Inter-generation effects of Estonian pension system *
-
Expert of the Foresight Centre
Over the last 15 year, the pension system in Estonia has undergone multiple reforms, such as the introduction of the social tax dependent 1st pillar, the introduction of the 2nd and 3rd pillars, or the raising of the retirement age. Every reform leads to changes for the beneficiaries of the system. The changes similarly affect the pension system where reforms have caused changes both within the confines of one generation and between generations. This article focuses on the inter-generation effects of the pension system and is a brief summary of a 2014 Master’s thesis from the University of Tartu.
The main message of the article is that the individuals from younger generations, whose salary level is average or above it, will most likely receive a larger pension than individuals of the same salary level in older generations. This is a result of the future pensions increasingly depending on individual salaries, as well as of the younger generations making larger payments in the pension system, and over longer periods. On the other hand, the individuals from younger generations whose salary level is below average will receive a smaller pension than the earlier generations, although their payments to the pension system are larger compared to the individuals with the same salary level from the older generations.
This analysis mainly uses the internal rate of return to assess payments to and from the system; the rate is usually applied to assessing the profitability of investment projects. Another criterion is the net present value ratio (NPVR). The analysis also uses pension replacement rates in comparison to the average salary and the actual salary of the individual at the time of retiring as well as ten years later. The analysis uses a simulation method to assess the intergeneration effects on equal grounds.
The results of the study suggested that the reforms have made the pension system more actuarial, as the internal profitability between salary levels within generations has become more uniform; this means that people receive a result, i.e. a pension, that corresponds better to their contribution. The benefit of working longer does not depend as much on the generation as on the salary level. Therefore, if the retirement age is to be raised universally, the individuals from every generation who receive an above average salary will also receive the highest replacement rate. At the same time, working longer reduces the internal rate of return more pronouncedly in older generations than the younger ones.
*Peer reviewed research paper.