¹ While this analysis contains a concrete proposal and a comprehensive computer simulation, it should be viewed not as an implementation plan but as a feasibility study. It seeks to show that an Investment-Based Social Security system can work and that the transition costs are fundable at levels of investment that can make Social Security permanently solvent. Much more work is required to convert this feasibility study into an implementation plan, and its use of simplifying assumptions and first approximations is readily acknowledged. The author is currently working with Sen. Pete Domenici and others to develop legislation to implement an Investment-Based Social Security system. The author is an economist and a senator from Texas.

² The investment options included the Standard and Poor's (S&P) stock indices, an index of the 20 percent of companies listed on the major stock exchanges with the smallest capitalization and the Salomon Brothers Long-Term High-Grade Corporate Bond Index. The investment portfolio was invested: 40 percent in the S&P Index, 20 percent in small company stocks and 40 percent in long-term high-grade bonds.

³ See Martin S. Feldstein and Andrew A. Samwick, "The Economics of Prefunding Social Security and Medicare Benefits," Working Paper 6055, National Bureau of Economic Research, Cambridge, Mass., pp. 8 - 9.

⁴ It is probable that funds managing Social Security investments would initially lose money while investment accounts are small but become profitable as investment accounts build up. If a maximum management fee were established by the Social Security system, it would reduce the use of aggressive sales forces and excessive churning of accounts.

⁵ The SI Board will coordinate the examination activities of the existing federal regulatory agencies overseeing the various financial institutions certified to serve as Qualified SI Funds. Actual examination of the SI Funds for compliance with safety and soundness standards will be conducted by the agency that chartered the institution serving as an SI Fund and which supervised its other activities.

For example, in order to ensure compliance with the standards and rules established by the SI Board, the Securities and Exchange Commission, which now examines and supervises mutual fund and other investment companies, will directly examine and supervise the mutual funds and investment companies that become Qualified SI Funds and manage SI Accounts. Similarly, the bank regulators, such as the Comptroller of the Currency, state banking authorities, the Federal Reserve Board and the Federal Deposit Insurance Corporation, will monitor the activity of any banks under their supervision that offer SI Accounts.

⁶ The annuitization of the SI Accounts is based on the assumption that the investments earn returns in the annuity similar to those received in the SI Accounts. This is a simplifying assumption which will have to be corrected as a full-blown annuity market develops and the actual cost of the insurance component of the annuity becomes known. Today's annuity market is so underdeveloped as to render existing cost data of little use as a guide for a full-blown system.

The conversion of the SI Account to an SI Annuity could follow the variable annuity model used by the Teachers Insurance and Annuity Association-College Retirement Equities Fund (TIAA-CREF). At the time of retirement, the initial payment from the SI Annuity would be a monthly amount that would completely exhaust the available funds over the normal remaining life expectancy for the retiree at an expected rate of return net of administrative costs. The rest of the retiree's retirement benefit would be paid by the current system.

In subsequent years, the actual payment from the SI Annuity would be adjusted based on the performance of investments held by the annuity and based on changes in life expectancy for the retiree's age group. Regardless of the amount of the SI Annuity payment in any given year, however, no one will ever receive less than they are promised by the current system, and each retiree will receive a bonus equal to 20 percent of their SI Annuity payment in that year.

TIAA-CREF's variable annuity carries a 37 basis point administrative charge, almost twice the 20 basis points assumed in the analysis above, possibly because it only has $621 million in its annuity program.

⁷ Including survivor benefits to be discussed below.

⁸ Under current law the retirement age will begin to rise in 2003 and reach 67 in 2027.

⁹ Unless otherwise stated, all figures are in inflation-adjusted dollars.

¹⁰ See Tables A-I and A-II in the Appendix.

¹¹ While this analysis seeks to show the feasibility of transitioning to an investment-based system without raising payroll taxes or cutting benefits, either action makes the achievement of a permanent solution easier.

¹² It will take almost 50 years for the buildup of individual investment accounts to yield a retirement benefit 20 percent above the level promised by the existing Social Security system. It seems improbable that workers who enter the investment-based system will reduce other savings by more than that 20 percent in response to the buildup of wealth in their individual Social Security investment accounts.

¹³ This number assumes an extension of the existing caps on discretionary spending.

¹⁴ Since an investment-based system requires real investment, if the federal government funds part of the transition by paying back 29 percent of what it has borrowed from the Social Security system, such funds must be obtained by spending cuts or tax increases. If the federal government simply borrowed the money from the public, the funds going into the system would not be net new investment.