November 18, 2003
Refer To:   
Stephen C. Goss, Chief Actuary
Chris Chaplain, Actuary
Alice H. Wade, Deputy Chief Actuary
Estimated OASDI Financial Effects of "Social Security Solvency and Modernization Act of 2003" introduced by Senator Lindsey Graham--INFORMATION

This memorandum provides long-range estimates of the financial effects on the Social Security (OASDI) program assuming enactment of "Social Security Solvency and Modernization Act of 2003", introduced on November 18, 2003. Specifications of the provisions in the bill were provided by Jen Olson of Senator Lindsey Graham's staff. A description of these specifications, reflecting our understanding of the intent of this bill, is given below. All estimates are based on the intermediate assumptions of the 2003 Trustees Report, as well as additional assumptions described below.

Proposal Summary

The proposal would allow workers who have attained age 25 to choose one of three options for program participation. One of these options involves the establishment of a personal account. Current retirees and workers aged 55 or older as of the beginning of 2004 would remain in the current-law program and would not participate in the personal account program. Brief summaries of the three options are listed below. More details concerning the proposed provisions of the bill are given in the following sections of this memorandum.

Option 1 (Default option): Beginning in 2006, workers would redirect 4 percentage points of their OASDI payroll contributions, up to $1,300 annually (in 2006, with this limit being wage-indexed in future years), to personal accounts (also referred to as individual accounts (IA) in the memo). The personal accounts would be invested in pooled funds similar to those of the Federal Thrift Savings Plan (TSP), with a default portfolio set at 60 percent stocks and 40 percent long-term government bonds. After the account balance reaches $10,000 (in 2006, with this threshold being wage-indexed in future years), workers could then choose to invest in specific private-market, centrally-managed, SEC-approved retirement funds. In exchange for the personal account contributions, OASI benefits would be offset by a hypothetical annuity based on the worker's account contributions compounded at an interest rate of 0.3 percent below the realized or expected market yield on long-term Treasury bonds. The proposal would also include a number of specific changes to scheduled OASI benefits (the defined benefit portion). These changes include:

Option 2: Workers would not have a personal account. However, workers would still be subject to the three specific changes to scheduled OASDI benefits that are bulleted under Option 1.

Option 3: Workers would not have a personal account and would maintain current-law scheduled Social Security benefits by paying additional payroll contributions to the Trust Funds. Initially, the payroll tax rate would be set at 14.4 percent. This rate is 2 percentage points higher than under current law and approximates the long-range actuarial deficit of 1.92 percent projected under the 2003 Trustees Report. Each year thereafter, the long-range actuarial balance would be calculated as if all individuals had selected this option. Whenever the long-range actuarial deficit under this calculation becomes higher than 0.25 percent of payroll, then an automatic 0.25 percent increase in payroll tax would take effect.

The proposal also includes the following changes to the OASDI program for all individuals, regardless of the option they select:

Even though participation in personal accounts would be voluntary upon attainment of age 25, universal participation in Option 1 (personal accounts) is assumed for these estimates. Option 1 and Option 2 would result in approximately equal monthly benefit levels (OASDI and IA benefits combined) if the personal account under Option 1 were invested in long-term government bonds and annuitized upon retirement. Monthly benefits under Option 1 will be larger than benefits under Option 2 if the yield on personal accounts is generally above the interest rate on long-term government bonds. In addition, even if monthly benefits are the same under Options 1 and 2, the potential availability of some of the IA accumulations in a form other than a monthly annuity (provided that the remaining IA balance plus the monthly Social Security benefit payment is at least 100 percent of the poverty level, as detailed in the "Account Distributions" section) makes Option 1 attractive.

It should be further noted that in the later years of the projection period, even if the yield on personal accounts were somewhat lower than the government bond yield, Option 1 could still generate a higher monthly benefit than would Option 2. This is because the benefit provisions of the proposal generally decrease the Social Security "defined" benefit over time so that offsets to benefits due to the personal accounts, which are limited to the size of the Social Security defined benefit, become increasingly likely to be smaller than the value of the IA distributions.

