The minimum pension as an instrument of poverty protection in the defined contribution pension system – an example of Poland*

Abstract

AbstractPension systems' reforms are often related to a shift towards (fully or partially) defined contribution (DC) systems, in which the pension distribution reflects to a larger extent the wage distribution. In addition, relatively shorter working lives of those who have lower earnings increase the risk of receiving lower benefits. The aim of the paper is to present the changing role of a minimum pension as a tool of redistribution in the country that replaced a defined benefit (DB) pension system with a DC pension system. The old system in Poland had a significant income redistribution in the pension formula and the minimum pension was only a tool supporting this redistribution. After the introduction of the new mandatory pension system the main mechanism of redistribution (and a tool of social policy preventing poverty) is the minimum pension, financed from general taxes. According to the current rule of indexation, the minimum pension is expected to fall relative to the average wage in the economy. According to our simulations, the lack of changes of the current indexation method means that the minimum pension will fall below the International Labour Organisation (ILO) standard of the poverty protection of elderly by mid 2020s and in practice the last instrument of the poverty protection of elderly is going to disappear. However, the sole decision to change the indexation mechanism to the one based on full wage can create a significant pressure on public finance and distort incentives for prolonging work as 45% of women would be probably covered by the minimum pension guarantee (MPG). Results of simulations show that a raise and equalization of the retirement age for men and women combined with keeping a constant ratio of the minimum pension to the average (and also minimum) wage in the economy can be considered as a balanced solution that assures no further reduction of poverty protection and effective maintaining of this redistribution instrument.