Adequacy of Pensions: Policy Options to Strengthen Retirement Income in DC pensions

1. 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

2. 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?

3. 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

4. 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.

5. Retirement Saving Adequacy (RSA)

6. 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.

7. 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

8. 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

9. Policy Options to Strengthen Retirement Income in DC

10. Policy Options - Guiding principles • The policy options based on three guiding principles: • Coherence • Adequacy • Efficiency

11. 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%.

12. Main policy messages • Encourage people to contribute and contribute for long periods • Improve the design of incentives to save for retirement to increase contributions and coverage

13. Measures to promote contributions and participation in DC pension plans

14. 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.

15. Encourage people to contribute and contribute for long periods • ∆ contributions or the contribution period ∆ the probability of reaching the target retirement income (RR).

16. Contribution rates linked to age

17. 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?

18. 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

19. 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

20. Tax incentives

21. 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

22. Tax incentives • Most common: deductions on income  Tax deductions (incentives increase with income) • Alternatively, tax credits (inversely related to income) • Matching contributions

23. Tax incentives - Tax deductions

24. Tax incentive – Tax credits Tax credit based on a fixed amount for all Tax credit based on a percentage of contributions plus a cap

25. Incentive – Matching contributions Fixed contribution match (1 pp) Fixed contribution match with a cap (1 pp, plus cap of median income)

26. 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

27. 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)

28. Thank you very muchpablo.antolin@oecd.orgwww.oecd.org/daf/pensions