Compared to Options 1 and 2, Option 3 might provide a higher monthly benefit through the guarantee of present-law benefits. However, it is anticipated that very few individuals would choose to have their combined payroll tax rate (employer plus employee) increased by a minimum of 2 percentage points with later increases that could be much larger and are unknown. A preliminary estimate of the total increase in the combined payroll tax rate needed in 2040 is about 3.2 percentage points.

The proposal would require the Social Security Trustees to recommend specific program changes to the Congress if projected trust fund balances fall below a critical level at any time in the future. These recommendations, or similar measures, would be required to be implemented quickly. Conversely, if the trust fund ratio were at least 200 percent as of the initial year of the 75-year projection period and were expected to rise steadily thereafter, the Trustees would be required to recommend program changes to Congress. These changes could include increasing the "defined" Social Security benefit, increasing payroll tax contributions to personal accounts, reducing total payroll taxes, or other changes.

Enactment of this proposal, assuming universal participation in Option 1, is expected to eliminate the estimated long-range OASDI actuarial deficit (1.92 percent of taxable payroll under present law) based on "intermediate" assumptions described below and to result in sustainable solvency for the foreseeable future.

The Proposal: Personal Accounts

Contributions and Investment Up To Benefit Entitlement

Personal accounts would be available to all Social Security covered workers who have not attained age 55 at the beginning of 2004 (that is, to workers born in 1949 or later). Current workers aged 25-54 at the beginning of 2004 would be initially placed in the default option (Option 1 above). Workers then have one year to switch to one of the other two options. All future workers are placed in default Option 1 until age 25. At age 25, workers can then choose to change to one of the other options, but are locked into their preferred option upon attaining age 26. If Option 2 or 3 is selected, then the personal account balance as of age 26 is required to be rolled over to an IRA.

Starting in 2006, SSA would redirect, from the OASDI Trust Funds to individual personal accounts, 4 percent of the OASDI taxable earnings (up to a specified dollar limit), for those covered workers who choose Option 1. The dollar limit for 2006 would be $1,300. For subsequent years, the dollar limit would be increased by the growth in the average wage indexing series.

The proposal allows voluntary contributions to personal accounts (for those who have selected Option 1), above and beyond the payroll tax redirections, with government matching contributions for specified lower earners. Workers who choose to participate in personal accounts and have earnings of less than $27,500 in 2006 would each receive a $100 contribution to their accounts from the Federal government if they voluntarily contribute $1 extra to their accounts (both contribution amounts would also be indexed in future years by average wages). The government would then match 50 percent of any additional voluntary contributions, up to a total government subsidy of $500 per year. This government subsidy would be phased out for workers earning $32,500 in 2006. The General Fund of the Treasury would fund this subsidy for low-income workers. The voluntary contributions from low-income workers can be "funded" from any earned income tax credit they have on their individual tax returns. The estimates in this memorandum assume that, on average, such low-income workers will contribute $101 per year, thereby receiving a matching government subsidy of $150 ($100 for the first $1 of worker contributions, plus $50 for the additional $100 in contributions). In addition, all workers, regardless of income level, can voluntarily contribute up to $5,000 per year to their personal accounts.

Disabled workers (who select option 1) may contribute to their personal accounts during their period of disability and may benefit from the government matching subsidy described above. Neither voluntary additional contributions nor the Federal matching subsidy would be included for the purpose of calculating benefit offsets under Option 1. All amounts-the contribution limits, the earnings threshold, and contribution amounts from both workers and the matching government subsidy-would be indexed in years after 2006 by average wage growth.

Accounts would be established as soon as practicable. For the purpose of these estimates, it is assumed that accounts would be established by the end of 2006. Account contributions would be collected using the existing structure for collecting OASDI payroll tax contributions. In addition, account contributions would be managed by a central authority in a manner similar to that of the Federal Employee Thrift Savings Plan. Initially, available investment choices would be limited to a first tier of options that would include several broad index funds (equity, government bonds, and corporate and other bonds) plus several balanced funds.

After a worker's account balance reaches $10,000 (wage-indexed after 2006), the worker would have the option of investing in a second tier of funds. The second tier, still managed centrally, would offer a range of funds provided by approved private investment firms. The worker would select an investment firm and the funds offered by that firm. For both tiers, the central authority would maintain individual account records and would combine account transactions in aggregate amounts when dealing with the private investment firms.

