By Michael A. Fletcher
Washington Post Staff Writer
Saturday, March 19, 2005; Page A01

GALVESTON, Tex. -- County workers here were confronted with a momentous choice nearly a quarter-century ago when Social Security's financial problems prompted ominous warnings that the program was headed toward bankruptcy. The employees could either ride out the federal retirement program's problems or leave the system altogether.

After a series of emotional meetings, Galveston County's 2,000 workers voted overwhelmingly to abandon Social Security in 1981. They replaced the venerable program with a private package of life, disability and annuity benefits run by a Houston firm that promised appreciably higher payouts than they would earn from Social Security. Public employees in two other Texas Gulf Coast counties, Matagorda and Brazoria, soon followed, joining millions of other public employees across the country who did not participate in the federal plan.

The Texas plan has proved to be a boon to most middle- and upper-income workers, who enjoy more flexibility and greater benefits than they would have under Social Security. But independent studies have concluded that low-income workers often do worse than they would have under Social Security.

Despite the mixed reviews, the "Galveston plan," as it was called, impressed Texas's Republican governor, George W. Bush, as he plotted his first presidential bid. Galveston's experience deepened Bush's long-standing interest in personal Social Security accounts, and as president he is advocating them as a key part of his plan to remake Social Security, which again faces financial problems.

"Bush was very interested in the Galveston experience," said Stephen Moore, president of the Free Enterprise Fund, who said he met with the president to discuss ideas to revamp Social Security in 1999. "I think it was one of the things that sold him on this whole issue."

Bush's idea for revamping Social Security differs from the Galveston plan in that it would not affect the program's disability and survivor benefits and it would allow workers to divert only a third of their retirement taxes into personal accounts. Still, Bush's proposal and the Galveston plan share a controversial assumption: that the wealth-building power of private markets can be harnessed to deliver reliable retirement benefits better than those provided by Social Security.

It is an idea long promoted by free-market thinkers and others who would like to shift the responsibility and spiraling cost of retirement away from government and onto individuals, who in turn would have a shot at greater financial rewards. Critics say such an approach weakens Social Security's safety net and opens the possibility that the nation's retirement system could produce financial winners and losers. The experience of workers in Galveston offers evidence for both views.

"The Galveston plan is highly individualistic," said Eric R. Kingson, a Syracuse University professor who has studied the plan. "It reduces government by moving away from the principles that have driven Social Security, which is based on the belief that we sometimes have responsibility not only for ourselves but also for our parents and our neighbors."

For many government workers here -- particularly longtime employees with above-average incomes -- the promise of greater retirement earnings has been fulfilled. Not only do they receive better life and disability insurance coverage while they are working, but once they retire, they can expect significantly higher benefits than they would have received under Social Security.

Harold Yvette Isaac, 62, worked more than 11 years as an auditor for Galveston County before retiring in 2002. Although her salary was never more than $30,000 a year, she managed to accumulate about $60,000 in her retirement account, which she used to pay off her four-bedroom home and give substantial gifts to her two adult children.

"If I were asked to choose between Social Security and the alternative plan, I would choose the alternative plan," said Isaac, who, like the other workers is also covered by a separate pension program administered by the state of Texas. "But some of it has to do with how people handle their money."

But the advantages are less clear for lower-paid workers. Outside experts, including researchers for the Government Accountability Office and the Social Security Administration, have found that workers earning less than $17,100 a year in 1999 would have done better under Social Security, mainly because of annual cost-of-living adjustments. The Galveston plan offers no such increases.

But plan administrators and other supporters take issue with some of the fiscal assumptions used in the 1999 reports, and they insist that nearly all workers do better under the private plan. "Initially, most people get a return of two to four times what Social Security gives you," said Ray Holbrook, who formerly served as Galveston County's chief administrator. "But if you are in there a short time, you don't get much out of it. And people who took money out along the way for emergencies, those people got hurt pretty bad."

The 5,000 employees in Texas counties who opted out of Social Security are among more than 5 million state and local government employees nationally who do not belong to the Social Security system. AARP, the advocacy group for senior citizens, has proposed that all new government workers be required to be part of Social Security to help bring more money into the system.

The exemption for public employees is a holdover from the original Social Security law, which excluded state and local workers when it was enacted in 1935 because of congressional concern about the legality of taxing them. Fifteen years later, the law was amended to allow local government workers the option of being part of Social Security, which many chose. Then, in 1983, the law was changed again to prevent any more state and local employees from opting out.

By then, the Galveston plan was well underway. Under the program, workers contribute 6.13 percent of their pay to private accounts, while the participating counties add 7.8 percent -- making for an overall contribution slightly larger than the 12.4 percent required by Social Security.

The money is used to buy disability and life insurance policies, which pay as much as 60 percent of workers' salaries in the case of disability and up to $215,000 in life insurance benefits. The rest of the money is invested in annuities that guarantee workers a minimum 4 percent return on their contributions before inflation (workers in Brazoria County also have the option of some stock and bond investments). Upon retirement, workers can either take a lump sum or opt for one of several annuity payouts. The transactions are handled by the plan's manager, First Financial Benefits of Houston.

"We've been through a lot in this country since 1981, and this plan has just been as stable as anything," said Rick Gornto, president of First Financial and an architect of the Galveston plan.

Plan managers acknowledge that some workers were left short on retirement income because they took hardship withdrawals from their retirement accounts (an option that is no longer permitted), by spending money too quickly once they retired or by choosing to retire too soon. Unlike Social Security, the plan allows workers to receive payouts from their accounts whenever they leave the county's employ -- an option not contemplated under Bush's proposal.

Still, Gornto said, most workers come out ahead. Projections developed by his company show that, assuming a 5 percent annual investment return over 40 years , a worker earning $25,596 a year could receive retirement benefits of $1,549 a month -- far more than the $853 a month the worker would get from Social Security on retirement. A worker earning $75,000 a year over a 40-year career would be entitled to a monthly retirement benefit of $4,540 -- nearly three times the $1,645 a month that Social Security would provide, according to the company's figures.

But those numbers do not tell the entire story. While retirement payments under the Galveston plan are fixed, Social Security builds in annual increases that not only protect participants against inflation but also allow them to keep pace with wage increases. Factoring that in, analysts have found that Social Security is a better deal for low-income workers.

Also, personal accounts are accompanied by the financial risk that comes with any private investment. In Galveston, the insurance company that handled the retirement system's annuity investments fell into financial trouble two years after the private plan was launched. County officials waited nervously for three years before they were able to recoup the money. "The system worked," Gornto said. "Nobody lost a dime."

Frank Carmona, 70, who served as a Galveston County commissioner for 20 years and then as a judge for eight years, was among the officials who approved the alternate plan. He said that the plan has done well by him but that he supported it only because he knew that Galveston workers would also be covered by the separate state pension plan that provides them with added retirement security.

Part of his reluctance to jettison Social Security stemmed from his family history. His father died in 1957, leaving his mother with three minor children to rely on the program to pull them through financially. Carmona likes knowing that similar financial guarantees are there for everyone. "It was those benefits that kept her and my three brothers going," he said. "It's a good program."