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EXECUTIVE SUMMARY

Gradually, we are coalescingaround an understanding thatthe nation’s retirement systemneeds an overhaul. Social

Security, as it is currently structured, createsno property rights and builds no pool ofnational wealth. It is a combined taxationscheme and welfare scheme, with thetaxation and welfare elements of the systemlargely unrelated to each other. In this paperwe frame the broad outlines of a investment-based social security program that in ouropinion best addresses, balances, andharmonizes the desire of the libertarian thatthere be reduced state regulation and thedesire of the statist that government have arole in mitigating risks associated withmarket forces and human behavior.

One objective of a new investment-basedsystem should be to minimize the potentialfor legal challenges. It should be groundedin some combination of the Tax and GeneralWelfare powers of Congress. We propose asystem with 6 key players: PRA Owners,Employers, Private Financial ServiceProviders (PFSPs), PRA Administrators, aNational Clearinghouse (NC), and a FinalRegulatory Authority (FRA). The National

Clearinghouse is a quasi-self-regulatingbody similar to the NASD or DTCC. Theobjective of a government regulatorystructure is to ensure the safety andintegrity of the national retirement system.Accountants and attorneys developsystems that rely on monitoring.Economists prefer systems that minimizecompliance costs and are self-regulating.“Self-regulation” is not a code phrase for“no regulation”. Self-regulating systemsachieve their objectives with lowereconomic and social costs. The NationalClearinghouse regulates the system andprovides a pooled-fund “default”investment vehicle for small accounts thatminimizes employer involvement. PFSPsshould be free to develop alternativeoperational models that meet theregulatory requirements of the NationalClearninghouse. A competitive marketsystem will evolve the most efficientmodels.

Taxation: There are three “levels” inthe system that are subject to taxation:(1) Contr ibut ions , (2) Investmentaccumulations, and (3) Distributions.Notating each level as L1, L2, and L3,and either taxed (T) or exempt (E), wecan choose any combination of system

A Legal and OperationalFramework for the

Privatization of Social Securityby Karl J. Borden and Charles E. Rounds, Jr.

BHI Policy Study

Karl Borden is a professor of financial economics at the University of Nebraska. Charles RoundsJr. is a professor of law at Suffolk University Law School. An earlier version of this paper waspresented under the auspices of the Cato Institute.

March 2002

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from TTT to EEE. We argue for an EEEsystem based on: administrative andtransactions cost efficiency, marginal costs/benefits, tax equity considerations,avoidance of perverse incentives, andtransition cost minimization.

Retirement Age: Rather than think of a“Social Security” system in terms ofpreparing for “retirement” from theworkforce, we need to shift our thinkingto view the system as a means of liftingindividuals to a”“hold harmless” level ofpersonal wealth that eliminates moralhazard. Allow individuals who havereached”“hold harmless” status to accesstheir “retirement” accounts according tocertain rules that protect basic fundbalances.

Spendthrift and Assignability Issues:One element of law that will evolvearound PRA accounts will be provisionsto protect account assets from irrationalbehavior and predation. Spendthrift andassignability-limitation provisions dothat. The law must include an air-tightPRA anti-alienation requirement.Equally crucial is protection againstaccount owners assigning their propertyrights to others.

Marriage and Divorce Provisions: One ofthe thorniest issues for a new system is howit handles marriage and divorce. Wepropose that individuals in anyrelationship legally defined as“marriage” by any state be required toform a “marriage” PRA account. Therequirement is important to avoid a non-earning spouse being left without assetsand to minimize litigation. Marriedcouples would not be permitted separateaccounts during their marriage. When amarriage dissolves, both members of themarriage partnership revert to“individual rules” for asset accumulation.The community assets of the marriageaccount are equally divided and addedto the partner’s individual PRA accounts.We propose a number of detailed rules

for such accounts to minimizeadministrative and litigation expenses.

INTRODUCTION

Gradually, we are coalescing around anunderstanding that the nation’sretirement system needs an overhaul.Social Security, as it is currentlystructured, creates no property rights andbuilds no pool of national wealth. It is,rather, a combined taxation scheme andwelfare scheme, with the taxation andwelfare elements of the system largelyunrelated to each other. Given thePonzi-like nature of the system, it isprobable that sooner or later SocialSecurity will be transformed into aninvestment-based system, citizens willenjoy property rights to their ownaccounts, and real wealth willaccumulate to the benefit of all levels ofour society. But what form will aprivatized social security system take?Will the legal and regulatory structurethat sustains a system of individualaccounts look, for instance, more like theone that supports 401(k) Plans, or morelike that which supports IRA’s?

These questions, and others like them, arebeginning to be asked. The focus of thedebate, in fact, is very likely about toshift: away from questions of whetherand when to discussions of how and howmuch. What is to be the legal, regulatory,and operational framework of a nationalinvestment-based Social Securitysystem? Just how will funds flow fromindividuals into the system, who will runit, which government entities andprivate-sector institutions will beinvolved and how will they interact, towhat extent will funds be taxed, who willwrite and enforce regulations, and whatwill be the legal and operational detailsof the system?

Getting from here to there will meantreading a perilous path through armiesof accountants and attorneys who are

going to try to regulate the new systeminto oblivion. What is more, the mannerin which the basic law is framedconstitutionally and the fundamentalstructure of the system that is created willbe critical to its success or failure. It is time,we believe, to start paying attention tosome of the details of the plan that is likelyto emerge from the political process aheadof us.

In this paper we frame the broad outlines ofan investment-based Social Securityprogram that in our opinion best addresses,balances, and harmonizes the desire of thelibertarian that there be reduced stateregulation and the desire of the statist thatgovernment have a role in mitigating risksassociated with market forces and humanbehavior. We start with a fundamentalquestion: What is the constitutional basisfor an investment-based Social Securitysystem? The core of our proposal issomething we call the Private RetirementAccount or PRA. The reader will see thatthe PRA is closer to the IRA model than the401(k) model. We then propose afundamental regulatory structure that isdesigned to protect the system, minimizecosts and maximize flexibility andinnovation. Finally, we address severalspecific system elements that are critical tooperational success: start-up funds-flowprocedures, limits on investment discretion,marriage-and-divorce provisions, “holdharmless” status and the age of “retirement”,taxation of contributions and disbursements,and assignability and spendthrift provisions.

I. CONSTITUTIONALITY

Congress may not institute a nationalforced savings program without theauthority to do so, and that authority mustcome from the U.S. Constitution. IfCongress has such authority, it is likely tobe found in its power to tax (Art. 1, §8),its power to provide for the generalwelfare (Art. 1, §8), or its power to regulate

commerce among the several states (Art.1, §8). Of these three options, the leastpalatable choice is probably the third(Commerce). Opponents of a nationalforced savings program are most likely toargue that the Commerce clause is notsufficiently elastic to accommodate sucha scheme, i.e., that such a scheme is theprovince of the states (Amend. X). Theymight also argue that it violates theTakings clause (Amend. V) in that the PRAowner’s equitable or beneficial propertyinterest in the principal, i.e. the use of thatprincipal, has been taken by the statewithout just compensation during theperiod of employment. What is more,grounding a new system in the Commerceclause could lose the philosophicalsupport of some of its strongest potentialadvocates. Libertarians and conservativeswould not want to be put in the positionof having to advocate a further expansionof the reach of the Commerce clause.1

Grounding any new law in somecombination of the Tax and GeneralWelfare powers of Congress makes goodsense for several reasons. It is settled lawthat the Social Security program as itcurrently exists, for instance, isconstitutional, because it is actually twolegally unrelated regimes: one involvingtaxation and the other involving welfareappropriations.2 They are so autonomous,that it is likely that Congress would havethe authority to abolish the welfareappropriations provisions of the SocialSecurity Act while leaving intact thetaxation provisions.3

If a new investment-based retirement systemutilizing Personal Retirement Accounts is tobe constitutionally bullet proof, it should beestablished as an incident of Congress’power to tax and stay within current practiceand precedent. Accordingly, we suggest thatit “borrow” from the traditional IRA modeland incorporate that model by amendmentinto the existing taxation provisions of theSocial Security Act. The worker would begiven a choice: he and his employer could

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We start with afundamental question:What is theconstitutional basis foran investment-basedSocial Security system?

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pay the Social Security income and excisetax, or he and his employer could transferto a PRA an amount of pre-tax incomeequivalent in value to what otherwisewould go to the Treasury as Social Securitytax payments. In theory, Congress wouldhave the authority to terminate altogetherthe welfare appropriations provisions of theSocial Security Act. Presumably, however,it would begin the process of cutting backor eliminating the PRA owner’s right toSocial Security welfare payments.4

II. A PROPOSED OPERATIONALSYSTEM

An investment-based Social Securitysystem is in many ways inevitably goingto occupy a unique middle ground in therange of government-sponsored andprivate pension and retirement programsthat form the panoply of current systemsavailable to American workers. On theone hand, the new system will primarilybe designed as a “Defined Contribution”(DC) system that both mandates andlimits contributions, but leaves to marketforces the exact accumulations andbenefits available to individualparticipants. On the other hand, it ispolitically probable that the system thatemerges will include some minimum levelof support that will be guaranteed by thegovernment (thus taxpayers). Thatguarantee produces something like aminimum Defined Benefit (DB), andcreates a number of interesting andcomplex economic and legal issues.5

Operational systems for a nationalretirement program will be critical to itssuccess, as there will be literally millionsof accounts to be created andadministered, with hundreds of millionsof individual contributions flowing intothe system each year. Employees willgenerate, sometimes, single paychecksfrom a short-term employment contractthat produce contributions measured incents that must find their way intocumulative balances credited to that

individual’s account. Unlike SocialSecurity, which merely taxes employersand employees in the aggregate and waitsuntil year-end to sort out who paid howmuch, the new system must somehowcredit individual accounts and allowparticipants to start earning a return ontheir contributions virtually immediately.And, the system must assure that allemployers and participants have accessto the program, regardless of the size orvalue (to the administrator) of themanagement contract.

