About 5m Turkish workers have automatically enrolled in private pension plans and the total amount of savings has reached about $700m. However, despite the high level of state incentives for the system, opt-out rates still exceed 60%, according to an article in IPE.com, a leading European publication for institutional investors and pension fund managers.
The Insurance Association of Turkey has prepared a research report using both qualitative and quantitative survey data. The top three most common reasons given for opt-outs were high expenses or indebtedness (71%), lack of affordability (56%) and lack of confidence in long-term investment (35%).The issues with the private pension system are:
- High expenses or debt. About half of the working population earn the minimum wage in Turkey, forcing employees to give priority to their immediate needs (such as rent, as well as consumption of goods and services) rather than to save for a distant future. Moreover, despite a low household debt-to-GDP ratio (17.4%) compared with other countries, more than 60% of household debt has a maturity of two years or less, imposing short-term fiscal burden on minimum-wage workers. As a result, low-income earners need larger financial incentives to invest for the long term, compared with high-income groups.
- Lack of affordability. Under the social security programme (including state pension and health insurance), employees and employers are obliged to contribute 14% and 20.5% of worker’s monthly gross wage, respectively. So high contribution rates in state pensions are an important factor in deterring employees from affording an additional 3% contribution for private pension.
- Lack of confidence in long-term investment. In the Turkish private pension system, fund management styles do not seem to comply with long-term investment philosophy. On average, pension plans allocate more than 80% of their assets to fixed-income instruments and the average pension fund has yielded a cumulative annual rate of return less than the average deposit rate over the past 10 years. This is poor performance. Moreover, there are no predetermined default fund offers such as age-based funds for auto-enrollers. Consequently, people have concerns about long-term investment.
Introduced in 2017, auto-enrolment reform in Turkey's private pension system aims to boost accumulated savings in private pension plans, which are currently about 2.5% of the country’s GDP.
Under the current legislation, all employees (but not the self-employed) below the age of 45 years are automatically enrolled into private pension schemes by their employers and are required to contribute a minimum 3% of their gross salaries. Despite a stated two-month opt-out period in the system, participants can cancel their membership at any time without any penalties on their contributions.
In providing incentives to the private pension system, the state matches 25% of employee contributions up to a defined limit and offers a one-time bonus payment of TRY1,000 ($184), which participants are eligible to receive in full at the age of 56 after at least 10 years of contribution.
Moreover, if workers prefer to draw down their pension benefits in a 10-year annuity, there is an additional government contribution that amounts to 5% of the assets accumulated at retirement.
Ms Seda Peksevim, a PhD student and researcher at the Centre for Applied Research in Finance (CARF) at Bogazici University in Istanbul, who wrote the article, said that to resolve the problems in private pension plans, there are several possible solutions, including:
- Larger financial incentives for low-income earners. To provide relatively higher incentives for low-wage earners, state contributions may be offered as flat subsidies, which decrease with higher income levels.
- Transfer from public to private pension system. Given high contribution rates in state pensions, a proportion of these mandatory payments could be transferred to the auto-enrolment system. This mechanism would make the system more affordable, as well as decreasing the state’s pension deficit over the long term. The old-age dependency ratio in Turkey is forecast to reach the projected OECD average (58.6%) by 2075, which will probably lead to further pressure on the government’s budget in the future.
- Well-designed default fund options. As lessons from behavioural finance show, most people tend to stick with default options in auto-enrolment plans. Given that, selected default options should offer low-cost, simple and efficient products for pension investors.
Turkey is an emerging economy with distinctive characteristics. There are a strong state pension system, a young population, and an underdeveloped financial market structure.