Adequacy of Pensions: Policy Options to

Strengthen Retirement Income in DC pensions

Pablo AntolínOECD DAF/FIN Pension Unit

OECD-IOPS Global Forum on Private Pensions

Cape Town, 25-26 November 2011

Policy questions

Are people saving enough for retirement?

Are private pensions fulfilling their complementary role in providing for retirement?

Should we introduce measures to increase retirement savings or postpone retirement?

Are people ready for retirement?2

OECD and its WPPP developing …

• Set of policy options to strengthen retirement income in DC plans

proposals to increase coverage, participation and make sure retirement income is more protected against several risks

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OECD and its WPPP developing …

• Study assessing how much actual people have to finance retirement

• This will allow determining whether people are saving enough for retirement and examine the role that private provision plays in the retirement adequacy of the working age population.

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Retirement Saving Adequacy (RSA)

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RSA

• Preliminary results using survey data for Germany and the US show:

Future retirees would enjoy as much resources to finance retirement as current retirees.

However, if the labour market continues to be depressed and people experience shorter careers future retirees may enjoy less retirement income.

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RSA

Social security or public pensions may remain the main source to finance retirement in both countries.

More so for Germany than for the USA

The importance of public pensions fall with income levels

Women and low income individuals would rely more on public pensions

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RSA Assuming an extension of private provision

(e.g. all prime age workers will join a Riester plan in Germany and a 401(k)s in the US) future retirees would enjoy higher financial resources to finance retirement.

Increasing employment prime age workers (improving labour market) would increase the financial resources to finance retirement of future retirees as compare to current retirees and those close to retirement

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Policy Options to Strengthen Retirement Income in DC

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Policy Options - Guiding principles

• The policy options based on three guiding principles:– Coherence – Adequacy – Efficiency

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Adequacy

• DC pension plans are complementary to other sources to finance retirement (e.g. PAYG-financed pensions).

• DC plans need to be designed (e.g. contribution rates, contribution periods, payout phase, etc.) taking into account that they may provide a ret. income that complement other sources.

• What is an adequate ret. inc. is highly controversial. But assuming that for example, one can get by on 70% of pre-retirement income CR=5% to get 20-25% if PP 45-50%.

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Main policy messages

3. Encourage people to contribute and contribute for long periods

4. Improve the design of incentives to save for retirement to increase contributions and coverage

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Measures to promote contributions and participation

in DC pension plans

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M3. Encourage people to contribute and contribute for long periods

• Best way reduce uncertainty about achieving a target retirement income is to contribute large enough amounts and for long periods.

• Long contribution periods allow for higher retirement income for given level of contributions (compound interest)

• Lengthening contribution period by postpo. retirement more efficient approach of increasing retirement income.

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Encourage people to contribute and contribute for long periods

• ∆ contributions or the contribution period ∆ the probability of reaching the target retirement income (RR).

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Prob (RR≥30%) Prob (RR≥70%)

5% C – 40 years 61.6 13.9

10% C – 40 years

91.7 52.8

5% C – 20 years 2.8 0.1

10% C – 20 years

33.0 1.3

Contribution rates linked to age

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Contribution rates linked to age• Reasonable to have contribution rates

increasing with age. Young people lower income and more expenses (housing, kids)

• Contribution rates would have to increase to high levels at the end of one’s career to achieve the same target retirement income.

• Time inconsistence problem: would be people be willing to pay such high contributions levels?

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M4. Improve the design of incentives to save for retirement to

increase contributions and coverage

• Contribution could be ∆ through mandates or with the help of “nudge” measures.

• “Nudge” measures include matching contributions (employer or state), and auto-escalation (e.g. SMTP).

• Also important to increase the number of people saving for retirement in DC plans

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Improve the design of incentives to save for retirement to increase

contributions and coverage• Compulsion• Soft compulsion: auto-enrolment with an opt-

out clause (Italy, New Zeeland, UK). Take advantage of behavioural financial literature stressing the role of inertia or passive decision.

• Strengthen the value of tax incentives for mid to low income people: tax credits or matching contributions instead of tax deductions.

• Better communication and improve fin-ed

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Tax incentives

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Tax form – tax incentives

• Earned income• Deductions, exemptions, reliefs

(e.g. charity)• Taxable income• Applied tax rates by income

brackets• Tax due• Tax credits (e.g. credits per child)• Tax payments

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Tax incentives

• Most common: deductions on income Tax deductions (incentives increase with income)

• Alternatively, tax credits (inversely related to income)

• Matching contributions

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Tax incentives - Tax deductions

Tax incentive – Tax credits

Tax credit based on a fixed amount for all

Tax credit based on a percentage of contributions plus a cap

Incentive – Matching contributions

Fixed contribution match (1 pp)

Fixed contribution match with a cap (1 pp, plus cap of median income)

Tax deduction + matching contributions

Tax deduction with a matching contribution of 1pp

Tax deduction with a matching contribution of 1 pp and a cap at the median income matching

Work in preparation• OECD developing project to examine tax

rules on pensions systems • Tax rules on contribution, returns &

benefits• Tax rules on the accumulation, on the

payout phase and on different products (annuities, PW, lump-sums)

• Assess the impact of tax incentives (country specific)

• Assess the impact of alternative ways of introducing incentives (country specific)

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Thank you very much

pablo.antolin@oecd.orgwww.oecd.org/daf/pensions

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