PRAs: What If?

President Bush??¢â???¬â???¢s idea to allow Americans to save for their own retirements through personal retirement accounts is hardly the ??¢â???¬?????risky scheme??¢â???¬  former Vice President Al Gore claimed in the 2000 campaign. It is, instead, a sensible and long-overdue way to let workers truly take charge of their retirements and take part in an ownership society.

Despite its potential, though, President Bush??¢â???¬â???¢s plan has caused a great deal of consternation among critics. Senate Minority Leader Harry Reid, for example, complained after the State of the Union address that ??¢â???¬?????the Bush plan isn??¢â???¬â???¢t really Social Security reform. It??¢â???¬â???¢s more like Social Security roulette.??¢â???¬  The main point of contention among the opponents of this kind of ownership society reform is that it would take undue risks with workers??¢â???¬â???¢ retirement dollars.

Or would it? To get an idea of how well future workers likely will fare under the president??¢â???¬â???¢s plan, let??¢â???¬â???¢s look back at the last 40 years and see where we??¢â???¬â???¢d stand now if PRAs had been enacted then.

What if President Lyndon B. Johnson had erected an ownership society rather than a Great Society back in the mid-1960s? How would today??¢â???¬â???¢s retirees, most of whom were young workers at the time, be sitting today? How would the checks they??¢â???¬â???¢d be receiving stack up against those they get now from Social Security?

We at The Heritage Foundation??¢â???¬â???¢s Center for Data Analysis consider several different scenarios, and while the numbers differed some, the conclusions were unarguable. An ownership society would have greatly increased the retirement security of these workers, as the case studies in the accompanying sidebars show. Our analysis comes to the following conclusions:

  • New retirees with PRAs would receive incomes about 30 percent higher than they do now under Social Security.
  • In some cases, the difference amounts to hundreds of dollars per month.
  • These higher incomes more than offset the reduction in traditional Social Security benefits.

In principle, we looked at three representative workers who were born in 1940 and participated from 1965 to 2004 in a hypothetical PRA plan. Workers??¢â???¬â???¢ incomes are expressed in real inflation-adjusted dollars. The low-income worker earned $15,000 a year, the moderate-income worker $35,000 and the upper-income worker $65,000.

Their PRAs were funded through Social Security payroll taxes on a sliding scale, with workers at the low end of the income scale allowed to invest 7 percent of their incomes in PRAs and those at the top allowed to invest 2.5 percent. The mythical PRAs were invested in balanced portfolios of large-company stocks and government bonds. With the introduction of these PRAs, traditional Social Security payments would be cut in half, in order to prevent double-dipping.

This approach is novel because, unlike most other research, our analysis uses actual rates of return for stocks and bonds over the course of those 40 years. Since the mid-1960s, the economy has withstood six recessions. It has weathered wage-and-price controls in the early 1970s, stagflation in the late 1970s and the bursting of the Internet bubble. Yet, through all this, the markets have appreciated in value sufficiently to add thousands of dollars to these PRAs.

This simulation demonstrates not only the promise of PRAs but also the lost opportunity on the part of current retirees who won??¢â???¬â???¢t enjoy the benefits of this reform.

So when should lawmakers move forward with these reforms? The sooner, the better — before even more workers miss out. This research underscores the tremendous potential of PRAs for Generation Xers and the generations that follow. Congress should act now — in this legislative session — to implement these important ownership society reforms.

Case 1: Low-Income Worker.
If a worker earning $15,000 per year had set aside 6 percent of his earnings in a PRA, at retirement, the worker??¢â???¬â???¢s PRA, under this study, would??¢â???¬â???¢ve been worth $111,000, which could be used to purchase an annuity that would provide $640 per month for life. The worker also would receive a reduced Social Security benefit of $419 per month for a monthly income of $1,058. Today, that worker receives $837 per month from Social Security, a difference of 26.5 percent.

Case 2: Low-Income Dual-Earner Couple.
A couple earning $40,000 annually would have been able to divert 6.5 percent of the wife??¢â???¬â???¢s earnings and 5.5 percent of the husband??¢â???¬â???¢s earnings to their individual PRAs. At retirement, they would have a combined PRA of more than $288,000, which could be used to purchase a joint and survivor annuity that would provide $1,553 per month for life. Combined with their reduced traditional Social Security benefits of $995, this would provide them with a monthly retirement benefit of $2,548.

Under current law, the couple would receive Social Security benefits of only $1,990 per month. Put another way, the couple??¢â???¬â???¢s retirement income would be 28 percent higher if they had been allowed access to PRAs 40 years ago.

Case 3: Moderate-Income Worker.
A worker earning $35,000 per year who put 5 percent of his earnings into a PRA would build an account worth $215,000. That could be converted to an annuity that pays $1,244 per month for life. That, combined with $734 in reduced traditional Social Security benefits, adds up to $1,978 in monthly income. That??¢â???¬â???¢s 35 percent more than the $1,468 per month that worker receives today under traditional Social Security.

Case 4: High-Income Worker.
The high-income earner, the worker making $65,000 per year over that 40-year period, also would fare better. Allowed to contribute just 2.5 percent of earnings to a PRA, this worker still would build a nest egg of more than $280,000 by retirement. That would be enough for an annuity that pays $1,618 per month, which, combined with the reduced traditional Social Security benefit of $955, would give this worker a monthly retirement benefit of $2,572. Under current law, that worker receives $1,909 per month in Social Security. Again, we see a 35 percent advantage for the worker in a PRA.