The operational plan we envisionincludes the following key players, eachwith an essential role to play:

1). PRA Owner: The PRA Owner is theessential, and central, legal player in thesystem. This is an important concept:that the PRA Owner maintains at all timesproperty rights to his or her accountbalances, is responsible for certainelements of investment direction, andmakes personal decisions regardingwhen to access account balances oncethreshold values have been achieved. Inthis sense, the PRA is much more like anIRA than a 401(k) or 403(b) plan. In thePRA world, in fact, there is no plan in theERISA sense.6 There are simply millionsof individual accounts under thedirection of individual account owners,restricted in their choices only in orderto optimize the achievement of system-wide objectives.7

2). Employer: Employers continue toplay an important role in the new,investment-based Social Security system.They are the middlemen in the cash flowprocess, just as they are now. In fact,that role will probably need to besomewhat enhanced by the increaseddata-transmission requirementsnecessary for an investment-basedsystem.8 But, the employer is not in anysense a “Plan Administrator (as ERISAuses the term), and has no fiduciary

The system must assurethat all employers andparticipants have accessto the program,regardless of the size orvalue.

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responsibility for account balances oraccount management.

3). The Private Financial ServicesProvider (PFSP) is an institution thatoffers PRA investment account services.Every employee must either choose aPFSP or (see below) participate in aNational Clearinghouse “pooled fund”,and any employee is free to move toanother PFSP at any time. The PFSPprovides a series of investment vehiclesthat are designed to meet systemrequirements (see below) and that providea range of investment choices to PRAowners. The PFSP is not a trustee of themutual fund participations, and has nocontractual rights in the bank accounts,the insurance contracts or mutual fundbalances that are being managed on behalfof the PRA owner. The PFSP is acting,through its agent, much as an IRA-typecustodian.

4). PRA Administrator: The PRAAdministrator is an agent of and worksfor the PFSP. The PFSP itself may serveas PRA Administrator, i.e. it need notcontract with and act through agents.“Administration” in this context shouldbe clearly distinguished from the ERISArole of “plan administrator”. The termas used here merely connotes a providerof financial administrative services forPRA owners through their employers.The PRA Administrator handles assetcustody and transfer; record-keeping andaccounting; customer contact; anddocumentation storage, all according toprocedures and regulations promulgatedand enforced by a NationalClearinghouse. The PRA Administratoris an agent of the PFSP, and as such thechoice of PRA Administrator is made bythe PFSP, which must be able to workefficiently with the Administrator for asmooth cash flow process. The PRAAdministrator issues an order to anemployer to pay withheld funds to thatAdministrator when an employee has

chosen a PFSP that handles fundstransfers through that Administrator.

5). National Clearinghouse (NC): AllPFSPs, PRA Administrators, andindividual account representatives mustbelong to a National Clearinghouse. ANational Clearinghouse is a privatecorporation or trust, licensed by the FinalRegulatory Authority (FRA) to overseePRA services and provide commonoperational functions that are necessaryto an integral system. Specifically, theNC:

a) Sets standards for and licensureof PFSPs, PRA Administrators, andtheir agents and representatives. Thiscould include setting minimumcapital requirements for PFSPs andPRA Administrators.b) Sets asset allocation and portfoliodiversification standards forapproved PFSP funds.c) Approves PFSP-sponsored fundsas meeting NC asset allocation andportfolio diversification requirements.d) Approves life annuity productsfor PRA owners who have reached“hold harmless” threshold values.e) Defines administrative andmarketing expenses and setsmaximum expense ratio standardsfor PFSPs.9

f) Approves cash flow andparticipant contribution systemsoffered by PRA Administrators.g) Provides a low-cost forum fordispute resolution.h) Provides a mechanism for theeasy electronic transfer, rollover, and/or aggregation of small accounts asemployees move from employer toemployer.i) Maintains a pooled-asset fundinto which PRA Administrators maypay PRA contributions until balancesreach a threshold level making themeconomically attractive as customeraccounts. This pooled-asset fund is

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essential to the smooth operation ofthe entire system, as it is the “default”investment for most small accountsand the primary means by whichemployers are relieved of the burdenand the responsibility of ERISA-type”“plan administration”.

6). Final Regulatory Authority (FRA):Some agency of the Federal governmentwith final regulatory authority. Thisagency licenses a NationalClearinghouse, sets broad policyobjectives and standards for the system,is a court of final appeal for NC disputeresolution, and has final authority overand responsibility for the fiscal integrityof the system. On behalf of thetaxpayers, this agency also reviewsNational Clearinghouse asset allocationand portfolio diversification standardsfor investment vehicles such that thesystem both avoids asset substitutionproblems and minimizes poor-portfolio-performance problems (this bydetermining maximum allowablestatistical limits for the expected numberof system participants falling into thesystem “safety net.)10

The Role of the NationalClearinghouses (NC)

The National Clearinghouses (NCs) arearguably the most unique element of theproposed PRA operational system design.These bodies, licensed by the FinalRegulatory Authority, share regulatoryresponsibility with that Authority, andexercise that authority under theguidance of, and with the final approvalof, that Authority.

The argument in support of such a quasi-self-regulatory system is made below, andwe believe it is compelling. But becausethe role of the NC is central to theoperational plan we envision, it isappropriate to first detail more fully whythis institution is operationally necessaryto the system.

First, we must appreciate the magnitudeof the task that will confront the newSocial Security program, and theproblems inherent in the mandate ofuniversal employee participation. AsShipman has detailed, the current cashflow system utilized by Social Securitytakes up to 18 months to allow individualemployee contribution data to catch upto the aggregate cash flows submittedperiodically by employers.11 This processworks sufficiently for a system thatmaintains no property rights toindividual accounts and for whichindividual returns on investment areirrelevant. But a PRA system depends onintricate record-keeping and crediting ofreturns, and it becomes essential not toimpose lost-opportunity costs on PRAowners by delaying either accountingrecognition of their contributions or, moreimportantly, actual investment of theirbalances in wealth-producing vehicles.

Couple this task with the reality ofmillions of small employers with just afew employees. Initial account balanceswill for some start with just a few centsto be contributed, invested andadministered. All employees will bemandated to find a PFSP, but which PFSPis likely to offer its services to anemployee with small account balancesthat generate little fee income?Eventually, most people’s individualbalances will reach a level where it is aprofitable activity to administer them,and it is tempting to say simply thatmarket forces will provide some PFSPwho will invest the carrying costs now tobenefit from profitable accountadministration later. But that answerignores that 1) Individual employeeswould often be unmotivated to seek outPFSPs, or to make choices amongcompeting PFSPs when a choice isoffered, 2) They often do not have theinformation to make such decisionsintelligently, even when they aremotivated and 3) Employers will bemandated to send the withheld

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funds’somewhere and must have a defaultrecipient for the funds if they (theemployers) are not to make investment-direction decisions for their employees.12

In order for our new national system tobe successful, there must be an assurancethat no one will be left out.

In the final analysis, there are only twoways to pay for the carrying costs ofsmall-account maintenance. Either theremust be some form of “cross subsidy”from larger accounts to smaller accounts,or the taxpayers, through the Federalgovernment, must pay the costs of small-account administration. The lattersolution is, we believe, appropriate onlyas a last-choice default should no privatesystem emerge from the structure wepropose (see below). But before resortingto a Federal system, we believe it ispreferable to allow private organizationsto come into existence with their ownsolution to the problem. These are whatwe have termed the NationalClearinghouses.13

A National Clearinghouse must in somemanner provide a mechanism whereby allcontributions are moved into interest-bearing or other investment vehicles witha minimum of delay. Shipman’ssuggestion of a three-level system, forinstance, is a logical one: The first levelwould move capital into a pooled money-market fund that “holds” thecontributions and bears interest until suchtime as individual contributioninformation”“catches up” with theaggregate contribution. Once theindividual contribution data catches up,the contribution (plus accumulatedproportional interest) is moved from thepooled money market fund into either a(level 2) pooled balanced fund vehicle (forPRA owners whose account balanceshaven’t yet reached profitable-administration-threshold values), or into(level 3) individual account balances ofthe PFSPs (for those who have). PFSPsare free to “mine” the pooled-fundaccounts and offer services to pooled-

fund balance holders at any time, eachPFSP determining for itself the lower-threshold limits of profitability.14

Since all PFSPs and PRA Administratorsmust be a member of a NationalClearinghouse, fees paid for membershipwould support the work of the NC and theadministrative costs of pooled-fundmaintenance. In that sense, since thePFSPs are in the business of profiting fromPRA investment and administration, thelarger-account holders are effectivelycross-subsidizing the costs of small-account maintenance. Each PFSP wouldbe required to accept any employee whowants to utilize its services, even if thatmeans giving that employee access to theNC’s pooled fund system.

But is this the only solution to the problemof moving contributions into productiveinvestment vehicles with a minimum ofdelay? Perhaps – or perhaps not.Fredrich Hayek observed that–“for someproblems, there is only one best solution.”But he also observed that it is a “fatalconceit” to believe that we can design thatsolution in advance. We must allow thatbest solution to emerge from a competitiveprocess. Maybe someone has a better idea;maybe technology will provide othersolutions. This need to provide for thepossibility of alternative designs forms oneof the fundamental justifications forallowing the emergence of competitiveNational Clearinghouses.15

III. A QUASI-SELF-REGULATORYSTRUCTURE

That an investment-based social securitysystem will be regulated by some arm ofthe Federal government is a certainty, andfew would argue that some form ofgovernmental oversight is not desirable.But there is regulation light and there isregulation heavy, and all the goodintentions of those who have worked forthe past two decades to make aninvestment-based system a reality could be

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destroyed by a Rube Goldberg regulatorystructure that imposes huge transactionsand compliance costs on the system.

