Question 1. What was the pension system like in Armenia prior to the reforms?
Armenia’s pension security system was characterized as PAYG (pay-as-you-go) pension system financed on the principle of solidarity of generations. This means that pensions are financed only from the current income of the RA State budget, gained from taxes and social contributions. In other words, the employed generation provides the older generation with dignified pensions.
The system actually performs distributive function; the payments made by employees, employers and individual entrepreneurs are paid to the State budget of the Republic of Armenia, of which the pension payments are made (by the order defined by the law).
Employment pension and social pension are paid within the frames of the RA pension system (taking into consideration the essence of pension starting from January 1st, 2014 social pensions have been turned into social benefits).
The pension amount is calculated based on the basic pension amount, the number of years in service and the compensation amount for each ensured service year, as well as pensioner’s personal coefficient (the latter is also calculated based on the number of eligible years of service).
The pension system of any country has to solve one problem; to ensure adequate living standards by providing respective amount of pensions for their pensioners.
Having outlined the main issues of the current pension system (see Question 3) we have to state that the situation resulted from the socio-economic realities in our country for the last 20 years, in this regard, is far from being satisfactory. Although the pension funding is considered to be the largest expenditure program of the RA Sate budget, and the RA Government continuously increases these expenditures on social security, pensions are still low and don’t perform their basic function.
At the same time all sorts of predictions and analyses show that even in case of the most optimistic scenarios of economic development, the current pension system will have no possibility to provide population with dignified retirement.
Question 2. What is the pension system like in Armenia after the reforms?
The implementation of pension reforms in the Republic of Armenia aim sto introduce multi pillar pension system; i.e. in addition to PAYG pension system financed on the principle of solidarity of generations, 2 new: voluntary and mandatory funded pension options have been introduced.
The reformed pension system of the Republic of Armenia incorporates 4 components.
Social pension (benefit) will be granted to individuals who have reached the age of 65 but do not have the minimum eligible number of years in service, or have been recognized disabled or a survivor. This component aims to overcome poverty. Social pensions (benefits) are funded by the State budget. Individuals who have no eligible number of years in service but are funded pillar participants will be granted social pensions (benefits), too.
Employment pension will be granted to individuals who have the minimum eligible number of years in service and have reached the age of 63, or have been recognized disabled or a survivor. Employment pensions are also funded by the State budget. Funded pillar participants who have the minimum eligible number of years in service will be granted employment pensions, too.
Pillar 0 and pillar 1 will compose the State pension component of the pension security system of the Republic of Armenia.
Pillar 2 or Funded Pension:
This component will provide pensions to funded pension participants; i.e. individuals who make targeted social contributions either on mandatory or voluntary principle). Funded pensions are provided from social contributions and return on their investment.
Pillar 3 or Voluntary funded Pension:
This component will ensure the payment of voluntary funded pensions. Voluntary funded pensions are provided from voluntary contributions and return on their investment.
Thus, as a result of pension reform, in addition to the existing PAYG system we shall have other pension funding sources as well, which are gained respectively from personal contributions. To state the obvious, the funded pillar comes to replenish the existing pension system and never instead of it. With the help of Pillar 0 and Pillar 1 the State maintains social responsibility towards its citizens.
Question 3: Why was it necessary to reform the pension system?
The need to reform the existing pension security system of the Republic of Armenia is attributed to a number of issues (see Q. 1, System Overview), some of which are noteworthy. Here they are:
First of all, the present system lacks the link of a person’s income and the amount of future pension. As a result, now we face a situation where a highly qualified individual who has got high salary throughout his life receives as much pension as the one who has always got minimum salary, and that is not fair.
Financial stability of the system is another issue. Worldwide, the pension systems financed on the principle of solidarity of generations are considered sustainable if the ratio of employee to pensioner is 3 to 1; i.e. three employees make social contributions, of which pension is paid to one pensioner. Yet, in Armenia this ratio is 1 to 1; i.e. one employee makes social contributions, of which another one gets his pension. It is evident that in this case radical changes have to be made in order to save the situation.
Another important problem leading to pension reform implementation are the tendencies to demographic situation development.
In particular, today we come across a situation where the majority of population are pensioners, and the number of individuals reaching the working age is gradually decreasing; in other words we are facing “aging population”.
Whereas, PAYG (State) pension systems are vulnerable towards aging population.
Nowadays, the problem is much more urgent as in the coming years the offspring of 1950’s (the birth rate being rather high at that time) is hitting the retirement age. Instead, the young generation of 1990’s (years, notorious for low birth rate) is entering the labor market.
Therefore, in the years ahead a small group of young people will have to provide the large number of elderly retirees with an appropriate level of pension.
Question 4: What’s the aim of the pension reform and what results to expect?
The pension system of any country has to solve one problem; to ensure its pensioners an appropriate level of living standards. In this regard, the pension reform is aimed at providing dignified retirement.
It should be noted that in the international experience the main indicator of pension system efficiency is the ratio of a person’s salary and his pension amount (this indicator is also called compensation coefficient). Accordingly, the system is considered efficient in case the monthly pension amount comprises at least 40-45 % of a person’s salary ( meanwhile, the system should be financially sustainable).
It must be pointed out that in the Republic of Armenia that coefficient is 25 % on average; i.e. the average monthly employment pension (nearly 36000 AMD) comprises 25 % of the average monthly salary. By the way, taking into account the form of pension calculation, this indicator is inversely proportional to a person’s income (the higher the income, the lower the coefficient).
