how the Israeli pension system works part 2 – types of pensions
Until the mid 90′s, Israeli pension plans were defined benefits (DB) plans, where one would pay into the pension plan based on his or her salary, and would receive an annuity (monthly amount received) upon retirement as well as a certain level of insurance. The annuity is decided based on a number of factors such as (1) your age when you started paying into the fund (2) how many years you worked (3) your last salary (or in some cases, your average salary) (4) how long you are expected to live (they use actuaries, although it wouldn’t shock me if some use black magic) and other factors. Back then it was easy to choose a pension; one would compare the benefits of the plans and pick the one he or she felt best suited his or her needs.
In the mid 90′s the investment companies complained to the Israeli government about having to take responsibility for their investing and successfully lobbied for a defined contributions (DC) system, a system where the annuity one gets upon retirement is based on how much money is in the fund. Okay, now in English. The money I deposit into my pension fund is invested for me. When I begin to retire, the pension fund manager looks at how much is in my fund and based on that (and a few other factors) decides how much I get as an annuity (if you’re wondering, you can get some as a lump sum, but that just affects the amount you’ll get for an annuity afterwards.)
On one hand, this new system means that the worker can now cash in on the money that is earned by his or her fund; in the previous system the fund managers got to keep all the extra for themselves. On the other hand, this new system pushes the risk of retirement away from the pension funds and insurance companies and onto the worker, who in the overwhelming majority of cases does not understand all the issues of investing. So now, not only does every Israeli worker have to choose a pension based on his or her insurance and retirement needs, but one also has to make sure that the money is really being invested wisely.
This incredible responsibility make it imperative that every single Israeli be educated about this crazy system and learn the basics of investing required for the common citizen to keep track of his or her money. The aim of this series is to assist in such education.
To begin, there are two types of defined contributions (DC) pension funds, חדשות and כלליות (just to confuse you more, sometimes כלליות are called חדשות כלליות). The difference between these two pension funds is that the חדשות are allowed to include government subsidized savings bonds and include a certain level of life insurance and disability insurance.
So then why would anybody want the כלליות if the חדשות are available? The answer is obvious; no one would. The only people who usually invest in כלליות are those who make a bit less than twice the average wage money, as the limit for how much one can invest in a חדשות is 20.5% of twice the average wage. Workers who make beyond this amount typically invest as much as they are allowed to by law into the חדשות and then, with whatever money they have leftover to still use for a pension, pay into the כלליות funds.
In the coming posts I will focus on the חדשות funds, because frankly, I’m not rich and I only care about the funds that will affect the average person. Nonetheless, most of the stuff I post about will be applicable to all of the funds.
In Part 3, I will discuss what is contained in your pension fund. Stay tuned…