What we propose is a quasi-self-regulatorysystem; one that balances both the role ofthe Federal government to safeguard andoversee the system and the role ofcompetitive forces to minimizescompliance and monitoring costs.

Objective of Regulation

The objective of a government regulatorystructure should be to ensure thefundamental safety and integrity of thenational retirement system. To the extentthat regulation minimizes dishonesty,optimizes risk-taking, and minimizes thecosts of compliance, it is successful.Unfortunately, the history of governmentregulation is generally otherwise. AsNobel-laureate James Buchanan hasshown with his Public Choice theory, theincentives and rewards for representativesof the government are largely structuredto encourage over-regulation and toreduce risk beyond optimal levels,increasing costs to both taxpayers andsystem participants.

And there is particular cause to beconcerned about the regulatory structurethat will be imposed on an investment-based retirement system, for the followingreasons: (1) There will be tremendouspressure on politicians to regulate away“excessive risk taking” on the part ofsystem participants; and (2) There arenumerous private-account retirementplans already regulated by the Federalgovernment, many of which haveregulatory structures that are ill suited tothis purpose.

The Wrong Model

Some have proposed adopting the 401(k)and 403(b) regulatory structure, codifiedin ERISA, for PRA accounts.16 Tounderstand why the ERISA regulatory

structure is inappropriate to the task, itis necessary understand the legal contextwithin which it has developed.

ERISA came about because of theperception that retirement plan sponsorswere breaching their fiduciary duties toemployees. As such, the entire focus ofERISA and its accompanying regulatorystructure is to protect plan participantsfrom either predation or incompetence onthe part of plan sponsors. In the ERISAworld, plan sponsors are fiduciaries forplan participants. But because plansponsors are frequently in a position tounfairly benefit themselves at the expenseof other plan participants, and becausethose plan sponsors make plan-widedecisions that affect all of the planparticipants, it is necessary to providesome oversight mechanism that assuresthat those decisions are made fairly andresponsibly.

But PRAs are entirely different world.There is no plan and neither the employernor the PFSP are in any meaningful sensea fiduciary of the PRA owner.17 At most,the employer and the PFSP are agents ofthe employee for the limited purpose ofcarrying out the employee’s lawfuldirections regarding the administrationof the PRA.

ERISA is an inappropriate regulatorymodel simply because the entire focus ofERISA’s regulatory effort is unnecessaryin a PRA world of individually-owned-and-managed accounts. It is of someconcern to us that the ERISA model,however, may be seen as a“simple”solution to the regulatory question. Theargument will go something like this:“The IRS and the Department of Laborhave decades of experience regulatingthis sort of thing.18 Let’s just weave thePRA into the ERISA regulatoryframework...Let’s not re-invent thewheel.” When someone objects to theunnecessary complexity of the ERISAsystem, the response is equally likely to

What we propose is aquasi-self-regulatorysystem; one thatbalances both the role ofthe Federal governmentto safeguard andoversee the system andthe role of competitiveforces to minimizecompliance andmonitoring costs.

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be “But ERISA has simplified forms, likethe 5500EZ, that can be used for PRAs”.19

But this misses the essential point. ThePRA structure does not require eveninformation returns to the IRS. Recordswill be kept by the PRA Administrator.The contributions are set by law and willbe what they will be. The market valuesof investment accounts managed by thePFSPs will be what they will be based onthe asset allocation and diversificationstandards set by the NC. 20 The employerhandles the W-2s. Where is there a rolefor another level of reporting or oversightfor which the 5500EZ was designed?

Regardless of how complex or simple onemakes the ERISA structure, it isfundamentally inappropriate for a PRAwhich is not a plan and which has nofiduciaries. One cannot be a fiduciary foroneself. If we were to impose the ERISAregulatory structure on PRAs we wouldactually have to create plan sponsors andasset trustee analogues, a totally artificialexercise with no social utility whatsoever.It is no coincidence that IRAs are notsubject to ERISA regulation.

A Quasi-Self-Regulatory Structure

Accountants and attorneys are trained inlaw and regulation, and tend to developoversight systems that rely extensively onmonitoring, audit and enforcementprocedures for their effectiveness.Economists, on the other hand, prefer tocreate systems that attempt to minimizecompliance costs by creating a set ofinternal incentives that are self-regulating. The uninitiated often assumethat “self-regulation” is a code phrase for“no regulation,” but that is not true.“Self-regulatory” systems aredistinguished from “monitoring”systems by their objective function.Monitoring and audit systems have astheir primary objective the elimination ofall non-compliance, with little or noregard for the cost of securing marginal

compliance. Self-regulatory systemsrecognize that imperfect compliance isinevitability regardless of the approach,and thus seek to minimize costs to achievean optimal level of compliance. Neitherapproach in fact eliminates non-compliance, but self-regulating systemstend to achieve their objectives with lowereconomic and social costs.

Such self-regulatory systems arerelatively rare in practice (most regulatorysystems are created, after all, by attorneysand accountants, not economists). Butwhere they have been tried, they havebeen extremely effective. Happily, severalsuch systems are already in place in thesecurities industry and have been modelsof low-cost, effective self-regulation forthe past seven decades; creating,implementing and enforcing a complexset of industry-wide regulations andprofessional licensures as well asproviding secure mechanisms forsecurities and capital holding andtransfer.

Example One: National Associationof Securities Dealers (NASD): TheNational Associat ion ofSecuri t ies Dealers is the largestsecurities-industry self-regulatoryorganization in the United States.Through i ts subsidiar ies , NASDdevelops rules and regulat ions ;conducts regulatory reviews ofmembers ’ business act ivi t ies ;disciplines violators; and designs,operates, and regulates securitiesmarkets and services a l l for theultimate benefit and protection of theinvestor.

In 1938, Congress passed the Maloney Actas an extension of the Securities Act of1934. The Securities Act of 1934 hadcreated the Securities and ExchangeCommission (SEC) as a Federal agency,and charged it with the responsibility forregulating securities markets. The

Self-regulatorysystems recognizethat imperfectcompliance isinevitabilityregardless of theapproach, and thusseek to minimizecosts to achieve anoptimal level ofcompliance.

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Maloney Act “encouraged” the over-the-counter securities market toestablish”“private trade associations forself-regulation.” The SEC is givenauthority to oversee and to change therules of these “private associations,” andsuch associations must be registered withand approved by the SEC. Effectively,all decisions and enforcement actions bysuch associations are appealable to theSEC.

The Maloney Act specifically stipulatesthat one or more associations of brokersand dealers may apply for registrationwith the SEC, that these groups mayregulate themselves within the guidelineslaid down by the SEC, and that thegroups may grant discounts on securitiestraded among their members. To date,only one such association of dealers hasregistered with the SEC under theprovisions of the act: The NationalAssociation of Securities Dealers (NASD).The NASD has approximately 7,000member firms that operate over 20,000branch offices and employ approximately500,000 registered representatives whosell securities. The NASD hasestablished a series of tests that must bepassed by any individual wishing to join,and those tests have for all practicalpurposes become the admission ticket toa career in the financial services industry.The NASD has established and enforcesa set of rules prohibiting fraud,manipulation, and excessive profit-taking; a uniform-practices codestandardizing and expediting routinetransactions, such as payments anddeliveries; and a procedure fordisciplining members who engage inillegal or unethical conduct.

Two elements of the NASD’s status areof particular significance to ourdiscussion here: (1) Although the NASDis the only association ever to haveapplied to the SEC for registration,nothing prevents another suchcompetitive association from coming into

existence. Any time the NASD fails tooperate efficiently, or becomes tooonerous in its regulatory structure,another such competitive organizationmay be formed. (2) This natural brakeon regulatory zeal is counterbalanced bythe oversight function of the SEC, whichis there as a court of appeal and as theultimate determinant of whether theNASD, as a registered association, isdoing the regulatory job that wasintended under the act and that the SECitself considers appropriate. Thisconstant tension between the standardsand levels of enforcement that the SECexpects on the one hand, and thepotential of a competitive entry into theirmarket on the other, maintains anappropriate equilibrium level ofenforcement and efficiency.

Example Two: Depository Trust andClearing Corporation (DTCC): InSeptember, 1999, the SEC established anew holding company, the DTCC, tocombine the functions of the formerDepository Trust Company (DTC) andthe National Securities ClearingCorporation (NSCC). These two firmsbetween them provide the primaryinfrastructure for the clearance,settlement and custody of the vastmajority of equity, corporate debt andmunicipal bond transactions in the U.S.The DTC subsidiary, for instance,provides for the custody and safekeepingof traded securities, proxy distributionservices, principal and incomedistribution, corporate action processing,withholding tax services, collateral loanservices, delivery and payment services,sets and enforces settlement risk controls,and provides clearing and settlementlinks.

The DTCC, through its two subsidiaries,is the world’s largest securitiesdepository and the world’s largestprovider of centralized clearing services,with over 20 trillion dollars in assets. Ina single year, the organization processes

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hundreds of millions of individualtransaction entries and handles securitiesdeliveries totaling over 70 trillion dollars.

Firms may choose to be “members” of theNSCC, and “membership” is open to anyinstitution that meets DTCC standards.The DTCC itself is a limited-purpose trustcompany organized under the New YorkBanking Law, a “banking organization”within the meaning of the New YorkBanking Law, a member of the FederalReserve System, a “clearing corporation”within the meaning of the New YorkUniform Commercial Code, and a“clearing agency” registered pursuant tothe provisions of Section 17A of theSecurities Exchange Act of 1934, asamended. “Direct Participants” in thesystem include securities brokers anddealers, banks, trust companies, clearingcorporations, and certain otherorganizations. DTCC is owned by anumber of its Direct Participants and bythe New York Stock Exchange, Inc., theAmerican Stock Exchange, Inc., and theNational Association of SecuritiesDealers, Inc. But access to the DTCCsystem is also available to others such assecurities brokers and dealers, banks andtrust companies that clear through ormaintain custodial relationship with aDirect Participant, either directly orindirectly (“Indirect Participants”).

