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Dissecting the president's Social Security plan

President Bush's proposed overhaul of Social Security would require many participants to convert at least part of the accumulated wealth in thei personal accounts to annuities, which expire at death.

President Bush frequently argues that one of the big advantages of his proposed personal retirement accounts is that unlike traditional Social Security they would allow participants to leave any accumulated wealth to their “children or grandchildren.”

But that is not completely true under the proposal that has been advanced by White House officials, which would require many workers to convert some or all of their savings into annuities that would expire at death.

Annuities, which are sold by insurance companies, include a wide variety of financial instruments but generally offer a lifetime stream of income to owners in the payout phase. It’s a fair bet that annuities are understood poorly, if at all, by most workers in their 20s, 30s or 40s who are the prime target for Bush’s proposed personal accounts. But in fact they are likely to play a major role in any plan that moves forward.

According to a senior administration official who briefed reporters on the still-sketchy proposal this week, many workers who elect to participate in the personal account program would be required at retirement age to purchase an annuity to ensure they have a minimal stream of annual income for the rest of their life.

“We think it's very important that people not be in a position where their personal account money is withdrawn and it has the effect of pushing people into poverty,” said the official, who provided the background on condition he not be identified. “We specifically say that the money that is not annuitized can be left as an inheritance.”

The idea that workers would be required to use their savings to purchase an annuity might come as a rude surprise to anyone who is envisioning a system with the relative freedom and unfettered access offered by private IRAs and 401(k)s.

But it comes as no surprise to industry lobbyists and inside-the-Beltway operatives, who for years have been discussing the possibility of a partly privatized system that would retain one of the most basic characteristics of Social Security – namely, a lifetime stream of income.

“I think requiring the annuity makes good sense because that way people have a steady income for the rest of their life,” said Ron Gebhardtsbauer, senior pension fellow at the American Academy of Actuaries.

“That is what I would recommend for people even if they weren’t required to do it,” he said. “Of course it goes against what people thought, that it would be ‘their’ money.”

In crafting a plan to overhaul the 70-year-old Social Security system, President Bush wants to ensure nervous lawmakers that any money saved within personal accounts is used for retirement and not cashed in, say, for a boat. Gebhardtsbauer, an actuary, calls such frivolous spending of retirement funds “leakage” or “wastage,” inappropriate for all but the most affluent retirees.

The White House Social Security proposal would require workers to annuitize enough of their savings upon retirement to guarantee they would get at least enough monthly income to keep them above the poverty line, according to the anonymous administration official, whose remarks were transcribed and posted on the Web at 

That could affect many, if not most, workers who set aside the proposed maximum allowable in the new accounts, 4 percent of salary or one-third of the current total 12.4 percent paid into the Social Security system by workers and their employers.

The current average monthly benefit for Social Security retirees is $955 a month, only $200 above the $755 needed for a poverty-line income.

Workers who invested one-third of their Social Security taxes into a personal account presumably would have their benefits reduced by a similar amount, resulting in a monthly check that on average likely would fall below the poverty line. So a typical worker probably would have to annuitize at least part of the savings.

One question that arises is the timing of an annuity purchase. In , the National Academy of Social Insurance offers the fictional example of a personal account holder who dies a week after purchasing a standard annuity. "His account balance has disappeared; Joan (his wife) cannot inherit it because the money has gone into the annuity," according to the report, written by a bipartisan panel.

John Rother, director of policy and strategy for AARP, says if personal accounts are approved by Congress they probably would require even more annuitization than described by the White House because Social Security benefits likely would be cut to achieve long-term solvency.

“Almost all the money for most people is going to be required to be annuitized, and it will look a lot more like Social Security,” he said. “If you have to annuitize it anyway, why are you going through the higher expense and higher risk than you would if you just fixed Social Security in a straightforward manner?”

Of course if personal accounts substantially outperform what the Treasury is able to do under the traditional system, workers could have something left over that would be inheritable. “Obviously they would not even be offering this option if they didn’t think  you would do better,” said Berna Brannon, a Social Security analyst at the Cato Institute, which advocates privatization.

The proposed annuity feature raises a host of questions, including what types of annuities would be offered and when the purchase would have to be made. Annuity prices can vary significantly depending on market conditions.

The process of selling annuities, would be “channeled through the federal government,” said the senior administration official. “People wouldn't be out there shopping on their own for a private sector annuity.”

But the annuity feature would require a significant amount of education. Any annuities sold presumably would include protection against inflation, as Social Security provides through cost-of-living adjustments.

But workers still might have other features to choose from, such as life-insurance benefits for a spouse. Without such protection, a worker’s hard-earned personal account could disappear overnight.