The life cycle distributional consequence of pay-as-you-go and funded pension systems

Using a dynamic cohort microsimulation model (LIFEMOD), the authors examine the life-cycle distributional consequences of a variety of pay-as-you-go (PAYG) and funded pension systems. This technique allows them to investigate both the socioeconomic characteristics and the number of people affected by a change in contribution or eligibility rules in any pension system. LIFEMOD uses 1985 parameters for the United Kingdom so specific results are not valid for other countries. But winners and losers are likely to be similar across countries. They find the following: Women benefit much more than men in a flat-rate PAYG system. In simulations, 84 percent of surviving women but only 33 percent of surviving men are net beneficiaries, because women have higher life expectancy and lower lifetime earnings. Imposing minimum contributions substantially reduces the number of women who qualify for a pension. Imposing a joint contribution rule on the earnings of married couples significantly increases the number of women qualifying without significantly reducing the proportion of qualifying men. In funded pension systems, on average men accumulate much more pension capital than women do because of men's higher earnings and more continuous paid work. Different rates of real interest and earnings growth affect individuals'fund accumulation differently. Women benefit more from high rates of return and low earnings growth because they tend to receive a higher proportion of their lifetime earnings when young. But some men and many women fail to achieve minimum pension levels. If the pension shortfall is compensated for by lump-sum capital top-ups, women receive 93 percent of top-ups (70 percent if joint contributions are used). In hybrid pension systems that combine both PAYG and funded elements, the higher the proportion of PAYG payments, the greater the replacement rate for people in the bottom 40 percent of the lifetime earnings distribution (the majority of whom are women). But replacement rates for people in the middle of income distribution are insensitive to any variant of the PAYG-funded combination. In short, flat-rate pay-as-you-go pension plans and funded pensions produce very different distributional outcomes, the single most important determinant of which is the different lifetime employment and earnings records of men and women.