The SEC’s recognition of the DTCC is anexample of a quasi-self-regulatingsystem, in that nothing in the lawprevents a second organization beingformed to compete with the DTCC toprovide either depository or clearanceservices. On the other hand, the DTCC isrecognized and approved for its activitiesby the SEC (the “Final RegulatoryAuthority”), which provides someassurance that the corporation acts in thebest interests of the nation and securitiescustomers at large. Once again, thenatural tension between competition (orpotential competition) on the one handand Federal-agency oversight on the

other produces an equilibrium level ofefficiency and security that balances theconcerns of both the libertarian and thestatist.

Final Regulatory Authority (FRA): TheSEC

One key to the effectiveness of both theNASD and the DTCC has been the abilityof the SEC to set regulatory mandates andstandards, but to allow both the NASDand the DTCC to develop their ownprocesses and procedures to implementthem. Elaborate attempts to develop “onesize fits all” funds collection andinvestment systems are unlikely to beflexible enough to meet the needs of tensof thousands of employers and millionsof participants with differingcircumstances. Nor would such amandated system be nimble enough totake advantage of advances in technologyor systems design that cannot be foreseen.

The roles of the DTCC and of the NASD arenot unique within the SEC administrativestructure. The SEC is itself comprised offour Divisions.21 The Division of MarketRegulation already serves as the FinalRegulatory Authority over a panoply ofSROs (Self-Regulatory Organizations),including the DTCC, NASD, MSRB andothers.22 The SEC defines a SRO as “amember organization that createsand enforces rules for its members basedon the federal securities laws” and is theFederal agency with the most experience inoverseeing self-regulatory structures.

Combined with this SRO experience is arole in the securities markets that isalready analogous to that which will benecessary to oversee a PRA operationalsystem. The SEC’s Division ofInvestment Management already reviewsinvestment company and investmentadvisor filings, mutual funds, and “worksto improve disclosure and minimize riskfor investors without imposing unduecosts on regulated entities.”

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The SEC has a long history of workingwith quasi-independent SROs,understands the securities markets thatthey already are responsible forregulating, and is we believe theappropriate Federal oversight agency toexercise Final Regulatory Authority overa new investment-based Social Securitysystem.

IV. TAXATION OF PRA ACCOUNTS

Government, of course, rarely passes upany opportunity to assess a new tax orextend the reach of an old one, andremoving any economic activity fromtaxation is more often viewed as takingresources from government than allowingthem to be retained by their owners. Wecan be certain that there will be politicsaplenty surrounding the question ofwhether, which, and to what extent PRAaccount balances should be taxed.

For our discussion here, however, let usadhere to the fundamental principles welaid out at the beginning of the paper. Weare interested in an investment-basedsystem that, in this context, (1) Minimizesgovernment intervention, (2) Minimizessocial engineering effects, and (3)Minimizes costs both during and aftertransition.

Broadly speaking, there are threefundamental “levels” in the investment-based retirement system process, and PRAbalances are subject to taxation at each ofthose three levels. We can broadly classifyPRA taxation schemes according to thelevel at which the taxation occurs: (1)Taxation of contributions, (2) Taxation ofinvestment accumulations, and (3)Taxation of distributions. We can furthernotate the total taxation approach bydesignating a level that is taxed “T” and alevel that is not taxed that is exempt fromtaxation, as “E”. Thus, if only one level ofthe system is taxed, we have the followingpossible system notations: TEE, ETE, EET.

If all three levels are taxed, we have a TTTsystem.23

Various of the current private-accountretirement options available to Americansare taxed according to different schemes.Depending on one’s income level and theavailability of an employer-providedqualified retirement plan, a traditional IRAis either a TET or EET. A Roth IRA is TEE.SEPs, Keoghs, 403(b)s, 401(k)s, variableannuities – each is subject to taxation at oneor more levels. Ultimately, we believe thatthe entire system should be exempt from taxation.In other words, we argue for an EEE system.

Administrative Efficiency

We start with the presumption that an EEEsystem is the most administratively efficientalternative available. The cost of doingnothing is … nothing.24 Any form oftaxation, by whatever system, at any levelwill incur transactions costs to the nationaleconomy that are avoided by simplyexempting the entire retirement systemfrom taxes. Furthermore, any amount oftaxation, according to any scheme, willultimately incur economic costs by skewingcapital allocation decisions and negativelyaffecting productive incentives.

What is more, the marginal cost of even avery little taxation of the system is very, veryhigh; and marginal revenue, particularlyfrom taxation of low-wage-earner accounts,is likely to be low. Additional modeling isnecessary to prove this contention, but iftrue then marginal cost/benefitconsiderations are likely to weigh againsttaxation at any level. Regardless of whetherwe look at Level One (L1), Level Two (L2),or Level Three (L3), the EEE approach, thatis the totally “hands off” policy, is the mosteconomically efficient choice. The EEEapproach totally eliminates the vastmachinery necessary for the accounting,collections, monitoring, audit, compliance,enforcement, and regulatory processesrequired to impose any taxation system on

We are interested in aninvestment-based systemthat minimizesgovernment intervention,minimizes socialengineering effects, andminimizes costs bothduring and aftertransition.

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PRAs. It also avoids overlapping authorityfrom a tax-enforcement agency that is likelyto impose rules either beyond or in conflictwith those imposed by the self-regulatoryagencies overseen by the SEC (see above).In fact, allowing the”“camel’s nose in thetent” by inviting oversight by any taxingauthority at any level will almost inevitablylead to the development and imposition ofonerous and complex accounting andreporting rules that violate the entire spiritand purpose of the privatization effort.

Taxing the Poor: L1 & L2

If the purpose of imposing a mandatednational retirement system is to avoid themoral hazard implicit in either personalfinancial irresponsibility or the effects ofindividual destitution in old age, then itmakes little sense to tax the contributionsof those who are in the first place leastcapable to accumulating the resourcesnecessary for their own maintenance intheir senior years. No economictransaction is costless, and it is clearly lesseconomically efficient to tax away eithercontributions or accumulations to thepoint that low-wage-earning individualswill be unable or barely able to generatethe funds necessary to reach “holdharmless” status. Anyone who fails toreach that status ultimately must fall backon the governmental “safety net”, whichmeans returning their own tax dollars tothem (less transactions costs) in the formof an old-age subsidy.25

Taxing the Not-Poor: L1 & L2

It will be argued, of course, that taxation ateither L1 or L2 will only affect the non-poor,as current exclusions and graduated taxrates will eliminate lower-income workersfrom the effects of taxation. Such reasoning,however, violates the financial principle ofmarginal analysis. At some point, somemarginal group of earners will begin to bemarginally taxed on their earnings. Thosemarginal earnings would have beenavailable as personal savings in order to

provide for their own retirement. If we taxthose savings either before or after we placethem within a PRA (at L1 or L2), then weare effectively voiding the benefits of thePRA system itself and retarding theseindividuals’ ability to remove the moralhazard they potentially pose to the rest ofsociety. Any retardation of that processultimately increases the potential liability toother taxpayers. In other words, there is nonet benefit to the larger taxpayer baseassociated with taxing PRA contributions(L1) or accumulations (L2). We either payfor their retirement by lowering taxes ontheir contributions and accumulations inorder to allow them to build up to “holdharmless” status, or retard their ability todo so and wind up with greater marginalcosts to the taxpayers who must subsidizethe safety net. To do either results in anequal and offsetting potential liability to therest of the taxpayer base.

Consider the retardive effects on assetaccumulation of even a small tax on eithercontributions (L1) or accumulations (L2).Start with a young worker earning, say,twenty dollars/hour (approximately$41,600/year). Let’s further assume that inorder to reach “hold harmless” status, thisworker must accumulate sufficient funds tobe able to purchase a life annuity of somereasonable value relative to the povertylevel. If we allow this worker to contribute,say, 4% of his earnings to his PRA ($1,664/year), he will build over 40 years aninvestment portfolio with a real-dollar valueof $257,523.91.26 If our worker then wantsto retire and we project a life expectancy ofanother 40 years, he will be able to withdrawa pension of approximately $17,000 per yearfrom his account.27

Now perform the same calculation, butsubject our worker’s contributions to 15%taxation at L1, reducing initial contributionsto ($1,664 * .85) = $1414/year. The result isan accumulation of only $218,895, and anannual benefit reduced to $14,548. Evenmore devastating would be to subject thePRA to taxation at L2, reducing our annual

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growth rate to (.06 * .85) = 5.1%. The result(without L1 taxation) reduces our finalbalance to $205,984 and our annual benefitto $12,169. The combined effects of a 15%tax on L1 and L2 would reduce the totalaccumulation to just $175,037 and theannual benefit to $10,341.

Nor does it make good sense to tax the “notpoor”, the “not marginal”, or even thewealthy at either L1 or L2. The PRA systemshould not be designed to facilitate theaccumulation of great wealth. To thecontrary, it should be purposely designedto limit the extent of either mandated orvoluntary contributions to the system (seesection on ‘How Much Is Enough” and thenegative implications of over-accumulations in PRA accounts). To theextent that we as a nation want to effectsocial policy and wealth redistributionthrough our taxation system, PRA accountsare a singularly inappropriate mechanismto effect such objectives.

Note, finally, that taxation at either L1 or L2effectively turns the entire investment-basedretirement system into little more than anenforced savings plan with lots ofgovernment rules. There is really no benefitassociated with saving “inside” a PRA asopposed to saving “outside” a PRA. Formany savers (particularly those with greaterassets), the forced participation in the PRAwill be a wealth-reducing exercise, as aportion of their income that would havebeen saved outside the PRA is shifted toforced savings within it, but subjected as aresult to rules and restrictions andtransaction costs that could have beenavoided. Without the tax advantages ofbeing able to (1) contribute untaxed dollarsand (2) defer or avoid taxation onaccumulations, these individuals willpossibly be net losers in a mandatedsystem.28

Avoiding Perverse Incentives

But what about L3? Surely there are goodreasons to tax distributions, either to the

PRA owner or, at death, as part of the PRAowner’s estate. A strong moral argumentwill almost certainly be heard that thesefunds must not “escape taxation”, and thatto allow them to do so would be “unfair”.

