The 4% Solution

By Karen Tumulty; John F. Dickerson

George W. Bush prides himself on keeping his focus on the big picture. But when a challenge is as tall as transforming Social Security, the details can kill you. As the President warned last week in his State of the Union address that the system is "collapsing"--an assertion many experts dispute--the White House offered the first glimpse of his most radical proposal for changing it: allowing younger workers to invest part of their payroll taxes in private accounts.

The plan that was unveiled did nothing to change the political obstacles Bush faces in Washington. Republicans are still skeptical; Democrats are still opposed. So the President took his sales pitch on the road to five conservative states represented by Democrats in the Senate. His Cabinet will fan out across the country as well. Will they succeed? That may depend on how satisfied Americans are when they get answers to their questions about Bush's idea for reforming the biggest and most popular social program ever.

HOW WOULD PERSONAL ACCOUNTS WORK?

Under the current system, workers generally contribute 6.2% of their wages to the Social Security system. Under Bush's plan, you would eventually be able to divert as much as 4% into a personal investment account that could be invested among a limited number of government-selected funds. The account could not be spent or borrowed against until retirement. At retirement, you would still get a traditional Social Security check, but it would be smaller, reflecting your diminished contribution to the system. You would also be required to commit a portion of your personal account to an annuity--to trade in the assets for a guaranteed monthly payment for the rest of your life. Your annuity commitment would have to be large enough that the monthly proceeds plus your Social Security check would keep you at least above the poverty line. Any money left over in your personal account could be used as you wished--taken as a lump sum, drawn down over time, added to your annuity or even left invested to continue growing. By most estimates, if a personal account earned annualized investment gains of 3% (after inflation was factored in), it would produce roughly the same retirement income as Social Security provides under existing rules. Investment gains above that level would give you a surplus in your private account; smaller gains would leave you with less to live on.

WHO WOULD BE ELIGIBLE FOR A PERSONAL ACCOUNT?

The accounts would be available to workers born in 1950 or later and would be phased in over three years, starting in 2009. People born in 1965 or earlier could start investing the first year; those born in 1978 or earlier could begin in 2010; and all younger workers could begin in 2011. Those 55 and older would continue to be covered by Social Security in the traditional manner.

HOW MUCH COULD I INVEST?

Initially, the amount would be limited to $1,000 annually, but according to Bush's plan, it would rise by $100 a year, to a maximum of 4% of your income.

COULD I INVEST IN THAT REALLY HOT STOCK MY BROTHER-IN-LAW HAS BEEN TOUTING?

No. Investors' choices would be limited, much as they are under the Thrift Savings Plan now available to federal-government workers, who can invest in five broad, general funds: a large-cap stock fund, a small-cap stock fund, an international stock fund, a corporate-bond fund and a Treasury-bond fund. The government would also offer what is called a life-cycle fund, in which the mix of investments changes according to the investor's age. None of those options are particularly sexy, but because they are more diversified than individual stocks and bonds, they are less likely to suffer quick, crippling losses. They also cut down on the government's costs of administering the program.

WHAT ABOUT INHERITANCE? COULD I LEAVE THE MONEY IN MY PERSONAL ACCOUNT TO MY KIDS?

If you should die before reaching retirement, all the money would go to your heirs. If you should die after you retire, they could inherit only that portion of your personal account that had not been committed to an annuity. They would not receive any payout from the annuity.

WOULD INDIVIDUAL INVESTMENT ACCOUNTS REDUCE THE FUTURE INSOLVENCY PROBLEMS FACING SOCIAL SECURITY?

No. In the next few decades they would actually make the problem worse. That's because the money that workers would invest in their personal accounts would no longer be available to pay the benefits of today's retirees. As things now stand, Social Security is expected in 2018 to start paying out more in benefits than it brings in from payroll taxes. If individual accounts were established and no other reform was enacted, the system's finances would deteriorate even faster and the shortfall would begin six years earlier, in 2012, according to the Center on Budget and Policy Priorities, a liberal think tank whose numbers are widely respected.

Additional "transition costs"--amounting to trillions of dollars--would be incurred in the early decades. The Bush Administration argues that those costs would eventually be offset by savings in future decades, when people who invest in personal accounts begin to retire and get smaller Social Security payouts than they otherwise would receive. In the meantime, huge new borrowing would be needed to cover the gap left over by the transition. Paying back that debt would fall to the same future generations that Bush says he's trying to protect by revamping Social Security.

SO HOW WOULD BUSH FIX SOCIAL SECURITY'S LONG-TERM FUNDING PROBLEM?

That remains the big unanswered question. Everyone in Washington knows it would be political suicide to cut the benefits of today's retirees or those about to retire. Absent those options, there are only three ways to bring the system into fiscal balance: cut future benefits, raise taxes or borrow the money, which adds to the debt.

In his State of the Union address, Bush cited four types of benefit cuts that are "on the table." One under serious consideration is changing the formula for calculating initial benefits, basing them on inflation rather than faster-rising wages. What this technical-sounding change would mean is smaller Social Security checks. For instance, according to a 2002 analysis by the chief actuary's office at Social Security, a 38-year-old earning $35,000 would now expect to receive $1,343 a month when she retires at 65, but with indexing to inflation, that benefit would drop 18.2%, meaning she would get $1,099. Given the existing system's long-term funding challenges, of course, that kind of cut could happen anyway. --With reporting by Perry Bacon Jr./Washington

With reporting by Perry Bacon Jr./Washington