19.10.2009
 
A new study by the Bank of Israel:
The Effect of Pension Arrangements in Israel on Income Distribution
 
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  The amount of government support for retirement savings in Israel is similar at all income levels: among low-income earners the value of National Insurance old-age-allowances (including the means-tested component) is much larger than their capitalized lifetime contributions, while high-income earners enjoy tax benefits for their pension savings.
  Pension savings at the rates set in the mandatory pension arrangement would impose a financial loss on low-income households compared to the pre-compulsory pension period. This loss is due to the offset of the pension with the means-tested national insurance allowance.
  Mandatory pensions unsmooth the consumption patterns of low-income households: it reduces their income in periods when their per capita income is lowest in return for larger benefits when incomes are already relatively high.
  Households' behavior in the pre-compulsory pension period was in line with the incentives embodied in the tax and national insurance systems.
  Households are not passive with respect to the decision whether to save for retirement or not: a significant share of the public adapted its pension choices to changes in incentives during the last decade.
   
A study by Adi Brender* from the Research Department at the Bank of Israel examined the effects of benefits for retirement-age savings in Israel on lifetime income distribution and how it would be affected by the compulsory pension arrangement introduced in Israel in 2008. The study examined ten types of household representing the common family structures in Israel and their employment and income patterns, and analyzed the effects of the national insurance system and of the pension savings tax benefits on their lifetime income. The analysis shows that for low-income households the value of national insurance allowances (including the means-tested component) is much larger than the capitalized value of their contributions during their working years. This gap narrows as incomes rise, and at the top two deciles of the lifetime income distribution the contributions are higher than the allowances. In contrast, low-income earners hardly enjoy any pension tax benefits during their working years, since many of these employees never reach the income-tax threshold during their working lives, while high-income earners benefit from large tax incentives that increase with their income. The income-tax and national insurance retirement-age benefits together provide similar total lifetime public support for most households.
The study also examined the financial benefits deriving from pension savings. While high-income households enjoy a clear benefit due to the tax advantages, those with low lifetime incomes (about 25–30 percent of all households) hardly receive any tax breaks but lose part––or all––of their means-tested national insurance income supplement. Accordingly, pension savings at the mandatory rates set recently would impose a financial loss on low-income households during the course of their lives. It was also found that, in the current old-age-allowances system, the level of disposable retirement-age income (net of taxes, national insurance charges and pension contributions) of employees from the weakest groups who save at the mandatory rates is expected to be much higher than their pre-retirement disposable income. Moreover, the obligation to save for pension implies that workers from these groups will have to give up income in the period when they are raising children (and perhaps also paying a mortgage), and hence per capita incomes are low, sometimes even below the poverty line, in return for a particularly high retirement-age income.
The Israeli public's behavior in recent years indicates that decisions regarding pension savings were quite consistent with the incentives embodied in the system, and that substantial parts of the public adjusted their decision on whether to save or not to the structural changes in the system. In particular, a high positive correlation was found between income and the decision to contribute to a pension fund (Figure 1), and employment of the spouse and his/her pension savings were also found to substantially raise the tendency of an employee to save in a pension account. It was also found that the tendency to save declines when employees have young children, and that the share of savers is lower among Arabs and among immigrants who arrived in Israel aged more than 40. Another finding is that between the years 2000 and 2007 the share of contributors to pension schemes among low-income earners fell sharply, including among those who contributed in the year 2000. This shift is consistent with the change in incentives due to the almost full elimination of pension subsidization through special government bonds and various public guarantees.
The analysis suggests that the mandatory pension arrangement may hurt large sectors of the population, especially among its weakest segments. Due to the significant and long-term effects of these arrangements, it would be desirable to adjust the current system on the basis of an integrated examination of pension benefits and national insurance allowances, focusing on making the mandatory pension arrangement more flexible and reallocating the budgetary resources that support retirement-age savings.
 
 
* The views expressed in the paper are those of the authors, and do not necessarily reflect of the Bank of Israel.