More than 65 million Americans now choose to supplement their retirement nest eggs through investing in Individual Retirement Accounts (IRAs) and employer-sponsored 401(k) and 403(b) pension plans.

Within the next 20 years great gains can be achieved for lower-income workers by partially privatizing Social Security.

Under current law, workers can invest up to $10,000 per year in their 401(k) or 403(b) accounts with a variety of investment choices such as mutual funds. Workers are thereby able to supplement their retirement assets and take responsibility for their own futures rather than depending upon Social Security to meet their retirement needs.

KPMG Peat Marwick, a major accounting firm, surveyed companies and individuals to determine that the rate of employee participation in 401(k) retirement plans is high and increasing (see Chart 1). The 1998 data show that 59 percent of nonhighly compensated employees and 81 percent of highly compensated employees participated (in 1998, the government considered workers making over $80,000 to be "highly compensated"). Employees contribute on average five to seven percent of their paychecks to their retirement plans, a figure roughly equivalent to what Social Security taxes take from their pay.

In many cases, employers match employee contributions to their plans at rates of 25 to 50 percent, which enhances the amount of savings employees can invest for retirement purposes. Another benefit for employees using these plans is that their contributions are pre-tax dollars, meaning the money is invested before taxes are taken out. Having this extra money to invest can add up. For example, an employee in the 15 percent tax bracket will have $150 more per year to invest for every $1000 he contributes. An employee in the 28 percent bracket would have $280 more per year, and so on. The taxes are deducted upon withdrawal of the money. Funds from IRAs and 401(k) and 403(b) plans cannot be withdrawn except for emergencies of personal hardship and are therefore working throughout an employee’s life to earn returns on the investment.

The Wall Street Journal recently reported that market forces have created low-cost retirement plans for even very small employers: 33 million people who work for companies of less than 50 employees are now becoming eligible to participate in building their own secure retirement through private plans. This will further boost the number of Americans investing in private retirement plans and likely create irresistible pressure for fundamental Social Security reform.

How do these 401(k) and 403(b) plans perform? Based on historical returns of at least seven percent in the stock market and four to five percent in bond markets, employees investing in these plans will far exceed anything Social Security will ever provide. The Cato Institute has documented the much higher returns generated by private investment over Social Security (see Chart 2). Cato has also established an interactive Internet feature at www.socialsecurity.org that allows users to supply their birth date and income estimates to calculate how much they can gain in future benefits through private investment.

Meanwhile, however, lower-income workers remain at risk, with employees in the bottom 20 percent income group depending most heavily on Social Security benefits (see Chart 3, next page). The top 20 percent of earners are much better prepared and less dependent on Social Security. Within the next 20 years great gains can be achieved for lower-income workers by partially privatizing Social Security.