If Washington is looking for a solution to the long-term financial challenges facing Social Security, it my try looking overseas, to, say … Kazakhstan.
The formerly Soviet satellite country had a pay-as-you-go system, but after it gained its independence the country switched to a fully funded pension system with the adoption of the Pension Act in 1997.
Under the current system, workers contribute 10 percent of their monthly income to an individual retirement account. Today Kazakhstan, with its 16 million citizens, has 13 operating pension funds; only one is a state owned and the rest are private.
The government regulates the activities of the pension funds, which helps minimize the investment risks. Indeed, if the pension fund bears a certain financial losses, it must make up that loss from its own resources. In other words, workers cannot lose money.
And if a retiree exhausts his account, the government will provide additional assistance for the rest of his or her life.
The pension funds can manage the investments and develop the main investment strategy, or partner with a management company. But they limit their risk exposure and so most of the funds provide similar returns over the long term.
If depositors are not satisfied with the results of their fund—for example, its income level—then they have the right to take their pension assets to another fund where, in their view, there are more optimal opportunities for growth.
The funded pension system in Kazakhstan covers more than 9 million people. By January 2011, their pension funds amounted to about $ 16 billion.
Of course, the country had to continue meeting the needs of current retirees when it switched to a fully funded plan, just as the U.S. will have to do if it adopts a similar system. But those obligations will be paid off in a generation, which means the government is slowly eliminating its long-term unfunded liabilities.
Kazakhstan is not unique in that several formerly soviet countries switched to fully funded private pension plans upon leaving the Soviet Union. They learned their lesson the hard way and decided to reform the right way. Will Washington do the same?
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This TaxByte was prepared by Talgat B. Yerzhanov, a research fellow at the Kazakhstan Institute for Strategic Studies and IPI resident scholar Merrill Matthews.