in the case of substitute account plans
                            with benefit offsets that reflect those decisions. Individuals may consider
                            the extent of flexibility in opting in and out when deciding whether to
                            participate in the accounts. In the United Kingdom, workers can opt out of
                            or opt back into part of the national pension at any time. Ultimately, the
                            national pension benefit calculation adjusts by reflecting any periods of
                            time that a person has opted out. In the case of supplemental accounts, it
                            is less complicated to opt in and out. In the Czech Republic, individuals
                            can stop making contributions to their accounts after 3 years and resume
                            them when they wish. Government contributions to the accounts reflect
                            any such changes in participation because they are based on reports from
                            the pension funds about the individuals’ contributions. In Germany,
                            individuals can participate in accounts through their employer or
                            approved financial service companies. The ability to opt-in and opt-out of
                            would depend on the plan in which they participate.

                            In contrast to opting in and out, plans can also give participants the ability,
                            to varying degrees, to cancel their accounts and get a refund of their past
                            contributions. Generally, penalties are associated with canceling accounts,
                            and government contributions are taken back from the participants’
                            accounts. The ability to cancel accounts may encourage participation by
                            giving individuals the ability to reverse their decision. At the same time,
                            individuals who cancel their accounts may be diminishing their eventual
                            retirement incomes, especially because of any penalties and forfeited
                            government contributions.

                            The flexibility of participation also varies according to how much latitude
                            participants have with the size of their contributions. Some individual
                            account plans allow participants to contribute at various rates while other
                            plans specify one contribution rate for everyone. Also, some plans set a


                            Page 9                              GAO-03-309 Social Security Voluntary Accounts
dollar limit on account contributions per year. In some cases, minimum
and maximum contributions primarily relate to eligibility for government
contributions or tax advantages. (See discussion of government
contributions and tax advantages below.) U.S. proposals have ranged
widely in the size of the contributions they would allow. Some proposals
set contribution rates at 2 percent of taxable earnings, while another
varies contribution rates by income level. Still another allows a range of
contributions up to $1,500. In the United Kingdom, one type of pension
account permits contributions of as little as $327 at various intervals and
limits contributions depending upon an individual’s circumstances. In the
Czech Republic, participants can contribute as little as $3 per month. In
Germany, participants will be able to contribute from 1 to 4 percent of
their annual salaries that is subject to social security tax. The flexibility of
contribution rates may encourage participation. Individual retirement
incomes will clearly depend on the contributions individuals actually
make.

In contrast to providing flexibility of participation, some plans use an
administrative process to facilitate participation. In both the United
Kingdom and the United States, employers can use automatic enrollment
to place employees in voluntary company pension plans as a default
option, while still allowing employees the choice not to enroll. According
to one U.K. provider association, companies with automatic enrollment
have employee participation rates around 90 percent compared with
70 to 80 percent for companies without it. Similarly, a U.S. study found
that after automatic enrollment provisions were enacted in 3 companies,
employee participation rates in 401(k) plans increased dramatically to
more than 85 percent.8

In addition, the size of administrative costs and who bears them could
influence participation decisions and retirement incomes. The costs of
administering individual accounts can be substantial, especially for small
accounts. If individuals directly bear such costs, the costs could
substantially diminish the account balances and the retirement incomes



7
 All currency values have been converted to U.S. dollars, using the following average
exchange rates for the month of January 2003: U.S.$1=£0.61882; U.S.$1=29.88 Czech koruna
(CZK); U.S.$1=€0.94203.
8
 Participation rates were initially 57 to 69 percent for employees that had over 3 years of
tenure. Participation rates were initially 26 to 43 percent for employees that had over 6
months of tenure but less than 3 years.




Page 10                                     GAO-03-309 Social Security Voluntary Accounts
                          received from them. In the United Kingdom, for example, administrative
                          costs for one type of individual pension account are deducted from the
                          accounts up front. According to one study, such costs have diminished the
                          account balances by 40 to 45 percent on average.9 However, under another
                          type of account, administrative charges are limited to 1 percent of the
                          account balance per year. In the United States, estimates of the
                          administrative costs for individual accounts have ranged from one-tenth of
                          a percent to 3 percent per year, depending on how the accounts are
                          administered.10 In addition to basic costs for administering the accounts,
                          individuals may also pay fees or penalties for a variety of activities,
                          including early withdrawal or termination, investment changes, and
                          purchasing annuities.

Government and Employer   Government and/or employer contributions can provide a major financial
Contributions             incentive for individuals to participate in accounts and are one of the most
                          powerful, according to some U.S. pension providers. To encourage
                          participation, many U.S. employers provide matching contributions,
                          including the federal government in its TSP for workers under the Federal
                          Employees Retirement System. Germany and the Czech Republic also
                          provide matching contributions to encourage participation. Such
                          contributions clearly increase account balances, which will generally
                          increase retirement incomes in turn. Such contributions can also be
                          designed to help redistribute income.11

                          In Germany, workers contributing a specified percent of their pay into an
                          individually arranged pension plan may receive a government




                          9
                           Mamta Murthi, J. Michael Orszag, and Peter R. Orszag. “Administrative Costs under a
                          Decentralized Approach to Individual Accounts: Lessons from the United Kingdom,” in
                          Robert Hollzman and Joseph E. Stiglitz, New Ideas About Old Age Security: Toward
                          Sustainable Pension Systems in the 21st Century. The World Bank (Washington, D.C.:
                          2001).
                          10
                           U.S. General Accounting Office, Social Security Reform: Administrative Costs for
                          Individual Accounts Depend on System Design, GAO/HEHS-99-131 (Washington, D.C.:
                          June 18, 1999).
                          11
                            Such account contributions are generally related to annual income rather than lifetime
                          income. As a result, they could go to people who turn out to have relatively high lifetime
                          incomes, such as students and people with irregular but not necessarily low annual
                          earnings. Under national defined benefit pension plans, redistribution is generally based on
                          lifetime incomes.




                          Page 11                                    GAO-03-309 Social Security Voluntary Accounts
                 contribution.12 This approach encourages participation in a way that
                 rewards lower earners proportionally more than higher earners. The
                 government also provides contributions to reflect marital status and the
                 number of children. Some individuals may participate in individual
                 account plans through their employers. Such plans do not receive direct
                 government contributions but do qualify for tax advantages. Employer
                 contributions to such accounts depend on the specific arrangements for
                 those plans.

                 The Czech Republic makes matching contributions to encourage
                 participation. For the lowest worker contribution allowed, participants
                 receive a 50-percent matching contribution. As contributions rise, the
                 matching rate gradually declines to 0.13 The Czech Republic also allows
                 employers to contribute to their workers’ accounts, although such
                 contributions do not receive government matches.

                 In the United States, some individual account proposals would provide for
                 government contributions, and some would redistribute income in the
                 process. The Clinton Administration’s Universal Savings Account proposal
                 would have provided account contributions only for those with incomes
                 below certain levels. Also, under one of the proposals of the Commission
                 to Strengthen Social Security (CSSS), account participants would
                 contribute 1 percent of taxable earnings to their accounts (in addition to
                 the 2.5 percent diverted from their payroll taxes), which the government
                 would subsidize with a refundable tax credit that phases out as participant
                 incomes rise.14

Tax Advantages   Favorable tax policies also provide incentives for individuals to participate
                 in voluntary accounts. In the United States, such tax advantages encourage



                 12
                  In 2008 and thereafter, Germans contributing a recommended 4 percent of their salary to
                 an individual account will receive a direct payment of $163. Those contributing less will
                 receive a smaller direct payment. Individual accounts are being implemented between 2002
                 and 2008. Individuals investing 1 percent of their annual salary as of 2002, 2 percent as of
                 2004, 3 percent as of 2006, and finally 4 percent as of 2008 will receive the respective
                 maximum government subsidy.
                 13
                   Note that in contrast to the German approach, the Czech matching schedule is not
                 progressive with respect to income, only with respect to contributions. In effect, the Czech
                 matches decline relative to contribution levels while the German matches decline relative
                 to income, which is not the same. See appendix II for more details on the Czech Republic’s
                 matching levels.
                 14
                  GAO-03-310.




                 Page 12                                    GAO-03-309 Social Security Voluntary Accounts
participation in employer-sponsored defined-contribution plans and IRAs.
Proposals to add individual accounts to Social Security would extend such
tax advantages to those accounts to varying degrees.

All three countries we studied also make some portion of the individual
account contributions tax exempt. In Germany, individuals are allowed to
deduct government subsidies along with personal contributions from their
income taxes.15 In the Czech Republic, contributions exceeding the
government matching level are tax-deductible up to a limit. Czech analysts
we interviewed explained that tax advantages are more attractive to higher
earners for whom the government contributions are relatively small. For
lower earners, who pay little or no tax, tax advantages offer little benefit.
They believe that offering both tax advantages and government
contributions provides a balanced approach that gives effective incentives
across a range of income levels.

Also, in contrast to government contributions, which actually increase
account balances, tax advantages generally have the effect of making
participant contributions cost less out-of-pocket. For example, individuals
making deductible IRA contributions will pay less income tax than if they
did not, and they do not have to deposit those income tax savings into the
IRAs.

Initially, to encourage workers to join individual account plans, the United
Kingdom offered additional tax incentives in the form of reduced social
security taxes. The government offered an “incentive bonus” which was an
additional rebate of 2 percent of payroll taxes from 1988 to 1993. A smaller
incentive bonus of 1 percent was offered from 1993 to 1996 to individuals
over age 30. The government also encouraged people to join individual
account plans by making a special, one-time offer when the law became
effective in July 1988. The government credited individuals’ accounts with
rebates, tax incentives, and incentive bonuses in a single lump sum for
both the years 1987 (retroactively) and 1988.




15
  Tax deductions may only be claimed up to a specified amount. In the assessment periods
2002 and 2003, individuals can deduct up to $557. In the assessment periods 2004 and 2005,
individuals can deduct up to $1,115. In the assessment period 2006 and 2007, individuals
can deduct up to $1,672. Finally, in the assessment period 2008 and thereafter annually,
individuals can deduct up to $2,229.




Page 13                                   GAO-03-309 Social Security Voluntary Accounts
Substitute and              Individual accounts that supplement national pension benefits affect
Supplemental Accounts       participation and retirement incomes differently than accounts that
Have Different Effects on   substitute for some portion of them. Participation in supplemental
                            accounts does not affect national pension benefits, and such accounts do
Participation and           not draw on revenues of that national system. As a result, supplemental
Retirement Incomes          accounts normally require additional out-of-pocket contributions from the
                            individual and thus a higher total contribution rate. The higher
                            contribution rate offers the prospect of higher retirement incomes than
                            participants would receive from the national pension alone. Both Germany
                            and the Czech Republic employ supplemental accounts.

                            In contrast, substitute accounts do draw on revenues of the national
                            pension system and have benefit offsets to adjust for contributions
                            diverted from that system. Typically, a substitute plan does not affect the
                            total contribution rate. Any potential for higher retirement incomes thus
                            results primarily from the opportunity to earn potentially higher returns on
                            plan contributions through investment in the private market. The United
                            Kingdom employs substitute accounts, though some of its accounts can
                            also be used as supplemental accounts.16 Some U.S. account proposals
                            employ substitute accounts, some employ supplemental accounts, and
                            some use a combination approach.

                            In deciding whether to participate in voluntary accounts, individuals may
                            be sensitive to whether the accounts supplement or substitute for the
                            national pension benefit and also to the amount of that benefit individuals
                            expect to receive. In the case of supplemental plans, their willingness to
                            make additional out-of-pocket contributions may depend on how adequate
                            they expect their retirement income to be without the account. In the case
                            of substitute accounts, their decision might depend more on the
                            investment returns on the accounts they expect to receive. In either case,
                            any reductions in the national pension benefit that are enacted (or
                            expected to be enacted) to maintain program solvency could also affect
                            their participation decision.


                            16
                              In the United Kingdom, for any or all years they work, workers can contract out of the
                            State Second Pension (S2P), which provides a defined-benefit retirement pension that is
                            related to earnings and years of service. When workers contract out to an individual
                            account, they receive a rebate to deposit into the account, which represents the value of
                            the benefits they give up, as calculated actuarially. In turn, any S2P benefit they ultimately
                            receive is calculated to reflect any periods in which they have opted out. Still, other
                            national benefits they receive, such as the Basic State Pension and disability benefits, are
                            not affected. The Basic State Pension is a flat-rate benefit paid to all retirees worth roughly
                            $122 per month in 2002.




                            Page 14                                     GAO-03-309 Social Security Voluntary Accounts
Benefit offsets under substitute accounts may have built-in incentive
effects that favor some individuals over others, and these effects and the
offsets generally may be confusing and poorly understood by the public. In
a substitute plan, retirement benefits would generally come partly from
the national pension benefit and partly from the account assets. Offsets
could be applied to the retirement benefits from either the national
pension or the accounts, and the incentive effects could depend on which
of the two is subject to the offset.

For example, if the offset reduced monthly Social Security benefits for life,
it might be calculated using life-expectancy assumptions for the
population at large. Individuals who do not live as long as assumed would
be subject to this benefit reduction for fewer years, so the offset could
cost them less, in effect, than those who live longer. In such a situation,
individuals who do not expect to live long in retirement, perhaps due to
known health issues or family histories, could have more to gain by
participating in the accounts than individuals who expect to live longer.

In contrast, hypothetically, if the benefit offset took a lump-sum at
retirement from the individuals’ account balances, all participants would
be subject to the full offset no matter how long they lived. For participants
purchasing an annuity, it would reduce the monthly annuity income they
could receive from their accounts. For everyone else, it would reduce the
account balances they could either spend during their remaining lifetimes
or leave to their heirs. Under this approach, monthly national pension
benefits would be unaffected. In this case, the lump-sum offset might also
be calculated using life-expectancy assumptions for the population at
large. Those individuals who live shorter than the assumed life expectancy
would be subject to the same total benefit offset as those who live longer
even though they would collect benefits over fewer years. In effect, this
lump-sum offset approach would transfer income from people who live
shorter lives to those who live longer lives, just as life annuities do.

