Payback Time

As Russia begins to implement a pension reform plan that has been in the works for two years, seniors and working people take stock of Russia’s retirement system.

As a well-known astronomer, Vitaly Bronstein has authored a dozen books and over a hundred articles. He retired over two decades ago, when Russia was still part of the Soviet Union. Yet Bronstein is still working at 85 – he has just sent yet another article in for publication and is reviewing a book written by a colleague from Ukraine.

For Bronstein, this work is more of a hobby (or maybe a habit), than a way of making a living. Scientific journals pay kopeks, if they pay anything at all. And he certainly cannot live on his pension: the postman brings just 1100 rubles ($38) a month, which Bronstein mostly spends on postage, to underwrite his frequent correspondence with universities around the world.

Fortunately, Bronstein has a daughter, Alyona, whom he moved in with after his wife died. Alyona and her husband make enough money to feed themselves, her father, and their sixteen-year-old daughter. But next year their daughter will apply to enter the university, which means the extra expense of tutors, so the family has to be thrifty.

“I myself reach retirement age in six years,” Alyona said. “We haven’t managed to save anything, and living on a state pension is impossible. I’ll just have to keep working.”

Alyona’s son-in-law, 33-year-old journalist Maxim Kamensky, has his own question: “Listen, I got this letter from the pension fund. Maybe you can tell me what it is all about and what I should do?”

This question dogged me all autumn, from all quarters. The letter in question was part of a large-scale campaign by the Pension Fund of Russia (PFR) – the state body responsible for providing pensions throughout the country. It is the culmination of a two year process of pension reform begun in 2002.

Russia’s pension reform came at the barrel of a demographic gun. Like many developed countries, Russia has a rapidly aging population, accompanied by precipitously declining birth rates. The result: a growing number of pensioners must be supported by a declining pool of workers. Yet, despite the gravity of this situation, the reforms in the works are far from revolutionary.

Different age groups will feel the impacts of reform differently. Today’s pensioners, for example, have not been affected by the reform in any way and will not feel its impact in the future. The innovations will only have an impact on men born after 1953 and women born after 1958. For these Russians, pensions will consist of three parts. First is the basic pension guaranteed by the state, which is the same for everyone, without exception. It will provide for minimal living standards and will be paid no matter the length of an individual’s working life, the size of their salary or other life circumstances. Second is the insurance part, which will take into consideration the length of one’s working life and income levels.

These first two aspects of the pension system are unchanged from what is currently in place. As always, deductions from current worker’s paychecks fund monthly allotments to pensioners.

The crux of the current pension reform is in the third, accumulative part of future pension. With time, this portion of the pension funds could become the largest part of the three (at least for those who work long enough and receive an official salary high enough to live on). This accumulative part of pensions began accumulating on individual Pension Fund accounts of workers in the beginning of 2002.

At the moment, just 7-10% of workers’ pension deductions are put into these individual accounts. In 2006, the first group of future pensioners will start having the maximum amount – just over 20% – diverted to the accumulative part of their pensions. The remaining 75-80% will remain in the current pension system, whereby pensioners live at the expense of the working, and pension levels are based on the situation in international markets, on how close elections are, or simply on the whims of the Powers That Be.

In July 2003, the PFR started sending account holders information about the balance that had accumulated in the third part of their pension accounts. Citizens could make a rough estimate of how much money should be in their account without looking at the PFR’s assessment – it all depends on one’s age and level of taxable income. The current payroll deduction for the PFR is 14-28%, and is contributed by the employer.

Yet many who received the PFR letter were greeted with an unpleasant surprise: the account balance was much lower than expected. Thirty-year-old Igor Zotov, manager at a grocery wholesaler, earns about $1,500 a month. He did not understand why his account balance was so low, so he brought his PFR letter to the company’s accounting department. “The chief accountant explained that my officially-stated salary is 20 times less than my actual salary. I get the difference as ‘interest’ on a bank account purportedly created in my name,” he explained.

Until very recently, almost anyone in Russia who received a salary over $200 a month received the bulk of their salaries as “insurance” or “deposit payments.” Company accountants were using a loophole in the tax code that encouraged employers to compensate their employees with non-salary benefits, thus avoiding the high social taxes on high salaries. Many companies stopped this practice when personal income taxes were lowered in 2000, with the introduction of a 13% flat tax. But since the pension deduction is tied to income taxes, employees who for the past decade received a large portion of their income through non-salary benefits saw only miserly contributions to their pension accounts.

The transition to an accumulative system is to be implemented over several decades. The PFR, for its part, has sought to drag the process out over the longest period of time possible (perhaps because, in a non-transparent system, it can be extremely profitable to manage someone else’s money).

By the end of last fall, the PFR had finished sending out its letters to all working Russians. In addition to the balance statement of individuals’ accumulated pension accounts, there was a request form for transferring one’s pension accounts to one of several private asset management companies. Persons who do not choose to have their funds transferred to one of the companies noted in the letter will have their pension accounts managed by the state-owned Vneshekonombank (Foreign Economic Bank).