A default portfolio allocation of 60 percent stock and 40 percent long-term government bonds would apply to all workers, unless they opted to change the allocation. Switching among investment funds would be allowed once per year. Withdrawals prior to benefit entitlement to retired worker, aged spouse, or aged survivor benefits would be permitted only if one could purchase an annuity from the personal account equal to 100% of the monthly poverty level.

Personal Account Accumulations

IA portfolios are to be invested, both prior to retirement benefit entitlement and after benefit entitlement, in approved funds with individual account records and transactions being centrally managed. We assume that the aggregate investment portfolio of all IAs will on average be distributed at about 60 percent in equities and 40 percent in long-term government bonds. An annual average administrative expense charge of 30 basis points is assumed.

The long-term ultimate average real yield on stock investments made in the future is assumed to be 6.5 percent, the same as used for other proposals over the last couple of years. This assumed equity yield is somewhat less than the 7-percent real yield that was assumed for the analysis of the plans proposed by the 1994-96 Advisory Council. This reduction in expected average yield is consistent with both (1) a growing consensus among economists that the market may value equities at somewhat higher average price-to-earnings ratios in the future based on broader access and a reduction in the perceived level of risk, and (2) the Trustees' increase in the assumed real yield on Treasury bonds from the level assumed in 1995. The expected ultimate average real portfolio yield for the base projection would thus be 4.8 percent, net of administrative expense,

(0.6*6.5% + 0.4*3.0% - 0.3%) = 4.8%.

Account Distributions

Under Option 1 of the proposal, workers could have some flexibility in the nature of account distributions. Life annuities are required to be purchased from the personal accounts, if needed, so that monthly annuity payments, when added to the Social Security benefit, provide for total payments that are not less than 100 percent of the monthly poverty level amount for the applicable year and family size. Any remaining balances may be used at the discretion of the account holder.

The proposal does not allow for withdrawal from the personal accounts in the event of disability. If a worker dies before OASI benefit entitlement, the proceeds of the worker's personal account is transferred to the account of the spouse. If there is no spouse, then account proceeds go to the worker's estate.

For workers who participate in Option 1, Social Security retirement and aged survivor benefits payable, as revised under the proposal, will be reduced according to a hypothetical account accumulation and annuity computation using a specified "offset yield rate." The offset yield rate for each year for this plan is the actual realized yield from long-term U.S. bonds (the intermediate assumptions of the OASDI Trustees Report would be used for future years) minus 0.3 percent.

The hypothetical account accumulation at retirement would be equal to the worker's redirected payroll taxes (but not including voluntary additional contributions by the worker or government subsidies to the account for low-income workers discussed in the previous section) accumulated using the specified offset yield rate for each past year. The retirement (retired worker, aged spouse, and aged survivor) benefit offset would be the computed amount of a CPI-indexed life annuity purchased with this hypothetical accumulation, and based on the expected future mortality, inflation, and real interest rates used for the intermediate assumptions of the most recent OASDI Trustees Report. Offset annuities would be based on expected unisex mortality for workers who are not married at retirement. Joint and two-thirds survivor life annuities would be computed for workers who are married at retirement, reflecting the actual ages of each spouse and sex distinct expected mortality.

If this hypothetical offset annuity exceeds the OASI benefit, then no Social Security benefits are paid. It should be emphasized that no benefit offset is computed or applied to benefits from the DI Trust Fund.

This provision provides a financial gain, relative to the Social Security defined benefit under the proposal, for workers who realize an average actual net annual return on their personal accounts that is higher than the accumulated offset rate. On the other hand, workers who realize an average net return that is lower than the offset rate can be disadvantaged by this provision, especially if the present value of expected OASI benefits exceeds the hypothetical accumulation of the personal accounts. In this scenario, a worker's combined personal account and Social Security proceeds would be less than the Social Security benefit that would be payable without personal account participation. However, because the offset yield rate is set at the long-term government bond yield rate minus 0.3 percent (assumed to ultimately be 2.7 percent real), workers investing in the default portfolio would be "worse off" through personal account participation only if accumulated returns on investments in equities (assumed to be 6.5 percent real) actually turn out to be less than the offset yield rate on average throughout their working lifetime.

