The Financing of Pensions
Statutory earnings-related pension in Finland is mainly financed through the pay-as-you-go system, in other words through the earnings-related pension contributions from each year. Some pensions are financed according to the principle of partial funding, by utilizing both earnings-related pension expenditure and previously collected funds.
The assets needed for pension payment are primarily collected from the insurance contributions paid by employers and employees as well as the self-employed. In addition to earnings-related pension assets and related investment profit, payments transferred from the unemployment insurance system to the earnings-related pension system are also used in the financing, as well as state shares.
In time, the earnings-related pension is granted and paid by the pension provider with whom the employee was last insured prior to retiring. The pension may be consolidated with several different pension providers, if the insured has worked for many different employers in the course of his or her career.
The pension provider who ends up paying the pension charges the other pension providers for any possible outstanding pension shares, through the system for division of costs managed by the Finnish Centre for Pensions.
The State is responsible for the national pension costs.
- The Social Insurance Institution of Finland
- Division of Costs in Graphs and Figures, SlideShare
- Division of Costs in Graphs and Figures, slideshow (pptx 1.7 Kb)
The pay-as-you-go system and partial funding
The earnings-related pensions of the public sector are financed based on the principles of the pay-as-you-go system, with support from buffer funds specific to certain legislative acts. The pensions of the self-employed and farming entrepreneurs are paid for with the insurance contributions and state shares of each year.
The private-sector old-age, disability and unemployment pensions, among others, are financed according to the principle of partial funding. Earnings-related pension providers fund a certain part of each employee’s wages per type of pension.
Methods of financing earnings-related pension from the perspective of different generations
In the pay-as-you-go system, it is mainly the working population that pays for the benefits of the retired population. Each generation thus receives funding for their pensions from the younger generation. The working population must be large enough in order for the pensions of previous generations to be paid. Employment, and the age structure of the population, each have a crucial effect on the functionality of the system.
In Finland, the share of pensioners is constantly growing, and time spent in old-age retirement is increasing. There are fewer people working than before, and thus fewer people paying the pensions. Going forward, the pensions of younger generations will be affected by the life expectancy coefficient, tied to life expectancies. The coefficient lowers the pension unless the effect is balanced by working longer.
Partial funding eases the level of future pension contributions, since funded assets and related long-term investment profit can be utilized in the payment of later pensions and the maintenance of the system. Partial funding thus serves to uphold the pension promises made. If our earnings-related pension system was fully funded, each generation would pay their own pensions.