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Universal Voluntary Accounts: A Compromise Retirement Solution

Soon, the Social Security trustees will release their annual report, focusing the debate once again on this crucial program. President Bush has been anxious to give every worker an individual retirement account by cutting back a portion of his or her Social Security benefit. He has argued that workers should have control over their own savings in order to better prepare for their retirement.

He has a good point. Workers do need to have additional savings in order to provide themselves with a secure retirement. However, there is no reason that these savings should come at the expense of Social Security. Social Security is the one secure pillar of support for workers’ retirement. It has provided a core retirement income to tens of millions of workers over the last seven decades, reducing the poverty rate among seniors from close to 50 percent in the pre-Social Security days, to the same rate as the average for other adults.

Social Security is also extremely efficient, with administrative costs that are less than 1/20 as large as the cost of private pension plans. In addition, contrary to the widely circulated scare stories, the program is extremely secure. The trustees report, the accepted basis for Social Security projections, shows that the program can pay all scheduled benefits for nearly 40 years into the future. It also shows that Social Security will always be able to pay a higher benefit (in today’s dollars) than what current retirees receive, even if no changes are ever made.

While there is no good reason to cut back Social Security, there is a very good argument to extend access to pensions in order to supplement the core retirement income that Social Security provides. Traditional defined benefit pension plans are disappearing fast. Even counting 401(k) plans, only half the workforce has access to a pension at the workplace.

Furthermore, many workers manage to accumulate little money in these plans by the time they reach retirement age. In today’s economy, workers frequently switch jobs. Since they often have to wait a year or two before qualifying for a plan at their workplace, they may be ineligible for pension coverage for much of their working career, even if they are working at jobs that offer pension coverage. In addition, workers are often tempted to cash-out their savings when they switch jobs, preventing them from building substantial retirement accumulations.

Not surprisingly, lack of pension coverage is a problem that disproportionately hits lower-income workers. Not only is it harder for these workers to find the money to save for their retirement, but they are also far more likely to lack a convenient mechanism to allow savings.

This is where my proposal for a Universal Voluntary Account (UVA) system can be a big step forward. The basic plan is extremely simple. It would give every worker in the country a defined contribution pension account – along the lines proposed by President Bush’s Social Security commission – which employees – either by themselves or together with their employers – could contribute to, on a voluntary basis, following rules similar to those for 401(k) accounts. The system would be centrally managed (the management could be contracted out to a private business) in order to minimize administrative costs. The system would offer a limited set of investment options, similar to the Thrift Savings Plan for federal employees, in order to keep it simple and expenses low.

This system would provide a huge step towards increasing workers’ retirement security. First, and most obviously, it gives every worker in the country a convenient mechanism for saving. They could contribute regardless of where they worked, or even if they are self-employed. They also could keep a single account through their entire working career, regardless of how many times they switched employers.

The UVA system should also be an enormous boon for small employers. The reason most often cited by small employers for not providing pensions is the administrative hassle it involves. Employers would be allowed to contribute to their workers’ UVAs without having to take on the costs and risks associated with supervising their own pension plan. Since workers value pensions, access to the UVAs will make it easier for small businesses to compete for workers with larger firms, by making it simple for small firms to provide pensions.

In addition, the low administrative costs of a UVA system will enormously increase workers’ retirement savings. And as many people have become aware in the debate over recent mutual fund scandals, administrative fees can take quite a bite of people’s savings. According to President Bush’s Social Security commission, a centralized UVA type system would have annual administrative costs equal to just 0.3 percent of its assets. By contrast, existing 401(k) plans have administrative annual expenses that average more than 1.4 percent of assets. The lower fees associated with the UVA system would have the same effect as increasing the annual return on investment by 1.1 percentage points.

This difference in costs has an enormous impact on retirement savings over the course of a worker’s career. A worker who placed $1,000 in an account every year for 40 years would accumulate an additional $22,000, an increase of more than 27 percent, as a result of the lower administrative costs of the UVAs compared with the current 401(k) system. By increasing the efficiency of the pension system, the UVAs will make an enormous contribution to workers’ retirement income, at absolutely no cost to the public=

The UVA system will not solve all the problems of the retirement system. The tax system should be restructured so that it provides at least as much incentive for retirement savings to low and moderate-income workers, as it does to high-income workers. It may also be desirable to have some additional savings subsidy for low-income workers who find saving for retirement almost impossible at the same time they struggle with supporting a family.

However, establishing the UVA system will be a huge step forward. It also should be possible to build a consensus behind it even in the current political environment. After all, it is essentially what President Bush proposed – except this system is a voluntary add-on to Social Security, instead of a mandatory replacement. What free-market conservative could be opposed to that?

Dean Baker is the co-director of the Center for Economic and Policy Research in Washington, D.C.