Taxation of Personal Accounts and Distributions

Funds accumulate in the personal accounts on a tax-deferred basis, including additional voluntary contributions. Voluntary additional cash contributions to personal accounts are allowed up to $5,000 yearly, in after-tax dollars.

The taxation treatment of distributions from the personal accounts differs depending upon the source of the contribution. Distributions related to redirected Social Security payroll taxes (whether annuitized or not) receive the same taxation treatment as Social Security benefits do under current law. Revenue from personal income tax on these distributions would be transferred to the OASI and HI Trust Funds in the same manner as for revenue taxed on OASDI benefits under current law.

Distributions related to additional voluntary contributions would be tax-free, though the contributions would come out of after-tax dollars (similar to the tax treatment of Roth IRAs). Contributions and distributions from the government matching subsidy for low-income earners would be completely tax-free.

For workers who die before OASI entitlement and have no surviving spouse, personal account balances that go to the estate of the deceased worker are not taxed.

The Proposal: Additional Changes to OASDI Benefits

1) CPI-Index the Benefit Formula Factors (applies to all except those in Option 3)

For OASI beneficiaries becoming newly eligible for benefits in 2009 and later, this provision would modify the primary insurance amount (PIA) formula factors (90, 32, and 15), reducing them successively by the measured real wage growth in the second prior year. This provision does not apply to DI beneficiaries but would apply to young survivors (surviving spouses under 62 with a child in care). The provision would result in benefit levels for individuals with equivalent relative lifetime earnings across generations (relative to the average wage level) that would increase at the rate of price growth (CPI), rather than at the rate of growth in the average wage level as in current law. Calculation of the average indexed monthly earnings (AIME) and the PIA bend points used in computing the benefit would be unaffected by this provision.

For disabled workers who reach disability conversion age, the reduction in the retirement benefit due to this provision would be limited as shown below:

1. The following formula would be used to prorate the conversion benefit between DI and the OASI levels:

DI benefit level (present-law scheduled DI benefit) times (years receiving DI benefits in the elapsed year period1 / 40)


OASI benefit level times (years not receiving DI benefits in the elapsed year period / 40).

2. In determining the OASI benefit level, a PIA would be computed using the formula applicable for newly eligible retired workers in the year the converting worker reached age 62. The disability freeze years would apply in computing the AIME.

For example, a worker who becomes disabled at age 32 and is thereafter continuously receiving disability benefits would receive no reduction in his/her benefit level due to this provision until disability conversion age (ultimately, age 67). At conversion, monthly benefits would be paid from the individual account, and a portion of the reduction due to the change in benefit formula factors would begin to apply to the PIA. Of the 40 potential working years, 10 years (ages 22 though 31) were years that the worker did not receive a disability-worker benefit. Thus, for this worker, only one-fourth of the reduction due to CPI-indexing the benefit formula factors would apply to his/her PIA level.

This provision alone would increase the long-range OASDI actuarial balance (reduce the actuarial deficit) by an estimated 2.10 percent of taxable payroll.

2) Variable Minimum PIA for Retired Workers, for Retired Workers Converted from DI, and for Survivors (applies to all except those in Option 3)

This provision would set a minimum retired worker PIA at 120% of the Monthly Applicable Poverty Level (see below for definition) for workers newly eligible in 2011 with 35 years of work (quarters of coverage equal to 3.5 times the number of elapsed years), decreasing to no minimum with 10 years of work (quarters of coverage equal to the number of elapsed years). The variable minimum PIA is phased in during the years 2007 through 2010. For workers newly eligible in 2007, the percentage of the Monthly Applicable Poverty Level is one-fifth of the fully phased-in percentage in 2011. This fraction increases by an additional one-fifth for each year during the phase-in period, reaching four-fifths in 2010.

The Annual Applicable Poverty Level for 2002 is set equal to $8,628 (the poverty level for an individual aged 65 or older in 2002). The Monthly Applicable Poverty Level would equal one-twelfth of this amount. The Annual Applicable Poverty Level that applies to an individual in his/her year of initial eligibility is determined by increasing the 2002 level by the COLA for 2002 through the year prior to the year of initial benefit eligibility.