If individuals accurately perceive any built-in incentives in the benefit
offsets, given their personal circumstances, and make their participation
decisions accordingly, then “adverse selection” could result, which occurs
when certain groups of individuals (for example, those with longer life
expectancies) are more (or less) likely to participate than others and when
such participation patterns result in a net cost to the government. (See
section on total cost effects below.)




Page 15                             GAO-03-309 Social Security Voluntary Accounts
Other Design Features   A range of other design features have the potential to affect whether
Could Also Affect       individuals participate in a voluntary account plan. Design features
Participation           relating to the accumulation and withdrawal phases could affect the
                        appeal of participation. In addition, complexity of individual account plans
                        might discourage participation while educational efforts might encourage
                        participation by helping participants understand and be more comfortable
                        with their decisions.

Investment Choices      Under both voluntary and mandatory approaches, individual account plans
                        have provisions regarding the range of investment choices participants
                        have. Such choices affect earnings on account balances during the
                        accumulation phase, and retirement incomes will depend on how
                        participants exercise those choices. However, under a voluntary approach,
                        the appeal of participating will depend on whether individuals are satisfied
                        with those options. Individuals might consider how high expected returns
                        are, how much risk is associated with those returns, and how much
                        flexibility they have to adjust their investment choices. Regulation of the
                        investment choices, as well as their design, affects the rates of return
                        individuals might receive and the risks they face. In the Czech Republic,
                        pension fund investments are strictly regulated in order to minimize risk;
                        accordingly, returns on those funds have been relatively modest. One
                        analyst we spoke with does not participate because the returns are too
                        low from his perspective, even after accounting for the government match
                        and tax advantages.

                        To address concerns individuals may have about risk, several individual
                        account plans offer guarantees that benefits will reach a certain level.
                        Under a voluntary approach, such guarantees are intended to encourage
                        participation by reducing risk to the individuals. However, even some
                        mandatory plans have offered guarantees. Guarantees can take a variety of
                        forms. For example, some proposals would guarantee that Social Security
                        beneficiaries would receive total benefits at least as high as those
                        promised under current law. Germany requires that account providers
                        return to participants on withdrawal an amount at least equal to the
                        contributions participants made to their accounts.

Tax Advantages          Under many individual account plans, investment earnings on account
                        balances are not taxed during the accumulation phase. Both the United
                        Kingdom and Germany allow most or all investment earnings to accrue to
                        the accounts tax-free. In the Czech Republic, investment earnings also
                        accrue tax-free for individuals; however, pension funds are required to pay
                        taxes on the investment earnings. In the United States, investment



                        Page 16                            GAO-03-309 Social Security Voluntary Accounts
                     earnings on retirement savings also generally accrue tax-free during the
                     accumulation phase.

                     Individual account plans also have provisions for tax treatment during the
                     withdrawal phase. In Germany and the United States,17 withdrawals from
                     individual accounts are fully taxable, but marginal tax rates are often
                     lower for individuals during retirement when their incomes are lower. In
                     the United Kingdom, part of an individual’s benefit can be paid as a tax-
                     free lump sum upon retirement or death.

Loans                Some individual account plans allow participants to take out loans from
                     their accounts before retirement, often for specified purposes such as
                     buying a home or educational or medical expenses. Such provisions
                     encourage participation by assuring participants that they can still use
                     their money if they really need it. However, loans can reduce retirement
                     incomes if they are not repaid, incur penalties, or miss out on periods of
                     high investment returns. According to our 1997 study, in 401(k) plans that
                     allow borrowing, participants contribute 35 percent more than those in
                     plans that do not.18 Also, the effects of account borrowing provisions on
                     retirement income may affect certain participants more than others.
                     Borrowers from 401(k) plans, on average, have less family income, lower
                     net worth, and more nonhousing debt than nonborrowers.

                     None of the countries we studied allow loans on accounts. The Czech
                     Republic allows participants to withdraw their own contributions after
                     1 year, though they cannot collect any government matches or subsidies.
                     In the United Kingdom, officials explained that doing so would not be
                     consistent with the purpose of government expenditures on the accounts,
                     which is to provide for retirement income. Additionally, one expert said
                     that the United Kingdom prohibits loans from individual accounts as a way
                     to preserve retirement income and keep individuals from claiming means-
                     tested benefits.

Withdrawal Options   Individual account plans can provide for withdrawals during retirement
                     through lump-sum distributions, annuities, and installment payments.



                     17
                       For one type of individual retirement account in the United States—the Roth IRA—
                     withdrawals are not taxed though contributions are not tax-deductible.
                     18
                      U.S. General Accounting Office, 401(k) Pension Plans: Loan Provisions Enhance
                     Participation But May Affect Income Security for Some, GAO/HEHS-98-5, (Washington,
                     D.C.: Oct. 1, 1997).




                     Page 17                                  GAO-03-309 Social Security Voluntary Accounts
Individual accounts that offer only one type of withdrawal option may
discourage participation among those interested in other withdrawal
options. In addition, plans typically set an age at which participants can
withdraw all their funds and apply penalties for any withdrawals before
that age. Such age provisions help ensure that the assets are preserved for
retirement. Neither the Czech Republic nor Germany allows full
withdrawal before age 60. In the United Kingdom, individuals may retire
early at age 50 (due to be raised to age 55) or due to ill health and start to
draw on their accounts at that time.

Lump-sum withdrawals give participants flexibility in using their accounts’
funds.19 However, lump-sum withdrawals also pose the risk that
participants might outlive those funds. Only the Czech Republic allows
participants the option to withdraw the entire voluntary account as a lump
sum. Still, lump-sum withdrawal can help avoid prohibitively high
administrative or annuity costs for relatively small accounts.

Lifetime annuities provide a guaranteed income for life and protect
individuals from the financial and longevity risks of outliving their assets.
However, annuity providers charge to assume that risk and cover their
administrative and other costs. In addition, “adverse selection” can occur
when consumers who expect to live a long time are more likely to
purchase an annuity than those who do not. As a result, annuity prices can
be as much as 14 percent higher than they would be if every retiree
purchased an annuity, according to one study.20

Making annuities mandatory could mitigate the effect of adverse selection.
It could also help ensure that account assets provide life-long income.
However, making annuities mandatory transfers income from those who
do not live very long to those who do. It could also discourage
participation in voluntary accounts, especially for those who do not expect
to live long, perhaps due to known health problems or family history.
Moreover, depending on the annuity provisions, prospective participants
may be concerned that they would be forced to annuitize at a time when



19
  In the case of U.S. employer-provided accounts, individuals can typically take their funds
if they leave a plan prior to retirement. While this provides pension portability, it also
creates the possibility that individuals will not preserve those lump sums for retirement.
20
 James M. Poterba and Mark J. Warshawsky, “The Costs of Annuitizing Retirement
Payouts from Individual Accounts,” (Cambridge, Mass.: National Bureau of Economic
Research, Jan. 1999).




Page 18                                    GAO-03-309 Social Security Voluntary Accounts
                        market conditions are unfavorable, either with respect to the value of the
                        account balance or prevailing annuity prices, which depend significantly
                        on interest rates.

                        Whether mandatory or not, annuities can have a variety of features that
                        may make them either more or less attractive and, as a result, influence
                        individual participation in the accounts. For example, a cash refund
                        feature such as death benefits might be incorporated to accommodate
                        those with an especially short life expectancy at retirement. Annuities
                        could also account for family risk by incorporating a survivor feature.

                        Some individual account plans, such as IRAs and some 401(k) plans, also
                        offer a phased withdrawal option, under which individuals receive
                        installment payments on a schedule that attempts to ensure that the funds
                        last until death. Such a phased withdrawal is not an annuity and does not
                        provide insurance because it leaves the financial and longevity risk with
                        the individual. Still, it would avoid the issue of adverse selection and some
                        of the costs and other issues associated with annuities, though phased
                        withdrawals also involve some administrative costs. Providing a phased
                        withdrawal option may encourage participation by those who would
                        object to mandatory annuitization.

                        Germany allows for different account draw-down options. One option is a
                        lifelong annuity. Another allows a draw down of assets until age 85 when
                        the participant would have to purchase a life annuity. The United Kingdom
                        requires annuitization of 75 percent of the voluntary account balance by
                        age 75. The other 25 percent may be taken in a lump-sum payment. Some
                        U.S. account proposals would require annuitization while others offer
                        more withdrawal options.

Complexity and Public   Under both voluntary and mandatory approaches, individual account plans
Education               can be very confusing to participants given the wide range of design
                        features and other considerations they face. However, under a voluntary
                        approach, such confusion may have the effect of reducing participation.
                        Moreover, voluntary plans may have additional sources of confusion and
                        complexity that do not arise in mandatory plans, such as how the
                        incentives work and, in the case of substitute accounts, how national
                        pension benefits are affected. Public education efforts can play a major
                        role in helping participants understand both voluntary and mandatory
                        individual account plans. However, their effectiveness can also influence
                        participation in voluntary plans. In all three countries we visited, officials
                        reported that individuals experienced substantial confusion over the
                        complexity of the individual account plans. Some experts in Germany


                        Page 19                             GAO-03-309 Social Security Voluntary Accounts
                          believe participation is lower than expected because the tax subsidies are
                          too complicated for the general public to understand. In all three
                          countries, officials underscored the importance of educational efforts.

Market and Demographic    Market factors can affect the investment returns individual accounts earn
Factors Can Also Affect   in both voluntary and mandatory plans. In voluntary plans, consumer
Participation             confidence in the market can also affect participation. For example, in
                          Florida, which recently added individual accounts to the state retirement
                          system, participation has been lower than expected with just 5 percent of
                          employees opting in.21 Officials cite the accounting scandals at a number of
                          major corporations, a slowing economy, and the generally weak condition
                          of the financial markets as possible reasons for the low participation.

                          Moreover, if the market offers attractive, alternative investment
                          opportunities, individuals may choose those instead of participating in the
                          accounts. For example, advanced financial markets, like that in the United
                          States, offer workers the ability to participate in employer-sponsored
                          pensions and IRAs. In the case of supplemental accounts, such alternatives
                          could compete for the workers’ contributions. In Germany, for example,
                          improvements in employer-sponsored pension plans may be responsible
                          for lower than expected participation in government-sponsored voluntary
                          accounts, according to government officials. In the Czech Republic,
                          “building savings” accounts that help individuals save for purchasing a
                          house may compete with the voluntary retirement accounts, especially
                          since they receive a more generous government subsidy. According to one
                          U.S. pension provider, it is difficult to predict whether new Social Security
                          accounts would diminish participation in employer-provided pension
                          accounts, even in the case of substitute accounts. The ability of individuals
                          to alter their savings and even consumption behavior in other areas when
                          they have Social Security accounts makes it especially difficult to predict
                          how such accounts will ultimately affect retirement incomes.

                          Demographic factors could play a role in investment choices for either
                          voluntary or mandatory accounts. Some groups such as lower income



                          21
                            Since June 1, 2002, approximately 160,000 Florida State employees were given the option
                          of participating in a new individual account plan. The first choice period was open from
                          July 1, 2002, to September 3, 2002. There will be three more choice periods when the
                          remaining employees can decide whether or not to participate in the plan. The government
                          initially predicted approximately 35 to 40 percent of state workers would participate in the
                          new accounts. However, later the government revised its estimates and predicted
                          approximately 17 to 24 percent would participate.




                          Page 20                                    GAO-03-309 Social Security Voluntary Accounts
                         groups and women appear to be more conservative in their investment
                         choices on average; over the long term, on average, such choices can
                         result in lower retirement incomes. At the same time, a lower tolerance for
                         risk may be quite understandable under their circumstances. Under a
                         voluntary approach, such characteristics could also correlate to
                         participation patterns. Participation patterns appear to vary by
                         demographic factors in other countries as well as in the U.S. private
                         pension market. In the United Kingdom, for example, individual accounts
                         were initially popular with younger workers and workers with higher
                         earnings. In the Czech Republic participation in individual accounts
                         steadily increases with age until age 60, and the average age of participants
                         is about 48 years, 10 years higher than the population average.

                         The design of individual account plans can attempt to compensate for the
                         effect of both market and demographic factors. In the case of market
                         factors, the investment choices and the companies who manage them can
                         be selected to promote consumer confidence. In the case of demographic
                         factors, government subsidies and other incentives and withdrawal
                         options can be designed with particular groups in mind. For example, the
                         German government developed individual accounts with subsidies
                         designed to benefit those with low or average income as well as families
                         with children. In the United Kingdom, older workers are given higher
                         payroll tax rebates than younger workers to encourage their participation
                         in the individual accounts.


                         Under a voluntary approach to individual accounts, a variety of design
Giving Choice of         features can have implications for the total costs to the government,
Participation Could      providers, employers, or participants. In some cases, giving choice can
                         involve additional administrative, incentive, regulatory, and educational
Affect Total Costs and   costs. In many cases, the uncertainty of participation rates in turn creates
Increase Uncertainty     uncertainty for total costs.22 Such costs include those associated with the
                         participation decision and contribution phase. In addition, plans using
                         substitute accounts pose transition costs and costs related to benefit
                         adjustments that do not arise with supplemental accounts. Also, costs



                         22
                          A mandatory approach to individual accounts can also involve a variety of costs that
                         depend on the plan’s design, even though participation rates are not at issue. See U.S.
                         General Accounting Office, Social Security Reform: Administrative Costs for Individual
                         Accounts Depend on System Design, GAO/HEHS-99-131 (Washington, D.C.: June 18, 1999)
                         and Social Security Reform: Implementation Issues for Individual Accounts,
                         GAO/HEHS-99-122 (Washington, D.C.: June 18, 1999).




                         Page 21                                  GAO-03-309 Social Security Voluntary Accounts
                                 associated with the accumulation and withdrawal phases of the account
                                 and interaction effects with other government programs might also
                                 depend on participation rates.


Participation Decisions          The participation decision available to individuals in voluntary plans
Create Unique Costs and          increases complexity and creates costs that do not arise in mandatory
Add Uncertainty                  plans. Such costs include tracking the participation decisions themselves,
                                 some startup costs, incentive costs, and education costs. The extent of
                                 such costs is uncertain because they depend partly on participation rates.

