What Is a Pension Pillar?
A pension pillar is one of five pension formats outlined by the World Bank. The five pillar concept was developed in 2005 and has since been adopted by many economically reforming countries in Central and Eastern Europe.
The World Bank’s policy five-pillar framework defines a range of design elements to determine the pension system modalities and options that should be considered. There were originally three pillars outlined by the World Bank, along with mandatory individual funded savings. It ranges from a basic, minimal degree of social protection to financial and nonfinancial support from various generations to the elderly.
- A pension pillar is one of five pension formats outlined by the World Bank, which were developed in 2005.
- The five-pillar framework defines a range of design elements to determine the pension system modalities and options that should be considered.
- The system ranges from a basic, minimal degree of social protection to financial and nonfinancial support from various generations to the elderly.
- The Canada Pension Plan, the U.S. Social Security system, the 401(k), IRA and RRSP schemes all fall within the scope of the five pillar system.
Understanding the Pension Pillar
The World Bank's pension pillar policy framework focuses on how best to achieve the core objectives of pension systems—that being the protection against the risk of poverty in old age and smoothing consumption from one’s work life into retirement.
By establishing these objectives, the World Bank encourages policymakers to consider broader questions of social protection and social policy, which consider the poverty and vulnerabilities of different income groups. Some of these key questions include:
- Whether resources should be devoted toward providing old-age poverty protection in societies where other groups—such as children—may face a greater risk of poverty and vulnerability.
- How much should a society aim to redistribute income through the pension system, and how it can ensure that this redistribution is made transparent and progressive.
- What measures should be taken to strengthen the enabling environment, which is conducive to reform options best geared toward core objectives.
Once these core objectives are identified, one can then identify the mandate of the public pension system, the balance between insurance and adequacy functions, and appropriate system design options.
The Five Pillars
The goal of the five-pillar system is to separate the major objectives of pension and/or retirement plans into the following pillars:
- Pillar 0: The first pillar is a general social assistance program designed to specifically deal with the poverty alleviation. This pillar is meant to provide the most basic social protection. The Canada Pension Plan is one such example.
- Pillar 1: This pillar addresses, among other things, the risks of individual myopia, low earnings, and inappropriate planning horizons due to the uncertainty of life expectancies, and the lack, or risks, of financial markets. Mandatory systems that depend on public contributions fall under this block such as the U.S. Social Security system and the Canada Pension Plan.
- Pillar 2: Under this pillar, recipients and employers pay into a privately-funded system. This includes pension funds and defined-contribution accounts and/or plans with a wide array of design options. A 401(k) plan is an example.
- Pillar 3: Voluntary privately-funded accounts are part of this pillar. These include individual savings plans, insurance, etc. This is a supplemental pillar and encompasses accounts like the individual retirement account (IRA) in the U.S.
- Pillar 4: The final one is a non-financial pillar that provides access to informal support such as family support, other formal social programs like healthcare and/or housing, and other individual financial and non-financial assets such as homeownership and reverse mortgages where available.
Examples of Retirement Plans
Many countries have pension plan systems in place that fit with the objectives of the World Bank's five pillars. Country-specific conditions require a tailored approach that should substantially define what is feasible for each country. So there is no one-size-fits-all approach.
The United States has a number of different systems in place. The Social Security system was created in 1935 and is run by the Social Security Administration. It depends on mandatory contributions from the public. The system provides retirement benefits, as well as disability and survivor benefits. Anyone who made contributions for at least 10 years qualifies. Benefits begin to kick in for people who turn 62 and get larger for anyone who waits to collect them after age 67.
Since financial and social conditions vary by country, there is no one-size-fits-all approach to pension systems.
American citizens can also build their retirement accounts by investing in a 401(k), a qualified employer-sponsored retirement plan that allows for tax-deferred contributions from their salaries or wages. Another option is the IRA, an investment account that allows the holder to build retirement savings through tax-free growth or on a tax-deferred basis.
In Canada, citizens are able to receive retirement income from two different sources—the Old Age Security (OAS) system and the Canada Pension Plan. The OAS system is a taxable pension made available through tax revenues from the government. Citizens and those who can prove Canadian resident status who are 65 or older qualify. The Canada Pension Plan is just like the U.S. Social Security system, which relies on contributions made by employees.
Registered retirement savings plans (RRSPs) give Canadians another avenue through which they can save for retirement. Both employees and employers are able to make contributions on a pre-tax basis. The money in this account grows tax-free until the account holder retires and begins to make withdrawals.