World pension systems: Which work best?

When it comes to public pension systems, they are most often distinguished according to the way pensions are funded.

What are the different models of pension systems in the world?

There are different pension models that do not depend 100% on the state and combine public and private pensions.
One only has to look at the OECD report "Pensions at a Glance" to see the differences in the way pensions are funded and even in the setting of arrangements in public and mandatory contribution systems. In some countries, contributions to the public system are combined with mandatory contributions to private savings.

Types of pension systems

When it comes to public pension systems, they are most often distinguished by the way pensions are funded. There are different ways of structuring the model. Here are the most common ones:

Pay-as-you-go system

This is the pension system used in most Southern European countries. This system uses contributions from current workers to distribute them to retirees. In other words, current workers pay pensions to retirees, making it a solidarity system between generations. Each generation supports the previous one by paying its pension from the money it contributes to social security and expecting the next generation to do the same.

This model poses sustainability problems because it is completely dependent on having enough workers to pay public pensions, and with an aging population, this can be a problem. This is why many countries that use a pay-as-you-go system are looking for ways to encourage private savings.

Contributory system

In contrast to the pay-as-you-go system, there are contributory systems. This model is based on each worker contributing to the system and then receiving what is built up from those contributions. In other words, something similar to the way a pension plan or investment fund works, where you invest capital and over time get that money back plus the profit or income it has generated. These systems, more common in Anglo-Saxon countries, exclude the component of intergenerational solidarity. Each worker makes their contributions and the pension they receive is matched by their contributions.

There are two problems associated with this system:

The impact of inflation (the interest that must be earned in order for the system to work and have an amount to overcome the effects of inflation) and the inequality that can arise depending on each worker's length of service. For this reason, this type of system usually has a public and private part.

Contingent account system

A variant of the traditional "pay as you go" system. Defined contribution individual account systems, more commonly known as notional account systems, use contributions from workers throughout their careers.

The pension is calculated according to how much the worker has contributed to the individual account where their contributions are accumulated. Thus, the pension is a kind of real deferred salary. This is a Scandinavian model that is currently being offered as an alternative to the traditional PAYG system.

Contingent accounts directly link contributions to the system to the benefits received, which is fairer in theory, but may not be fair enough for everyone. The main problem with this system is that it does not set a minimum income, and there may be a segment of the population that retires without such a guarantee. It is possible to overcome this problem with basic benefit systems covered by the state.

A funded system with auto-enrolment

This is the system that is used in the UK. The difference with a traditional or basic savings system is that it requires companies to enrol workers into the system. The employee would then have to opt out of the system if they do not want to contribute a portion of their salary to these contributions.

With this small change, the system ensures that workers build up their retirement savings. Based on these minimum contributions, either the employee himself, the company or the government can add additional contributions. From these basic systems, different combinations can be created, where only the state contributes and the system depends on state pensions, mixed systems with compulsory contributions from the state or the private sector, and voluntary systems.

Examples of different pension systems around the world

There is nothing better than looking at some of the most well-known pension models to understand the dichotomy between public and private funding and how countries provide pensions for their retirees:

Pensions in Sweden

The Swedish system directs the contributions of its employees towards investments. The difference with the other systems is that citizens can choose where to invest their money. However, these investments are mandatory.

In particular, the state offers various private alternatives and one public alternative, which is the Swedish sovereign wealth fund. The employee chooses which option suits them best (if they choose none, the money is invested in a sovereign wealth fund). This competition means that the Swedish sovereign wealth fund must perform well to be chosen. The money invested by employees is integrated into a system of individual notional accounts of a virtual nature.

In addition to this system, there are company pension funds, which are more common than in Spain, and individual savings for each employee.

Sweden also has a guaranteed minimum pension for those who have not contributed sufficiently and a housing and living allowance supplement for the elderly.

Pensions in Norway

Norway has one of the best known and most recognised pension funds in the financial community. Norwegian workers contribute part of their salary to this fund and their retirement depends on the amount of contributions, the number of years worked, the age at which they decide to retire and the average life expectancy in the country. The difference between the Norwegian fund and the Spanish one is the way the money is inverted, which helps the country's companies on the one hand and diversifies assets on the other. Norway also allows people to receive a pension and work at the same time, allowing pensioners to contribute to the system.

Pensions in the Netherlands

The Dutch pension system is based on three pillars and is a mixed system with a mix of public and private pensions. The first pillar of the system is the state pension, which is paid on a pay-as-you-go model with defined benefits. The state pension (AOW) is paid from employee contributions, just like in the Spanish system. The difference is that it is a basic pension, which depends on the minimum wage. There is also a minimum assistance pension (AIO), which is a non-contributory pension for those who have not contributed sufficiently for several years.

The second pillar of the Dutch pension system is the occupational pension system, which is the corporate pension plans for employees that are mainly used. Ultimately, it is this that will account for the bulk of the pension that pensioners will receive, unless they contribute to a third pillar. This third component is already the individual savings of each worker.

Pensions in Austria

Austria uses the so-called Austrian rucksack, which is nothing but an individual savings system. Each month, companies contribute a portion of the employee's gross salary to a personal savings account managed by private funds.

This rucksack will accompany the worker for the rest of their life, even if they change jobs. When you retire, you get your money back, and if by some chance your investment doesn't work out, the state guarantees that you get back at least the money you contributed.

Under this system, the amount of your pension always depends on how much you have contributed.
To these public savings are naturally added the private savings of the employee.

Pensions in the United States

Contrary to what many believe, the United States does have a retirement system that is divided into three components: government, voluntary savings plans, and company plans. On the one hand, there is Social Security or compulsory social insurance. The system works on a pay-as-you-go basis, and both workers and companies contribute to it. Employees accrue credits according to time worked and salary, and the pension will depend on these figures. However, the amount of this pension is minimal.

As a result, most workers have no choice but to sign up for their own voluntary investment plans, such as 401(k) plans, which are company plans. Its speciality is that most companies co-operate and double the investment made by the employee.

Best pension systems

Different models and systems, but which one works best? The answer to this question is complex, and to answer it, the consulting firm Mercer and the CFA Institute publish an annual Global Pension Index report that looks at this question through three prisms:(ol)

The adequacy of the system in terms of the level of basic income it provides and the design of the system itself.
 Sustainability of the system, which takes into account factors such as the age of retirement or the country's level of public debt.
Integrity, which is characterised by laws and regulations that protect the system.

According to these parameters, the best pension systems in the world today are Iceland, Netherlands and Denmark.