Costs Related to Participation   In voluntary individual account plans, tracking individuals’ participation
Decisions                        decisions requires administrative processes that do not arise in mandatory
                                 plans. Under a substitute plan, such tracking might also be needed for
                                 computing benefit offsets. The tracking process depends partly on how
                                 account contributions are collected and deposited into the accounts. If
                                 individuals have a one-time choice to participate, the tracking process
                                 could become even more critical. Using a centralized administrative
                                 structure could help address tracking and related issues. Moreover,
                                 centralized administration offers the opportunity for economies of scale.
                                 However, in a voluntary plan, low participation rates could diminish
                                 opportunities to take advantage of economies of scale that centralized
                                 administration could offer.

                                 All three countries we studied used a central government authority to
                                 handle account contributions. In the United Kingdom, voluntary account
                                 providers present the government revenue authority with a request for the
                                 account rebates. However, it takes about a year for rebated contributions
                                 to arrive to providers to allow for reconciliation. Officials described the
                                 delay as a price individuals pay for having the ability to opt out. In
                                 Germany, the tax authority largely manages government administration of
                                 the individual accounts via tax returns. In the Czech Republic, pension
                                 funds administer the accounts and reconcile funds with the Ministry of
                                 Finance to obtain the government matching contribution.

                                 Also, administrative costs are generally relatively higher for smaller
                                 accounts because of the fixed costs associated with maintaining accounts.
                                 As a result, account providers may have an incentive to focus marketing
                                 efforts on individuals who are likely to have higher account balances. On
                                 the other hand, one U.S. provider speculated that many low earning
                                 individuals would chose to not participate under a voluntary account
                                 approach, which would reduce the number of smaller accounts.



                                 Page 22                            GAO-03-309 Social Security Voluntary Accounts
                                 In addition to costs for administering the accounts on an ongoing basis,
                                 startup costs would be incurred for creating new systems for a variety of
                                 administrative functions, including recording individual investment
                                 decisions, collecting account contributions, transmitting contributions to
                                 investment managers, recording account value changes, and sending
                                 periodic statements. Under a voluntary approach, such functions would
                                 also include recording participation decisions. Some of these
                                 administrative functions would need to be developed before actual
                                 participation rates were known. Such costs would need to be paid for by
                                 the government, account providers, program participants, or some
                                 combination thereof, and the cost per participant would depend on
                                 participation rates.

Incentive Costs                  Many voluntary individual account plans include participation incentives,
                                 as noted earlier. Incentive costs can be significant, depending on their
                                 design and on participation rates. For example, Germany offers tax
                                 incentives and government subsidies to participants. Germany has
                                 allocated $10.6 billion for incentives through 2008, but actual costs will
                                 depend on participation.

                                 In the United Kingdom, soon after accounts were introduced in 1988,
                                 participation was much higher than predicted, and as a result so were
                                 incentive costs. An expert on the UK’s pension system asserts that the
                                 reasons for the high rates included overly generous rebates and tax
                                 incentives. In fact, in 1997, the UK Department of Social Security
                                 estimated that the net present value of savings resulting from opted-out
                                 voluntary individual accounts was $11.6 billion for the period from 1987-88
                                 to 1994-95. During the same period, contribution rebates and incentives
                                 paid to voluntary account participants totaled $35.1 billion at net present
                                 value. Thus, the total government revenue foregone as a result of opted-
                                 out voluntary individual accounts was about three times the expenditure
                                 savings.23 However, since 1997 the government has moved to a rebate that
                                 is estimated to equal the actuarial value of the forgone benefits.

Education Costs Related to the   Under a voluntary approach, individuals would face the decision of
Participation Decision           whether to participate, which they would not face under a mandatory


                                 23
                                  The ratio of expenditures to savings would be slightly higher if tax relief were included.
                                 For the years 1988-89 to 1995-96, the net present cost of income tax relief for contribution
                                 rebates to voluntary individual accounts amounted to $3.2 billion. For more information
                                 see Lillian Liu, “Retirement Income Security in the United Kingdom,” Social Security
                                 Bulletin, vol. 62, no. 1, 1999.




                                 Page 23                                    GAO-03-309 Social Security Voluntary Accounts
                          approach. Helping them make an informed decision would entail costs for
                          education, financial advice, and marketing efforts that would go beyond
                          what mandatory plans would require. Such efforts and their costs could be
                          the responsibility of the government, employers, account providers, or
                          individuals, depending on the plan’s design. If employers or account
                          providers were given the responsibility, the government might still incur
                          costs for regulating those efforts. All of the countries we studied
                          emphasized the need for significant educational efforts to explain the
                          voluntary system, but none identified any concrete expenditures.


Substitute Accounts Can   A voluntary plan using substitute accounts raises potential costs that do
Have Special              not arise with supplemental accounts and which depend on participation
Consequences for Total    rates. Such costs include costs associated with moving from pay-as-you-go
                          to advanced funding. Also, substitute accounts adjust benefits to reflect
Costs                     the diversion of social security contributions to individual accounts. Such
                          benefit adjustments can affect system costs, depending both on their
                          design and participation patterns.

Transition Costs          Under a substitute individual account plan, some Social Security
                          contributions would be diverted to the accounts. However, under Social
                          Security’s pay-as-you-go financing, some of those contributions would also
                          be needed to pay for current benefits. Making account deposits while also
                          meeting current benefit costs requires additional revenue, which we refer
                          to as “transition costs.”24

                          For example, according to one study, contribution rates to the national
                          pension system in the United Kingdom were an estimated 2.5 percent to
                          3.0 percent higher in 1999 to 2000 than they would need to be without
                          opted-out voluntary accounts.25




                          24
                            In the United States, the amount necessary to pay the benefits already accrued by current
                          workers and current beneficiaries is roughly $9 trillion, according to the Social Security
                          Administration. Under the CSSS proposals, transition costs would be funded through
                          general revenue transfers, which would be repaid in future years when decreasing benefit
                          costs fall below payroll tax revenues.
                          25
                           See Richard Disney, Carl Emmerson and Sarah Smith, “Pension Reform and Economic
                          Performance in Britain in the 1980s and 1990s.” Discussion paper available at:
                          http://www.nottingham.ac.uk/economics/staff/details/papers/PensionReformEconomicPerf
                          ormance.doc.




                          Page 24                                   GAO-03-309 Social Security Voluntary Accounts
                   While such transition costs would also arise under a mandatory approach,
                   they would vary with participation rates under a voluntary approach and,
                   therefore, would be smaller with less than 100 percent participation.
                   Under a supplemental account plan, transition costs would not be an issue
                   because no resources are diverted away from paying current benefits,
                   though such plans do require additional contributions.

Adjustment Costs   Substitute account plans adjust participants’ contributions or benefits in
                   some manner to reflect that they are replacing some portion of their
                   national pension benefit with an individual account. Under some U.S.
                   proposals, a specified percentage of Social Security contributions would
                   be deposited in the accounts, and a benefit offset would be calculated to
                   reflect those diverted contributions. In contrast, in the United Kingdom,
                   the account contributions, or “rebates,” are calculated to reflect the value
                   of the national pension benefit that participants forego. In either case, the
                   adjustment calculations can implicitly provide an incentive to participate,
                   as they did initially in the United Kingdom, as previously discussed. In
                   addition, the calculations depend on assumptions that, if incorrect, could
                   either cost the government or participants money, on average. Under
                   either situation, the costs arising from such adjustments depend on
                   participation. Moreover, under any benefit offset, the potential for adverse
                   selection exists, resulting in costs to the government. In short, the total
                   actuarial value of the benefit offsets could differ from the total value of the
                   diverted contributions, depending on the interaction of the benefit offset
                   design and participation patterns. In that case, a subsidy either from or to
                   the government could occur.

                   In the United States, some proposals would calculate the benefit offset as
                   the annuitized value of the diverted contributions, assuming they earned a
                   rate of interest specified by the proposal; in effect, the specified interest
                   rate is applied to a “hypothetical account.” For example, under the three
                   alternative options offered in 2001 by the President’s Commission on
                   Strengthening Social Security (CSSS), three distinct interest rates are
                   specified for the offsets, but only one rate would yield an offset with an
                   actuarial value equal to the diverted contributions, even assuming that
                   participation patterns are predicted with perfect accuracy. Implicitly, any
                   other rate would represent either a subsidy or cost to the government.
                   Under a voluntary approach, the total cost of (or revenue from) any such
                   subsidies depends on the level of participation.

                   The benefit offsets under the CSSS and similar proposals would also make
                   a variety of actuarial assumptions in converting the hypothetical account
                   balances into an annuitized monthly amount. Such assumptions include


                   Page 25                             GAO-03-309 Social Security Voluntary Accounts
                           mortality rates and the interest rates that insurers would use to set annuity
                           prices (in contrast to the interest the accounts earn during the
                           accumulation phase). To the extent that actual experience differs from
                           these assumptions, the offsets will be either higher or lower than they
                           would have been with perfect foresight, and there will be either a net loss
                           or gain to the government fund; such effects will depend on the level of
                           participation.

                           Still, even with perfect foresight of actuarial assumptions, the potential for
                           adverse selection exists. The characteristics of those who participate in
                           the accounts may not reflect the actuarial assumptions used in calculating
                           the offsets. For example, offset calculations might assume that men and
                           women participate at the same rate. If they do not, the rebates could pose
                           a net loss or gain to the government fund because women live longer than
                           men on average and therefore would collect benefits longer. Varying
                           participation patterns by earnings level and household type could also
                           result in adverse selection because U.S. Social Security benefits also
                           depend on these factors. In fact, according to a recent report by the
                           American Academy of Actuaries, adverse selection is inherent in any
                           system involving voluntary participation.26


Participation also Makes   Under either a voluntary or a mandatory approach, the total costs of an
Other Costs Uncertain      individual account plan include costs associated with the accumulation
                           and withdrawal phases of the accounts. During the accumulation phase,
                           they may include administration, investment management, investor
                           education, and tax deferrals. During the withdrawal phase, they may
                           include administration of account withdrawals or annuitization costs.
                           However, under a voluntary approach, participation rates can affect all
                           these costs. In particular, participation rates can affect economies of scale,
                           account size, the total cost of tax deferrals, and the contingent costs of
                           benefit guarantees.

                           Under either a voluntary or a mandatory approach, individual accounts
                           could also affect the costs of other government programs. For example, if
                           income from substitute accounts leaves particular individuals with less
                           retirement income than if they had not participated, some may qualify for
                           other government programs such as Supplemental Security Income in the



                           26
                             American Academy of Actuaries, “Social Security Reform: Voluntary or Mandatory
                           Individual Accounts.” September 2002 Issue Brief.




                           Page 26                                 GAO-03-309 Social Security Voluntary Accounts
                        case of the United States, which provides income supplements to aged,
                        blind, and disabled individuals with low incomes. On the other hand, to the
                        extent that the accounts increase retirement incomes, costs for such
                        programs may fall. Under a voluntary approach, such effects could depend
                        partly on the rate of participation.


                        Under a voluntary approach to individual accounts, individuals face a
Significant Education   complex participation decision in addition to the contribution, investment,
Efforts May Help        and withdrawal decisions they might face in a mandatory plan. Individuals
                        could benefit from both education and financial advice in making
Individuals Make        informed decisions, but the liability associated with providing advice can
Informed                be an obstacle to providing education. Still, public education campaigns
                        can offer a variety of tools to help with their decisions.
Participation
Decisions

Individuals Face        To make informed decisions about participating in voluntary accounts,
Complex Choices         individuals need to understand the social security system, the role of the
                        accounts, and how much income they will need in retirement. For
                        example, a German study shows that one of the reasons participation in
                        individual accounts has been lower than expected is because the public
                        believes they will have adequate income in retirement without the new
                        accounts.

                        Furthermore, to make informed participation decisions, individuals need
                        to understand who should participate in the accounts. Voluntary accounts
                        can be designed to provide benefits to a broad range of people or select
                        groups of people. In the United Kingdom, for example, voluntary accounts
                        were initially designed to allow individuals without access to employer-
                        sponsored pension plans the ability to opt out of part of the national
                        pension system. However, strong incentives encouraged workers who had
                        employer-sponsored pensions to leave their pension plan for an individual
                        account. As a result, workers often reduced their future retirement income
                        because they lost employer contributions in their employer plans.

                        Individuals should also understand the implications of individual accounts
                        that interact with national pension benefits. For example, in the United
                        Kingdom, individuals can opt out of part of the national social security
                        system to participate in an employer-sponsored pension plan or an
                        individual account. One government survey showed a quarter of public
                        and private sector workers did not know whether they were participating


                        Page 27                            GAO-03-309 Social Security Voluntary Accounts
in the national system or whether they were participating in an opted-out
plan. Furthermore, government research conducted in 1997 with a small
group of people showed that although the principle of opting out was
fairly well-known, they had difficulty understanding the implications.
Recently, the government in the United Kingdom announced a number of
initiatives designed to improve financial education and awareness.27 In the
United States, some proposals would reduce (or offset) an individual’s
Social Security benefit to reflect the diversion of program contributions
into an individual account. According to one expert, it could be difficult to
explain these Social Security benefit reductions to the public because the
offset calculations can be complex.

Individuals could also make more informed choices if they received
education about the effects of individual accounts on their family if they
become disabled or die. Under some U.S. proposals, benefit offsets would
reduce disability and/or survivors’ benefits as well as retirement benefits.
On the other hand, individual account balances could provide income in
cases of disability and death, though the balances may not be very large
for younger workers.

Individuals have varying levels of financial interest, which can further
complicate the educational efforts associated with a voluntary approach to
individual accounts. In particular, one survey in the United Kingdom
highlighted individuals’ lack of interest in financial matters, including
pensions. Overall, it found that 60 percent of respondents thought about
financial matters when it was absolutely necessary and that 10 percent
didn’t think about financial matters at all. The same survey also found that
older individuals have a more pronounced interest in financial matters
than younger individuals.

The Social Security program includes workers from all levels of income,
those who currently invest in equity and bond markets and those who do
not. It is unlikely that a “one size fits all” educational effort would be
appropriate for an individual account program. Investor education is
especially important for individuals who are unfamiliar with making
investment choices, including low-income and less well-educated
individuals who may have limited investing experience. Specifically, one


27
  In December 2002, the government announced a number of proposals to help individuals
access information about their retirement. These proposals include telephone and Web site
information services, interactive financial planning tools, interactive digital television,
retirement planning around life events, and an online retirement planner.




