Under the White House Social Security plan, workers who opt to divert some of their payroll taxes into individual accounts would ultimately get to keep only the investment returns that exceed the rate of return that the money would have accrued in the traditional system.
The mechanism, detailed by a senior administration official before President Bush's State of the Union address, would hold down the cost of Bush's plan to introduce personal accounts to the Social Security system. But it could come as a surprise to lawmakers and voters who have thought of these accounts as akin to an individual retirement account or a 401(k) that they could use fully upon retirement.
"You'll be able to pass along the money that accumulates in your personal account, if you wish, to your children . . . or grandchildren," Bush said last night. "And best of all, the money in the account is yours, and the government can never take it away."
The plan is more complicated. Under the proposal, workers could invest as much as 4 percent of their wages subject to Social Security taxation in a limited assortment of stock, bond and mixed-investment funds. But the government would keep and administer that money. Upon retirement, workers would then be given any money that exceeded inflation-adjusted gains over 3 percent.
That money would augment a guaranteed Social Security benefit that would be reduced by a still-undetermined amount from the currently promised benefit.
In effect, the accounts would work more like a loan from the government, to be paid back upon retirement at an inflation-adjusted 3 percent interest rate -- the interest the money would have earned if it had been invested in Treasury bonds, said Peter R. Orszag, a Social Security analyst at the Brookings Institution and a former Clinton White House economist.
"I believe you should be able to set aside part of that money in your own retirement account so you can build a nest egg for your own future," Bush said in his speech.
Orszag retorted: "It's not a nest egg. It's a loan."
Under the system, the gains may be minimal. The Social Security Administration, in projecting benefits under a partially privatized system, assumes a 4.6 percent rate of return above inflation. The Congressional Budget Office, Capitol Hill's official scorekeeper, assumes 3.3 percent gains.
If a worker sets aside $1,000 a year for 40 years, and earns 4 percent annually on investments, the account would grow to $99,800 in today's dollars, but the government would keep $78,700 -- or about 80 percent of the account. The remainder, $21,100, would be the worker's.
With a 4.6 percent average gain over inflation, the government keeps more than 70 percent. With the CBO's 3.3 percent rate, the worker is left with nothing but the guaranteed benefit.
If instead, workers decide to stay in the traditional system, they would receive the benefit that Social Security could pay out of payroll taxes still flowing into the system, the official said. Which option would be best is still unclear because the White House has yet to propose how severely guaranteed benefits would be cut for those with individual accounts.
The administration official explained that the "benefit offset" merely ensures that those who choose personal accounts are not given an unfair advantage over the traditional system.
"In return for the opportunity to get the benefits from the personal account, the person forgoes a certain amount of benefits from the traditional system," the official told reporters. "Basically, the net effect on an individual's benefits would be zero if his personal account earned a 3 percent real rate of return. To the extent that his personal account gets a higher rate of return, his net benefit would increase."
Robert Pozen, a Massachusetts investment executive who served on the president's Social Security Commission, said the mechanism makes sense. Workers who draw money out of the Social Security system for their accounts should have to pay that money back with interest.
But critics of the Bush plan said the proposed "claw back" renders the whole idea of "personal retirement accounts" virtually meaningless. Indeed, the system would ultimately look something like a proposal made by President Bill Clinton, in which the government would have invested Social Security taxes in the stock market.
That idea was criticized by conservatives because the federal government could end up choosing winners and losers in the financial markets. But under the Bush system, the government is still choosing the stocks and bonds to be bought with Social Security money, said Jason Furman, a former Clinton administration economist. Individuals would get a limited choice, and the government would still keep most of the returns.
"They hope people will think they will take on these accounts and after 40 years, they'll have this huge windfall, but that won't happen," said Dean Baker, co-director of the liberal Center for Economic and Policy Research. "I think they're trying to confuse people."
Stephen Moore, a conservative supporter of Bush's Social Security effort, said the mechanism would undermine the president's notion of an "ownership society."
In a nod to lawmakers worried about the budget deficit, the White House will also hold down the initial cost of the Social Security plan by phasing it in over three years, beginning in 2009. The administration official said funding the individual accounts would cost $754 billion through 2015. But because of the phase-in, the personal-accounts system would not be fully effective until 2011.
In its first 10 years, 2009 to 2018, the system would cost more than $1 trillion, Furman said. Between 2019 and 2028, the cost would jump to about $3.5 trillion, he said.