This provision does not apply to DI beneficiaries. For the purpose of computing a benefit at disability conversion age, the minimum PIA, when applicable, would augment only the OASI benefit level, as detailed in the prior description of CPI-indexing the benefit formula factors for DI conversions. In doing so, the year-of-work requirements for the minimum PIA would be "scaled" to the proportion of elapsed years for which the worker was not entitled to a disabled worker benefit.2 Such "scaling" of year-of-work requirements, for calculating the minimum PIA, would also apply for survivor cases where the worker died before attaining age 62.

The incremental effect of this provision after applying provision 1 would be to reduce the long-range OASDI actuarial balance (increase the actuarial deficit) by an estimated 0.03 percent of taxable payroll.

3) Increased Benefits for Widow(er)s (applies to all except those in Option 3)

Under this provision, starting in 2006, all aged surviving spouses (aged 62 or older) would receive 75 percent of the benefit that would be received by the couple if both were still alive (including all applicable actuarial reductions and delayed retirement credits), if this is higher than their current benefit. The benefit provided by this option would be limited to what the survivor would receive as a retired worker beneficiary with a PIA equal to the average PIA of all retired worker beneficiaries for December of the year prior to becoming eligible for this option. Actuarial reduction for this limitation would be computed as if the survivor had begun receiving a retired worker benefit on the earliest of the actual ages upon which benefits began as an aged spouse, an aged surviving spouse, or a retired worker beneficiary, but not before 62. This provision alone would reduce the long-range OASDI actuarial balance (increase the actuarial deficit) by an estimated 0.08 percent of taxable payroll.

4) Redirect Taxation of Benefits Revenue from the HI Fund to the OASDI Trust Funds

Currently, revenue collected by the IRS from Federal income taxes payable on OASDI benefits, in excess of the tax on 50 percent of such benefits, gets transferred to the Medicare HI Trust Fund. Under this provision, this revenue would be redirected to the OASDI Trust Funds. The provision would redirect 10 percent of this revenue for 2006, 20 percent for 2007, ..., and 100 percent for 2015 and later. This provision alone would increase (improve) the long-range OASDI actuarial balance by an estimated 0.43 percent of taxable payroll.

5) Transfers from the General Fund of the Treasury

This provision would require specified transfers from the General Fund to the OASDI Trust Funds equaling 1.25 percent of payroll, starting in 2006. Under this provision, a commission would be appointed to recommend cuts in corporate welfare programs to offset the cost of these transfers. However, these transfers would be made whether or not the cuts in corporate welfare programs were achieved. This provision alone would increase (improve) the long-range OASDI actuarial balance by an estimated 1.18 percent of taxable payroll.

Annual Estimates of Trust Fund Operations, Estimated Effects on the Unified Budget Balance, and Cash Flow between the Trust Funds and the General Fund of the Treasury

Provided below are summarized descriptions of the attached tables, some of which have been referenced throughout this memorandum. For a more detailed description of tables 1 through 1c, please see our January 31, 2002 memorandum (pp. 21-26) on financial effects of the three models developed by the President's Commission to Strengthen Social Security. This memorandum is available on the Internet at

As stated earlier, we assume that all workers will participate in the individual account option (Option 1). Tables 1 through 1c reflect this assumption.

OASDI Trust Fund Operations

Table A provides a brief description of the plan provisions and provides estimates of the effect of each provision, as well as the effect of all provisions combined, on the long-range OASDI actuarial balance assuming that all workers choose Option 1. The table also shows that, for the basic provisions only, without increased payroll taxes (i.e., the same as universal participation in Option 2), the estimated effect on the long-range OASDI actuarial balance would be an increase of 3.53 percent of taxable payroll. In addition, table A shows that, assuming 100-percent worker participation in Option 1 of the proposal, the estimated effect on the long-range OASDI actuarial balance would be an increase of 2.55 percent of taxable payroll.

