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Personal Social Security accounts may have hidden pitfalls

WASHINGTON — As President Bush leads a national debate over Social Security, he is focusing on the benefits of personal investment accounts.

But the details of how those investments could be be used, plus a raft of unanswered questions, could have a big impact on people's retirement income if the accounts ever become a reality.

Central to Bush's plan is a requirement that retirees use part of their account to buy an annuity that would give them a monthly payment for the rest of their lives.

The accounts "would not be emptied out all at once, but rather paid out over time, as an addition to traditional Social Security benefits," says a White House pamphlet.

Americans are largely unfamiliar with life annuities. These are sold mostly by life insurance companies and account for less than 2 percent of the industry's revenues, according to Virginia P. Reno, vice president for income security at the nonpartisan National Academy of Social Insurance (NASI).

Basically, a life annuity is a contract. In return for a large up-front payment, the insurer promises to pay a certain amount of money on a regular basis for the rest of the buyer's life.

It's a trade-off of risks. The buyer risks dying before recouping the purchase price, and the insurer risks that the buyer will live longer than expected and continue drawing payments.

To meet buyers' concerns about dying early, some annuities guarantee payments over a certain amount of time, such as 10 years, or until the original cost is met. Other annuities allow a second person to continue receiving a payment after the primary beneficiary dies.

Every expansion of an annuity's benefits, however, comes at the price of a lower monthly payout.

For example, a life annuity that costs $10,000 would pay $80 a month to a single beneficiary for life, according to estimates compiled by Social Security and published by NASI. But that monthly benefit falls to $62 for the first payment if the annuity contains an inflation adjustment.

Annuities that cover two people would pay even less.

An annuity that features inflation protection and full benefits to the surviving owner would pay $50 a month. An annuity that pays a two-thirds benefit to a surviving owner would pay $57 a month while both owners were alive, but only $38 after one owner died.

Beyond these little-understood payment details, there are a plethora of questions about how annuities would be structured under Social Security, how they would be sold, and how they would be regulated, Reno said.

Bush's plan would require people to buy an annuity which, when combined with traditional Social Security benefits, would give them an income at least equal to the federal poverty level.

That provision is designed to keep people from squandering their investment account and turning to other federal assistance programs such as Supplemental Security Income or Medicaid, said Jeffrey Brown, a finance professor at the University of Illinois at Urbana-Champaign.

But it means a low-income worker might have to use more than two-thirds of his or her account to buy an annuity, while a high-income worker might have two-thirds left over to spend or leave to heirs, according to Jason Furman, a senior fellow with the Center on Budget and Policy Priorities.

A question still to be resolved is how the annuities would be administered and whether anybody might be exempted from buying them.

Paul Yakoboski, a principal research fellow with the TIAA-CREF Institute, predicts that since Bush stresses personal choice in investment accounts, he likely will offer a similar choice in annuity purchases. But whether those purchases would be offered by individual insurance companies or the federal government has not been decided.

Who will regulate the products if they are privately sold also has not been addressed. Currently, state governments regulate annuities as part of their insurance oversight. Reno noted that on rare occasions annuity companies have gone bankrupt, but no federal entity guarantees annuities the way the Pension Benefit Guaranty Corp. underwrites private pensions.

Then there is the question of whether there should be any exemption from the annuity requirement. Should a person with a terminal or chronic illness be allowed to instead use his or her investment account to help pay medical bills? If so, who would make those decisions and who would reconsider those decisions on appeal?

Also unresolved is whether men and women, with their differing life expectancies, would be treated equally in purchasing an annuity. Paying women less each month because they live longer makes economic sense, but might generate political opposition, said Martha Priddy Patterson, director of employee benefits policy analysis for Deloitte Consulting LLP's Human Capital Advisory Services.

And finally, Bush has not made clear whether married workers would have to purchase joint annuities when they retire, or whether a worker who dies before retirement would be required to leave his or her investment account to the surviving spouse.

Under Social Security, even divorced spouses who were married at least 10 years receive a death benefit, and the benefit remains the same no matter how many current and former spouses qualify for it.

"You don't have to fight over it, and it's not a finite pie," said Deborah Chalfie, senior counsel to the National Women's Law Center. But each time a private account was divided, the share would get smaller, she noted.