As a result, Russians are abuzz with investment fever. Even those who previously were pessimistic about ever getting anything of value from their country, not to mention from life itself, seem to have caught the bug. Recipients of the letters are hunting among family, friends and friends of friends, trying to find someone – anyone – who has even the most distant relationship with the stock market, or who has, at the least, heard that such a thing exists.

The head of PFR, Mikhail Zurabov, has meanwhile become something of a celebrity. He shows up all over the television dial: even simultaneously on an analytical program and on a popular talk show. Serious business publications and the yellow press express equal zeal in publishing interviews with him.

Poor organization of the pension mailing (it was completed only six months after the original deadline) and titanic efforts by the PFR to cut private asset management companies out of the process led to considerable media criticism of pension reform.

Zurabov’s typical retort is that “lately, questions about the people’s trust in the new pension system have been asked increasingly often. But the reform started as early as the beginning of 2002. And even before that, before everything started happening, public discussions should have been undertaken. But, back then, the impression was that our people were not ready to learn about their future before that future actually arrived.”

Indeed, now, after all the necessary laws have been adopted and the new pension system has been in place for some two years, it seems rather late to initiate public discussion about what kind of pension system Russia needs. Russians, having grown up in a paternalistic state, seem to prefer not to try to understand this or that pension system, but would rather wait for the State to think everything through and announce how much it is ready to pay its pensioners, then criticize the situation after the fact.

Twenty-seven-year-old landscape designer Natalya Stefanovich is a case in point. “It is absolutely impossible to survive on the pension that people who have worked for 30-40 years receive today,” Stefanovich said. “My mother gets about R1500 ($50) and, if I weren’t helping her, she would not be able to buy clothes or shoes. All of her pension is spent on groceries and at that it only lasts her two weeks.”

Natalya does not have any children, and she has not managed to save anything up for her old age. She said she is quite simply scared to think of what will happen to her thirty years from now, when she reaches retirement age. And yet she categorically refuses to support an increase in pension deductions, which would mean a lower salary. “How do I know whether I will live to be a pensioner anyway? And this extra money won’t hurt me right now. Maybe in ten years I will start thinking about this, but, for now, a higher salary is better.”

Without an increase in pension deductions, PFR’s Zurabov asserts, there will be no improvement in the lives of pensioners. “It is no use talking about what pensions should be,” Zurabov said. “We should compare how much the person could earn under the old pension system to how much he can earn now. And this, considering the fact that the employer is not paying any more into the pension fund. In fact, they pay even less now, because of the effects of the regressive unified social tax* introduced a couple of years ago. The volume of tax income is decreasing every year. Therefore, deductions have not increased; no one is paying more. People ask: So how will I live under the new system? Can I start to live better? Strictly speaking, if the sum of contributions is the same, you will have to live the same way.”

Some heads of private asset management companies which have earned the right to invest pension savings feel that higher pension deductions is not the answer. In their view, private investment of pension funds in the Russian stock market is the only way the system can create a brighter future for Russia’s retirees. And they may be right. In recent years, the Russian stock market has enjoyed rapid growth, and stocks of many companies are still undervalued. Under favorable market conditions, responsibly-invested pension funds could, in a couple of decades, deliver solid returns.

Not surprisingly, this line of thinking leads many to conclude that current reforms could go farther still in privatizing the system. Victor Pleskachevsky, head of the Duma’s Property Committee, calls Russia’s pension reforms at best an imitation of real reform. “Pension savings,” Pleskhachevsky said, “have remained in the Pension Fund of Russia, which is not a financially transparent organization, and has always been used by the government as an ‘extra pocket,’ from where money can be taken to cover up some gap. And this is what causes payment delays to pensioners, which happen quite often in Russia. Lately, as oil prices have been high and the budget has received additional income, this practice has been used less, but the situation in the world’s markets is not a constant, and the government remembers this.”

If nothing else, Russia’s
pension reform project has empowered Russians with a feeling largely forgotten during the post-privatization decade: that the choices they make today will in some way influence their tomorrows. It is also the first time that the Powers That Be have graphically demonstrated to citizens how the amount of taxes they and their employers pay is linked to what the state will return to them in their old age.

Lessons of the past have also been accounted for. Unlike the voucher privatization debacle, pension savings will not be handed out in toto, so that they can be sold irresponsibly or “converted” to vodka. The government is also doing its best to protect the population from fraud, through highly-specific regulations about what asset management companies can do with citizens’ money. The companies will be overseen by the Ministry of Finance, the Federal Securities Commission and a special depository, which will register every deal made by asset management companies. There will also be compulsory, independent audits.

The PFR letters also served a useful social purpose: reminding working Russians that old age is coming for everyone, sooner or later. How one meets that stage in life, Russians now understand, is a matter no longer entirely up to the State, but largely in the hands of the individual.   RL