In 1981, during the dictatorship of General Augusto Pinochet, Chile radically reformed its pension system. It changed from a traditional public pension system to a system of mandatory individual retirement accounts. These accounts are privately managed by firms selected by the government and workers are required to contribute 10 percent of their earnings to the accounts. Over the past three decades the Chilean model, as it has been called, has been held up as an example of how other countries can reform their systems- and they have. As many as 33 other countries have copied the Chilean model in part and nine have copied it completely. Even here in the United States, President Bush extolled the Chilean model during his push to partially privatize Social Security. What’s the catch? The Chilean model has failed.
Recently, hundreds of thousands of Chileans have taken to the streets of Santiago to protest the failure of Chile’s privatized pension system. As the first generation of workers who participated in the system of private individual accounts begin to retire, they are realizing how little they have to retire on. The reformers who created Chile’s privatized pension system promised that everyone would achieve 70 percent income replacement in retirement; the reality has been closer to 38 percent. The average monthly retirement benefit is a meager $400, but many workers only have between $160 and $260 per month, hardly enough to sustain a dignified retirement.
Chile’s president has promised major reforms of the private retirement accounts system. For the first time, employers will be required to contribute to the system. Others, however, have called for scrapping the current system completely. As one Chilean economist said: “The system was imposed during the dictatorship, it was seen as a simple way for the state to separate from such an important part of fiscal spending… Given its origins and the results, the system has no legitimacy.”
What lesson does Chile offer us? It is yet another example of the failure of defined contribution plans. Just like 401(k)s here in the United States, the system of privatized individual accounts in Chile has failed to deliver adequate retirement security to working families. In Chile, the privatized pensions, on average, replace only 38 percent of income in retirement. Also like 401(k)s, the private individual accounts in Chile carry exorbitant fees that eat away at a significant portion of workers’ retirement savings. The privatized pensions have enriched the country’s financial sector, while leaving ordinary Chileans behind. It is clear after three decades of experience in Chile and the U.S. that 401(k)-style defined contribution plans are a failure and need to be abandoned.