What, me worry? Social security reform could impose paperwork, education burdens for HR - human resources - Brief Article

Many Americans old enough to have begun thinking seriously about retirement are familiar with the goofy character Alfred E. Neuman, the icon of the late, great humor publication, MAD magazine. Neuman's freckled, gap-toothed, big-eared, grinning countenance provided the visual image they'll remember. But it's also hard to forget the pithy saying that Neuman applied to virtually everything in life: "What, me worry?"

When it comes to preparing for their "golden years," some Americans seem to have adopted the same devil-may-care attitude that Neuman did. According to former Treasury Secretary Robert Rubin, in 1998 the national personal savings rate averaged less than 1 percent of after-tax income, ranking the United States with Canada as "the lowest by far of the G-7 countries, and lower than many developing countries."

To a certain extent, Americans' neglectful attitude toward amassing retirement income is understandable. After all, why worry about having enough money stashed away for retirement when you still feel hale and hearty? Wouldn't it be nice to take that thousand bucks that you've saved up to put in your IRA and instead treat yourself to a well-deserved vacation or a 32-inch TV with all the goodies?

Besides, there's always Social Security to rely on. Or is there?

Up until five or so years ago, the bad news seemed to come mostly from economists, talking heads and government bureaucrats. They warned us that we needed to truly rethink the Social Security system, cautioning that when the baby boomers reached 65 and started retiring in droves in the early 21st century, they'd run through the nation's collective retirement savings like a hot knife through butter. Today, with the next millennium right around the corner, the warnings sound less like the cries of alarmists than the sound of common sense. The need to rejuvenate, reform or even scrap Social Security has become a top priority of congressional leaders, business executives, Clinton administration officials and - lest we forget - the presidential candidates.

But human resource professionals may be thinking: "What does this have to do with me, at least in my work capacity? Isn't this mostly a nonworkplace issue that will primarily affect employees as taxpaying citizens? Sure, the payroll deductions that we send to the Social Security Administration may go up. But won't the accounting systems take care of that fairly easily?"

It's hard to provide a clear answer at this point, simply because there are so many vastly different Social Security reform plans being circulated, creating so many options to consider. Some proposals, if enacted, would cause few headaches for HR professionals. But the ones that currently are dominating the debate are definitely worth watching because they involve "privatizing" the system in one way or another. The current Social Security system could be either replaced or supplemented by new "personal retirement accounts" that would give individuals more choices about how to invest their retirement money.

Even if Congress were to enact a reform plan that didn't directly increase the tax burden on employers, whatever comes to pass likely will be so complicated and daunting that employees will have no idea what to do next. Where are those anxious employees likely to turn for answers? The HR department, of course.

Privatization: Definitions and Examples

Simply put, privatization means shifting investments to the private sector. In the Social Security arena, it entails taking some or all of the money now going into the Old-Age, Survivors and Disability Insurance (OASDI) fund - or Social Security trust fund, as it is commonly called - and shifting it into individual accounts over which employees would have some control. Currently, employers send all payroll deductions required under the Federal Insurance Contributions Act (FICA) to the Social Security Administration, which by law must invest the collected taxes in government securities. (The current FICA tax rate is 7.65 percent on the first $68,400 of income. Both employers and employees pay the tax. Of that amount, 6.2 percent goes toward Social Security and the remainder toward Medicare.)

Although the various privatization plans differ as to how much control employees would have over their investments, most of the major reform proposals would allow employees to invest in private securities, such as stocks. Supporters of privatization say this would allow employees to accumulate retirement savings at a much faster rate because the rate of return on stocks is generally much higher than on low-risk but low-interest government bonds.

Under another form of privatization, FICA payroll deductions would continue to flow into the Social Security trust fund and to be managed by the federal government. However, the Social Security Administration would no longer be required to buy government bonds with the money; instead, it could invest the money in private-sector stocks and bonds. Wall Street types, of course, would love to see the enactment of either type of privatization, which would result in an infusion of capital for U.S. companies.