Page 28                                   GAO-03-309 Social Security Voluntary Accounts
                      provider said that different communication strategies should be developed
                      for low-income workers and high-income workers. Additionally, the
                      provider noted that a simple plan design with few investment choices
                      would make it easier to educate low-income workers, in particular.
                      According to another pension provider, the workers who have not
                      participated in employer-sponsored defined contribution pension plans
                      will need more education about individual accounts than those who have.
                      One pension professional said that inequality would exist in a voluntary
                      system if workers were unable to develop financial planning skills.


Financial Education   A critical tension exists between financial education and financial advice.
versus Advice         Government agencies, employers, account providers and others who
                      might provide financial education may be reluctant to do so because those
                      educational efforts might be construed as advice. Providers of advice can
                      be held responsible for the outcomes of decisions based on that advice.
                      Although this tension would arise under any approach to individual
                      accounts regarding individual investment decisions, it would arise under a
                      voluntary approach also regarding participation decisions. This distinction
                      becomes even more relevant in a substitute system where individuals give
                      up a portion of their Social Security benefit to participate in an individual
                      account. In this instance, a provider of advice could be held liable for
                      wrongly advising people to participate in an individual account when they
                      would have been better off by not doing so.

                      For example, in the United Kingdom, financial service industry
                      salespeople advised people to participate in individual accounts instead of
                      the social security system or employer-sponsored pensions, where many
                      of them would have been better off, given their particular circumstances.
                      As a result, the government ordered the financial service industry to
                      reimburse the individuals who were mis-sold individual accounts.

                      Governments often try to define the roles and responsibilities of those
                      who would educate and advise the public in individual account plans. In
                      the U.S. private pension market, the tension between investment
                      education and investment advice led the Department of Labor to issue
                      guidance to investment advisers and employers. In particular, the guidance
                      shows how advisers and employers can provide educational investment
                      information and analysis to participants without becoming a fiduciary




                      Page 29                             GAO-03-309 Social Security Voluntary Accounts
                            under the Employee Retirement Income Security Act.28 In the United
                            Kingdom, employers are allowed to provide individuals with education,
                            but not advice. However, employers are wary of providing education,
                            fearing it will be misinterpreted as advice. Additionally, many workers do
                            not seek financial advice because advisors are expensive. Similarly, in
                            Germany, employers are allowed to inform employees about individual
                            accounts; however, employers could be held liable if they provided
                            employees with bad information.


Public Education            Pension systems in the United States and other countries have used a
Campaigns Involve Variety   variety of educational tools to inform the public about pension options,
of Educational Tools        including electronic tools. For example, Florida recently gave state and
                            local employees the option of participating in the state’s defined benefit
                            pension plan or in an individual account. To educate employees about
                            participation decisions, Florida used a variety of communication mediums
                            that included printed materials, Web sites, workshops, and a toll-free
                            telephone line. Focus groups revealed that individuals had a strong
                            preference for printed materials. To accommodate that preference,
                            information kits were mailed directly to individuals’ homes.

                            Educating the public about a voluntary approach to individual accounts
                            would have associated costs. For example, in 2000, approximately
                            153 million people worked in employment or self-employment covered by
                            the Social Security program. The majority of these individuals paid Social
                            Security payroll taxes on their earnings. According to SSA staff,
                            information on changes to the program would most likely be sent to every
                            working individual through the mail. As we reported previously, SSA
                            estimated the minimum mailing cost would be $0.50 per letter, which
                            totals more than $70 million per mailing.29

                            Florida also experienced associated costs to educate workers about their
                            pension choices. For example, the state budgeted roughly $42 million over
                            2 fiscal years to educate 617,000 employees that worked for 800 separate
                            employers. The budget was designed to provide comprehensive education



                            28
                              The interpretive bulletin (29 C.F.R. 2509.96-1) by the Department of Labor provides
                            examples of educational investment information and analysis, including: plan information,
                            general financial and investment information, asset allocation models, and interactive
                            investment materials.
                            29
                             GAO/HEHS-99-131.




                            Page 30                                   GAO-03-309 Social Security Voluntary Accounts
                        through a variety of communication mediums. Additionally, the state
                        expects that a number of the education assets provided by the budget will
                        be in place for the long-term. Furthermore, the state points out that the
                        $23 million budgeted for education costs in the first fiscal year represents
                        0.10 percent of the annual payroll of Florida Retirement System employers
                        and 0.03 percent of the amount of assets invested in the system’s trust
                        fund.

                        A variety of tools can be used to inform individuals about participation
                        decisions. Other governments have used a number of tools, such as
                        customized statements, decisions trees, and financial education classes
                        and workshops to inform the public.

Customized Statements   Customized statements provide information on a personalized basis. In the
                        United States, an example of a customized statement is the Social Security
                        Statement. This statement is mailed annually to workers and provides
                        estimates of Social Security benefits based on their own earnings histories.
                        Florida also provides state and local employees with a customized
                        statement, known as a personalized Benefit Comparison Statement. The
                        statement compares projected benefits in the defined benefit plan with
                        benefits from the individual account, using one set of assumptions. The
                        statement is directly mailed to the employee’s home as part of a
                        Retirement Choice Kit. Furthermore, workers can use an Internet-based
                        service to forecast their future benefits under both plans, using a variety of
                        different assumptions. According to state experts, approximately
                        20 to 25 percent of employees used the Internet-based service to forecast
                        future benefits.30

                        The United Kingdom is also using customized statements to educate the
                        public about social security issues. For a number of years, the United
                        Kingdom has offered national pension forecasts upon request. These
                        forecasts show individuals what they can expect to receive in retirement
                        from their national pension. Recently, the government announced that it
                        plans to automatically provide national pension forecasts to the working-
                        age population. Additionally, the government is providing individuals with
                        a combined pension forecast that shows what they can expect to receive
                        in retirement from both their national pension and their employer-


                        30
                          Florida introduced individual accounts to state employees in different groups. In the first
                        group eligible to participate in individual accounts, 20 to 25 percent of employees used the
                        Internet-based service. At the time of our interview, the state did not yet have statistics on
                        the remaining groups.




                        Page 31                                     GAO-03-309 Social Security Voluntary Accounts
                        sponsored or private pension plan. Dissemination of the combined
                        pension forecasts will rely on the voluntary participation of employers and
                        pension providers.

Decision Trees          In the United Kingdom, individuals must decide whether they should
                        participate in the national social security system, their employer-
                        sponsored pension plan, or an individual account. The Financial Services
                        Agency publishes decision trees on its Web site.31 Decision trees in the
                        United Kingdom ask basic questions about pension arrangements to help
                        individuals make their own choices.

                        Government officials said that usually individuals need more
                        individualized attention than the decision trees can provide. Additionally,
                        the decision trees are not very helpful for individuals with little financial
                        planning skill. Some individuals may find the decision trees too
                        complicated to understand, especially given the United Kingdom’s
                        complicated pension system. While decision trees are designed to help
                        individuals make informed choices, they are not intended to provide
                        financial or professional advice. Further, the trees recommend that
                        individuals in need of additional assistance consult with their financial
                        advisor or pension provider.

Classes and Workshops   Classes and workshops provide ways to educate adults on financial
                        matters. In Florida, the state conducted 3,000 workshops to educate state
                        and local employees about their pension choices. A number of local
                        governments have required their employees to attend the workshops. The
                        workshops lasted approximately 2 hours and provided employees with the
                        opportunity to ask questions. The workshops were conducted by a
                        nationally known financial services firm and were well received by the
                        employees, according to state officials.

                        Some educational efforts have explored trying to promote financial
                        education in the schools and prepare students for future choices
                        concerning their retirement. For example, the United Kingdom introduced
                        personal financial education as a nonstatutory part of the national
                        curriculum in England. Additionally, Scotland, Wales, and Northern
                        Ireland are also developing ways to improve personal financial education.




                        31
                         www.fsa.gov.uk/pubs/public/stakeholder.pdf.




                        Page 32                                 GAO-03-309 Social Security Voluntary Accounts
               If policymakers decide to restructure Social Security to include individual
Concluding     accounts, making participation voluntary has significant implications for
Observations   designing the plan. Giving individuals the ability to participate or not is the
               most fundamental type of choice an individual account plan can offer.

               While offering the choice to participate may be desirable to some
               policymakers, doing so creates additional administrative tasks,
               substantially increases the complexity of an individual account plan, and
               potentially increases its total costs. The full range of design features found
               in individual account plans can influence whether people participate or
               not. In turn, design and participation can interact to have significant
               effects on both the individual retirement incomes people enjoy and the
               plan’s total costs, whether borne by the government, employers, providers,
               or participants. In particular, in any substitute voluntary account plan,
               care should be taken to anticipate and minimize the potential for adverse
               selection. As a result, policymakers would be wise to consider the design
               of a voluntary plan with careful attention to the effects on participation
               and its consequences. Moreover, as we have said in the past, reform
               proposals should be evaluated as packages that strike a balance among
               various objectives, including achieving sustainable solvency, balancing
               benefit adequacy and equity, and ensuring the feasibility of implementing
               and administering the reforms. While using a voluntary approach has the
               potential to cost more than a mandatory approach, such costs should be
               weighed as part of a total package that could contain offsetting savings.

               The role of incentives deserves particular attention in a voluntary plan.
               Early on, policymakers should make a deliberate decision about whether
               they intend to actively promote participation or simply to offer another
               retirement planning choice. Actively promoting participation generally
               requires offering costly incentives that should be weighed against the costs
               of other approaches to restoring Social Security’s long-term solvency. If
               incentives are offered, they will have the desired effect only if the public
               understands them.

               In addition, individuals will need education and advice to help them make
               their participation decisions as well as the many other decisions
               associated with their accounts. Otherwise, confusion about their decisions
               may discourage participation or lead them to choices that could make
               them worse off than if they did not participate. In particular, any plan
               should offer a variety of educational tools that allow individuals to
               examine their specific circumstances given their own level of financial
               knowledge and experience. Achieving a high degree of transparency in
               how the account plan works would help ensure that people make choices


               Page 33                             GAO-03-309 Social Security Voluntary Accounts
                     that are in their best interest. Also, clearly articulating the reason for
                     reform would promote system understanding and encourage participation.

                     If policymakers decide to create individual accounts as part of Social
                     Security, using a voluntary approach is a fundamental decision with
                     implications that flow through to many other design features. While the
                     decision is ultimately a policy choice, successful plans would require clear
                     objectives as well as design features that are consistent with those
                     objectives.


                     We provided SSA an opportunity to comment on a draft report of this
Agency Comments      report. The agency provided us with written comments, which appear in
and Our Evaluation   appendix IV. SSA also provided technical comments, which we have
                     incorporated where appropriate.


                     As arranged with your office, unless you publicly announce its contents
                     earlier, we plan no further distribution of this report until 30 days from its
                     issue date. At that time, we will send copies of this report to appropriate
                     congressional committees and other interested parties. Copies will also be
                     made available to others upon request. In addition, the report will be
                     available at no charge on GAO’s Web site at http://www.gao.gov. Please
                     contact me at (202) 512-7215, Charles Jeszeck at (202) 512-7036, or Ken
                     Stockbridge at (202) 512-7264, if you have any questions about this report.
                     Other major contributors include Charles Ford and Ali Bonebrake.

                     Sincerely yours,




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




                     Page 34                             GAO-03-309 Social Security Voluntary Accounts
                 Appendix I: Summary of the United Kingdom’s
Appendix I: Summary of the United
                 Retirement System



Kingdom’s Retirement System

                 In the United Kingdom, retirement income comes from a variety of
Description of   sources, which can be organized in three levels—base, earnings-related,
Current System   and additional. (See fig. 1.) The country’s social security system provides
                 both base level and earnings-related benefits.1 The base level consists of
                 the Basic State Pension (BSP) and means-tested benefits for pensioners
                 with low income. The earnings-related level consists of the government-
                 run State Second Pension (S2P) and opted-out arrangements. Workers can
                 choose to participate in S2P, employer pension plans, or individual
                 pension accounts. Individuals can also set aside additional private savings
                 for retirement on a voluntary basis. A variety of voluntary savings
                 instruments enjoy tax-relief to encourage workers to save for their
                 retirement.




                 1
                  In the United Kingdom, the term “social security” refers to a dual social insurance and
                 social assistance system that includes benefits for old-age, disability, survivors, sickness
                 and maternity, work injury, unemployment, and family allowances. In this appendix, the
                 term “social security” refers specifically to the government-run retirement income security
                 programs: the Basic State Pension and the State Second Pension.




                 Page 35                                    GAO-03-309 Social Security Voluntary Accounts
                            Appendix I: Summary of the United Kingdom’s
                            Retirement System




                            Figure 1: Overview of the United Kingdom’s Retirement Income Sources

                            Additional

                                                                              Private
                                                                             savingsa



                            Earnings-related                                        Personal        Stakeholder
                                                                    Employer-     Pensionsa,b,c,d   Pensionsa,b,c,d
                                                      State
                                                                   sponsored       (voluntary        (voluntary
                                                     Second
                                                                   DB and DC       individual        individual
                                                     Pension
                                                                   pensionsb,c     accounts)         accounts)


                            Base                                                              Means-
                                                              Basic
                                                                                               tested
                                                              State
                                                                                              benefits
                                                             Pension
                                                                                             ("Pension
                                                              (flat)
                                                                                              Credit")


                            Source: GAO.

                            Notes: “Base” income sources include flat-rate or means-tested government benefits. “Earnings-
                            related” income sources relate to earnings levels either through DB benefit formulas or DC
                            contribution levels. “Additional” income sources consist of voluntary individual savings that are not
                            directly related to earnings.
                            a
                             Some individuals may use personal or stakeholder pensions as additional rather than earnings-
                            related sources of retirement income.
                            b
                             Can either substitute for (when “contracted-out,” or opted-out, of) or supplement (when “contracted-
                            in,” or opted into) S2P benefits.
                            c
                                Individuals may also make additional contributions to these accounts.
                            d
                                Can either be arranged individually or through employer.



