How Do Individual Accounts Work in the Swedish Pension System?

Introduction

Many countries are discussing how to reform their pension systems in order to meet the demands of an aging society. A trend in these reform discussions is to introduce individual accounts as part of both public and occupational schemes. Sweden was an early mover in this process. In 1998, Sweden introduced a second tier of mandatory individual accounts — the Premium Pension — in the public system. The individual account component in the public pension system was designed as a “carve-out” and constitutes a relatively small portion of the new system. The contribution rate to the overall system is 18.5 percent: 16 percent is paid to the first tier, which is financed on a pay-as-you-go basis and pays a benefit determined by a worker’s lifetime earnings, while 2.5 percent is credited to a funded individual account. In addition, a means-tested guarantee benefit provides a minimum pension for workers with low earnings. The individual accounts are self-directed and participants can invest in a broad array of domestic and international funds. For individuals who do not wish to make an active investment decision, the government has established a default fund. The first investment elections in the Premium Pension plan took place in the fall of 2000 when all Swedes born after 1938 were able to choose how to invest their contributions from a menu of about 500 mutual funds. This brief evaluates the Swedish experience with individual accounts to date and discusses the lessons that can be learned from the first four years…