In fact, however, the exact opposite is true.That the wealthy among us do, and willcontinue to, bear the primary burden ofincome taxation is a simple fact under ourcurrent progressive tax rate structure.Exempting from taxation distributionsfrom PRAs is unlikely to have a significanteffect on that already-skewed distributionof the tax burden. For the very wealthy, infact, PRA balances are likely to beextremely small relative to other assets andincome. Allowing PRA balances to“escape” taxation is easily compensated forwith minor adjustments to the progressivetax rate structure to which the remainderof their income will continue to be subject.

For low- and middle-income PRA owners,that is those workers on whose behalf the“equity” argument is likely to be made, thesituation is quite the opposite. There isthe very real potential of creating an“ordinary tax machine” that convertsincome from a status in which it wouldhave been either lightly taxed or untaxedinto a status in which it is subject tosubstantial taxation.

Tax planners are already aware of this effectas a result of the taxation of IRAdistributions to savers. IRAs built withafter-tax dollars can actually be a tax-inefficient investment vehicle for manysavers. Had they invested those sameafter-tax dollars in an equity portfoliocomposed of “growth” stocks (non-dividend paying securities that experiencecapital gains over time), accountaccumulations would be untaxed until thesecurities were sold, and then they wouldbe taxed at a lower capital gains rate. Butwhen contributing those same funds to anIRA, all income within the IRA (whetherfrom dividends, interest or capital gains)is taxed at the “ordinary” rate when it is

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distributed. What is more, for manymiddle-income individuals accumulatedIRA fund balances combined with othersources of pension and retirement incomemean that they are actually shifted into ahigher marginal tax bracket on retirementthan they were in during their early ormiddle-age income years.

The same will be true for many PRAcontributors who in their early years manybe subject to no or low marginal tax rates,but who build substantial account balancesbefore retirement (remembering, too, thatincome quintiles are not static. Many, manypeople who start their earning years in thelowest earning quintiles end them in theupper income ranges). For theseindividuals, a perverse effect of the PRAsystem that taxes at L3 would be to reducetheir retirement wealth.

A further complication arises if we choosea TET, ETT, TEE, or ETE system. If eithercontributions or accumulations are taxedon a differential basis than distributions, adual-balance phenomenon arises thatimmensely complicates distributionplanning and again invites armies ofaccounts and regulators into the system toplay. That problem exists now, for instance,when calculating distribution benefits forvariable annuities. Since investments tothe variable accounts are made with after-tax dollars, but investment income accruestax-deferred, all account balances must bedisaggregated into their “taxed” and“untaxed” components. Complexdistribution rules govern how much of eachdistribution is composed of pretax vs. post-tax dollars so that some level of taxationcan be applied to the portion of thedistribution that has not yet been taxed.Similarly, basis calculations for bequests areimmensely complicated by the mixed-taxstructure of the account balances.

Finally, should distributions be taxed atdeath?29 (Should we call this L4?) Thenational debate over a “death tax” iscurrently underway, and many of the same

arguments being brought to bear in thatdebate will apply here as well. “Deathtaxes” create perverse incentives toirrationally consume, create very largetransactions and administrative costs ofavoidance, and particularly punish the verypoor who have few means now ofaccumulating wealth and transferring it tofuture generations.30 This last observationis a particularly poignant one. The verypoor, by definition, are those most likely topose a moral hazard in old age, and PRAbalances are likely to be their major asset atthe end of their lives. Taxing away thoseassets denies the least among us theopportunity to build intergenerationalwealth that has the potential to lift theirprogeny out of poverty and into a higherstandard of living, removing in turn a nextgeneration’s moral hazard.

Taxes and Transition Cost Minimization31

Although it would require detailed scoringto determine the exact economic effects tobe anticipated, we suspect that the low-costprojection for EEE tax treatment of aninvestment-based system may extendbeyond the (somewhat obvious)implications for individuals and taxpreparation and monitoring costs to includecosts to the national economy for overallretirement liability as well. This observationis far from intuitive, however, and willnecessitate some more sophisticatedeconomic analysis to test.

What we are suggesting is that there is atrade-off between the amount of “bridge”financing needed during a transition to aninvestment-based system, and the timingassociated with various individualsreaching a requisite “replacement rate” fortheir Social Security benefits. However thenew system is structured, and however thetransition process is devised, it is most likelythat millions of individuals will findthemselves “on the cusp” between a clearbenefit associated with moving to the newsystem and a clear preference for retainingtheir rights to Social Security benefits. In

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general, the sooner an individualaccumulates enough wealth to reach thepredetermined “replacement rate” for whatwould have been his or her Social Securitybenefits, the sooner the government’sobligation to that individual ends.

Assuming that the government finances thetransition with debt, then debt service asan explicit cost is reduced.32 It is a legitimateeconomic issue whether if, in present valueterms, the debt service saving is greater orlesser than the loss of tax revenue causedby the contribution being pre-tax versusafter tax. This is an empirical question thatdeserves study and further thoughtfulinquiry. Assume for the moment, however,that they are offsetting effects; that is, thatthe bridge financing gain equals preciselythe pre-tax contribution loss. In such a case,it is probable that the result is still a net gainto the system as more people make thedecision to move to the market-basedstructure as a result of the ability tocontribute pre-tax dollars to it. 33

Surely we already have enough complexityin our tax system and don’t need to addmore? We vote for EEE.

V. QUESTIONS AND SUBSIDIARYISSUES

Q: What if no one forms a NationalClearinghouse (NC)?

A: The question, while wellmeaning, is really a naive one in terms ofhow the SEC works in relation to thesecurities industry. If the SEC ischarged as the Final RegulatoryAuthority, the Commissioner will take aleadership role in organizing elements ofthe securities industry to form an initialNational Clearinghouse. The importantelement of the system is that whichallows additional, competitiveClearinghouses to come into existence. Itis the existence, or the potential, of suchcompetitive systems that creates thebalance between government’s tendency

towards regulatory overreach vs.appropriate oversight.

Q: Are PFSPs required to accept allemployees who want to join theirsystem?

No. PFSPs may “mine” the NationalClearinghouse “pooled fund” for anycustomers to whom they want to offerservices, and it is anticipated that avariety of alternative investment vehicles(within the regulatory limits) will bedeveloped to appeal to employees. ButPFSPs are free to se their own criteria foraccepting PRA account management.

Q: When could PRA owners accesstheir accounts and take distributions?

It is curious that one consistent featureof almost every investment-basedretirement system that has yet beenintroduced in Congress or proposed byreformers is an assumption that thegovernment should decide when it isappropriate for an individual to removehim or herself from the workforce. Mostcommonly, the age 59.5 has become thetouchstone. The provenance of that ageis unknown to these authors, but therecan in any case be no rational economicjustification for choosing it or any otherfixed point in time.

Let us remember that the only economicpurpose of a national retirement systemis to limit the social liability associatedwith people not saving sufficientresources for their own old-agemaintenance, thereby imposing a moralhazard on the rest of the population.Once a person has accumulated sufficientresources to indemnify others against thishazard, why not let an individual choosethe timing of his exit from the workforce?For that matter, why do we assume that thedecision to begin drawing on one’saccumulated assets is the same decision asthat to exit the workforce? It is time toretire the word “retire” from our

The only economicpurpose of a nationalretirement system is tolimit the social liabilityassociated with peoplenot saving sufficientresources for their ownold-age maintenance,thereby imposing amoral hazard on the restof the population.

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vocabulary as we refer to an investment-based Social Security system. We suggestreferring to meeting “thresholdrequirements” for “hold harmless” statusthereby affording individuals the luxuryof making life style choices independentof the need to assure a minimum standardof living.34 This converts the SocialSecurity system into a “wealth-specific”rather than an “age specific” system,where the trigger for account access is theamount of wealth accumulated ratherthan any specific chronological age.35

The object of the system should be to raiseeveryone in it at some point to a level ofpersonal wealth that is capable ofproviding a lifetime income sufficient tomeet minimum living standards, thusremoving from others the impliedobligation to care for them. The “HoldHarmless” threshold should be the testthat determines whether an individualmay have access to his or her accountbalances. Borden has suggested, forinstance, that PRA fund distributionoptions could be available under threeoptions:

1) A 100 percent payout to purchasea minimum-wage life annuity from theprivate insurance industry. Annuitizationrequirements and regulations would beset by the SEC-licensed self-regulatoryassociations governing the PRA industry(the National Clearinghouse).

2) Withdrawals as desired with onlyone constraint: the amount remaining inthe account after withdrawal mustalways be at least 110 percent of theamount necessary to purchase a lifeannuity guaranteeing a minimum-wageincome.

3) A combination of 1 and 2 with thepurchase of a partial annuity andvoluntary withdrawals up to 110 percentof the amount necessary to purchase theremaining minimum-wage annuity.36

For obvious reasons, the amountnecessary to purchase such an annuity inthe open market would vary by age andother mortality characteristics. Theprovision of options 2 and 3 allow, also,for higher-asset individuals to gain accessto their accounts at any time withoutsacrificing their assets to annuitization ifthey prefer otherwise.

One objection that has been raised toallowing individuals to effectively choosetheir own access to the Social Securitysystem is that many individuals wouldexit the workforce as a result, reducingeconomic production and loweringnational wealth. This argument fails ontwo counts:

1) There is no way to predict whetherthe average person will exit the workforceearlier or later when the “retirement” and“account access” decisions are delinked.Some would doubtless exit early, butothers might find the fact of financialindependence to be professionallyliberating, moving into a series ofemployment contracts by choice. And,the disincentives produced by the highmarginal tax rates imposed by theretirement mandate would disappear.

