MANDATORY PENSION SYSTEMS- Excerpts of the book "Finance for dad"

What do they consist of?

They are social security structures that most countries have in order to provide for their people during the old age. In most cases, these plans make companies and institutions (both public and private) and their employees contribute a specific amount of their income. This money will be used to cover the pension of those who have gathered all requirements needed by law. There are two systems of mandatory pension plans: the traditional system, also known as pay-as-you-go system, and the individual capitalization system.

Traditional or pay-as-you-go system, what does it consist of?

It is based on the social solidarity concept in which people at a productive age contribute a part of their income to support those who have retired. At the same time, they also expect that when they reach a non-productive age, there will be another generation of people who will contribute to their support. This system has worked efficiently for many years in many countries. However, it has started to collapse as the number of retirees has grown rapidly to more than the number of people that contribute. Advances in health have contributed as well. It has made people live longer and, therefore, they will require longer pensions. We can also add the fact that in many regions birth rates have decreased drastically. In most nations that have this kind of system, contributions will soon not be enough to cover pensions. This list includes developed countries such as: United States, Switzerland and Germany. On the other hand, these programs generally work under public institutions of social security of each state. In many cases, bad management and corruption are speeding up their collapse. This is bad news for new generations of countries with such a system. It is not likely that they will receive a pension. The good news is that many countries have foreseen the crisis and they are working to change this situation. Some countries (Chile, Argentina, Colombia, Mexico, Hungary, Poland, etc.) have started significant changes, whereas others (Brazil, USA, England, etc.) have modified some aspects of their system such as: increasing the retirement age, promoting corporate and individual pension systems. Many countries, which have taken such measures, have followed a model of individual capitalization started in Chile in 1980.

Individual capitalization system, what does it involve?

Unlike the previous one, in which you contribute to elderly people hoping that someday you’ll receive the same, this capitalization is individual. You contribute to create your own retirement fund and you choose the managing company, from the ones approved by the government, is going to be in charge of administrating your funds. As with the traditional system, you can’t touch this money until you gather all requirements to retire. Both companies and employees are obliged to give a part of their income. The difference with the previous one is that these contributions are given to your individual account, to the retirement fund administrator you choose. You will see how your pension fund will grow as you contribute to it. After 34 years of its creation, it seems like a good alternative to fill in the gaps of the traditional system. Nevertheless, it might not be that perfect. There are certain faults. Since it is controlled by the government, they make administrators invest an important part of the received money in government bonds. Eventually, governments face problems and they can’t pay and change the rules of the game, so pensioners may see their funds jeopardized.

What system is best: the traditional or the individual capitalization?

No one is better than the other one. Both systems have some advantages and weaknesses. Therefore the choice will depend on the individual situation: age, income, future plans, etc. Whereas some countries give you the possibility to choose, in some others you can’t. There are countries such as Bolivia, Chile or Mexico that only have the Individual Capitalization System. On the other hand, other countries only have the traditional systems such as the USA, Spain or Germany. There is a third group of countries in which you can choose either one, for example: Australia, Noruega, Colombia or Peru. In other countries these systems are currently undergoing a period of transition from pay-as-you-go to individual capitalization, or adaptation in the case that there some changes have been made.

Can an emigrant that has contributed to social security and still lives abroad, complete the time needed to apply for a pension?

It can be done in most countries. It is interesting how some countries have changed their systems to help emigrants. Some people who have worked for a long time in their countries of origin and have contributed for several years to their systems of social security assume that this money was gone. The good news is that their contributions are still alive, based on the new laws. Sometimes they represent a considerable amount.

Is the Social Security pension enough for your

retirement?

In most cases, this pension won’t be enough to have a comfortable life during old age, especially if the country you live in has an inefficient social security system. Even so, you should contribute. At old age any regular income, even a little one, will be welcome.