 The simple(r) algebra of pension plansDimitri Vittas No 1145, Policy Research Working Paper Series from The World Bank Abstract: Chile's success with pension reform in the early 1980s and the continuing financial pressures facing the social security systems of many developing (and some industrial) countries have elicited considerable interest in the mechanics of pension systems that are based on fully funded individual capitalization accounts. The author sets out the simple(r) algebra of both defined contribution and defined benefit plans. The author notes the following results: (a) unless the real rate of interest exceeds the growth rate of real wages by a significant margin, payment of a reasonable pension rate requires a high contribution rate or a high active worklife ratio (the ratio of working life to retirement life); (b) it is more difficult for a high-growth economy to provide a high pension rate, although the absolute level of the pension could be higher than the pension level in a low-growth economy with a high pension rate; (c) when pensions are indexed to prices, the level of interest rates and growth rates affects positively the level of the pension rate. But when pensions are indexed to wages, only the difference between interest rates and growth rates has an effect on pension rates. In all cases, the active worklife ratio has a positive effect on the pension rate; (d) the timing of contributions, and therefore the pattern of earnings over a person's full career, has a significant but not major effect on pension rates; (e) employer-based, final-salary, defined-benefit plans penalize early leavers and favor late high-fliers; (f) full funding with universal coverage and full lifetime careers would lead to a massive accumulation of capital, especially if the demographic structure resembles a pillar rather than the more traditional pyramid. This would have major implications for the productivity of capital and the functioning of financial systems; (g) a mixed system -- combining a redistributive first pillar and a fully funded defined-contribution second pillar -- represents a more prudent, perhaps more equitable, approach to reforming pension systems; (h) variable contribution and pension rates, within specified limits, might be preferable and more consistent with greater reliance on personal choice. Keywords: Environmental Economics&Policies; Insurance&Risk Mitigation; Pensions&Retirement Systems; Economic Theory&Research; Banks&Banking Reform (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:wbk:wbrwps:1145 Access Statistics for this paper More papers in Policy Research Working Paper Series from The World Bank 1818 H Street, N.W., Washington, DC 20433. Contact information at EDIRC. |
Is your work missing from RePEc? Here is how to contribute.
Questions or problems? Check the EconPapers FAQ or send mail to .
EconPapers is hosted by the
School of Business at Örebro University.