The Base Level: The Basic
State Pension and
Means-Tested Benefits
The Basic State Pension     The U.K. social security system began in 1908 with the enactment of the
                            Old-Age Pensions Act. At that time, the system provided flat-rate, means-
                            tested benefits for individuals over age 70. In the 1940s, economist Sir
                            William Beveridge advocated major changes to the country’s social
                            security system. In a report, he proposed a universal social security system
                            that would provide a minimum benefit to all individuals funded by worker
                            contributions. Eventually, the Beveridge report led to the passage of the
                            National Insurance Act of 1946, which created the basis for the current
                            social security program.



                            Page 36                                           GAO-03-309 Social Security Voluntary Accounts
                        Appendix I: Summary of the United Kingdom’s
                        Retirement System




                        BSP is the foundation of the country’s social security system. BSP benefits
                        are paid to over 10 million people, which is nearly 100 percent of the
                        country’s pensioners. BSP provides a flat benefit based on the number of
                        “qualifying years” that individuals contribute to the system. Individuals
                        make contributions to the BSP and a variety of other benefits through
                        payroll taxes known as National Insurance Contributions (NICs).2 To
                        receive full benefits, men are required to have 44 qualifying years;
                        whereas, the number of qualifying years for women will gradually increase
                        from 39 to 44 between 2010 and 2020. Individuals with fewer qualifying
                        years will receive less than the full benefit amount; however, they may be
                        able to earn credits towards the full BSP for periods of unemployment due
                        to caregiving, disability, and certain other circumstances.

                        Workers are eligible for BSP benefits at the normal retirement age, which
                        is 65 for men and will gradually increase from age 60 to age 65 for women
                        between 2010 and 2020. Currently, full BSP provides a benefit of $1223 per
                        week for a single person.4 Relative to average wages, the benefit provided
                        from BSP has declined since the 1980s. This decline in benefit levels,
                        relative to average wages, reflects a 1980 change to benefit indexing. Prior
                        to 1980, annual increases to BSP were linked to inflation or real wage
                        growth, whichever was higher, but after 1980 annual increases were linked
                        only to inflation. In December 2002, the government announced that it
                        would increase BSP benefits in future years by at least 2.5 percent per
                        year, even if this amount were larger than the increase in inflation.

Means-Tested Benefits

                        The Minimum Income Guarantee

                        The Minimum Income Guarantee (MIG) was introduced April 1999. It is a
                        means-tested entitlement that provides extra financial support to poor
                        pensioners. MIG is available to pensioners who are aged 60 and older,




                        2
                         Individuals earning more than $7,458 a year (in 2002/03) are required to pay NICs towards
                        the BSP. However, individuals earning between $6,302 and $7,458 a year (in 2002/03) can
                        still build entitlement to the BSP even though they do not pay NICs.
                        3
                         In this appendix, all British pounds are converted into U.S. dollars using a conversion of
                        0.61882 British pounds per U.S. dollar. This figure represents the monthly conversion
                        average in January 2003.
                        4
                        Beginning in April 2003, the full BSP will increase to $125 a week for a single pensioner.




                        Page 37                                    GAO-03-309 Social Security Voluntary Accounts
Appendix I: Summary of the United Kingdom’s
Retirement System




have savings under $19,392, and work less than 16 hours per week (or less
than 24 hours per week if they have a partner).

MIG provides poor pensioners with a minimum income that is higher than
BSP. Currently, poor pensioners can receive weekly MIG entitlements that
top up their income to $159 for a single person or $242 for a couple.5
Individuals receive different MIG entitlement amounts, based on whether
they have a full- or reduced-rate BSP, their amount of savings, and their
income. Additionally, individuals can receive higher weekly MIG
entitlements for certain circumstances, including disability and caregiving.

Some experts were concerned that MIG provides poor pensioners with a
disincentive to work and save money for retirement. This is because MIG
entitlement amount is reduced £1 per £1 based on income an individual
receives from an occupational, personal, or stakeholder pension. Under
MIG, some pensioners with modest savings would be no better off than
pensioners without any savings. This concern, among others, led the
government to reform MIG with the Pension Credit, which will be
introduced in 2003.

The Pension Credit

In response to concerns regarding MIG, in October 2003 the Pension
Credit will become the major form of means-tested social assistance to
individuals with modest incomes over the national pension age. The
Department for Work and Pensions (DWP) believes that the Pension
Credit will reward pensioners for their retirement savings efforts. DWP
estimates that over 5.3 million pensioners (about half of all pensioner
households) will be better off from the introduction of the Pension Credit.
The government expects that the Pension Credit will entitle nearly half of
all pensioner households to gain an average of $646 a year.

The Pension Credit consists of two elements: (1) a guarantee credit and
(2) a savings credit. The guarantee credit tops up the income for a single
pensioner to $165 a week and for a pensioner couple to $252 a week.6 The



5
 In April 2003, the MIG will increase so that poor pensioners can receive weekly
entitlements that top up their income to $165 for a single person or $252 for a couple.
6
 The guarantee credit links benefit increases to changes in wages; whereas, BSP links
benefit increases to changes in prices. As a result of the differences in benefit indexation, it
is likely that in the future more pensioners will be entitled to means-tested benefits.




Page 38                                     GAO-03-309 Social Security Voluntary Accounts
                          Appendix I: Summary of the United Kingdom’s
                          Retirement System




                          savings credit provides a “reward” element, so that those with savings,
                          second pensions, or earnings that fall between the amount of BSP and
                          $218 a week ($323 for couples) will receive a credit.7 The savings credit is
                          designed to taper away as an individual’s income rises. For example,
                          income between BSP and the guarantee credit is entitled to a 60-percent
                          savings credit, whereas, additional income (up to $218 a week) is entitled
                          to a 40-percent savings credit.


The Earnings-Related      To provide more adequate retirement income, the U.K. government
Level: The State Second   created the second tier to the national pension system in 1959. This tier
Pension and Contracted-   was a supplemental earnings-related plan called the graduated pension.
                          The government allowed employers to “contract out” their employees, that
Out Arrangements          is, opt them out, of the national graduated pension plan if they offered
                          comparable benefits in occupational pensions. The U.K. history with
                          contracting-out continued with the Social Security Pensions Act of 1975.
                          This act created the State Earnings-Related Pension Scheme (SERPS) to
                          provide more substantial benefits and to further help those without
                          employer pensions. In 1986, SERPS was further reformed to provide
                          workers themselves with the option of contracting out of SERPS for
                          participation in an employer-sponsored, defined contribution plan or a
                          personal pension.

                          In July 2000, the U.K. government enacted reforms that called for replacing
                          SERPS with S2P. In April 2002, the government implemented S2P to
                          provide a more generous national pension plan than SERPS would have
                          provided to individuals with low and moderate incomes. In addition, S2P
                          provides more generous benefits to individuals caring for young children
                          or a disabled person and individuals with long-term disabilities who have
                          intermittent work records.

                          Although workers are required to participate in the second tier of the U.K.
                          social security system, they have a range of participation choices. For
                          example, workers can either participate in S2P, their employer’s pension
                          plan, a personal pension, or a stakeholder pension. Additionally, workers
                          can choose to participate in S2P while simultaneously participating in
                          their employer’s pension plan and a personal pension or stakeholder
                          pension plan.



                          7
                           In 2003, the maximum credit payable is $22 a week for single pensioners and $30 a week
                          for pensioner couples.




                          Page 39                                  GAO-03-309 Social Security Voluntary Accounts
                       Appendix I: Summary of the United Kingdom’s
                       Retirement System




State Second Pension   On April 6, 2002, the government introduced S2P to replace SERPS, the
                       second tier national social security system that existed from 1978 to 2002.
                       While SERPS provided individuals with earnings related benefits, S2P
                       provides more generous redistributive benefits targeted to low earners,
                       disabled individuals, and caregivers. The government intends to convert
                       S2P into a flat rate benefit once stakeholder pensions have become
                       established. It is the belief of the government that stakeholder pensions
                       will provide an incentive for moderate earners to opt out of the national
                       system.

                       S2P provides individuals earning up to $39,753 annually (in 2002/03 terms)
                       a larger pension than they would have received under SERPS. Individuals
                       build entitlements to S2P by earning at least $6,302 in income per year.8 In
                       2002/03, individuals earning more than $6,302 but less than $17,453
                       annually will be treated for S2P purposes as if they had earned $17,453.
                       Low and low-to-middle income individuals are also better off in S2P
                       because the accrual rate (the rate at which the pension builds up) is more
                       generous than it was in SERPS.9

                       Similar to BSP, contributions are made to S2P through payroll taxes
                       (NICs). Currently, employees who remain in S2P pay NICs on 10 percent
                       of weekly earnings between the primary threshold ($144) and the upper
                       earnings limit ($945). Employers are also required to pay NICs on
                       11.8 percent of earnings above $144 per week.10 Also, like BSP, individuals
                       can build entitlements to S2P during periods when they cannot work due
                       to long-term illness or disability or when they are providing certain types
                       of care. These individuals will be able to build up about a $1.62 per week
                       in S2P for each year they are eligible.

                       When S2P was introduced in 2002, the government estimated that
                       approximately 18 million people would begin accruing entitlements from
                       the program. Individuals accruing entitlements from S2P include
                       4.5 million low earners (less than $15,352 a year), 9.5 million moderate



                       8
                       In 2002/03, the lower earnings limit was $6,302.
                       9
                        SERPS had a 20-percent accrual rate; whereas, S2P has three different accrual rates
                       related to annual earnings.
                       10
                        From April 2003, NIC rates will increase by 1 percent for employers and employees on
                       earnings above a threshold. Employees will also pay 1 percent of earnings above the
                       earnings limit, and the earnings limit will be raised in line with inflation.




                       Page 40                                   GAO-03-309 Social Security Voluntary Accounts
                              Appendix I: Summary of the United Kingdom’s
                              Retirement System




                              earners (between $15,352 and $34,905), 2 million caregivers, and 2 million
                              individuals with long-term disabilities.

Contracted-Out Arrangements   Individuals may choose to contract out of S2P to participate in employer
                              pensions, personal pensions or stakeholder pensions. However,
                              individuals may also choose to participate in these arrangements while
                              remaining in the national system. Those choosing to contract out of the
                              national system will either pay reduced NICs or will receive government
                              rebates. In particular, individuals choosing to participate in an employer-
                              sponsored pension plans pay reduced NICs on a portion of their weekly
                              earnings.11 Whereas, those participating in personal pensions and
                              stakeholder pensions pay full-rate NICs but receive a rebate from the
                              government paid directly into their private pension account. Individuals
                              participating in an employer-sponsored defined contribution pension plan
                              will receive a rebate from the government in addition to paying reduced
                              NICs. The amount of rebate an individual receives depends on their age
                              and the amount of their earnings. The age-related rebate allows individuals
                              to receive a larger rebate amount as they grow older. For personal
                              pensions and stakeholder pensions, there is currently a 1-year delay
                              between when NICs are paid and when the rebates are paid to the pension
                              provider. However, rebates may be paid more quickly to individuals
                              participating in an employer-sponsored defined contribution plan.

                              Employer Pension Plans

                              There is no statutory obligation for employers to establish, or for
                              employees to join, employer-sponsored pension plans. Rather, it is up to
                              the employer (or group of employers) to establish the pension plan and
                              decide upon the rules and benefits of the plan. Approximately 50 percent
                              of the working population is covered by an employer-sponsored pension.

                              Many employers offer defined benefit or defined contribution pension
                              plans. A defined benefit plan promises to provide a benefit that is generally
                              based on an employee’s salary and years of service. Whereas, a defined
                              contribution plan provides a benefit based on the contributions to and
                              investment returns (gains and losses) on individual accounts. Similar to




                              11
                               Currently, employees that contract out of S2P to participate in an employer-sponsored
                              pension receive a flat rate reduction of NICs at a rate of 1.6 percent. Similarly, employers
                              also receive a flat rate reduction of NICs ranging from 1 percent to 3.5 percent.




                              Page 41                                     GAO-03-309 Social Security Voluntary Accounts
Appendix I: Summary of the United Kingdom’s
Retirement System




the United States, a number of employers in the United Kingdom have
begun offering defined contribution plans instead of defined benefit plans.

Personal Pensions

Personal pensions are tax-deferred, defined-contribution individual
pension accounts that were created by the 1986 Social Security Act and
implemented in 1988. The original purpose of personal pensions was to
allow individuals without access to employer-sponsored pensions the
ability to contract out of the second tier government-run social security
system. A variety of financial service providers, such as, banks, mortgage
companies, investment trusts, and other financial institutions offer
personal pensions. Individuals are subject to contribution limits depending
upon certain circumstances. For example, those participating in an
employer-sponsored plan or those with nontaxable or minimal earnings
can contribute up to $5,818 in a personal pension each year. Otherwise,
individuals can contribute up to a certain percentage of their taxable
earnings. The maximum percentage individuals can contribute increases
with age. These contributions can be made by the individual, the
employer, and from tax relief received from Inland Revenue.

Administrative charges vary based on the type of personal pension an
individual chooses. Additionally, the government provides few regulations
concerning the administrative costs and fees that personal pension
providers can charge. In personal pension plans, providers can front-load
the administrative charges, thereby charging a high amount of fees in the
beginning stage of an individual account. These charges can consume a
substantial amount of an account balance, particularly for individuals that
may not have the means to make sizeable contributions or cannot make
contributions for a prolonged period of time. For example, one study
found that on average, various administrative costs in the United Kingdom
have historically consumed between 40 and 45 percent of an individual
account’s value.12

When personal pensions were first introduced, hundreds of thousands of
individuals were convinced to opt out of their employer-sponsored


12
 Mamta Murthi, J. Michael Orszag, and Peter R. Orszag. “Administrative Costs under a
Decentralized Approach to Individual Accounts: Lessons from the United Kingdom,” in
Robert Hollzman and Joseph E. Stiglitz, New Ideas About Old Age Security: Toward
Sustainable Pension Systems in the 21st Century. The World Bank (Washington, D.C.:
2001).