Taking into consideration the above-mentioned issues, the targeted aims of the pension reform (particularly, of the funded pillar implementation) are as follows:
1. ensure direct link between a person’s income and the amount of his future pension,
2. bring the compensation coefficient at least to 40-45% (e.g. including the pensions paid from the State budget, the amount of pension for an employee who gets 200000 AMD should comprise nearly 90000 AMD, and respectively in case of the salary of 300000 AMD pension amount should be nearly 135000 AMD),
3. reduce the influence of demographic situation development tendencies on pension system and ensure pension system’s financial sustainability in the long term future.
In the meantime, as the international practice shows pension reform implementation (particularly, funded pillar introduction) is a major impulse for the economic growth.
In particular, in the process of forming national savings countries, as a result, no longer depend on foreign investments, and investments made through mandatory pension funds only benefit for new workplaces to be open.
Consequently, the financial market goes on developing rapidly, high-paying jobs are created.
Question 5: What approaches exist in the pension reform implementation?
There are two approaches to the pension reform realization which are accepted in the international practice:
Parametric reforms; according to this approach situational changes are made in the pension system, i.e. they conduct a review of pension eligibility (age, years in service, etc.), the form of pension amount calculation and the like.
Systemic reforms: this type of reform assumes a review of the pension system principles (funding mechanisms).
It should be noted that pension reform programs are continuously implemented in many countries of the world. It is due to the fact that those countries also face the problems of aging population.
By the way, these very countries choose different ways to solve the problem; priority is given either to parametric reforms of pension system (increase in tax burden, increase of retirement age and a reduction of pension rights) or radical changes of pension system; funding mechanisms of pension security system are reviewed, and self-financed (accumulative) component is introduced.
Moreover, various experimental analyses show that parametric reforms meant to meet the current challenges are situational by nature and do not provide long-term and sustainable solution to the problem.
Question 6: How long did it take to develop the Armenian model of pension system before it entered into force?
Pension reform program has been high on the agenda since Armenia regained independence. The proof is that during the years of independence before the current pension reforms launched the RA pension legislation has been changed for three times; in 1992, 1996 and 2003, respectively (it is not about the changes of current law, but about adopting completely new law).
All the above-mentioned changes have proved parametric (situational) and have been designed for the pension system to match the new socioeconomic realities. And since 2004 the spotlight of the pension system discussion has been the introduction of a new funded pillar in Armenia.
Large analytical and research studies have been carried out to understand the funded pillar advantages and risks: particularly, the specialists and responsible employees of the RA Ministry of Labor and Social Affairs, RA Ministry of Finance, RA Central Bank, RA Ministry of State Revenues with the support of international counter partners have studied the practice of Russia, Sweden, Estonia, Macedonia, Chile, Peru, Kazakhstan, Poland, Croatia, Bulgaria and other countries.
As a result of four-year in-depth analytical and research studies, the RA Government with the decision № 1487-N made on 13 November, 2008 stated the pension reforms program and the agenda of pension reform implementation events, on the basis of which the five legal bills of multi pillar pension system have been developed.
On December 22, 2010 these laws were adopted by the RA National Assembly and entered into force on January 1st, 2011.
Question 7: The practice of which countries has been used to develop the Armenian pension system?
Before making a final decision on the reformed Armenian pension system, the policy makers have studied the international experience of pension policy of the last decades, have drawn comparisons, considered the challenges of the countries (like Chile, Bolivia, Uruguay, Mexico, Peru, Argentina, Columbia, Costa Rica in Latin America and Poland, Hungary, Romania, Bulgaria, Estonia, Croatia, Macedonia, Sweden in Eastern and Central Europe) which have undergone similar pension reforms. What is essential; they have also considered their practice of how to meet these challenges, manage and reduce possible risks of the system.
Question 8: Have the current pensioner’s pension calculation formula and payment form been changed as a result of the pension reform or not?
Yes. Starting from January 1st, 2014 the pension calculation form has been changed as a result of pension reforms. In particular, the differentiated compensation amount for each ensured service year has been introduced.
Question 9: What kind of changes have been made in the tax legislation in connection with pension reforms?
The pension reform also requires changes in the tax legislation. Starting from January 1st, 2013 instead of income tax and mandatory social security payment one combined income tax has been introduced. Income tax rate for gross salary and other income is as follows:
in case of getting up to 120 000 AMD monthly income 24.4% of the taxable income
in case of getting from 120 000 AMD to 2 000 000 AMD monthly income 29 280 AMD plus 26% of the amount exceeding 120 000 AMD
in case of getting more than 2 000 000 AMD monthly income 518 080 AMD plus 36% of the amount exceeding 2 000 000 AMD
Individual entrepreneurs and notaries should calculate the income tax at the following rates:
in case of getting up to 1 440 000 AMD annual income 24.4% of the taxable income
in case of getting more than 1 440 000 AMD annual income 351 360 AMD plus 26% of the amount exceeding 1 440 000 AMD
At the same time the introduction of the voluntary funded pillar set certain tax franchises.
According to the RA Law “On Income Tax”, the funded payments made by the taxpayer for himself/herself and/or by a third party (including the employer) under the voluntary funded pension scheme at the rate not exceeding 5% of taxable income of the taxpayer are considered deductible income.
And pursuant to the RA Law “On Withholding Tax”, the voluntary funded pension insurance payments made by the employer for the employee on the part of the employee’s labor remuneration and other payments not exceeding 5% are considered expenditure (it is reduced from withholding base), and on determining the taxable income, the gross income is deducted for each employee of the taxpayer up to 50% of the voluntary funded payments of the taxpayer but not more than 2.5% of the employee’s labor remuneration and other payments.
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