Move to defined-contribution pension system will change government’s regulatory role
| Author | Jan Walliser |
| Position | IMF, Fiscal Affairs Department |
| Pages | 12-14 |
Page 12
This article is based on “Regulation of Withdrawals in Individual Account Systems,” a paper presented at the September 1999 World Bank conference, “New Ideas about Old Age Security.” The study was subsequently also released as an IMF Working Paper.
Financing retirement income for the elderly imposes heavy fiscal burdens on many countries. For western industrial countries and a number of Asian countries, those burdens are expected to increase as their populations age. Others, notably transition countries, are already facing daunting financial problems in their social security systems. In both cases, policymakers face the same question: how to reform the public pension system so that its finances remain stable in the long run.
In response to those pressing policy issues, the World Bank under the guidance of its then-chief economist, Lawrence Summers (now U.S. Treasury Secretary), developed a new pension policy framework for its member countries in the early 1990s (see also Averting the Old Age Crisis, Oxford University Press, 1994). Among the Bank’s key recommendations is to replace public defined-benefit systems financed on a pay-as-you-go basis with a three-pillar system. In a pay-as-you-go defined-benefit system, contributions of current workers finance the benefits of current retirees, and benefits are set according to a formula that takes into account previous earnings, years of service, and age at retirement. In the suggested three-pillar system, only the first pillar, which provides a guaranteed minimum retirement income, would be financed on a pay-as-you-go-basis. The mandatory second pillar would be set up as a pre-funded defined-contribution system. In a defined-contribution system, benefits are determined by the contributions a worker makes to his or her retirement account and the returns on those retirement savings. The third pillar would be voluntary and would finance supplementary retirement income.
An important and little-discussed question in moving to a defined-contribution public pension system is how to draw down retirement savings accumulated in individual accounts.
In a defined-contribution system, individuals enter retirement with a stock of assets. In a mandatory system, workers must transfer a certain proportion of their...
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