Pension System:
The pension system is one of the most important economic and social structures in any country, as it is designed to provide an economic income to people when they retire from the labor market, usually due to old age or inability to work. Although we have all heard of it, its complexity and multiple facets make it a difficult topic to fully understand. 🌍💸
In this article I will guide you through everything you need to know about the pension system, from its history, types of pensions, how they are funded, its current challenges, and what the future holds for retirement systems. 🚀
What is the pension system? 🤔
A pension system is a set of public policies, programs, and mechanisms that ensure an income for people who have reached retirement age or who are in a situation that prevents them from continuing to work (for example, a disability). This system can be managed by the State, private companies, or a combination of both.
Its purpose is simple: to ensure that people do not run out of income at the stage of their life when they can no longer generate their own resources, offering an economic safety net to older people.
A look at history 📜🏛️
Pension systems, as we know them today, have not always existed. In fact, they are a fairly recent invention in historical terms.
Origins in Germany: the first modern pension system 🇩🇪
The first public pension system was created in Germany in 1889 under the leadership of Otto von Bismarck, the then German chancellor. This was the first state-run retirement system to offer a pension to older workers funded by mandatory contributions from workers and employers. The German system was pioneering and served as a model for many other countries.
The expansion of the pension system in the 20th century 🏗️
As industrial economies grew and societies became more urbanized, more countries adopted public pension systems. In the United States, Social Security was created in 1935 under Franklin D. Roosevelt as part of the New Deal, offering a form of income to retired people. During the 20th century, pensions became a fundamental part of the welfare state in many developed countries.
Today, almost all countries in the world have some form of pension system, although these vary in their design, coverage and sustainability.
Types of pension systems 📂
Pension systems can be classified into different types depending on their design and financing mechanism.
Here I explain the main ones:
1. Public (or pay-as-you-go) pension 💰🏛️
This is the most common in many countries. The government administers this type of pension, where active workers contribute a portion of their salary to a common fund through taxes or mandatory contributions. This money is used to pay the pensions of current retirees.
It is a pay-as-you-go system, which means that younger generations pay the pensions of older generations. (And that is a problem, since when it is our turn to receive said pension, there will be less births, and more older people🫣)
Governments set the retirement age (which can vary between 60 and 67 years, depending on the country and reforms), from which citizens can start receiving their pension.
It depends on demographic sustainability: if the population ages and there are fewer young people working, the system may face difficulties in paying all retirees.
2. Private (or capitalization) pension 🏦📈
This type of pension is managed by private companies, and each person has an individual account where they deposit their contributions throughout their working life. These funds are invested, and at the time of retirement, the worker receives a pension based on the accumulated capital plus the returns on the investments.
It is a capitalization system, which means that people save and invest their own money for their future. It can be supplemented with the public pension, and employers often also make contributions to this type of fund.
Workers assume certain investment risks, since the returns on the pension fund can vary depending on the behavior of the financial market.
3. Complementary (or voluntary) pensions 🏠📝
These are savings plans that a person decides to contract voluntarily, generally to supplement their public or private pension. It is a kind of «extra savings» that accumulates to have more income in retirement.
They usually offer tax advantages, that is, tax benefits for saving for retirement.
They can be managed by banks, insurance companies or investment funds.
How are pensions funded? 💰
The funding of pension systems can vary depending on the type of system and the country, but the most common methods are:
1. Contributions from workers and employers:
Both employees and employers make contributions to pension systems. In some cases, governments also contribute, especially in public systems.
2. General taxes:
Some countries fund their pension systems through general taxes. This is more common in pay-as-you-go systems, where pensions are paid from tax revenues.
3. Financial investments:
In individually funded systems, funds accumulated by workers are invested in financial markets. The success of these investments is crucial to ensuring a good level of pensions in the future.
The current challenges of the pension system 🚨
Pension systems around the world face major challenges in the 21st century.
Among the most prominent problems are:
1. Population ageing 👵📉
One of the most serious problems is the ageing of the population. In many developed countries, the birth rate has decreased, while life expectancy has increased. This means that there are more retired people receiving pensions and fewer active workers contributing to the system.
In countries such as Japan, Spain and Italy, where the population is ageing rapidly, this is a critical problem, as younger generations are not large enough to finance the pensions of older generations.
2. Insufficient individual savings 💸
In individual capitalisation systems, one of the biggest challenges is that many people do not save enough for their retirement.
In addition, factors such as low wages, informal employment and volatility in financial markets can mean that accumulated savings are not sufficient to cover the needs of old age.
3. Financial sustainability 📊
In many countries, public pension systems are under pressure due to funding problems. In some cases, governments have incurred large debts to cover the shortfall in pension systems, which could lead to broader economic problems in the long term.
What does the future hold for pension systems? 🔮
As current challenges cannot be ignored, many economies are exploring reforms to ensure the sustainability of pension systems.
Some of the most common proposals include:
1. Raising the retirement age ⏳
One of the most discussed measures is raising the retirement age, as people live longer and are able to work longer. However, this is a controversial issue, as many people prefer to retire earlier and enjoy more free time in their later years.
2. Encouraging private savings 💼💵
Governments are also incentivizing people to save more for their retirement by creating tax-advantaged private pension plans, or by strengthening individual capitalization systems.
3. Structural reforms 🔧
Some countries are considering more profound structural reforms, such as the partial privatisation of pension systems or the adoption of mixed systems that combine the advantages of pay-as-you-go and capitalisation models.
Conclusion 📜
The pension system is a fundamental pillar of any modern society, as it guarantees the financial security of people who are elderly or unable to work. However, it faces enormous challenges due to demographic changes, insufficient savings and financing problems.
The future of the pension system will depend on the ability of governments, companies and individuals to adapt to new realities and ensure that retirement income is sufficient and sustainable for future generations. Although solutions are not easy, one thing is certain: pension systems will continue to evolve as the world changes. 🌍💼