2) There is no loss of economicwealth when an individual chooses toexercise a personal values choice andexperience leisure. Our nationaleconomic accounting system does notrecord the benefit, but it is just aspersonally satisfying for person A toreceive his utils by laying on a beach inFlorida as it is for person B to continueworking, receive income that is recordedin the national accounts, and in turnexchange that income for something hevalues.

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Q: Would there be limits oncontributions to PRA accounts, and if sowhat should those limits be?

Bearing in mind that in no caseshould contributions exceed the level ofthe social security payroll tax for thecurrent system, the question of whetherand to what extent lower limits oncontributions should be placed on PRAaccounts is a surprisingly complex one,and bears on issues of system andindividual-account risk minimization aswell as broader social policy and personalchoice issues. Fundamentally, there arethree broad areas of concern: 1). Howmuch contribution is necessary in orderto reasonably assure that account balanceswill grow to the level necessary to achievethe hold harmless threshold? 2). Whatare the implications of allowingcontributions in excess of that level, andif such contributions are to be allowedhow will they be treated? And 3). Howdoes the system avoid “asset substitution”problems resulting from the interaction ofprivatized returns (ownership of PRAassets) coupled with socialized risks (DBelements of the plan that provide a“benefit floor”, or “safety net” for low-income earners)?37

1). How Much is Enough? In orderfor an investment-based Social Securitysystem to accomplish its primary objectiveof indemnifying the taxpaying publicagainst financial irresponsibility on thepart of others, it is necessary that amandated level of system contributions beset sufficiently high that all wage earners,even those on the lower end of thecontinuum, are able to accumulatesufficient assets to sustain themselves intotheir non-earning years. The exact levelof accumulation that will do that varies,of course, with one’s assumptions aboutwhat constitutes a minimally-acceptablelifestyle. A reasonable starting point fora new Social Security system, however, isto assume that the new system must atleast replace the benefits that the old one

provides.38 One way to view that level isto look at the extent to which SocialSecurity “replaces” end-of-earning-yearsincome in its initial benefit payment.39

The amount itself differs by incomecategory and age cohort, but varies froma low of 24.1% for a maximum wageearner retiring in 2030 to a high of 52.8%for a low-wage earner retiring in 2000.40

For our purposes, we will assume areplacement rate of 42% as the target ratefor an investment-based system.41

The level of contribution required toreach that replacement rate also dependson the rate of return one assumes for aninvestment portfolio, which in turndepends on the level of risk and portfolio-return assumptions one employs. Itwill, in our system, be up to the NationalClearinghouse (overseen by the SEC) toset asset allocation and portfoliodiversification standards. But for ourpurposes here, let us assume thefollowing portfolio allocation: 40% Large-Cap Stocks, 20% Small-Cap Stocks, 30%Investment-Grade Corporate Bonds, 10%Government Bonds.42 IbbotsonAssociates provides the following datafor nominal rates of return and annualCPI inflation between the period 1926and 2000:

Large-Cap Stocks 11.3%Small-Cap Stocks 12.6%Investment-Grade Corporate Bonds 5.6%Government Bonds 5.1%CPI 3.1%43

Adjusting for inflation, then, andallocating our assets as above, anassumption that the next 75 years aregoing to produce economic rates of returnsimilar to the last 75 years produces abalanced-portfolio return of [(0.40)(.113)+ (0.20)(.126) + (0.30)(.056) + (0.10)(.051)]- .031 = 6.23%. But – let’s be conservative,and assume that the next 75 yearsproduces a real rate of return 10% below

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that of the past 75 years, = 6.23 * 0.9 =5.6%.

The next projection necessary to make isthat concerning the expected growth inreal wages over the coming, say, 75 yearsor so. For our purposes, we will use aprojection of 2%/year.

Our final variable necessary to calculatea mandated contribution level is anassumption about longevity. The SocialSecurity system itself projects high, lowand moderate assumptions for expectedhuman longevity for a child born 75 yearsfrom now. The range for males is (yearsin retirement after leaving the workforcefollowing reaching Social Security’sminimum retirement age for benefits)from 16 – 23 years (moderate = 19.7), andfor females is 19 – 25.9 years (moderate =22.6).44 We will use the moderateassumptions and average them for apost-distribution life expectancy of 21years..

Using these assumptions, a simplecalculation indicates that a replacementrate of 42% can be achieved with annualcontributions of 4.65% of annual earnings

2). Can an individual make“Excess” Contributions? “Excess”contributions can arise in any one of fourways, all of which should be legitimatewithin the system: 1). A PRA ownerreaches his or her threshold for holdharmless status, but continuescontributing to the account above thatlevel. 2). A PRA owner who has reachedthe threshold and stopped contributingexperiences higher-than-expectedgrowth in account assets. 3). A PRAowner is allowed to make contributionsin excess of those needed throughout hiscontribution history. 4). A PRA ownerwho is independently wealthy is allowedto contribute to the PRA system in spiteof already having sufficient wealth topurchase hold harmless status.

We see no point in restricting PRAowners from contributing above thelegally-mandated minimum contributionduring the period of building assetstoward “hold harmless” status. Beyondthe accumulation of sufficient assets (ofperhaps 110% of sufficient assets) topurchase a life “hold harmless” annuity,however, excess contributions arisingfrom the third mechanism above shouldbe restricted in order to avoid theutilization of the system as a means ofescaping income taxation.

Q: Should it be possible for someoneof sufficient wealth to “Opt Out” of theentire PRA system?

Yes. As long as an individual haspurchased an approved life annuityassuring the availability of a life incomestream of sufficient magnitude, they shouldbe allowed to not pay into a PRA and retainas post-tax income what he would havecontributed.

Q: Would there be spendthrift andassignability provisions for PRAs thatlimit the possibility of PRA owners losingtheir accumulated assets?

Yes. One critical element of the body ofregulation and law that will evolvearound PRA accounts will be thoseprovisions that maintain a firewallprotecting account assets both fromirrational behavior and from predation.Irrational behavior in this context can takemany forms and any regulationsminimizing such behavior are necessarilyan infringement of personal liberty. Butit is probably true that those citizens whopose the greatest moral hazard to theirfellows are highly correlated with thosecitizens who are both easy financial preyand who are most likely to abuse the trustof maintaining their own accounts.45

Spendthrift and assignability-limitationprovisions are designed to prevent peoplefrom voiding through their own behaviorthe moral hazard protections inherent in

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the PRA concept. In the U.S., it has beena matter of public policy that one cannotplace one’s property in a trust or anagency account for one’s own benefit andkeep it beyond the reach of one’screditors.46 47 While that may be goodpublic policy in general, its application toPRAs would void the public protectionsinherent in the mandated-retirementconcept in the first place.

A partial precedent for removing PRAsfrom the usual ability of creditors andothers to access trust accounts is providedby ERISA. An employee benefit planmay well include an associated trust orcustodial account that serves as areceptacle for employer and employeecontributions. Under ERISA,contributions and the income generatedby their investment are entitled tofavorable tax treatment, provided the planmeets certain requirements. One suchrequirement is that the documentationgoverning the trust or custodial receptaclemust contain a “spendthrift” (anti-alienation) provision prohibiting theemployee from anticipating, assigning, oralienating his beneficial interest. Thesubject property also may not be subjectto attachment, garnishment, levy,execution or other legal or equitableprocess.”48

In most cases, an ERISA-mandated anti-alienation provision will preventcreditors, including the trustee inbankruptcy, from reaching the debtor’sinterest in a tax-qualified plan, eventhough the associated trust would nothave enjoyed protection under state law.This is because ERISA pre-empts statelaw.49 In any case, ERISA affords trustsand custodial accounts associated withIRAs no spendthrift protection. Thus,federal bankruptcy law, state statutes andthe common law determines whetherproperty held by an IRA trustee orcustodian is reachable by the taxpayer’screditors, including the trustee inbankruptcy.50

The lesson for a new investment-basedPRA system is that the law must includean air-tight PRA anti-alienation requirement.To put it another way, the law shouldavoid merely incorporating by referencethe ERISA precedent. Rather, it shouldexplicitly pre-empt all state lawsaffording creditors access to assets heldin self-settled trusts and custodialaccounts, as well as require explicitlanguage in the documentationproviding for spendthrift protection. PRAassets should also be off limits to thetrustee in bankruptcy.

Equally crucial is protection against anaccount owner knowingly orunknowingly assigning his or herproperty rights to others. Assets in a PRAshould be per se unassignable. Onlylawful distributions out of a PRA shouldbecome the subject of an assignment, andonly then after the property has left thePRA. Consideration might even be givento subjecting a purported assignor and apurported assignee to criminal liabilityand criminal sanctions for directly orindirectly entering into an assignment ofthe equitable or beneficial interest inassets that are held in a PRA. Withoutsuch provisions, it is a virtual certaintythat a market would develop in PRAanticipations and participations (similarto that which has developed aroundlottery payouts), thus negating the socialbenefits of the entire system.

All of this, however, can be done simply,with little actual regulatory oversight, aslong as the original legislation is carefullycrafted and any self-regulatory body thatcomes into existence to oversee planadministration is charged with theresponsibility to assure compliance. If theoriginating legislation is itself wellcrafted, then the body of case law thatdevelops around it will itself serve as ashield against abuse.

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In the same vein, the trustee, custodian,and/or PRA administrator should not besaddled with any enforcementresponsibilities as far as assignments areconcerned. All that should be required ofthe trustee or custodian is that it have onfile an affidavit of the PRA owner thatthere has been no direct or indirectassignments of the equitable or beneficialinterest. A fraudulent affidavit shouldsubject the PRA owner to severe criminalpenalties, and predators seeking tofraudulently entice PRA owners intoassigning their accounts should likewisebe subject to severe criminal sanctions.The former, however, should be a matterbetween the self-regulating PRAoversight agencies, and the latter a matterfor the criminal justice system. Neithershould be of concern to the private PRAadministrator and the private financialservices provider.

