Discouraging encouragement

 

Future pensions may be permitted as collateral for bank loans. In the current state of affairs, this could mean the end of pension reform. The Deputy Minister of Health and Social Development Yuri Voronin has said that the change should make people more active in investing their pension receipts and should demonstrate the benefits of accumulative retirement plans.

'If we let people use these funds for certain short-term borrowing for the most important needs such as housing or healthcare,’ Voronin said, ‘the appeal of this kind of development [i.e. pension plans] will become more apparent than it is now.’

The Russian pension system is based on three segments. The first - about $88 - comprises the basic pension paid by the government. In effect, this is a pay-as-you-go - it is funded by taxes levied on businesses.

The second segment, dubbed an insured portion, is comprised of eight per cent of a worker’s wage withheld by the employer and transferred to the State Pension Fund. Upon retirement, a return is paid from these lifetime contributions.

The third segment is the accumulative portion, introduced in 2004 as part of pension reform. Six per cent of wages are withheld by the employer and paid to the State Pension Fund. From there the employee can move these savings to licensed private pension funds.

Before the reform the pension system lacked these two latter elements and was a plain pay-as-you-go: it was funded by current taxation to support current retirees. The problem with such a system is that it works as long as the population is growing.

Yet it is shrinking at an accelerating speed. In 1992 the decrease in population was around 220,000 a year; now, it is almost 800,000. As a result, in 2010 there are less than 1.6 working people for one retired person, four times less than in the 1970-s. What is more, the UN Population Division predicts that 40 years from now Russia’s population will fall by a quarter from around 140 million today to 108 million in 2050.

The pension system that comes solely from the taxation of current workers will inevitably bankrupt the State Pension Fund, already facing a deficit of $39 billion.

That is why pension reform sought to encourage people to supplement their government-funded pensions with private savings. The latter should boost their living standards on retirement at a time when state benefits will be falling.

So far, however, the accruing pension segment, which is supposed to be the key element of the new system, hasn't worked. In 2009, over 63 million people, or 93.2% of all workers, did not transfer their pension savings to private managers and kept the funds in the SPF, which invests them in state bonds.

This means that the reform has failed. Pension money kept in low-yield state bonds doesn't make a difference as compared to the state-funded pensions. Though the system does appear to have an investment element, in reality it is still the good old pay-as-you-go.

So, why don’t people invest? Six per cent of wages as a contribution to an investment fund is not perceived as a sufficient amount to bother. Although in total savings are huge, individual accounts are miniscule. By April 2010 the SPF accumulated $23 billion of such ‘passive’ funds, yet in average one individual person has only $360.

Though actions to induce people to become active investors are needed, what Mr Voronin suggests is missing the point. While the amount on the SPF is too small to invest, it may be just enough to cash and spend. As a result, by encouraging people to use the money for ‘the most important needs’ the state will nudge them out of the system.

 

June 3, 2010
photo: Aquir - Fotolia.com

 

 

 

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