Chile’s New Pension Reforms

In PAYGO systems, as the ratio of retirees to workers increases, successive generations must pay higher taxes to cover the benefits of the previous generation. Personal account systems, by contrast, require workers to save for their retirement, invest workers’ savings productively, and fund workers’ benefits through their own accumulated funds. In 2008, a council appointed by Chile’s newly-elected, center-left coalition government to review the pension system reaffirmed the basic principle of reliance on private individual accounts and extended the system to groups not previously required to participate. At the same time, the new reforms expanded and restructured public benefits for individuals with little or no private pension. These changes will protect noncontributors and low contributors from a sharp drop in income after they retire. The danger under these new reforms is that fiscal costs may grow faster than expected. Furthermore, the phase out of the generous public benefits for those with larger private pension accounts creates an implicit marginal tax penalty that may discourage some individuals from contributing to personal accounts.

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