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• THE PENSION SYSTEM: A MODEL FOR RUSSIA AND INTERNATIONAL EXPERIENCE
  • Modeling the Pension System of the Russian Federation
    • 2. The Current Pension Law: A Brief Characteristic

2. The Current Pension Law: A Brief Characteristic

2001 can by rights be called the year of radical pension reform in the Russian Federation. The laws passed in this year replaced (since January 1, 2002) the pension system founded on the strictly PAYGO principle with a mixed system which combines the PAYGO and the funded principles.

As the RF Pension system is quite complicated, we shall just describe its principal, fundamental characteristics.

The core of the public pension system is the so-called labor pension, which is assigned upon the prospective pensioner’s reaching a retirement age established under the law (provided the recipient has at least a five-year pensionable service), the onset of disability (provided the person has an employment history of any length[1]), and in the case of loss of breadwinner.

The funded element of labor pension is mandatory and rests on individual accumulation accounts with defined contributions (DC). To calculate funded pension at the date of retirement, individual accumulations are divided by the expected duration of pension payment. At this stage, the funded element of labor pension is subject to indexation in accordance with the pension fund investment returns.

The PAYGO element of labor pension comprises: (1) flat basic pension and (2) notional defined contributions (NDC) pension, which is based on individual notional accounts.

Under the law, the basic element of labor pension is indexed to the rate of inflation of retail prices. The rate of indexation may also be higher so as to gradually bring up basic pension to a pensioner’s subsistence minimum.

For the persons who entered employment before January 1, 2002, “starting” notional pension capital is calculated, which increases thanks to the subsequent contributions and indexation. To calculate NDC pension size at the date of retirement, notional capital is divided by the expected duration of labor pension payment at the date of pension assignment. At the stage of pension payment, the notional funded part of labor pension is subject to indexation. The current law sets the same indexation rate for both notional accumulations and NDC pension (at the stage of pension payment). The rate of indexation is determined by the index of the growth of per person RF Pension Fund revenues (contributions for the NDC pension).

The current legislation also envisages a minimal guaranteed size of PAYGO (basic plus NDC) pension expressed in nominal monetary units, and does not contain instructions regarding the indexation of this element.

The basic part of pension is financed from the social tax, and the NDC and funded elements, from the insurance contribution. The latter is, in turn, divided into the NDC and the funded parts. For most contributors, the tax rate for the basic pension element is 14% of the wage, and the rate of insurance contribution (to the NDC and funded elements) is equal to the rate of the contribution for the basic pension element. The subdivision of contributions into the NDC and the funded parts depends on the year of the insured person’s birth; for the persons born in 1967 and after, the contribution for the notional funded and funded parts of the pension are 8% and 6% respectively.

Let us also note that the Russian Federation has a regressive social tax scale, that is, these tax/contribution rates are charged only on the first 100,000 rubles of annual income, eventually to decrease and cease altogether as the annual income exceeds 600,000 rubles.

            Comparing Russia’s pension system with the reformed pension systems of some other countries, one sees that notional accounts have recently become one of the main pension reform instruments[2] used in Sweden, Italy, Poland, and Latvia, to name but a few states, although there is an ongoing debate between the advocates of such accounts, who view them as the last word in public pension provision[3], and their critics, who believe that the NDCs have no advantage of principle over a well-organized PAYGO systems with defined benefits[4]. However, supplementing an NDC pension with a flat basic pension appears unnecessarily complicated. What is more, it defeats one of the main purposes of the introduction of notional accounts, i.e., to tie up the contributions with the benefits so as to reduce the risk of evasion of pension contributions. In the situation when basic pension is financed from a wage tax, which equals the sum of the contributions for the NDC and the funded elements, it would be pointless to talk about promoting participation in the pension system. The coexistence of basic pension and a minimal guarantee is not very logical, since the purpose of flat basic pension is, as a rule, precisely to provide minimal guarantees. It would also be more logical to set a minimal guarantee for total summary pension, as was done, for example, in Poland[5]. In Sweden, where, like Russia, the guarantee extends only to the PAYGO part of the pension[6], the funded element is relatively small: the contributions to this part are only 2.5% of the wage, while those to the NDC part reach 16%.