Table 1 shows estimated annual and summarized income rates, cost rates, and balances under the proposal. In addition, the table shows the trust fund ratio for each year, as well as changes in contribution rates to the OASDI Trust Funds under the proposal. As shown in the table, sustainable solvency is indicated for the foreseeable future, because the Trust Fund ratio is steadily rising at the end of the projection period.

Additional Aggregate Values for Trust Funds and Personal Accounts

Table 1a shows estimated trust fund balances at the end of each year under current law and under the proposal. In addition, the "IA/Annuity Assets EOY" column shows the total IA and annuity account assets at the end of each year, excluding transfers made to a worker's estate for death before benefit entitlement where there is no spouse, assuming that the accounts accumulate at the assumed average net yield rate (4.8 percent real). The next two columns show aggregate IA contributions and disbursements for each year. All of these amounts appear on a present value basis as of January 1, 2003.

The estimates of annual dollar flows and accumulations of the personal accounts are based on very specific assumptions that all personal account assets are converted to CPI-indexed life annuities at retirement (see description in the section on assumptions above). In practice, many individuals would likely annuitize only part of their personal account accumulation so estimated annuity assets are overstated to some degree. Total personal account and annuity assets (referred to as "IA/Annuity Assets EOY" in the tables) include both the assets of personal accounts held prior to retirement, and the assets held by the annuity provider after retirement. If the personal accounts are considered as a part of "Social Security", it is reasonable to combine the amounts of trust fund assets and personal accounts for a representation of total system assets.

Furthermore, the individual account estimates that are shown in table 1a are used in determining estimates of income from taxation of benefits. For the accumulation phase of the individual accounts, workers are assumed to maintain individual accounts that would have an average distribution of 60 percent in equities and 40 percent in long-term U.S. Treasury bonds. Based on the rates of return assumed for stocks and bonds, this implies an average annual real yield rate of 4.8 percent, after deducting 0.3 percent assumed for administrative expense. During the distribution or annuity phase, the net real yield is assumed to be the same as long-term U.S. Treasury bonds (3 percent).

The last two columns in table 1a provide, under the proposal, the present value of (1) net cash flow from the General Fund of the Treasury to the OASDI Trust Funds, and (2) the change in annual unified budget cash flows. Both sets of information appear in constant dollars-the former in table 1c and the latter in table 1b.

Effects on Annual Federal Unified Budget Balances

Table 1b provides a rough estimate of the effects of the proposal on the annual Federal unified budget balance for each calendar year through 2078. All amounts in this table appear in constant 2003 dollars (that is, dollar amounts that are indexed back to 2003 based on the consumer price index (CPI)). The first three columns in these tables include sources of changes to the unified budget balance, as follows:

The last three columns present the aggregate effects on the unified budget:

These unified-budget estimates are based on the intermediate assumptions of the 2003 Trustees Report, including the trust-fund interest assumption, and thus are not consistent with projections made by CBO and OMB (which use different assumptions). However, differences in payroll and benefit estimates are not large during the first 10 projection years so these values can be viewed as very rough approximations of the magnitude of effects on the unified budget balances through this period.

Annual Cash Flows from the General Fund of the Treasury to the OASDI Trust Fund

Table 1c provides the estimated annual net cash flow from the General Fund of the Treasury to the OASDI Trust Funds. All values in these tables are expressed in constant 2003 dollars (i.e., dollar amounts that are indexed back to 2003 based on the CPI).

For comparison purposes, cash flow estimates are provided in table 1c for three different cases:

For each of these cases, three columns are provided. The first column shows estimates of the specified amount of transfers from the General Fund under the plan. The second column is the estimated total net cash flow from the General Fund to the Trust Funds under the plan, including transfers and borrowing. The third column is the total net cash flow for years starting with 2003 through the end of the given year, including accumulated interest cash flows for the period.

Chris Chaplain
Alice H. Wade

Attachments: 5

  Table 1a
  Table 1b
  Table 1c

1Elapsed year period includes years from age 22 through age 61.
2For example, an individual who becomes disabled at age 32 and stays disabled until normal retirement age would need to have quarters of coverage equal to 140 (35 years) X 10 years of work / 40 total elapsed years for retired worker with no disability, or 35 quarters of coverage, to qualify for a minimum PIA of 120 percent of the Monthly Applicable Poverty Level.

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