By ROBERT MUKSIAN
The Providence Journal
31-OCT-05
The rhetoric about private Social Security accounts includes the passing of the funds to an estate upon the death of the owner of the account. President Bush emphasized this "ownership" availability in his April 28 news conference.
He spoke accurately. However, to enable such a transfer, the death of the owner must occur before the date of a conversion to a life annuity, because upon the conversion, the association of a dollar amount in the account with an owner's name ceases to exist.
Instead, the account is replaced by a stipulated monthly payment, which is a function of the amount available, the individual's age, and an interest rate at the time of conversion. The payments end upon the death of the annuitant, and since there will not be an account, there will be nothing to transfer to one's estate.
There are two broad categories of annuities: certain and contingent. Annuities certain require a specified number of payments (such as repaying loans), and contingent annuities require payments until the death of the annuitant. The latter are commonly called life annuities.
Now, if an individual converted a million-dollar account to a life annuity to begin payments on the first day of the next month and died during the month, all would be lost to the person's estate. To provide protection against such losses for married couples, joint and survivor life annuities were created by insurance companies.
These annuities will pay a monthly amount until the deaths of both husband and wife. The amount paid to the surviving spouse may be stipulated at the beginning of the annuity as 100 percent, 75 percent, 66 2/3 percent, or 50 percent of the initial payment amount. Now, if both die during that first month, again, all will be lost to the estate.
This unattractive feature of life annuities was removed by insurance companies in their creation of a joint and survivor life annuity with a period certain, which is normally 10, 15, or 20 years. Thus, the monthly-payment amount that was based on that million-dollar fund would continue for the lives of both husband and wife and to a contingent beneficiary for the balance of the period certain if both died within that period.
In this case, if both died one day after the period-certain date, an amount would still be lost to the estate. The selection of any of the options of life annuities has an effect on the monthly amount, the single life payment paying the most and the joint life annuity with 100 percent for the surviving spouse and a 20-year period certain paying the least.
Mortality tables are used to arrive at a monthly payment. These tables may be constructed from theoretical concepts, actual experience within a particular population (such as those born in 1900), an insurance company's own mortality experience, or a specified period, as is done by the U.S. Department of Health and Human Services.
For this analysis, I am using the department's 2002 Life Tables. These tables were created by using the actual death rate for each age in 2002. For example, dividing the number of males who died between their 67th and 68th birthdays by the number living on the 67th birthday gives the death rate for that age. These age-based death rates are then applied to a hypothetical cohort of 100,000 people, with an assumption of equal numbers dying each day, and are assumed to apply throughout 100-plus years.
These 2002 tables show that 75,501 of an original 100,000 males will survive from birth to age 67, and the life expectancy of those survivors will be 15.2 years, up to age 82.2. However, only 38,763 males of that group will survive to that age.
Thus, 51 percent of the male survivors at age 67 will survive to age 82.2.
Conversely, 49 percent will die before that age, and therein is the problem with life annuities from the individual's perspective.
The life tables provide accurate predictions for a large body of people, but the "half" to which a specific individual belongs is unknown, and if you are that individual, the survival "half" is important, because those who die early (before the life-expectancy age) pay for those who die later (after the life-expectancy age).
Therefore, regardless of the nature of a private account (Individual Retirement Account, 401(k), 203(b), or Social Security), one should look long and hard before converting to a life annuity.
Although recent rhetoric points to modifying Social Security without private accounts, until Congress enacts other legislation, President Bush's privatization proposal could become a reality in some form, such as converting part of the account to a life annuity, with the rest being discretionary.
The president's proposal to partly privatize Social Security is to divert 4 percent of the Federal Insurance Contributions Act (FICA) payroll tax to the private sector.
In my analysis, I have assumed a mix of stocks and bonds that will generate an annual investment rate of return of 7.5 percent. With this return, and an employee compensation of $40,000 in 2005, the diversion of a third of the FICA tax to the private sector would result in an individual's getting a fund of $1 million at the end of 45 years (ages 22 to 67), ignoring management fees in the investments.
Now, if death occurs before conversion of this account to a life annuity, this is a nice number to pass on to family. But when it is converted to a life annuity, the account value will cease to exist _ to be replaced by a monthly payment for life under one of the options that may be available at that time.
Since the concept of the private account is apparently intended to supplement the Social Security benefit, it is problematic that a period-certain option would be made available, and benefits would cease with the death of the individual or surviving spousal beneficiary.
This joint and survivor annuity mirrors Social Security under current law. The Social Security's Quick Calculator predicts that at age 67 _ the current full retirement age for a 22-year-old worker _ this worker would have an annual benefit of $88,332 in future dollars, beginning in 2050. This benefit would be about $17,160 in today's dollars.
The Social Security Administration has projected that, under current law, with a depleted Social Security Trust Fund and the current contribution rate of 12.4 percent of the worker's wages up to the indexed cap, the system will be able to sustain about 72 percent of the scheduled benefits, unless unforeseen factors cause a change. Then, if nothing is done to protect the system, this annual benefit would be reduced to $68,899, or $13,780 in today's dollars.
If the future market returns are 7.5 percent, it is improbable that funding companies will establish life annuities based on a rate this high. The insurance giant TIAA-CREF guarantees only a 3-percent return for its retirement annuities, and to emulate Social Security's guarantee, one cannot plan on a rate much greater than 3 percent.
I have used 5 percent and a starting age of 67. As with private pensions, the annual payments from the private account would probably be based on a gender-neutral life expectancy (to avoid sex discrimination), and with a $1 million fund, the annual payment of a life annuity would be about $90,500, neglecting any fees associated with the annuity.
However, to emulate the current Social Security system, married couples would have to elect a joint life annuity, with two-thirds of the monthly benefit going to the surviving spouse. This would cause a reduction of the annual benefit and excess cited above. A further reduction in that benefit would ensue if a cost-of-living factor was included in order to determine an initial benefit. The combined first-year benefit would be $159,399 (68,899 + 90,500), which is about $31,880 in today's dollars. This benefit amount supports privatization, if you are going to live a long life.
Assuming a $1 million fund, invested at 5 percent, and a level withdrawal stream of $90,500 a year, beginning at age 67 and payable monthly: If a retiree dies at age 70, the balance of the fund would be about $860,000; if he or she dies at age 75, the balance would be about $590,000; and if he or she dies at 80, the balance would be about $240,000.
As indicated above, about half the 67-year-old age group will die before the life-expectancy age, and the residual funds would be used to pay the benefits for the half that lives beyond the gender-neutral life expectancy of about 18.5 years to age 85.5.
The funding company remains whole. But the view from the individual's perspective is just the opposite. These are the amounts that would be "lost" to the owner's estate to pay the benefits to those who die after that life-expectancy age. Therefore, the president's comment about the benefit ownership would not be completely accurate if a life annuity is mandated from the privatized account.
I oppose the concept of diverting Social Security taxes to the private sector. I suggest diverting income taxes to a private fund, to be available, if needed, and to be returned to the government, if not needed _ or else diverting income taxes to a private fund in amounts sufficient to give everyone a combined benefit of $30,000 a year.
Younger workers should look long and hard before leaving the current Social Security system and going "full speed ahead and damn the torpedoes" for a voluntary private Social Security account.
(Robert Muksian is a professor of mathematics at Bryant University.)
(Distributed by Scripps Howard News Service, www.shns.com.)