Page 42                                 GAO-03-309 Social Security Voluntary Accounts
    Appendix I: Summary of the United Kingdom’s
    Retirement System




    pension into a personal pension when it was disadvantageous to them.
    These individuals found themselves with lower benefits than they would
    have had if they remained in their employer-sponsored pensions. This
    became known as the “mis-selling scandal.” The insurance industry was
    held responsible and required to compensate individuals that were mis-
    sold pension products. It is expected that payments in compensation to
    those mis-sold pension products will reach $19.4 billion.

    Stakeholder Pensions

    According to U.K. experts, stakeholder pensions were created to address
    the tarnished image of personal pensions after the mis-selling scandal.
    Stakeholder pensions were introduced in April 2001 and provide additional
    pension coverage to the self-employed and to employees with low to
    moderate incomes.13 Like personal pensions, stakeholder pensions provide
    individuals with the option of contracting out of the national second tier
    social security system to participate in the tax-relieved defined
    contribution individual pension accounts.

    Stakeholder pensions were designed to meet a number of standards
    concerning administrative costs, flexibility, and security. Specifically,
    stakeholder pensions differ from personal pensions in the following ways:

•   Administrative charges are capped at 1 percent of the account’s total
    value.

•   Individuals are not penalized for breaks in contributions or for transferring
    to another pension plan.

•   Individuals can contribute as little as $32, which can be paid weekly,
    monthly, or at less regular intervals.

•   Trustees and stakeholder managers are required to make investment
    decisions for individuals that do not want to make such decisions.

    Employers that do not provide an employee pension plan and have five or
    more employees are required to provide their employees with access to a
    stakeholder pension. However, employers are not required to make any


    13
     Stakeholder pensions are targeted to approximately 3.1 million employees who do not
    have pension coverage and earn between $16,160 and $32,320 per year. Stakeholder
    pensions are also targeted to about 1.5 million self-employed individuals.




    Page 43                                 GAO-03-309 Social Security Voluntary Accounts
                        Appendix I: Summary of the United Kingdom’s
                        Retirement System




                        contributions to the stakeholder pension. Stakeholder pensions are
                        subject to the same contribution limits as personal pensions. These
                        contributions can be made by the individual, the employer, and from tax
                        relief received from Inland Revenue.


The Additional Level:   The additional level to the U.K. pension system consists of individual
Individual Voluntary    forms of voluntary savings. For example, individuals can make additional
Savings                 voluntary contributions into their employer-sponsored pension plan.
                        Individuals can also save money for retirement by participating in a
                        personal or stakeholder pension while they are simultaneously
                        participating in S2P or an employer-sponsored pension. Individuals can
                        receive tax relief for these additional contributions, up to a ceiling.
                        Furthermore, individuals can also choose to make contributions to a
                        variety of other tax-relieved instruments, such as, annuities and life
                        insurance.


                        Voluntary individual accounts represent an integral part of the retirement
Key Design Features     system in the Untied Kingdom. Table 2 describes the key design features
of Voluntary            of voluntary individual accounts in four areas: (1) the interaction with
                        national pension benefits, (2) the contribution phase, (3) the accumulation
Individual Accounts     phase, and (4) the withdrawal phase.
in the United
Kingdom




                        Page 44                                 GAO-03-309 Social Security Voluntary Accounts
                                            Appendix I: Summary of the United Kingdom’s
                                            Retirement System




Table 2: Key Design Features of Voluntary Individual Accounts in the United Kingdom

 Interaction with national pension benefits (social security)
 Substitute or supplement              The United Kingdom has a system of substitute accounts. This is because individuals give
                                       up their benefits from S2P when they are participating in a voluntary individual account that
                                       qualifies for either a reduction payroll taxes or a government rebate.
 Contribution phase
 Who can participate                   Anyone who is eligible to participate in S2P can choose to opt out of S2P to participate in an
                                       individual account. (Individuals earning at least $6,302 a year—the lower earnings limit in
                                       2002/03—are eligible to participate in S2P.)
 Opt-in/opt-out ability                Individuals can decide to opt in and opt out of accounts at any time.
 How much individuals can contribute   Individuals are subject to contribution limits depending upon certain circumstances. For
                                       example, those participating in an employer-sponsored plan or those with nontaxable or
                                       minimal earnings can contribute up to $5,818 in a personal pension each year. Otherwise,
                                       individuals can contribute up to a certain percentage of their taxable earnings. The
                                       maximum percentage individuals can contribute increases with age.
 Government or employer contributions Once a year, the government contributes a rebate into individual account plans known as
                                       personal pensions and stakeholder pensions. The amount of the rebate an individual
                                       receive depends on their age and the amount of their earnings. Employers are not required
                                       to make contributions to their employees’ individual accounts.
 Automatic enrollment                  Employers can automatically enroll their employees into an employer-sponsored pension
                                       plan. However, employees have the right not to participate in such a plan.
 Tax advantages                        Individuals and employers receive tax relief for the contributions they make to individual
                                       accounts. Additionally, individuals are not taxed on any contributions that employers may
                                       make to their account.
 Accumulation phase
 Regulation of investment options      Financial service companies offer individual account investment options that provide varying
                                       degrees of risk.
 Regulation of administrative charges  One type of individual account, the stakeholder pension, limits the administrative charges to
                                       1 percent of the value of the account each year. Whereas, another type of individual
                                       account, provides few regulations regarding administrative charges.
 Tax advantages                        Individual accounts are exempt from the tax on capital gains and most of the investment
                                       returns accruing to the account are also tax exempt.
 Withdrawal phase
 Preretirement loans                   Individuals cannot take preretirement loans from their individual accounts.
 Withdrawal options—annuity,           Between the ages of 60 and 75, individuals must annuitize the portion of their account that
 installment payments, and lump-sum    was funded by tax rebates. Individuals have more flexibility with the portion of the account
 distributions                         funded by their additional contributions. They are still required to purchase an annuity
                                       between the ages of 50 and 75. However, they can choose to take up to 25 percent of the
                                       account balance as a lump sum provided that they purchase an annuity or take income
                                       withdrawals at the same time.
 Rate of return or minimum benefit     Individual accounts are not required to provide specified rates of return or minimum benefit
 guarantees                            guarantees.
 Tax advantages                        Individuals can receive some benefits from an individual account free of income tax.
                                       Specifically, the benefits an individual receives as a lump sum are not subject to income tax.
Source: GAO.




                                            Page 45                                   GAO-03-309 Social Security Voluntary Accounts
                       Appendix II: Summary of the Czech Republic’s
Appendix II: Summary of the Czech
                       Retirement System



Republic’s Retirement System

                       The Czech Republic has a pay-as-you-go social security system with old-
                       age benefits that provide individuals with base-level and earnings-related
                       benefits in retirement. (See fig. 2.) The base benefit consists of a basic,
                       flat-rate amount and an earnings related pension. Additional retirement
                       income comes from voluntary accounts. These voluntary accounts are
                       fully funded and encourage participation through government matching,
                       tax-deferred interest accruals, and tax preferred participant and employer
                       contributions.

                       Figure 2: Overview of Czech Retirement Income Sources

                       Additional
                                                    Supplementary                    Private
                                                  Pension Insurance                  savings
                                                 (voluntary accounts)             (annuities, life
                                                                                 insurance, etc.)


                       Earnings-related



                                                                    Earnings-
                                                                 related benefit

                       Base                                          Flat-rate
                                                                      benefit

                                                                 Social Security
                                                                Old - Age Benefit


                       Source: GAO.

                       Notes: “Base” income sources include flat-rate or means-tested government benefits. “Earnings-
                       related” income sources relate to earnings levels either through DB benefit formulas or DC
                       contribution levels. “Additional” income sources consist of voluntary individual savings that are not
                       directly related to earnings.



Description of
Current System

The National Old-Age   The Czech Republic first introduced laws relating to old-age, disability and
Pension                death benefits in 1906. The current system described below was enacted in
                       1995. The national pension system covers all employees, members of
                       assimilated groups, including certain groups of students, farmers, artists,
                       the unemployed, caregivers, military personnel, and the self-employed.
                       Employees, employers, and the government all contribute to the system’s



                       Page 46                                          GAO-03-309 Social Security Voluntary Accounts
Appendix II: Summary of the Czech Republic’s
Retirement System




funding. Employees pay taxes of 6.5 percent of earnings, employers pay
19.5 percent of payroll, and the government pays for any cash flow deficits
incurred by the system.1 To qualify for old-age benefits, one must have
25 years of insurance coverage2 and be within 3 years of retirement age.
The current retirement age is 61 years and 4 months for men. For women
the retirement age is between age 55 and 8 months or age 59 and
8 months.3 The retirement age will continue to increase by 2 months per
year for men and 4 months per year for women until they reach their target
level in 2007 of age 62 for men and age 57 to 61 for women. The expected
old-age replacement rate is on average 53 percent. However the
replacement rate varies across earnings levels as it falls from 81 percent
for those with the lowest wage to less than 30 percent for those with
double the average wage.

The old-age benefit is composed of a basic benefit and an earnings-related
benefit. The basic benefit is a flat-rate benefit that is currently $43.84 per
month.4 The second part of a participant’s national pension consists of an
earnings-related pension. The earnings included are indexed earnings, that
is, earnings are adjusted to reflect the average wage.5 Monthly earnings of
up to $247.62 receive 100 percent inclusion into the earnings calculation.
Monthly earnings amounts between $247.62 and $598.98 receive 30 percent
inclusion. Monthly earnings amounts over $598.98 receive 10 percent
inclusion into the earnings calculation. The earnings-related benefit is
derived from a calculation base that varies by type of pension. For old-age
(and full disability) pensions, 1.5 percent of the calculation base is


1
 Currently the income rate is 26 percent of payroll and the cost rate is about 28 percent of
payroll with the government contributing the difference.
2
One qualifies with 15 years of insurance if aged 65.
3
 The reason for this variation is that women are given allowances for the number of
children they raise. The current retirement ages are up from the retirement ages in 1995 of
60 for men and 53 or 57 for women.
4
 Under law, the government is authorized to increase this basic benefit. All Czech koruna
(CZK) are converted into U.S. dollars using a conversion of 29.88 CZK per U.S. dollar. This
figure represents the monthly conversion average in January 2003. The $43.84 amount per
month, converted to a yearly amount, equals only about 1.5 percent of 2001 per capita gross
domestic product (GDP) in the United States ($35,000 in 2001). However, the same benefit
amount equals about 9.6 percent of 2001 per capita GDP ($5,500 in 2001) in the Czech
Republic. In part, this comparison reflects that about $120 worth of goods in the United
States would be roughly equivalent to $43.84 worth of goods (or 2.7 times as much) in the
Czech Republic (on a purchasing power parity basis).
5
The annual coefficients determined by the Czech Statistical Office.




Page 47                                    GAO-03-309 Social Security Voluntary Accounts
                        Appendix II: Summary of the Czech Republic’s
                        Retirement System




                        multiplied by the number of insured years. The minimum earnings-related
                        pension is $25.77 per month, which combines with the base pension for a
                        total minimum of $69.60 per month. The average old-age benefit in 2002
                        was $228.92 per month. Old-age benefits at or above $4,015.49 a year are
                        subject to income taxation.

                        In addition to old-age benefits the Czech system provides for full disability,
                        partial disability, survivors, widows or widowers, and orphans. Partial
                        disability benefits are paid using the same flat benefit of $43.84 per month
                        and using half of the accrual rate (0.75 percent of the base multiplied by
                        the number of insured years). Widows and widowers receive that flat
                        benefit of $43.84 plus half of the deceased spouses earnings related
                        pension. This benefit is paid at any age for one year immediately following
                        the loss of the spouse, and thereafter paid to widows age 55 or older and
                        widowers age 58 or older. Benefits are payable at any age if the widow or
                        widowers is disabled, caring for dependent or disabled child or for
                        disabled parent.


Additional Retirement   In 1994 the Czech Republic introduced supplementary pension insurance.6
Sources: Voluntary      The supplementary pension insurance system is not integrated with the
Supplementary Pension   government-provided base or earnings related old-age benefits. The
                        system is characterized by voluntary participation and is largely
Insurance               administered by private pension funds with government supervision
                        performed by the Czech Ministry of Finance and the Czech Securities
                        Commission. Participants may contribute as little as $3.34 per month. For
                        participant contributions in the $3.34 to $16.73 per month range, the
                        government contributes a match related to the amount contributed by the
                        participant. (See table 3.) Contributions between $200.77 and $602.32 per
                        year are tax deductible. Participants may contribute more than $602.32
                        per year, but they do not receive any additional government contributions
                        or tax advantages.




                        6
                         To review the act enabling the creation of supplementary pension insurance in English
                        visit http://www.mpsv.cz/files/clanky/1140/No_42_1994.pdf.




                        Page 48                                   GAO-03-309 Social Security Voluntary Accounts
                                                                Appendix II: Summary of the Czech Republic’s
                                                                Retirement System




Table 3: Schedule of Government Matching Contributions for Czech Voluntary Supplementary Insurance

 Amounts shown in U.S. dollars
 Planholder’s monthly contribution                                                                Government contribution
 $3.34 to $6.66                                                                                   $1.67 + 40% of the amount over $3.34
 $6.69 – $10.01                                                                                   $3.01 + 30% of the amount over $6.69
 $10.04 – $13.35                                                                                  $4.02 + 20% of the amount over $10.04
 $13.38 – $16.70                                                                                  $4.68 + 10% of the amount over $13.38
 $16.73 and more                                                                                  $5.02
Source: State-Contributory Supplementary Pension Insurance Act (http://www.mpsv.cz/files/clanky/1140/No_42_1994.pdf).

                                                                Note: Contribution amounts are not continuous as they reflect whole Czech koruna amounts
                                                                (approximately $0.03). Amounts converted by GAO using a conversion rate of 29.88 CZK per
                                                                U.S. dollar.


                                                                The supplementary system has 2.5 million participants that account for
                                                                roughly 25 percent of the population and 50 percent of the labor force. In
                                                                2001 the average contribution was $11.54 per month and the average
                                                                government contribution was $3.11 per month. (See fig. 3.) In 2000 a
                                                                provision was introduced to allow participants to receive employer
                                                                contributions to their supplementary pension. The employer contributions
                                                                are not matched by government contributions, but employers and
                                                                employees receive tax advantages for employer contributions up to a limit.
                                                                (See table 5 for more detail on tax advantages.) About 25 percent of
                                                                participants receive employer contributions.




