A Note on the Use of Estate Taxes and Payout Restrictions to Fund Multi-Pillar Pension Guarantees

Abstract

This paper considers the use of an inheritance tax and payout restrictions to fund guarantees on a multi-pillar pension plan. A simulation model for a guaranteed multi-pillar benefit based on a pension plan similar to the old Chilean pension system reveals that the delivery of an economically viable guaranteed benefit requires strict control of disability benefits and significant inter-cohort transfers. Asset transfers from cohorts receiving high returns on their DC plans can be realized by controlling DC plan payouts and by taxing excess funds in the DC plan upon death of the plan’s member and spouse. Benefits guarantees do create an incentive for workers to invest in risky assets. However, this moral hazard might not be detrimental to the Defined Benefit (DB) component of the multi-pillar plan because historically risky assets have realized higher returns and under the plan considered here the DB component of the multi-pillar plan benefits when returns are high.