Mbeki's proposed state pension scheme - potentially fraught with complexities

President Mbeki proposed a new compulsory state pension scheme for SA in his recent state of the nation address. "From a global perspective, compulsory state pension schemes have had mixed success," says Gerald Seegers, tax expert at Pricewaterhouse Coopers.

"The best of them provide a substantial financial safety net for retirees," says Seegers. "The worst of them suffer from inefficient administration, unwise investment decisions and corruption. They consume and squander a large proportion of the collected revenue and provide meagre benefits to recipients."

State retirement and benefit schemes are desirable in theory, but there are many practical difficulties in their establishment and management. Seegers points out particular problems in countries where formal unemployment is high. "The scheme comes under great strain. The unemployed have to be included as beneficiaries even though they do not contribute. Also, those with substantial earnings in the informal economy get an undeserved benefit from the scheme without having to contribute any of their undeclared income."

Practically, the only way to achieve a functioning state pension scheme is to legislate compulsory contributions for every employee as well as for the self-employed. But Seegers says these compulsory schemes are often fraught with difficulties.

"Firstly, any contributory scheme reduces the contributors' take home pay. This hurts already cash-strapped low-paid workers, and gives rise to resistance and evasion."

He also identifies the uneasy co-existence between compulsory state schemes and private pension plans as problematic "There is usually cross-subsidisation in a state scheme where high-earners have to subsidise the low, or even zero, contributions from the poor and the unemployed. The top earners would then far rather contribute to private pension funds and not be part of the state system. The only way to bring them into the state scheme is to make contributions to the state plan compulsory (with some tax relief) and to allow private plans to offer top-up benefits (with little or no tax relief)."

Another problem is funding the benefits of a state social security scheme in its early years. A large number of people immediately qualify for benefits, but very little has been able to accumulate in the payout kitty. Inevitably, the state funds this initial shortfall, but must then find ways of recovering it from the taxpaying populace.

Seegers says that a state scheme has to be, in essence, a defined benefit plan, in which all members get at least a guaranteed minimum end-benefit, irrespective of the amount of their contributions over the years. This helps contributors who are not fully employed over their working lives or who suffer disabling illness or injury before retirement. However, substantial cross-subsidisation within the scheme is unavoidable, and affluent contributors, with some justification, view the scheme as just another tax in which they get out less than they put in.

Government's intention seems to be that the state pension scheme will be one component of a broader comprehensive social security plan, and if at any time there is a surplus in, say, the unemployment insurance fund, that surplus will be made available to fill a deficit in another aspect of the social security plan. Seegers warns that this cross-subsidisation between different funds will make for even greater complexity and uncertainty and could create competition for funds between various components of the overall state plan.

Seegers says part of the compliance burden of a compulsory state pension scheme will fall on already overloaded employers. "And the administrative burden on the state will be massive. This includes making payments to recipients, checking to see whether they genuinely qualify for benefits, verifying that the recipient is indeed who he claims to be, and ensuring that payments are discontinued when the individual dies. Ideally, workers should save comprehensively for their own retirement rather than become dependent on state hand-outs in their old age."