In just 15 years, workers' Social Security payroll taxes will fall short of what is needed to pay promised benefits, and the system will require increasing cash transfers from general revenues. One way to begin alleviating the shortfall is to allow workers to set aside a portion of their Social Security taxes in Personal Retirement Accounts (PRAs). These accounts would earn a market return over the workers' lives and replace some of the retirement benefits promised by Social Security. However, there are several concerns about a PRA system:
- Would the government be able to manipulate the stock market or make politically motivated investment decisions with PRA funds?
Would inexperienced investors make poor investment choices? - Would investors be subject to undue risk due to stock market volatility?
Used as a model, the Thrift Savings Plan (TSP) – a low-risk, low-cost retirement savings plan for federal employees – demonstrates ways to allay these concerns. The TSP is a voluntary program that functions like a 401(k) for federal employees, including members of Congress. Currently, the TSP manages about $100 billion in three million federal employees' individual accounts. The TSP:
1. Insulates Investments from Politics
The TSP has three features designed to insulate the fund from politics – including attempts to use the participants' savings to make political or ethical statements, influence corporate behavior or fund federal government deficits.
First, an independent Federal Retirement Thrift Investment Board administers the TSP. The board is comprised of five part-time presidential appointees who serve four-year terms and select a full-time executive director. The board is regularly audited and reviewed.
Second, the law requires the board to act in the best interest of the plan's participants and beneficiaries. Failure to do so would subject the board's members and employees to civil and criminal liability. According to TSP Executive Director Roger W. Mehle, "Congress wisely established this fiduciary structure because it recognized that all funds held in trust by the plan belong to the participants, not the government, and thus must be managed for them independent of political or social considerations."
Third, the structure of the TSP discourages political manipulation. The TSP invests in index funds rather than individual stocks. "Indexing" is a form of passive management in which securities are held in proportion to their share of the stock or bond markets as a whole. For example, the TSP's government securities investment fund holds special issue U.S. Treasury bonds. And the stock index fund tracks common stock indexes such as the Standard & Poor's 500 or Wilshire's 5000.
2. Protects Inexperienced Investors
TSP participants are not able to pick individual stocks. Rather, they choose their investment allocation from among five pre-constructed plans: U.S. Treasury bonds, common stocks, fixed income assets, international stocks and small capitalization stocks. These funds carry varying degrees of risk and reward.
Government Securities Investments. The "G" Fund is invested in short-term U.S. Treasury bonds guaranteed by the federal government. There is no possibility of a loss of principal, thus no risk of loss.
Fixed Income Index Investments. The "F" Fund is invested in a bond index fund, currently the Lehman Brothers Aggregate (LBA) index, which represents a diversified group of U.S. government, corporate and mortgage-related securities. Through the G and F Funds, TSP participants with low risk tolerance can avoid the stock market entirely.
Common Stock Index Investments. The "C" fund is invested in a portfolio that tracks the stock market as a whole by replicating the performance of an index such as the Standard & Poor's 500.
Small Capitalization Stock Index Investments. The "S" Fund is invested in a portfolio that replicates the performance of an index that includes common stocks, excluding the stocks in the C Fund. It currently uses the Wilshire 4500 index, which tracks the performance of the non-S&P 500 stocks in the U.S. market. Thus, the S and C Funds together cover almost the entire U.S. stock market.
International Stock Index Investments. The "I" Fund is invested in a portfolio designed to track the performance of an index that represents the international equity markets. The board chose to mirror the Morgan Stanley EAFE (Europe, Australasia, Far East) index, which tracks the stock markets in 21 countries.
The board selects the assets manager of the F, C, S, and I funds through competitive bidding, so individual workers are not bombarded by advertisements and promotional materials. Potential asset managers are evaluated on objective criteria, including their ability to track the relevant index, low costs, fiduciary record, experience and fees, according to TSP Executive Director Mehle. Currently, the board contracts with BGI, the largest American index funds investment manager. BGI invests TSP participants' savings in trust funds in which the holdings of public and private employee benefit plans are invested together.
3. Avoids Unnecessary Risk
How do TSP accounts fare? The figure shows TSP returns after deducting administrative expenses, and trading costs and accrued investment management fees. 
It shows that the funds' 10-year returns have been positive, despite ups and downs during the period.
TSP participants – and prospective personal account holders – should take note. While the market goes up and down from year to year, it is important to think long-term. For example, take the S&P 500 index on which the C Fund is based. An analysis of the returns on investment in the Standard and Poor's 500 Index by economists at the Private Enterprise Research Center at Texas A&M University shows:
- Over any 35-year period ending between 1872 and 2000, the market provided an average annual return of 6.4 percent after inflation.
- There were positive gains in every 35-year period and each outperformed what Social Security will pay in return for workers' payroll taxes.
And, as previously outlined, accounts need not be invested in stocks. Workers could instead invest in government or corporate bonds, which tender less risk but yield smaller returns.
Conclusion
Of course, the Thrift Savings Plan and Personal Retirement Accounts differ in significant ways. Notably, the TSP monitors fewer than 5 million accounts, while the Employee Benefits Research Institute predicts that a Social Security PRA plan could include up to 148 million participants. This difference in scale would impose limitations. Many options available to TSP participants, such as the ability to borrow against their accounts, would likely be unavailable to personal account holders. Social Security PRAs would be more difficult to manage because participants' incomes, earnings records, and types of employers and employment would be so diverse. Still, the TSP is an excellent small-scale model for the structure and administration of PRAs.
Matt Moore is a policy analyst with the National Center for Policy Analysis.