One concern accompanying privatization is that, if employees are given wide leeway in investing the money that's in their personal retirement accounts, they could make unwise decisions and buy stocks that ultimately plummet in value. This problem, of course, can affect even the most savvy investor. But it could pose severe problems for people in the lower and middle income brackets, who often have no experience with equities. Therefore, some privatization proposals would require that employees invest a proportion of their funds in fixed-return vehicles, such as government bonds. Other proposals would allow the government to set guidelines channeling investments into certain low-risk equities.

Distributing the Proceeds

There has already been a great deal of debate about how the money should be managed once an employee reaches normal retirement age (currently 65 years of age, but potentially going up to 68 or even 70). A major question is whether retirees should be able to receive all of the proceeds of their personal accounts as soon as they leave the workforce, or whether they should be required to spread their receipts out over a period of years.

There are three basic ways to pay retirement benefits: annuitizations, timed withdrawals and lump-sum payments. Under the first approach, the retiree contracts with an annuity provider, generally an insurance company, to provide income for an agreed-upon length of time. The contract specifies the premium to be paid to the provider, the monthly amount to be paid to the retiree and the interest rate that will be calculated over the life of the annuity. Interest rates may be fixed at the onset or they may be tied to the return on investments. The most common of annuities is the life annuity, which pays benefits for the remainder of the individual's life. Social Security is a prime example of a life annuity system.

Timed withdrawals, sometimes called "self-annuitizations," are a cross between annuities and lump-sum payments. Under that approach, a retiree would determine how much he or she wanted to receive each month for a specified period of time, and then would find an investment manager or record-keeper to handle the details.

Advocates for women are particularly concerned about the possibility that Congress, if it approves personal retirement accounts, might allow retirees to receive lump-sum payments as soon as they retire. One cause of concern is the possibility that male retirees, whose earnings continue to outpace those of women, might exhaust the nest egg - leaving their spouses with little to live on after the husbands die, which historically occurs first. Another, less morally grounded reason is that many people simply lack the discipline to manage a large amount of money that falls into their hands at one fell swoop.

Therefore, some proponents of privatization want to stipulate either that lump-sum payments be limited to a certain portion of the retirement accounts' value or that retirees be required to purchase annuities for the full amount of their accounts' value.

Mandating annuities would pose another problem: There currently is little market for private annuities, so they are expensive to buy. The United States' largest provider of annuities is the federal government, in the form of the Social Security Administration. Private insurance companies aren't often called upon to sell policies to individuals who have come into a great deal of money and want to make sure that they receive a small portion of it each month for the rest of their lives.

According to Congress' General Accounting Office (GAO), which in June issued a report, "Social Security Reform: Implementation Issues for Individual Accounts," the administrative cost of buying an individual annuity in the current market is "relatively high, averaging a one-time charge of about 5 percent of the premium." The GAO says that if Congress required retirees to annuitize their personal account balances, the cost of buying an annuity would drop due to economies of scale. Also, mandating annuities would eliminate the high cost of adverse selection. Under a voluntary system, the people most likely to buy annuities would be those who expected to live to a ripe old age. In contrast, those with serious health problems or reckless lifestyles would be more likely to opt for lump-sum payments.

Compared with annuities, the administrative costs of the Social Security system are very low - less than 1 percent of outgo, according to the American Academy of Actuaries. This low overhead in part results because the government can take advantage of economies of scale. But another explanation is that employers do much of the legwork by sending taxes to the IRS and W-2 forms to the Social Security Administration. Even small increases in administrative costs can result in major reductions in the amount of retirement income.

The GAO and others say there are several answers to the problems involving annuities. One idea is to follow the example set by Chile, which in 1981 established a pension system that has become a much-touted model and has helped revive that country's economy. In Chile, workers automatically have 10 percent of their wages sent by their employers to their individual savings accounts; a worker can add an additional, tax-deductible 10 percent of his or her wages to the account. Upon retirement, workers are required to purchase annuities representing 70 percent of the average worker's salary; after buying the annuities, the workers can receive the remainder of their account balances as lump-sum payments.

