Early Retirement Accounts are the Way Forward

Could a reformed public pension system give citizens more control over their retirement savings, as conservatives want, without undermining security in old age, as liberals fear? Here is a proposal that does just that in the American context, although it could apply equally well to any public pension system struggling with long-term debts and an ageing population.

The idea is to allow all US workers to divert a portion of their payroll taxes into personal "early retirement accounts", which would give individuals more control over their financial destiny and the timing of their retirement. In exchange, the age at which Social Security benefits kick in would be pushed back several years, but without any cuts in monthly benefits thereafter.

At a stroke, this proposal overcomes the most serious objections to privatisation plans. Although such a system would require some initial borrowing, it more than pays for itself over time. Say, for example, that individuals were allowed to divert one-sixth of their payroll taxes into early retirement accounts. Suppose further that the minimum age for receiving a Social Security pension rose from the current 62 to 68, and that the threshold for full benefits increased from 65 to 72. The Social Security Administration's Office of Policy estimates that the savings from this extension in the retirement age would not only cover the full cost of the early retirement accounts, but would also make the system solvent in the long term.

In his recent State of the Union address, George W. Bush, US president, outlined his vision of a new system in which all Americans now under the age of 55 would face significant cuts in their promised monthly benefits. The hope is that individuals could use their personal accounts to make up or exceed the difference.

But what happens if the market turns bearish several years into your retirement? Or if you exhaust your personal account and then have to subsist on substantially reduced Social Security benefits?

Our proposal preserves the core purpose of Social Security by protecting those in danger of outliving their savings from any cuts in monthly benefits. At the same time, it gives people a vehicle for financing early retirement.

While it leaves those aspiring to early retirement exposed to some financial risk, it allows them to bear that risk while they are still relatively young. If your early retirement account does not perform well enough for you to be able to retire at 62, then you will just have to work a few years longer before you receive full Social Security benefits. If you are physically unable to work, you would still be eligible for disability insurance.

There are other potential benefits to this plan. Most personal account plans call on individuals to purchase annuities when they retire. Annuities, however, are expensive, vulnerable to inflation, cannot be passed on to heirs and bear the risk that the company offering them will go broke. With early retirement accounts there would be no need to purchase annuities, because Social Security benefits would remain in full force in one's later years.

Best of all, early retirement accounts would encourage workers to remain in employment for longer, so as to retire in greater comfort later on. Research shows that people with 401(k) and other defined contribution plans tend to delay retirement. The longer citizens remain in the workforce, the more they will contribute to their own and the nation's economic well-being, and the likelier they are to remain healthy.

The original purpose of Social Security was to protect Americans from destitution in their final years -- a mission that remains as important today as it was 70 years ago. Since the first Social Security cheques started flowing, however, life expectancy at the age of 65 has increased by 34 per cent for men and 41 per cent for women. Today, a man retiring on Social Security at 65 can expect to collect benefits for a full 16 years, and a woman for 17.5. Given these gains in longevity, does it really make sense to maintain 65 as the standard retirement age?

Ensuring the strength and solvency of public pension systems in ageing societies need not require benefits cuts in old age nor massive new debts for our children. Rather, the best way to reform public pension systems is by encouraging all citizens to retire later and richer.