The future of pensions: Paying procedure versus capital coverage

In Germany, financing pensions is a topic of great importance that affects many people and leads to discussions again and again. The system is based on a specific principle where the current generation bears the pensions of the older generation. This principle is referred to as a pay-as-you-go method and has long formed the basis for social security in old age.It is important to understand the functioning of this system in order to recognize the advantages and disadvantages associated with it and to understand the differences to alternative methods of old-age provision. This is a complex network of economic, social and political considerations that have a strong influence on the future of pensions.

The pay-as-you-go method: how it works

In the case of the pay-as-you-go method, the contributions that the current worker makes are used directly for the pensions of the current pensioners. This means that the money that is being deposited today is paid out immediately without saving it on your own account. For pensioners, this is a secure form of supply because they can rely on the current payments.The current generation of employed persons bears the burden for the older generations, and in return they expect a pension later, which is financed from the contributions of the following generations. This system is based on a social contract based on mutual trust that the next generation also takes care of the previous one.

Capital coverage as an alternative

In contrast to this is the so-called capital coverage procedure, in which everyone makes provisions for themselves. This saves money that belongs exclusively to the respective saver. It is usually invested in the form of private pension products, stocks or funds. At first glance, this model sounds tempting because it gives individuals control over their own future. itHowever, it is a mistake when you consider that high interest rates are only possible against a correspondingly high risk. Especially with old-age provision, you should avoid risks as far as possible because you want to be covered in old age and cannot take into account any losses. The current situation shows that the yields in a safe, low-risk investment are significantly lower than the often propagatedHigh interest rates that can only be achieved with a higher risk.

Comparison of yields in the pay-as-you-go and capital procedure

If you look at the returns that are achieved in the allocation procedure, you only get a small amount of interest, which is usually just over three percent. That doesn’t sound very good at first glance, but if all people were to be prepared individually, they would have to bring their savings to the capital market. These would then reduce interest rates because the capital supply is increasing. From thisThe reason for this is not directly comparable to the two interest rates that are achieved in the pay-as-you-go system and in private provision. The pay-as-you-go method also offers services that are only available for private pensions at an additional cost, such as rehabilitation measures or surviving dependents. These services are included free of charge for the users of the pay-as-you-go system,Private supplementary insurances must cover these benefits, which reduces the return. It turns out that the pay-as-you-go system offers a certain social security that can hardly be achieved privately.

The economic perspective

From an economic point of view, self-protection is ultimately a form of pay-as-you-go. Because the pensions must always be generated by the work of the active population. It is impossible to live on capital saved alone, because it is not a “dead capital” that can exist without ongoing work. The capital coverage procedure only appears as a better alternative,If all the burdens could be spread on the shoulders of the community and some lucky people opt out to gain benefits. In reality, this primarily affects civil servants and the self-employed who often receive better conditions for old-age provision due to special regulations. If only the capital coverage procedure was left, the average return would beBe about the same as in the pay-as-you-go method, but distributed in a different way. Some people are smarter and put money better, others are lucky, others fall for scammers and lose everything. Therefore, the pay-as-you-go method is fairer because it excludes random results and treats everyone equally.

Comparison of actual returns

In practice, experience shows that the return on the pay-as-you-go system is even higher than in the capital coverage process. This is because the statutory pension insurance only incurs comparatively low administrative costs, which is around four percent. In the case of private pension products, the administrative costs are significantly higher because here also advertising, commissions for representativesand profits for insurance companies must be paid. These additional costs add up to over fifteen percent of the contributions that diminish the saver. This means that the actual return that benefits savers is significantly lower in the private sector than in the pay-as-you-go system. The social consensus that the statutory pension is secure is based onthese experiences and the low costs.

The security of the pay-as-you-go pension

The long-standing and undisputed proof of the security of the pay-as-you-go pension comes from well-known political figures who emphasize that this form of old-age provision is stable. The statement that the statutory pension is safe is correct as long as the framework conditions remain stable. In contrast, the funded pension is exposed to considerable risks. itThere is a risk that you will be in the retirement phase when you are dependent on income and the economic crisis or a crisis on the financial markets will minimize the values of stocks and real estate. These uncertainties make it clear why the statutory pension, on a solid allocation basis, provides better security for the broadpopulation represents. Without stable financing, old-age provision remains endangered and it is important that the statutory pension remains at a reasonable level in order to secure social security.