The Danish Pension SystemProperties, outcomes and challenges
Torben M. AndersenAarhus 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…..)
World Bank
1994
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
Labour market pensions – stepping up
7
19841987
19901993
19961999
20002001
20022003
20042005
20062007
20082009
20102011
20120
50
100
150
200
250Pension wealth, % of GDP
19931994
19951996
19971998
19992000
20012002
20032004
20052006
20072008
20092010
0
2
4
6
8
10
12
14
16
18
20
Contribution rates
LO-DA blue collarLO-DA white collarTeachersNursery teachersPublic sector, white collar
%
Changing importance of public and private pensions
19851988
19911994
19972000
20032006
20092012
20152018
20212024
20272030
20332036
20392042
20452048
20512054
20572060
20632066
20692072
20752078
0
1
2
3
4
5
6
7
8
9
Public pensions Private pensions
% of GDP Pensions, % GDP
Current system
-
5 10
15
20
25
30
35
40
45
50
55
60
65
70
75
80
85
90
95
100
105
110
115
120
125
130
135
140
145
150
155
160
165
170
175
180
185
190
195
200
205
210
215
220
225
230
235
240
245
250
255
260
265
270
275
280
285
290
295
300
305
310
315
320
325
330
335
340
345
350
0
50
100
150
200
250
300
350
400
450
0
50
100
150
200
250
300
350
400
450
SeriesForSecondAxis Supplement I
1.000 kr. 1.000 kr.
Private pensions
Phasing out of public pension supplements
Replacement rates (2012)
1 2. 3. 4. 5. 6. 7. 8. 9. 100
20
40
60
80
100
120
0
20
40
60
80
100
120
140
Capital income Private pensions Public Pensions
Income decile
%%
Projections:- Replacement rates will increase- Private pensions will increase in importance- Public pensions will remain important
Low income among pensioners
65 66 67 68 69 70 71 72 73 74 75 >750.0
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
%. %.
Age
Share with income below 50% of median income for entire population
0.3 % of persons above 64 fallsbelow 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
-
5
10
15
20
25
30
35
40
45
50
55
60
65
70
75
80
85
90
95
100
105
110
115
120
125
130
135
140
145
150
155
160
165
170
175
180
185
190
195
200
205
210
215
220
225
230
235
240
245
250
255
260
265
270
275
280
285
290
295
300
305
310
315
320
325
330
335
340
345
350
355
360
365
370
375
380
385
390
395
400
0
20
40
60
80
100
120
140
160
180
200
0
20
40
60
80
100
120
140
160
180
200Public pensions
Supplement ISupplement IIBase 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!
0 100 200 300 400 500 60035
45
55
65
75
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
Return taxatio
n - pension
s
Property
Shares Capital income
0
5
10
15
20
25
30
35
40
45
0
5
10
15
20
25
30
35
40
45
% %.
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 assetsFinancial liabilitiesFinancial net assets
Pension wealth, after taxDeferred 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?