Adequacy of Pensions:
Policy Options to
Strengthen Retirement
Income in DC pensions
Pablo Antolín
OECD 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
3
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.
4
Retirement Saving
Adequacy (RSA)
5
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.
6
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
7
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
8
Policy Options to Strengthen
Retirement Income in DC
9
Policy Options - Guiding principles
• The policy options based on three
guiding principles:
–Coherence
–Adequacy
–Efficiency
10
Adequacy
• DC pension plans are complementary to
other sources to finance retirement (e.g. PAYGfinanced 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%.
11
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
12
Measures to promote
contributions and participation
in DC pension plans
13
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.
14
Encourage people to contribute
and contribute for long periods
• ∆ contributions or the contribution period
∆ the probability of reaching the target
retirement income (RR).
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
15
Contribution rates linked to age
60.0
50.0
Contribution rate link to age starting
at age 35 from a low level (5%) to
achieve 70% of final salary in 40
years
40.0
30.0
20.0
Fixed contribution rate to achieve
70% of final salary in 40 years
Contribution rate link to age, starting
contributing at age 35 the same than fix
to achieve 70% of final salary in 40 years
10.0
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40
41
42
43
44
45
46
47
48
49
50
51
52
53
54
55
56
57
58
59
60
61
62
63
64
0.0
16
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?
17
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 autoescalation (e.g. SMTP).
• Also important to increase the number of people
saving for retirement in DC plans
18
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
19
Tax incentives
20
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
21
Tax incentives
• Most common: deductions on income
 Tax deductions (incentives increase
with income)
• Alternatively, tax credits (inversely
related to income)
• Matching contributions
22
Tax incentives - Tax deductions
Reduction in taxes relative to pre-tax income
(percentage points)
2.5
2
1.5
1
0.5
0
0.2
0.4
0.6
0.8
1
1.2
2
Income level
(times median income)
4
8
16
Tax incentive – Tax credits
Reduction in taxes relative to pre-tax income
(percentage points)
3
2.5
Tax credit based on a fixed amount for all
2
Tax credit based on a percentage of contributions plus a cap
1.5
1
0.5
0
0.2
0.4
0.6
0.8
1
1.2
2
Income level
(times median income)
4
8
16
Incentive – Matching contributions
Reduction in taxes relative to pre-tax income
(percentage points)
1.2
Fixed contribution match (1 pp)
1
0.8
0.6
Fixed contribution match with a cap (1 pp,
plus cap of median income)
0.4
0.2
0
0.2
0.4
0.6
0.8
1
1.2
Income level
(times median income)
2
4
8
16
Tax deduction + matching contributions
Reduction in taxes relative to pre-tax income
(percentage points)
3.5
Tax deduction with a matching contribution of 1pp
3
2.5
2
1.5
Tax deduction with a matching contribution of 1 pp and a cap
at the median income matching
1
0.5
0
0.2
0.4
0.6
0.8
1
1.2
2
Income level
(times median income)
4
8
16
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)
27
Thank you
very much
pablo.antolin@oecd.org
www.oecd.org/daf/pensions
28