                                                                Page 49                                                 GAO-03-309 Social Security Voluntary Accounts
Appendix II: Summary of the Czech Republic’s
Retirement System




Figure 3: Average Monthly Participant Contribution and Average Government
Contribution to Czech Voluntary Supplementary Pension Insurance, 1994-2001




Note: “State Supervision in Pension Funds: Annual Report 2000.” Data for 1994 reflects only one
fiscal quarter and data for 2001 reflects only the first two fiscal quarters of data.


Plan holders are eligible to receive both their own contributions and the
government contributions after they have contributed for at least 5 years
and have attained age 60. The current eligibility thresholds are higher than
3 contribution years and attainment of the age 50 that applied to
supplementary pensions from 1994 to 1999. The age was raised, as it
appeared that accounts were used as short-term savings vehicles just prior
to retirement rather than long-term retirement savings. However, since the
increase in contribution years and eligibility age, the average age of plan
holders has remained around age 48, about 10 years higher than the
population average age of 38.

Some flexibility exists regarding plan holders access to account funds
prior to retirement. Plan holders may also adjust the amount of monthly
contributions, though they may be required to wait up to 3 months by the
fund to change their contribution amount. Contributions to the accounts
may be suspended without penalty after a period of 3 years. In addition,



Page 50                                       GAO-03-309 Social Security Voluntary Accounts
Appendix II: Summary of the Czech Republic’s
Retirement System




plan holders may terminate their accounts after 1 year and receive both
their own contributions as well as accrued interest. In the event of
termination, the matching contribution is returned to the government. If
the plan holders terminate their accounts but transfer the accounts to a
new pension fund provider, the plan holders maintain both their own
contributions and government matching contributions.

Plan holders may choose the form of payout (annuity or lump sum) and
there are provisions for payout in the event of death (i.e., survivors) or
disability. At the present, it appears that lump sum payouts are a popular
form of payout. A representative of the pension funds estimated that only
5 percent of plan holders take benefit payouts in the form of an annuity.

Just a year after the Czech voluntary supplementary pension insurance
system began, there were 44 pension funds, yet by 2001 the number of
pension funds declined to 14. (See fig. 4.) The drop in funds is mainly due
to the consolidation of funds and the imposition of capitalization
requirements after early failures of some of the smaller funds. Some of
these failures resulted in liquidation and various degrees of accounts
losses for about 46,000 plan holders.7




7
Less than 2 percent of all current plan holders.




Page 51                                    GAO-03-309 Social Security Voluntary Accounts
Appendix II: Summary of the Czech Republic’s
Retirement System




Figure 4: Number of Pension Funds Providing Czech Voluntary Supplementary
Pension Insurance, 1994-2001




Note: June 12, 2002 Presentation, “The Czech Pension Reform.”


The Czech Republic’s Ministry of Finance regulates the funds, which must
have at least $1.7 million in registered capital. Funds are joint stockholding
companies. This means that funds are independent legal entities formed by
solely for capital financing as a pension fund. Both national and foreign
legal entities or individuals may establish a pension fund and be a
shareholder in it. One criticism of this arrangement is that operating costs
and distribution of profits between plan holders and shareholders are not
very transparent. Funds are allowed to make no more than 10 percent
profit or return distributions, with the remainder put in reserve (at least
5 percent) or to the benefit of the participant. Average rates of return
accruing to accounts have been fairly low. (See table 4.) In 1998 and 2001,
the average inflation-adjusted rate of return was negative. The portfolio of
the funds is fairly conservative. Most investments are in low risk vehicles
as laws regulate both the type of investment vehicle as well as the




Page 52                                     GAO-03-309 Social Security Voluntary Accounts
                        Appendix II: Summary of the Czech Republic’s
                        Retirement System




                        portfolio composition of pension funds.8 As of December 31, 2001, about
                        83 percent of the total funds were invested in bonds or treasury bills.

                        Table 4: Average Inflation-Adjusted Rate of Return for Czech Pension Funds,
                        1995-2001

                            Amounts shown in percent
                            Year                                                  1995       1996        1997       1998        1999 2000 2001
                            Average nominal rate of return                         11.0        9.9         9.2        8.2         5.6  4.0  3.9
                            Annual inflation rate                                   9.1        8.8         8.5       10.7         2.1  3.9  4.7
                            Average inflation-adjusted rate of                      1.7        1.0         0.6       -2.3         3.4  0.1 -0.7
                            return
                        Source: Czech Ministry of Finance, Office of the State Supervision In Insurance and Pension Funds and Czech Ministry of Labor and
                        Social Affairs.

                        Note: “State Supervision in Pension Funds: Annual Report 2000.”



                        Voluntary individual accounts are a part of the retirement system in the
Key Design Features     Czech Republic. Table 5 describes the key design features of voluntary
of Voluntary            individual accounts in four areas: (1) the interaction with national pension
                        benefits, (2) the contribution phase, (3) the accumulation phase, and
Individual Accounts     (4) the withdrawal phase.
in the Czech Republic




                        8
                         This includes not allowing more than 10 percent of a fund’s portfolio to be composed of
                        one security traded on the stock exchange, and no more than 25 percent of the total
                        portfolio can be composed of shares traded on the stock exchange. Additionally the
                        pension fund cannot own more than a 20 percent share of any one issuers stock.




                        Page 53                                                      GAO-03-309 Social Security Voluntary Accounts
                                           Appendix II: Summary of the Czech Republic’s
                                           Retirement System




Table 5: Key Design Features of Voluntary Individual Accounts in the Czech Republic

 Interaction with national pension benefits (social security)
 Substitute or supplement              The Czech Republic has a system of supplemental accounts.
 Contribution phase
 Who can participate                   Any permanent resident of the Czech Republic over 18 years of age that signs a contract
                                       for supplementary pension insurance with a pension fund.
 Opt-in/Opt-out ability                Can opt in at any time. Cancellation is also possible at any time though government
                                       contributions must be returned to the government and penalties may be due.
 How much can individuals contribute   To qualify for government contributions, individuals must contribute at least $3.35 per
                                       month.
 Government or employer contributions Plan holder contributions between $3.35 and $16.73 per month are eligible for government
                                       contributions between $1.67 and $5.02 per month. (See table 3 for complete schedule of
                                       government contributions.) Employers may make contributions of any amount, but tax
                                       advantages to the employer and employee are limited. (See below).
 Automatic enrollment                  There is no automatic enrollment.
 Tax advantages                        Employer contributions and individual plan holder contributions enjoy tax advantages up to
                                       a limit. Plan holder contributions between $200.77 per year up to $602.32 per year are tax
                                       deductible. An employer may receive tax deductions for contributions up to 3 percent of an
                                       employee’s earnings subject to social security tax. Further the employee is exempt from
                                       income tax on employer contributions up to 5 percent of the employee’s earnings subject to
                                       social security tax.
 Accumulation phase
 Regulation of investment options      To qualify as a pension fund, fund must adhere to certain investment choices including
                                       approved financial vehicles. Account holders may change pension fund provider at no
                                       penalty at any time.
 Regulation of administrative charges  The pension fund may keep no more than 10 percent of distributed profits.
 Tax advantages                        Investment returns accruing to the account is tax exempt.
 Withdrawal phase
 Pre-retirement loans                  No. However, account may be terminated after 1 year. Termination returns all individual
                                       contributions and accruals.
 Withdrawal options – annuity,         Individuals may take full distributions in the form of an annuity or lump-sum after
 installment payments, and lump sum    contributing for 5 years and attaining age 60.
 distributions
 Rate of return or minimum benefit     None.
 guarantees
 Tax advantages                        Non-interest income is subject to a preferential tax rate.
Source: GAO.




                                           Page 54                                  GAO-03-309 Social Security Voluntary Accounts
                 Appendix III: Summary of Germany’s
Appendix III: Summary of Germany’s
                 Retirement System



Retirement System

                 In Germany, retirement income comes from a variety of sources, which
Description of   can be organized in three levels—base, earnings-related, and additional.
Current System   (See fig. 5.) At the base level, Germany provides means-tested social
                 assistance benefits, which are not formally part of the social security
                 system.1 The country’s social security system provides pension insurance
                 benefits that are primarily earnings-related. Also, employer-sponsored
                 pensions offer earnings-related benefits but only to a small portion of
                 retirees. A system of voluntary individual accounts, known as “Riester
                 Pensions,” has recently been introduced, which will provide earnings-
                 related retirement income and which can be arranged either individually
                 or through employers. Finally, individuals can also set aside additional
                 private savings for retirement on a voluntary basis through a variety of
                 savings vehicles, such as, bank accounts, stocks and bonds, and
                 particularly life insurance contracts.




                 1
                  In Germany, the term “social security” refers to a social insurance program that includes
                 benefits for old-age, disability, survivors, sickness and maternity, work injury, and
                 unemployment. In this appendix, the term “social security” refers specifically to the old-age
                 pension system.




                 Page 55                                    GAO-03-309 Social Security Voluntary Accounts
                           Appendix III: Summary of Germany’s
                           Retirement System




                           Figure 5: Overview of German Retirement Income Sources

                           Additional
                                                                            Private
                                                                            savings
                                                                          (especially
                                                                          insurance)


                           Earnings-related                                                 Riester Pensions
                                                      Social                                (voluntary individual
                                                                          Employer-
                                                     Security                               accounts arranged
                                                                          sponsored
                                                     Pension                                  by individuals
                                                                          pensionsa
                                                    Insurance                                 or employers)


                           Base
                                                                            Means-
                                                                         tested social
                                                                          assistance



                           Source: GAO.

                           Notes: “Base” income sources include flat-rate or means-tested government benefits. “Earnings-
                           related” income sources relate to earnings levels either through DB benefit formulas or DC
                           contribution levels. “Additional” income sources consist of voluntary individual savings that are not
                           directly related to earnings.
                           a
                           Employer-sponsored pensions account for less than 5 percent of total retirement income.
The Base Level: Means-     Germany has a means-tested, social assistance program that provides
Tested Social Assistance   benefits for those needing assistance towards living expenses. Germany
for the Elderly            also provides assistance for special circumstances, such as, illness,
                           disability, or old age. Social assistance can come in the form of personal
                           assistance, cash benefit payments, or payments in kind. However, before
                           individuals are eligible to receive social assistance, they must draw upon
                           any personal assets.2 The amount an individual receives from social
                           assistance is dependent on their need.

                           In 2003, the government reformed social assistance for the elderly (those
                           over age 65) and the disabled. The reform is designed to encourage elderly
                           individuals to claim the social assistance that they are entitled to. In the
                           past, elderly individuals have not claimed social assistance because




                           2
                            There are some exceptions in drawing upon personal assets to be eligible for social
                           assistance. For example, individuals do not have to draw upon assets consisting of smaller
                           savings deposits or the house in which they are living.




                           Page 56                                          GAO-03-309 Social Security Voluntary Accounts
                             Appendix III: Summary of Germany’s
                             Retirement System




                             German family law holds relatives liable for social assistance payments.3
                             The new reform encourages elderly individuals to claim social assistance
                             by removing the obligation that their relatives pay for it. Specifically,
                             relatives with an annual income of less than $106,1544 will not be required
                             to pay social assistance. The government believes that this reform will
                             make it easier for elderly individuals to enforce their rightful claims to
                             social assistance, thereby improve their living conditions.


The Earnings-Related         The earnings-related level of the German retirement system consists of
Level: National Pension      national pension insurance, employer-sponsored pension plans and
Insurance, Employer-         Riester pensions. Individuals are compelled to participate in the national
                             pension insurance system; however, they can choose whether or not to
Sponsored Pensions, and      participate in employer-sponsored pension plans and Riester pensions.
Riester Pensions


National Pension Insurance   Chancellor Bismarck introduced Germany’s first social security system in
                             1889. Initially, the system was designed to provide disability insurance to a
                             limited segment of the workforce. However, over time the social security
                             system began to provide pension insurance and to increasingly larger
                             segments of the workforce. The current system of pension insurance has
                             been in place since 1957. The objective of the German system is to provide
                             a comfortable retirement income to workers based on the standard of
                             living they achieved during their working years. As a result of this
                             objective, the German pension insurance system, unlike the Social
                             Security system in the United States, incorporates only a few redistributive
                             properties.

                             In Germany, national pension insurance benefits provide the major source
                             of income for workers in retirement. Most workers, with the exception of
                             self-employed workers, are required to contribute to the social security




                             3
                              The social service office decides whether or not direct relatives will be required to pay
                             social assistance. The office also decides the amount of such payments. Only first-degree
                             relatives (parents and children) or spouses can be held liable for social assistance
                             payments.
                             4
                              In this appendix, all Eurodollars are converted into U.S. dollars using a conversion of
                             .94203 Eurodollars per U.S. dollar. This figure represents the monthly conversion average
                             in January 2003.




                             Page 57                                    GAO-03-309 Social Security Voluntary Accounts
Appendix III: Summary of Germany’s
Retirement System




system.5 The German system provides generous benefits that currently
replace approximately 69 percent of pre-retirement income for an
illustrative worker with average earnings. 6 In the future, the system will
replace a slightly lower proportion of a worker’s pre-retirement income.
By 2030, the government expects social security to replace between 67 and
68 percent of pre-retirement income.7 Furthermore, workers receive
annual increases in their social security benefits based on changes in net
wages.

The system is financed from equal contributions paid by employees and
employers plus a subsidy from tax funds to cover the gap between the
system’s income and payments. It is difficult to estimate the exact amount
of contributions that finance old age pensions because the German system
simultaneously collects contributions to finance disability benefits and
some health prevention plans. One expert estimates that approximately
two-thirds of the entire contributions collected finance old-age pensions.
Due to recent reforms, the government has specified total contribution
rates from 2002 to 2030 ranging from 18.3 percent in 2010 to 21.8 percent
in 2030.8

Within the social security system, workers can choose among several
types of old-age pensions: (1) standard old-age pension; (2) long service
pensions; (3) old-age pension after unemployment or partial retirement;
(4) old-age pension for women; (5) severe disability pension; and (6)
miner’s long service pension. Benefit eligibility and years of contributions
varies among the different types of pensions. However, most workers are
eligible for social security benefits at standard retirement age, which is 65
for men and is gradually increasing for women in monthly steps from age




5
 In addition to the self-employed, workers with low earnings and workers in some
professions that have their own mandatory retirement system (such as civil servants) are
not covered by social security.
6
 These replacement rates apply to an illustrative worker with 45 years of contributions who
always earned exactly the average income per worker. Since workers work less than 45
years on average actual replacement rates tend to be lower than those cited here. Thus,
these pension benefits are less generous than the replacement rate might suggest.
7
 Assuming participation in voluntary individual accounts, the government expects social
security to replace 76 percent of preretirement income in 2030.
8
Prior to reform, the contribution rate was 19.3 percent in 2000.




