Unlike the United States and most European nations, Chile does not face a long-term Social Security crisis. This is because lawmakers shifted to a system of personal accounts almost 30 years ago. As a result, Chile’s economy is much stronger, the financial system is healthy, workers are better off, and taxpayers are protected. It also turns out that a system of personal accounts has a positive impact on the labor supply of older workers. Instead of getting lured into retirement by a punitive tax-and-transfer government system, they remain active to reap the rewards of a system that rewards them (rather than tax collectors) for continued work. A former World Bank expert has the details in a new report from the National Center for Policy Analysis.
American workers live longer each decade but they continue to retire early. They often begin receiving Social Security benefits, quit working and stop contributing to national output well before age 65. Reversing these trends must be an important objective when designing long-term reforms to balance revenues and expenditures on elderly entitlements.
Chile faced similar problems prior to 1981. It had a traditional pay-as-you-go defined benefit system, like Social Security in the United States. Workers had strong incentives to start their retirement benefits as soon as possible, because postponing pensions and adding contributions did not increase benefits commensurately. Labor force participation dropped dramatically when workers became eligible for pensions.
This changed with reforms in 1981 that replaced the defined benefit system with a defined contribution system. All new workers were required to join the defined contribution system while existing workers had a choice. Most workers are now in the new system and are required to contribute 10 percent of their wages to an individual account. Contributions are invested in a pension fund chosen by the worker and accumulate a market rate of return. Payouts take the form of inflation-protected annuities or gradual withdrawals during retirement. The new system increased incentives for older workers to postpone retirement and continue working. The response was dramatic.
…Following the 1981 policy changes and reforms, and after controlling for other sources of change in retirement behavior, the percentage of individuals receiving early benefits fell significantly:
- The proportion who received benefits before age 65 decreased by about 8 percentage points.
- The proportion of individuals who started receiving retirement benefits by their early 60s fell by about a quarter.
- The proportion who started receiving benefits by their 50s was cut in half.
Postponing the commencement of benefits could be due to market returns on additional contributions, which made workers more willing to continue working in order to save more money for retirement. Or it could be due to tighter preconditions on early retirement, which required more individuals to continue working until age 65. Tighter preconditions seem to dominate, as the percentage of individuals who receive benefits after 65 has not changed.
More older workers kept working following the reform, after controlling for other factors:
- Labor force participation rates for individuals in their 50s rose 12 percentage points.
- Labor force rates rose 13 percentage points for those aged 65-70.
- Individuals aged 60-64 increased their labor force participation the most – by 19 percentage points.
The biggest change in labor force participation was for individuals who had started receiving benefits from their retirement accounts:
- Participation rates rose by 15 percentage points for pension recipients in their late 60s.
- Rates rose by 28 percentage points for those in their 50s and early 60s.
- Among all pension recipients under age 70, the proportion who continued working more than doubled.