Q: How will the complexities ofmarriage and divorce be handled by thePRA system, and how will it provide fornon-earning spouses?

One of the thorniest issues for aninvestment-based system, and one wherethere exists huge potential for excessivelitigation, for onerous regulation writing, forpolitical mischief, and for palpable inequity,is in the area of how the system handlesmarriage and divorce. There is little needto belabor here both the inequities and thecomplexities of the current Social Securitysystem in this regard. Divorce law isgenerally the province of the states, and is alegal quagmire everywhere. Add to thisthe difficulty of even defining “marriage”any more and the political repercussions oftrying to do so, and the field is set forpolitical battles unending.

Perhaps nowhere in the entire process ofbring a new system into being is it moreimportant to pay attention to the need forand benefits of simplicity and clarity in theplan’s legal and regulatory structure.Attempting to regulate perfect equity and

fairness into the system will almost certainlyresult in a cascade of further inequities andan avalanche of litigation and expense.

Whatever specific emerges from theprocess, it must address to some extentthese fundamental issues:

1) What manner of domesticpartnerships will be recognized by thesystem?

2) What body of law adjudicated atwhat level of government will apply tothe system?

3) What rights do non-contributingpartners have to a contributing partner’saccount balances in the case of death orseparation.

4) How will partnership ownershipof account balances affect determinationsof “hold harmless” status regardingmoral hazards and distribution optionsavailable to account owners?

We might start by recognizing that thereare no simple answers to these questions.Keeping that in mind, however, we offerthe following approach.

Recognizing that our objectives aresimplicity and clarity, not the making ofsocial policy; and further recognizing theimportance of maximizing personalchoice, we propose that individuals inany relationship that is legally defined byand recognized under state law as a“marriage” be required to makecontributions to a “marriage” PRA whilein that relationship. Such contributionsshall be deemed to be communityproperty. Each partner’s 50% interest ina marriage PRA (including any increasein market value of the property and anyincome thrown off by the property) maynot be disclaimed, renounced, assignedor made the subject of antenuptialagreements and/or equitable divisionincident to divorce. These state-imposed

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protections are important in order toavoid the moral hazard associated with anon-earning spouse being left in the coldas a ward of the state, and also tominimize litigation resulting fromseparation. Married couples would eachcontribute to the joint marriage accountand would not be permitted to maintainseparate accounts during their marriage.

We further propose that all matterspertaining to the ownership, disposition,and bequethal of PRA assets befederalized and removed from the statecourts and all divorce or partnership caselaw or proceedings.51 We then furtherrecommend that:

(1) A person while unmarried shallmake his or her contribution to anindividual PRA. Property held in anindividual PRA also may not bedisclaimed, renounced, assigned or madethe subject of antenuptial agreementsand/or equitable division. Each marriedpartner, before, during, and after amarriage, shall at all times have solediscretion over and property rights to hisor her individual PRA.

(2) At the time a PRA account isestablished, the participant, whether ornot married, will be required to file withthe PRA administrator an “Affidavit ofMarital Status.” The participant has theresponsibility of filing an amendedaffidavit each time there is a change ofmarital status, and failure to file withinthe time period prescribed causes theaffidavit to be deemed fraudulent. ThePRA administrator may rely on themarital status information contained in anAffidavit of Marital Status whether or notit has actual notice that the affidavit isfraudulent. Finally, the law shouldprovide a”“grace period” commencing atthe time a participant marries duringwhich continuing contributions to his orher pre-existing individual PRA accountare permitted and will not be deemed

community property. Failure to file anamended Affidavit of Marital Status andto establish a marriage PRA before thegrace period expires subjects theparticipant to criminal penalties.

It bears explaining that the Affidavit isessential to the marriage provisions of thePRA system because it is the mechanismthat allows the system to be “self-regulating”. Without the Affidavitrequirement, some oversight, monitoringor audit mechanism will have to be inplace. With it, the fraud statutes andcriminal law system serve as a post hocself-regulatory mechanism.

(3) Only one spouse need file anamended Affidavit of Marital Status,provided a duly authenticated copy of themarriage certificate or divorce decree isaffixed to the amending document. In thecase of marriage, receipt by the PRAadministrator will automatically triggerthe creation of a marriage PRA. In the caseof divorce, receipt will automaticallytrigger a termination and 50% division ofthe assets in the marriage PRA.

(4) With respect to a marriage PRA,investment discretion should residejointly in the marriage partners and allinvestment directions should be inwriting and signed by both partners. Theadministrator of a marriage PRA whodoes not have in its files an investmentdirection that is duly signed by bothpartners should park the assets of the PRAin a default commingled investmentvehicle that is operated by the privatefinancial services provider and that meetsthe specifications of our self-regulatingagency.

(5) For PRA purposes, a marriagemay only be terminated by death or by afinal and legally binding divorce decreeissued by a state court as evidenced byappropriate documentation.

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(6) Upon the termination of amarriage by the death of a spouse, thebalance of the assets in the marriage PRAaccount shall be distributed as follows:50% into the surviving spouse’sindividual PRA and the other 50% inaccordance with the terms of a dulyexecuted beneficiary designation formthat shall be effective notwithstandingthe laws of wills and agency of thevarious states. 52

(7) Determination of eligibility for“hold harmless” status (see “RetirementAge” above) should be made for eachindividual within a marriage separately.For such determination, half the value ofthe marriage IRA is at all times availableas a “virtual balance” in a marriagepartner ’s individual IRA. For PRApurposes, a marriage will only berecognized if it is sanctioned by state lawand evidenced by documentation issuedby a state or its instrumentalities. Noimplied marriage or other partnershipswill be recognized, regardless of livingcircumstances or verbal commitments.Finally, except as otherwise provided,federal law shall pre-empt state law inmatters pertaining to the establishment,administration, and termination of PRAaccounts.

VI. CONCLUSION

The Social Security system was designedalmost 70 years ago, when ourunderstanding of financial economicprinciples was still in its infancy. In those70 years, we have learned much abouthow financial markets work, the natureand management of risk, and theintergenerational economic effects ofpublic retirement financing. The socialand economic landscape of America inthe twenty-first century bears littlerelationship to that of the America of the1930’s. We are a nation of great wealth,with broad public participation in ourfinancial markets, and with extremesocial and economic fluidity. The last 70

years have seen a huge increase in thescope and power of the Federalgovernment, and at the same time haveeducated us about the limits ofgovernment and the essential wealth-creating role of private markets. And wehave experimented with a variety ofvoluntary personal-retirement vehicles[401(k)s, 403(b)s, SEPs, IRAs, Roths,Keoghs] that have been proving groundsfor the legal and regulatory structures thatare most efficient. It is time now to learnfrom those years, and to reengineer ournation’s retirement system to be consistentwith a more mature view of how privatefinancial markets work.

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ENDNOTES

1 It is not entirely clear that the Rehnquist court would allow it to moor there.See United States v. Lopez, 514 U.S. 549 (1995).

2 See Helvering v. Davis, 301 U.S. 619 (1937); Flemming v. Nestor, 363 U.S. 603 (1960).

3 See Oral Arguments in Helvering v. Davis.

4 The provision of a “claw back” in current parlance: the proportional reduction in expectedSocial Security benefits in response to the redirection of some portion of current FICA taxpayments.

5 Among them, the question of “Who speaks for taxpayers?” in the system. If individualslargely direct their own investments, and if PRA owners are allowed to invest in any mannerof portfolio, there will be a strong tendency toward” “asset substitution”: The preference forhigh-risk, high-potential-return assets for individuals whose account balances are at or nearthe minimum levels necessary to merely replace the “benefit floor” that a national safety netimplies (the DB portion of the system). Unlike an IRA, therefore, there must be some role forsome entity at some level to protect the interests of taxpayers and their potential liability.

6 Employee Retirement Income Security Act.

7 Minimization of the moral hazard associated with individuals reaching retirement age withno source of long-term support.

8 Consider, for instance, the simple fact that employers do not now transfer FICA funds to thegovernment with individual account balance data. Rather, employers simply pay their requiredFICA tax in a lump sum. The government has no idea whose tax, that is which employee’stax, is actually being paid until after the end of the calendar year, when W-2 forms are submittedwith employee detail that must be reconciled with the FICA cash transfers for the previousyear. An investment-based system must provide more detail if individual account balancesare to be updated and invested according to the owners ’ directions. But – the choice of PFSPand the direction of the account must remain firmly in the hands of the PRA owner. Theemployer’s role, while critical, is limited to simply paying withheld funds to the appropriateagency.

9 Defining the terms is probably more important than setting limits, as competitive forcesshould probably suffice for most circumstances. However, it is probably necessary to set outsideboundaries on these amounts in order to avoid the worst cases of PRA participant fraud andabuse.

10 “Asset Substitution” refers to the tendency of organizations and individuals facing financialdistress to substitute more risky assets for less risky assets. If a “safety net” provides a minimumlevel of support, and an individual’s investment portfolio is at a level that provides less, oronly barely more, than that minimum level of support, then as an individual approachesretirement he will be more likely to take extreme risks with his remaining assets. Any lossesconsequent to the risky portfolio mix will be effectively borne by the taxpayers, as the safetynet provides a minimum level of support. Any gains, however, potentially benefit the PRAowner by providing a larger-than-minimum level of support. Projections of expected portfoliovalue variances (based on historical returns for asset categories) can identify probabilitiesassociated with numbers of individuals expected to achieve portfolio values at the extremesof the distribution. The FRA can then set maximum allowable probabilities for expected“safety net utilization,” approve NC portfolio asset allocation on that basis, and avoid theworst cases of asset substitution.

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11 See “Administrative Challenges Confronting Social Security Reform,” a working paper publishedby State Street Corporation, March 22. This otherwise excellent paper is directed primarily towardproposing a cash-flow model for system participants ’ contributions, but by referring genericallyto 401(k) plans as a “model” it may inadvertently be blessing a regulatory structure that is ill-suited to this purpose.