Sources of Concern For EmpLoyers

Employers and organizations representing them, including the Society for Human Resource Management (SHRM) are closely watching the debate to be sure that what Congress does, if anything, doesn't impose heavy administrative burdens on them or increase their payroll taxes. A major worry of employers is that, should personal retirement accounts be authorized, the new administrative and record-keeping responsibilities might fall heavily on employers' shoulders.

One option is for administration of personal retirement accounts to be centralized at the Social Security Administration. But a drawback, as the GAO notes in its June report, is that "the current centralized Social Security record-keeping system was not designed to maintain records on individual accounts that are owned and managed by individual workers." The Social Security Administration's system is based on annual reporting; in contrast, a personal retirement account system that involved equities, the value of which often fluctuates wildly from day to day, would require a continuous flow of administrative hustle and bustle.

"The current reporting and tax collection system does not include other administrative activities that would need to occur under an individual account system, such as creating systems to collect and record individual investment choices, transmitting contributions to investment managers, recording account value changes, sending periodic account statements and providing payout entities with necessary account information," the GAO wrote. "While an investment manager could perform some of these activities, under a centralized system, government agencies would likely assume many of these responsibilities."

A second option is one that would involve employers: setting up a decentralized administration and record-keeping structure, possibly based on the current systems for 401(k) plans. However, while the number of employers sponsoring 401(k) plans has risen dramatically in recent years, the proportion is still relatively low. According to the GAO, only 25 million Americans participate in a 401(k) plan. "Under a 401(k) model, employers, especially those that currently do not provide any retirement plan, would bear the additional cost and responsibility of creating an infrastructure to quickly deposit contributions and provide employees with links to and choices among funds," the congressional agency concludes.

If employers were called upon to bear additional costs and responsibilities, some might decide to change or reduce the benefit packages they now offer, "thus possibly undermining the overall goal of pension plans and individual accounts: improved retirement security," the GAO says. Also, according to the report, a decentralized system probably would lead to additional government oversight and regulatory responsibilities.

Then there's the problem of how to ensure seamless administration of personal retirement accounts if an employer went out of business. Approximately 650,000 employers go out of business or start new businesses each year, for a turnover rate of some 10 percent. "Once an employer went out of business, making corrections to individual accounts would be difficult, if not impossible," the GAO says.

SHRM's Position on Reform

Because of the likelihood that Congress in the near future would make the first major reforms of the Social Security system since 1983, the SHRM Board of Directors last February debated what type of policy position the Society should take. A position paper, which the board adopted, includes the following key points:

* Social Security, by promoting a work ethic and individual dignity, differs from social welfare programs, and any legislative reforms should continue that approach.

* Any reforms should be implemented over time, with the greatest change reserved for those individuals with the time to accommodate the change.

* The self-supporting design of the system should be changed from the "pay as you go" basis, under which the current generation of workers provides retirement income for preceding generations, to a system that is actuarially balanced.

* SHRM opposes proposals for directly increasing payroll taxes in future years to maintain benefits and ensure solvency.

* There should be some amount of privatization, accompanied by "essential" investor education led by the government. When employers provide investment education, they should be protected against fiduciary liability.

* Account balances should be converted to life annuities upon retirement.

* Investments in equities should be applied to a "broad market," including Standard & Poor's 500 stocks, so that portfolios are diversified. These investments also should shift more of the burden of protecting against inflation to individual retirees.

* The normal retirement age should be indexed to life expectancy.

It should be evident by now that understanding, let alone implementing, Social Security reform is a complicated task. Not everyone agrees with congressional leaders, the Clinton administration and Wall Street that the current system needs major restructuring. Some think tanks, such as the left-leaning Economic Policy Institute, and many leaders of organized labor believe the current system needs to be fine-tuned - not scrapped. But as an increasing number of baby boomers start thinking about what they'll do in their retirement years, they'll become increasingly anxious that Social Security, as now structured, is not the safety net they once envisioned. So, HR professionals need to be aware that major reforms are likely early in the new millennium, and that they had best be prepared.

For links to resources on the World Wide Web about Social Security reform, see the HR Magazine section of SHRM Online at www.shrm.org.

Robert W. Thompson is managing editor of HR News.

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