Page 58                                   GAO-03-309 Social Security Voluntary Accounts
                              Appendix III: Summary of Germany’s
                              Retirement System




                              60 to age 65 between 2000 and 2004.9 Workers can choose to delay their
                              retirement beyond the age of 65 and, in return, receive a bonus that
                              increases their pension by 0.5 percent. Conversely, workers can choose to
                              retire before age 65 and receive pensions that are reduced by 0.3 percent
                              for each month of early retirement. The average age of retirement in
                              Germany is about 60.

Employer-Sponsored Pensions   Employer-sponsored pensions account for less than 5 percent of total
                              retirement income among elderly households. While overall employer-
                              sponsored pension coverage is low, it varies significantly from industry to
                              industry. For example, many more employees in the manufacturing
                              industry are covered by employer-sponsored pension plans than
                              employees in the wholesale and retail industries. Approximately
                              66 percent of employees in the manufacturing industry are covered by an
                              employer-sponsored pension; whereas, only 25 percent of employees are
                              covered in the wholesale and retail industry.

                              A number of reasons explain the slow development of employer-
                              sponsored pensions in Germany. For example, the ability of the national
                              pension insurance system to provide generous benefits has reduced the
                              need for individuals to have employer-sponsored pensions. Additionally,
                              employers have been offering pension plans at declining rates due to the
                              rise in unemployment, the establishment of specific indexation rules,
                              unfavorable changes in taxation, and complicated legal rules.

                              Germany has five different types of employer-sponsored pension plans:
                              “direct promises,” “support funds,” “pension assurance associations,”
                              “direct insurances,” and “pension funds.” Various supervisory authorities
                              and taxation rules regulates each type of plan. Direct promises and
                              support funds have traditionally been organized as defined benefit pension
                              plans. Increasingly, companies in Germany are moving away from these
                              types of plans because of the financial risks, administrative costs, inflated
                              balance sheets, and the lack of comparability of financial ratios between
                              German and foreign companies. The government recently introduced
                              pension funds as a way to promote occupational pensions while helping
                              companies improve both their balance sheets and their standing in
                              international capital markets. This new type of employer-sponsored



                              9
                               For workers with a severe disability pension, the retirement age is increasing from age 60
                              to age 63 between January 2001 and December 2003. Workers with a miner’s long service
                              pension can retire at age 60.




                              Page 59                                    GAO-03-309 Social Security Voluntary Accounts
                              Appendix III: Summary of Germany’s
                              Retirement System




                              pension provides minimum benefit guarantees and allows for more
                              flexibility of investment.

                              Recently, a number of reforms to the German social security system were
                              designed to strengthen employer-sponsored pension plans. One such
                              reform legally entitles employees to an employer-sponsored pension by
                              waiving certain parts of their income, such as, holiday pay or overtime to
                              be directly deposited into their employer-sponsored plan. Another reform
                              reduced the general statutory time limits for becoming vested in an
                              employer-sponsored pension from 10 years to 5 years.

Riester Pensions: Voluntary   In May 2001, the German parliament passed reforms that were designed to
Individual Accounts           make the social security system more financially sustainable and better
                              able to handle demographic challenges. One major part of the reform
                              created special incentives for workers to participate in voluntary
                              individual accounts, known as Riester pensions. 10 Individuals have been
                              able to participate in a Riester pension since January 1, 2002. Individuals
                              can receive the special incentives associated with Riester pensions by
                              participating in either employer-sponsored pension plans or individual
                              pension plans. However, only certain types of employer-sponsored
                              pension plans are eligible to receive the special incentives.11 Due to recent
                              reforms, collective agreements will play a larger role in establishing
                              employer-sponsored pension plans and such agreements could take
                              advantage of the Riester incentives. Agreements have already been created
                              in the construction industry, the metal industry, the chemical industry, and
                              the civil service. Those participating in Riester pensions on an individual
                              basis may also receive special incentives for a variety of approved
                              individual pension plans, including: private pension insurances,
                              investment funds, and bank deposit plans.

                              Riester pensions are composed of personal contributions, government
                              subsidies, and tax-free allowances. The government subsidies provide
                              direct payments to individual accounts and are designed to benefit
                              individuals with lower income and families with children.12 To obtain the


                              10
                               Named for Walter Riester, the Minister of Labor at the time of their adoption.
                              11
                                Employer-sponsored pension plans consisting of pension assurance associations, direct
                              insurances, and pension funds are eligible for the Riester incentives; whereas, the book
                              reserve funds and support funds are not eligible.
                              12
                               The maximum subsidy per child that can be claimed annually is $49 in 2002, $98 in 2004,
                              $146 in 2006, and $196 in 2008.




                              Page 60                                   GAO-03-309 Social Security Voluntary Accounts
Appendix III: Summary of Germany’s
Retirement System




full government subsidy, individuals must pay a certain proportion of their
annual salary that is subject to social security contributions into the
Riester pension. Individuals contributing 1 percent as of 2002, 2 percent as
of 2004, 3 percent as of 2006, and finally 4 percent as of 2008 of their
salaries will receive the respective maximum subsidy. Individuals
contributing less than the recommended amount receive correspondingly
lower payments from the government. As the contribution rate grows
between 2002 and 2008, the government subsidy also becomes larger. For
example, the subsidy for single individuals grows from $40 annually in
2002 to $163 in 2008 and the subsidy for married couples grows from $81
in 2002 to $327 in 2008. Instead of receiving the direct payments from the
government, individuals can choose to deduct their personal contributions
along with the amount of the government subsidy from their income taxes.
Tax deductions may only be claimed up to a specified amount that
increases between 2002 and 2008.13 The tax office will automatically check
whether individuals will benefit from the tax deduction.

To receive the subsidies and tax relief associated with Riester pensions,
individual account plans have to be certified by the Federal Insurance
Supervisory Office.14 This certification verifies that Riester pensions meet
certain legal requirements. For example, to receive certification the
individual account plan must not allow individuals to withdrawal benefits
until they reach age 60 or until they begin to receive pension insurance
benefits. Individuals withdrawing money before age 60 must repay the
government subsidies and tax relief they received. Furthermore, Riester
pensions must provide permanent and guaranteed benefits. Individuals
can have benefits paid in the form of a life annuity that provides payments
of equal or rising amounts. Additionally, individuals can take a portion of
their account as a lump sum or installment payment, provided that the
account balance meets certain criteria and provided that account will
revert to a life annuity at age 85. Riester pensions must also provide a
nominal capital guarantee; that is, individuals are guaranteed total
payments that are at least equal to the actual amount they paid into the
account, without an adjustment for inflation. In addition to these
requirements, Riester pensions are also subject to administrative,




13
 The maximum tax relief that can be claimed annually is $557 in 2002, $1,115 in 2004,
$1,672 in 2006, and $2,229 in 2008.
14
 Individual account plans require certification; whereas, certification is not required for
employer-sponsored plans receiving the Riester subsidies and tax relief.




Page 61                                     GAO-03-309 Social Security Voluntary Accounts
                        Appendix III: Summary of Germany’s
                        Retirement System




                        documentary, and transparency requirements. For instance, contracting
                        fees must be spread equally over a period of 10 years or more.


The Additional Level:   The additional level of the German retirement system consists of various
Private Savings         forms of private saving. Many Germans save in bequeathable vehicles,
                        such as, bank accounts, stocks and bonds, and life insurance contracts.
                        Life insurance is particularly popular among Germans with approximately
                        50 percent of individuals in West Germany and 64 percent of individuals in
                        East Germany covered by life insurance contracts.


                        Voluntary individual accounts, known as Riester pensions, have been part
Key Design Features     of the German retirement system since January 2002. Table 6 below
of Voluntary            describes the key design features of voluntary individual accounts in four
                        areas: (1) the interaction with national pension benefits, (2) the
Individual Accounts     contribution phase, (3) the accumulation phase, and (4) the withdrawal
in Germany              phase.




                        Page 62                              GAO-03-309 Social Security Voluntary Accounts
                                            Appendix III: Summary of Germany’s
                                            Retirement System




Table 6: Key Design Features of Voluntary Individual Accounts in Germany

 Interaction with national pension benefits (social security)
 Substitute or supplement                 Germany has a supplemental system of voluntary individual accounts. Participation in
                                          voluntary individual accounts does not affect the benefit an individual receives from the
                                          national pension insurance system.
 Contribution phase
 Who can participate                      Individuals can participate in the voluntary individual accounts if they are covered by the
                                          national pension insurance system. Those not covered by the national pension insurance
                                          system can participate in a voluntary individual account if they are disabled and working
                                          in workshops, insured during creditable child-raising periods, providing care, or are in
                                          military or civilian replacement duty.
 Opt-in/opt-out ability                   Individuals can terminate their voluntary individual account at any time and immediately
                                          receive the money they paid into the account. However, the government subsidies must
                                          be paid back and individuals will be taxed on the appreciation and returns to the account.
 How much individuals can contribute      Currently, individuals can contribute 1 percent of their annual salary that is subject to
                                          social security contributions into an individual account. This amount gradually increases
                                          to 4 percent in 2008.
 Government or employer contributions     The government provides direct payments to individual accounts. These payments are
                                          designed to benefit individuals with lower income and families with children The amount
                                          of direct payments from the government increases between 2002 and 2008. Instead of
                                          receiving the direct payments, individuals can choose to receive tax relief.
 Tax advantages                           Instead of receiving the direct payments from the government, individuals can choose to
                                          deduct their personal contributions along with the amount of the government subsidy from
                                          their income taxes. Tax deductions may only be claimed up to a specified amount that
                                          increases between 2002 and 2008.
 Accumulation phase
 Regulation of investment options         Individuals can choose among various types of individual accounts based on their
                                          willingness to take risks. For example, bank savings plans and private pension insurance
                                          represent low-risk individual accounts; whereas, investment funds have more risk but
                                          may yield higher returns. Although each of these individual account plans must undergo
                                          government certification, there is no guarantee as to how much profit an account will
                                          make.
 Regulation of administrative charges     Individual accounts are subject to administrative requirements. For instance, contracting
                                          fees must be spread equally over a period of 10 years or more.
 Tax advantages                           Individual accounts can accrue capital gains and investment returns tax-free.
 Withdrawal phase
 Preretirement loans                      Individuals withdrawing money from their individual account before age 60 must repay the
                                          government subsidies and tax relief they received.
 Withdrawal options—annuity, installment Individuals can have benefits paid in the form of a life annuity that provides payments of
 payments, and lump sum distributions     equal or rising amounts. Additionally, individuals can take a portion of their account as a
                                          lump sum or installment payment, provided that the account balance meets certain
                                          criteria and provided that account will revert to a life annuity at age 85.
 Rate of return or minimum benefit        Individual accounts must provide a nominal capital guarantee; that is, individuals are
 guarantees                               guaranteed total payments that are at least equal to the nominal amount they paid into
                                          the account.
 Tax advantages                           Individual accounts are fully taxable upon withdrawal.
Source: GAO.




                                            Page 63                                   GAO-03-309 Social Security Voluntary Accounts
              Appendix IV: Comments from the Social
Appendix IV: Comments from the Social
              Security Administration



Security Administration




              Page 64                                 GAO-03-309 Social Security Voluntary Accounts
           Appendix IV: Comments from the Social
           Security Administration




(130091)
           Page 65                                 GAO-03-309 Social Security Voluntary Accounts
                         The General Accounting Office, the audit, evaluation and investigative arm of
GAO’s Mission            Congress, exists to support Congress in meeting its constitutional responsibilities
                         and to help improve the performance and accountability of the federal
                         government for the American people. GAO examines the use of public funds;
                         evaluates federal programs and policies; and provides analyses,
                         recommendations, and other assistance to help Congress make informed
                         oversight, policy, and funding decisions. GAO’s commitment to good government
                         is reflected in its core values of accountability, integrity, and reliability.


                         The fastest and easiest way to obtain copies of GAO documents at no cost is
Obtaining Copies of      through the Internet. GAO’s Web site (www.gao.gov) contains abstracts and full-
GAO Reports and          text files of current reports and testimony and an expanding archive of older
                         products. The Web site features a search engine to help you locate documents
Testimony                using key words and phrases. You can print these documents in their entirety,
                         including charts and other graphics.
                         Each day, GAO issues a list of newly released reports, testimony, and
                         correspondence. GAO posts this list, known as “Today’s Reports,” on its Web site
                         daily. The list contains links to the full-text document files. To have GAO e-mail
                         this list to you every afternoon, go to www.gao.gov and select “Subscribe to daily
                         E-mail alert for newly released products” under the GAO Reports heading.


Order by Mail or Phone   The first copy of each printed report is free. Additional copies are $2 each. A
                         check or money order should be made out to the Superintendent of Documents.
                         GAO also accepts VISA and Mastercard. Orders for 100 or more copies mailed to a
                         single address are discounted 25 percent. Orders should be sent to:
                         U.S. General Accounting Office
                         441 G Street NW, Room LM
                         Washington, D.C. 20548
                         To order by Phone:     Voice:    (202) 512-6000
                                                TDD:      (202) 512-2537
                                                Fax:      (202) 512-6061


                         Contact:
To Report Fraud,
                         Web site: www.gao.gov/fraudnet/fraudnet.htm
Waste, and Abuse in      E-mail: fraudnet@gao.gov
Federal Programs         Automated answering system: (800) 424-5454 or (202) 512-7470


                         Jeff Nelligan, managing director, NelliganJ@gao.gov (202) 512-4800
Public Affairs           U.S. General Accounting Office, 441 G Street NW, Room 7149
                         Washington, D.C. 20548