12And it is critical that employers not make such decisions if the new system is to avoid ERISA-style regulatory oversight and the monitoring costs such oversight entails.

13 As we explain in a later section, there may be one or more “National Clearinghouses” thatcome into being. All would be licensed by the Final Regulatory Agency. The opportunity formultiple clearinghouses is essential to the quasi-self-regulatory structure we envision.

14 In other words, they would have access to the pooled-fund participant database, and could atany time market their services to pooled-fund participants.

15In practice, where similar self-regulatory agencies have been created, competitive institutionshave not emerged. But the potential of such a competitive organization is an important check onthe activities of the single agency that is formed.

16 See, “Administrative Challenges Confronting Social Security Reform,” Op. Cit.

17 A “fiduciary” is a person (e.g., an investment manager or the executor of an estate) or anorganization (e.g., a bank) that is entrusted with the property of another party, and in whose bestinterests the fiduciary is expected to act when holding, investing, or otherwise utilizing that party ’sproperty. The employer may temporarily “hold” the employer’s funds for a short time betweenwhen they are earned and when they are forwarded to the PRA administrator, the PRAAdministrator may likewise “hold” funds in the process of aggregating them and forwardingthem either to the PFSP or to the NC pooled fund, and the PFSP of course invests the fundsaccording to the PRA owner direction. But none of these parties is expected to make investmentdecisions for the PRA owner and ”act in the PRA owner’s best interests”. Discretion over accountbalances, within limits, is always in the hands of the PRA owner.

18 No thought being given to what “this sort of thing” is.

19 The 5500EZ was designed for HR10 plan sponsors with no employees to be able to report in asimpler fashion.

20 It is unlikely that a lot of active portfolio management will be taking place for PRA accounts.Competition is likely to take place primarily on the basis of client service and administrativecosts.

21 Division of Corporation Finance, Division of Market Regulation, Division of InvestmentManagement, Division of Enforcement.

22 Municipal Securities Rulemaking Board.

23 We are aware of only two countries with a TTT system: Belgium and Australia.

24 Economists will object that there is often a very real opportunity cost of doing nothing. Therhetorical point being made here, however, is that it costs less to administer no system than itcosts to administer some system.

25 Additional modeling here is appropriate. It is possible that a market-based system that istaxed could be more efficient than a PAYG system that is not taxed.

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26 This is a simplistic assumption. In fact, there will be a probability distribution surroundingboth accumulations and withdrawals and a range of probable outcomes.

27 The same simplifying assumptions create even more uncertainty around this number, but theprinciple being addressed in the argument is unaffected by this uncertainty.

28 Depending on the tax rules on savings outside the system.

29 We should keep in mind that at one time IRC §2039 provided an unlimited federal estate taxexclusion for most kinds of retirement benefits. See Natalie B. Choate, Life and Death Plannngfor Retirement Benefits 386 (3d ed.-1999). “Then the exclusion was limited to $100,000 by TEFRA’82 and repealed by TRA ’84. However a grandfather clause was included in TRA ’84 for both laws; andthen the Tax Reform Act of 1986 made major substantive retroactive amendments to these grandfatherclauses. The retroactive ’86 changes made it substantially easier to qualify for the exclusion that it wasunder the “original” grandfather provision in TRA ’84. However, the TRA ’86 amendments are so obscurethat they are not even mentioned in widely used estate tax reporting services. The casual researcher mayfind only the strict TRA ’84 grandfather rules (as embodied in IRS Temp.Reg. §20.2039-1T, 1/29/86)under which only participants who were “in pay status” and had “irrevocably elected a form of benefit by1982 or 1984 still qualified for the exclusion. But TRA ’86 simply repealed those two requirements andsubstituted others. Thus Temp. Reg. § 20.2039-1T is nugatory. The best explanation of this incredibletangle appears in PLR 9221030 (2/21/92)…” Id. at 386.

30 Raising the lower limit on inheritance and estate taxes eliminates some of this problem.Removing estate and inheritance taxes totally eliminates it.

31 The authors are indebted to William Shipman for his contributions to this section of the article.Most of the insights presented here are his.

32 Though it should be noted that it probably doesn’t matter to the analysis how the governmenttechnically “finances” the transition, that is what specific paper instrument the governmentuses to make explicit its implicit liabilities. Markets have already discounted the government ’sliability for future retirement benefits and the cash must be raised from somewhere either in thepresent or in the future.

33 And further assuming that the new plan is structured such that, at least for some people onthe cusp, such a move is an option and not a mandate.

34 We use the term “hold harmless” in an economic, not a legal, sense. It refers to attaining asufficient level of wealth such that one is capable of sustaining a minimally-acceptable lifestyle,thereby relieving society of any responsibility for one’s care and maintenance.

35 Moving to a wealth-specific system also eliminates system (taxpayer) liability for large,unanticipated increases in life expectancy. As life expectancies rise, the market will automaticallyreprice life annuity products to reflect the change.

36 Borden, Karl, “Dismantling The Pyramid: The Why and How of Privatizing Social Security.CATO Institute, SSP # 1. August 14, 1995, pp 42.

37 See footnote #10.

38 If for no other reason than needing to provide a rational basis for individual system participantsto choose to “switch” from paying FICA taxes for current benefits. If they are not reasonablyassured of achieving at least comparable levels of support with their contributions, the rationalchoice will be to stay with the old system. It is probable that, at least for some marginal earnerswithin some age range, a choice will be available.

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39 PIA or Primary Insurance Assessment.

40 2001 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors andDisability Insurance Trust Funds. (Washington: Government Printing Office, March 2001), p.185. Replacement rates at age 65 for low, average, high, and maximum earners in the year2000 were 52.8, 39.2, 31.7, and 23.7 percent respectively. For those retiring in 2030 at age 65, thereplacement rate drops across the board (except for the maximum earner) to: 49.3, 36.6, 30.2,and 24.1 percent, respectively. The replacement rate itself is a “moving target” as the currentSocial Security system alters mandated retirement ages, thus reducing tive rate for a comparableage. Also, low-income workers tend to have shorter life expectancies than high income workers.Since the current Social Security system provides no property rights to future expected benefits,low-income workers receive a smaller total income stream than high-income workers. Thisproduces many bizarre results. For example, the RAND Corporation concludes that the neteffect of this phenomenon is to produce a cross subsidy transferring wealth from the poor tothe rich and from African-Americans to whites. Constantijn Panis and Lee Lillard,“Socioeconomic Differentials in the Return to Social Security,” RAND Corporation WorkingPaper No. 96-05, 1996.

41 The 42% figure is, of course, arbitrary, but it is on the upper end of the range and can be usedto illustrate the calculation necessary to determine the required contribution level. Werecommend choosing a single contribution level and not trying to fine-tune an exact equivalenceto prior Social Security benefits for all system participants.

42 We will also assume that the portfolio is adequately diversified to eliminate all non-systematicrisk.

43 Stocks, Bonds, Bills, and Inflation, (Chicago: Ibbotson Associates, various years).

44 Trustees Report, Table V.A3, p. 77.

45It is likely, in other words, that the same lack of financial sophistication that leads people toplan inadequately for their retirement results also in an inability to distinguish betweenlegitimate investment advice and huckstering.

46Charles E. Rounds, Jr., Loring A Trustee’s Handbook (Frederick, MD: Panel, 2002). Itshould be noted only as a point of information that recently Alaska, Delaware, Rhode Island,and Nevada, by legislation have afforded certain self-settled trusts spendthrift protection thatthey would not otherwise have been afforded under common law.

47 It should be noted only as a point of information that recently Alaska, Delaware, RhodeIsland, and Nevada, by legislation have afforded certain self-settled trusts spendthrift protectionthat they would not otherwise have been afforded under the common law.) Ibid. 120.

48 Ibid., 131.

49 There is some legal confusion, however, as to whether a “self-settled” employee benefit planestablished by a sole proprietor, a sole practitioner or sole shareholder” who has no employeesis “ERISA-qualified ” and thus entitled to federal spendthrift protection in the bankruptcycontext. ”Ibid. 134.

50 Ibid. 135-135.

51 What we recommend here is effectively Federal preemption of state statutes to exempt allPRAs from equitable division incident to divorce. Congress can go a long way towards makingPRAs off-limits when it comes to equitable division incident to divorce. Admittedly, it can’t

28

prevent a state probate judge from taking the value of a PRA into account for computationpurposes; but it should be possible to keep the court’s hands off of the account itself.

52 If no such form is on file, then distribution shall be in accordance with the terms of the decedent’sown estate planning documents. If no such documentation is in place and/or operative thendistribution shall be directly to those who would be entitled to take under the laws of intestacyif the decedent had died intestate in his last domicile, by-passing to the extent possible thedecedent’s estate. The PRA administrator shall determine who the deemed intestate takers areand its determination shall be final and binding on all parties. Distributions to minors may beto those who have custody of such minors. The PRA administrator shall be held legally harmlessfor any negligent mistakes of law with respect to the identity of deemed intestate takers andminor custodians. The PRA administrator shall be entitled to deduct its reasonable compensationfrom the PRA account for effecting distribut ion of PRA assets.

The Beacon Hill Institute at Suffolk Univeristy in Boston focuses on federal, state and localeconomic policies as they affect citizens and businesses. The institute conducts research and

educational programs to provide timely, concise and readable analyses that help voters,policymakers and opinion leaders understand today’s leading public policy issues.

©March 2002 by the Beacon Hill Institute at Suffolk UniversityISBN 1-886320-12-8

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The Beacon Hill Institute for Public Policy ResearchSuffolk University

8 Ashburton Place

Boston, MA 02108

Phone: 617-573-8750 Fax: 617-720-4272

bhi@beaconhill.org

http://www.beaconhill.org

ISBN 1-886320-12-8