Decomposing Notional Defined-Contribution Pensions

It examines, in detail, four economic advantages of notional accounts that deliver retirement incomes in an equitable and economically efficient manner. The issue of equity arises in the treatment of people who draw their pensions at different ages and contribute for a different number of years. The issue of economic efficiency arises because pension systems can and do distort individual decisions to work and save.

First, benefits are based on lifetime earnings, rather than a subset of “best” or “final” years’ pay. Secondly, an extra year’s contribution gives rise to an additional benefit. Thirdly, benefits are reduced to reflect the longer expected duration of payment for people who retire early and, similarly, increased for people who retire late. Finally, benefits are reduced as life expectancy increases, again to reflect the longer duration for which benefits would be paid.

An analysis of OECD countries’ pension systems – of all different types – shows that most have already achieved most of these objectives, but without adopting notional accounts.