Pension Funds and Wealth Inequality

Pension funds are encouraged by governments all over the world. This is because there is a common belief that pension funds provide social justice along with economic benefits. Governments all over the world have stated on record that the benefits of pension funds accrue equally to people from all strata of society. Hence, it can be inferred that pension funds actually lead to wealth equality i.e. equitable distribution of wealth in the society.

However, many studies have shown that this is not the case. There are several economic experts who have been claiming that pension funds increase the wealth inequality present in society. They have provided several arguments to support their claim. Some of these arguments have been listed below:

  1. Wealthier People Have a Higher Life Expectancy: The end result of most pension products is an annuity plan. Both the defined benefit plan and the defined contribution plan provide a monthly income to people for as long as they and their spouses can survive.

    Now, studies have shown that socio-economic indicators are a very important parameter as far as survival rates are concerned. Time and again, it has been proven that people who rank higher on the socio-economic scale are able to live for a longer period of time. This can be attributed to several factors.

    People with higher incomes tend to spend more on preventive health check-ups. Hence, they can detect chronic diseases early and avoid them. At the same time, they also tend to have more financial resources to treat the disease if they are affected by one.

    Now, since wealthier people live longer than the average population, it inevitably means that they will connect more pensions over the longer run. Hence, pension funds end up being a type of fund where everyone contributes an equal amount but the rich end up getting more benefits. In essence, it is a transfer of wealth from the economically weaker section of society to the economically stronger section. Hence, the pension system can be said to be a regressive system that exacerbates income inequality.

  2. Higher Tax Acts as a Bigger Incentive: The amount of money that people have during their retirement is directly linked to the amount of money that they have in their pension funds.

    Rich people generally tend to contribute more to the pension fund during their working years. Hence, it should come as no surprise that they end up receiving more benefits from pension funds. It needs to be understood that their decision to contribute more is not based on their personal opinion only. Governments all over the world provide some tax incentives to people who invest in their pensions.

    Since the rich are taxed at a higher rate, they have a greater incentive to contribute to the pension fund. Hence, in a way, the government is encouraging increased inequality in the future by providing tax benefits. Many governments have realized this and as a result, have capped the maximum amount of money that can be contributed tax-free to a pension fund. This cap has been set in such a way that the tax advantage that the rich have gets nullified.

  3. Gender Difference: Pension funds not only lead to income inequality between the rich and the poor, but they also lead to income inequality between the genders. Several studies have shown that women have a significantly lesser amount of money held in pensions as compared to men. This can be attributed to the fact that child-rearing is still primarily considered to be a woman’s responsibility. Hence, women tend to stay out of the workforce when they raise a child.

    Now, since women do not contribute to their pensions when they are on sabbatical, they contribute a lesser amount of money, and also their money does not compound for as long. The end result is that women have lesser money in their retirement as compared to men even if they have earned similar incomes during their working life.

  4. Formal Jobs vs Informal Jobs: It is a known fact that wealthier people tend to work in more organized workplaces. This means that they tend to work with well-established companies and hold formal white-collar jobs. On the other hand, people who are not wealthy tend to work in blue collared informal jobs. They may not have a stable employer. Instead, they may be working as a contractor. Hence, a lot of the time, they may not have access to pension funds.

    A lot of the people from the poor class may not even be aware of the existence of a pension fund or the benefits that they provide. This can be considered to be one of the reasons that pension funds can lead to increased inequality.

  5. Defined Benefit vs. Defined Contribution Plans: Till the past couple of decades, all pension funds were defined benefit plans. This has now been changed and almost all pension plans now follow the defined contribution mechanism.

    It needs to be understood that the final amount of pension paid by defined contribution plans tends to be lesser as compared to defined benefit plans. Hence, the difference between the two types of pension plans has created intergenerational income inequality. People from different generations are enjoying different levels of economic benefits even though they contributed the same amount to their retirement corpus.

The bottom line is that pension funds do inadvertently end up creating wealth inequality-related issues. Governments should address some of these problems by reforming the pension fund system.

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The article is Written By “Prachi Juneja” and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to and the content page url.