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The Danish Pension System Properties, outcomes and challenges
Torben M. Andersen
Aarhus University, Denmark
Eight International FIAP- ASOFONDOS Congress,
Carteagena April 2015
Pension system: Multiple objectives
• Distribution: Ensuring that all elderly have a decent living standard (minimum standards)
• Consumption smoothing: Ensuring that living standards after retirement stand in a resonable relation to living standards while working
• Insurance: Coverage of various events (spouse, long life……)
Danish pension system
I: Public pensions (PAYG – defined benefits) – Base pension for all (flat rate)
– Supplements – means tested
– All benefits are wage indexed
II: Labour market pensions (defined contribution) – Bargained, but mandatory for the individual
– Covers the majority of the work-force
– Provide annuitities + insurance (spouse/children; health)
III: Private pension saving – Tax subsidized and tied until retirement
– Free savings (property, financial assets…..)
International comparisons
Background -Danish welfare model
• Extended welfare state – Pensions
– Health
– Old-age care
• Universalism – Equal entitlements for all
– Tax financed
• Strong distributional objectives
Current pension system -
developments
• 1980s – Savings deficit – systematic current account
deficits
– Political discussion on employee-owned firms (wage-earner funds)
– Social partners: Agreement on development of labour market pensions (centralized labour market; high unionization)
• Collective - voluntary /bargaining
• Individual - mandatory
Vælg layout 1. Højreklik uden for dit slide
2. Vælg et passende layout fra “drop ned” menuen
Tekstslide med punktopstilling
Brug knapperne ‘Forøge / Formindske
indryk’ for at skifte mellem de forskellige tekst niveauer
Labour market pensions – stepping up
7
0
50
100
150
200
250
19
84
19
87
19
90
19
93
19
96
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20
10
20
11
20
12
Pension wealth, % of GDP
0
2
4
6
8
10
12
14
16
18
20
% Contribution rates
LO-DA blue collar
LO-DA white collar
Teachers
Nursery teachers
Changing importance of public and
private pensions
0
1
2
3
4
5
6
7
8
9
1985 1995 2005 2015 2025 2035 2045 2055 2065 2075
% of GDP
Public pensions Private pensions
Pensions, % GDP
Current system
0
50
100
150
200
250
300
350
400
450
0
50
100
150
200
250
300
350
400
450
- 50 100 150 200 250 300 350
Supplement I Supplement IIBase amount Private pension
1.000 kr. 1.000 kr.
Private pensions
Phasing out of public pension supplements
Replacement rates (2012)
0
20
40
60
80
100
120
140
0
20
40
60
80
100
120
1 2. 3. 4. 5. 6. 7. 8. 9. 10
Income decile
Capital income Private pensions Public Pensions
% %
Projections:
- Replacement rates will increase
- Private pensions will increase in importance
- Public pensions will remain important
Low income among pensioners
0,0
0,5
1,0
1,5
2,0
2,5
3,0
0,0
0,5
1,0
1,5
2,0
2,5
3,0
65 66 67 68 69 70 71 72 73 74 75 >75
%. %.
Age
Share with income below 50%
of median income for entire
population
0.3 % of persons above 64 falls
below the official poverty line
Financially robust?
• Labour market pensions: – Funded
– Non-firm specific
• Public pensions: – Criteria for fiscal sustainability are met!
– Reforms to increase the statutory pension age • Reducing possibilities for early retirement
• Discrete increases in pension age from 65 to 67
• Indexation of pension ages based on life expectancy at the age of 60; expected pension period 14.5 years
Challenges
• Interplay between public and private pensions (means testing)
• Taxation of various types of savings
• Not all are covered by a labour market pension
• Balance expansion – macroeconomic (in)stability
Distribution dilemma
• Binding distributional constraint – ensure some minimum income (working age and pensioners)
• Impossible to reach this target through mandatory pension savings for groups with income close to the limit
• Division of labour between public and private pension via means-testing – targeting public pensions towards low-income groups
Means-testing and incentives
• How to transit from public to private pensions? (means-testing)’
• If higher private pension =
lower public pension ; implicit form of taxation in addition to regular taxes
• Effective tax rates can be high
- Slow phasing out: low tax rates, but costly
- Quick phasing out: high tax, less costly
0
20
40
60
80
100
120
140
160
180
200
0
20
40
60
80
100
120
140
160
180
200
- 50 100 150 200 250 300 350 400
Public pensions
Supplement I
Supplement II
Base amount
1.000 kr. 1.000 kr.
Private pension
Incentives – savings and retirement
• High effectiv tax rates
on pension savings
and later retirement
• Applies for low
income groups!
35
45
55
65
75
0 100 200 300 400 500 600
Private pension(1.000 kr.)
% %
Effective tax rates on pension savings
Means-testing and insurance
• Low contribution due to involuntary unemployment, illness etc.
• Low return on investments
etc.
= lower private labour market pension
= higher public pension
Stabilizes/insures total net pension
Taxation of savings
• ETT-regime for
pension savings
• Large variations in
taxation of various
types of savings
– Asset allocation
– Balance expansion
0
5
10
15
20
25
30
35
40
45
0
5
10
15
20
25
30
35
40
45
Returntaxation -pensions
Property Shares Capitalincome
% %.
Pension
savings
Other types of
savings
Balance expansion
• High level of pension savings (illiquid)
• High level of borrowing (large share with variable interest rate)
• High risk exposure?
• Effects on macroeconomic stability
Financial assets Financial liabilities Financial net assets
Pension wealth, after tax Deferred taxes
% of GDP
Pensions for all!
• Bargained solution= support from social partners
• But not all covered! (recipients of social transfers, some employed, self-employed)
• ”Myopia” – insufficient savings (The argument for mandatory pensions saving)
• Free-rider aspects + effect on public budgets
• Solution: Mandatory pension savings for all??
Conclusions
• Long transition phase – still on-going
• Robust system
– Meets distributional objectives
– Ensures high replacement rates
– Financially viable
• Unsolvable dilemma – how to reconcile (re)distribution with incentives?
– Current system has clear incentive problems (savings, retirement)
– Uneven taxation of various types of pensions saving
• Ensuring coverage for all – mandatory scheme or?