In 1980, Chile replaced its pay-as-you-go public pension system, under which benefits for current beneficiaries were paid with taxes from current workers, similar to Social Security in the United States, with a system of individual accounts that has become a possible model for public pension restructuring around the world. The preceding pay-as-you-go system had been foundering financially and was unable to pay full scheduled benefits. In addition, the previous system had been extremely complex, with more than 100 different combinations of contribution rates, retirement ages, and benefit amounts for different groups of employees. Chile's system of private pension accounts has been widely studied as one model for public pension restructuring. The U.S. Congress has considered a number of proposals to include private accounts in the Social Security system, either by carving contributions to private accounts out of Social Security's current payroll tax revenue stream or by adding private accounts onto Social Security's traditional benefit system. This report provides an overview of Chile's pension system, including a description of major reforms approved in 2008, the Chilean government's role, and challenges facing the system. The Chilean pension system consists of three tiers: a poverty prevention tier, an individual account tier, and a voluntary savings tier. The poverty prevention tier provides a basic benefit to aged persons who did not participate in the public pension system and to retired workers whose monthly pensions financed by individual account assets (the second tier) do not reach certain thresholds. Under the second tier, workers contribute 10% of wage or salary income to an individual account and choose a private-sector Administradora de Fondos de Pensiones (AFP) to manage the account. Upon retirement, the worker may withdraw the individual account's accumulated assets as an immediate or deferred annuity or through programmed withdrawals. A third, voluntary savings tier encourages workers to supplement pension income with additional savings. The 2008 reforms were designed, among other goals, to increase participation in the public pension system, reduce high investment management fees and administrative costs, and bolster the poverty prevention tier. The first tier of Chile's public pension system is a poverty prevention tier funded by general revenues. The poverty prevention tier is available to all citizens aged 65 and older who pass a means test and who have lived in Chile for at least 20 years, and for at least 3 of the past 5 years, whether or not they contributed to an individual account (the second tier). The Chilean government pays a Basic Solidarity Pension to individuals who have not contributed to individual accounts and pass the means test. The Basic Solidarity Pension is 75,000 Chilean pesos (about $154) per month, wage indexed starting from July 2008. A Pension Solidarity Complement is paid to individuals who contributed to individual accounts (the second tier) and pass the means test, but who would receive a monthly pension below a threshold amount of 255,000 Chilean pesos (about $523) in July 2011, wage indexed thereafter. In the case of retirees who have annuitized their individual account balances, the Pension Solidarity Complement is paid as the difference between the minimum benefit amount and the annuity financed by the individual account. In the case of pensions paid through programmed withdrawals from the individual account, the Pension Solidarity Component is paid once the member has used the balance in his or her individual account. Because the existence of a poverty prevention tier could discourage savings through the second tier (individual accounts), the state's contributions are designed so that every dollar saved always increases retirement income, but not by a full dollar. Employees are required to contribute 10% of wage and salary earnings to an individual account, up to a ceiling on monthly taxable earnings of 60 unidades de fomento (UF). Since 2009, the earnings ceiling has been indexed to growth in average earnings and stood at 67.4 UF in early 2012. Employers are required to withhold workers' contributions from their paychecks and to forward contributions to the AFP chosen by each worker. Employees' contributions are tax deferred: contributions do not count as income in the period they are made and interest earnings are exempt from taxation until withdrawal. Retirees pay regular income taxes on pension income when it is drawn as a retirement benefit. Employers are not generally required to contribute to employees' accounts. Since 2008, employers have been required to pay premiums for survivor and disability insurance, which in Chile is provided by private insurance companies. Survivor and disability insurance premiums have recently totaled about 1.49% of employers' payroll, on average. Tax incentives are available to employers who make matching contributions to employees' supplemental savings through the third, voluntary savings tier. Workers choose one AFP with which to invest their 10% pension contributions. An AFP is a private company that is regulated by Chile's Superintendent of Pensions. An AFP exclusively manages a worker's pension investments and administers pension benefits, including collecting pension contributions, keeping records, managing pension investments, calculating retirement annuities (unless a worker chooses to contract with an insurance company), and paying retirement annuities. Workers may choose any AFP and may switch AFPs at any time for a fee. In February 2012, there were six AFPs. Each AFP offers up to five government-approved funds, called Funds A to E, with different levels of risk. Fund A, with the highest proportion of equities, carries the highest risk and potentially the highest return. The five-fund portfolios operate within regulations established separately for each type of fund concerning the credit rating and liquidity of investments, diversification, and other factors. Participants pay administrative charges to the AFPs for managing individual account assets. These charges are levied in addition to the 10% mandatory contribution. The AFPs are free to set fees and commissions, as long as these are standard for all members. In other words, it has been assumed that participants' freedom to choose their AFPs, combined with competition among AFPs, will result in an appropriate level of commissions. Administrative charges and AFP profits have historically been significant, however. A worker's pension annuity is calculated based on the accumulated assets, plus returns, in his or her individual account. The annuity calculation is based on age and gender-specific life expectancy. If the pension annuity is below certain thresholds, the Chilean government provides additional payments to bring the total pension up to the monthly Solidarity Pension (first tier) amount. Early retirement is possible at any time as long as the capital accumulated in the account is sufficient to finance a pension that (1) starting from August 2010, replaces 70% of the worker's average earnings in the 10 years prior to drawing the pension, and (2) starting from July 2012, equals 80% of the Pension Solidarity Complement. The normal retirement age (NRA) is reduced by one or two years for each five years of work in certain specified, arduous occupations, with a maximum reduction in the NRA of 10 years. The assets accumulated in the individual account can be withdrawn in the following ways: 1. Programmed Withdrawal . The AFP calculates monthly annuity amounts, including an annual inflation adjustment, and manages the pension payments. The account balance is held in one of the three lower-risk funds, at the retiree's choice, to avoid risk-taking that might result in premature account exhaustion and trigger the government's minimum benefit guarantee. The account holder retains ownership of the account, and can leave any remaining balance to heirs, but assumes longevity and investment risk in the case of monthly withdrawals that exceed the minimum benefit guarantee. 2. Life Annuity . Members may choose a life insurance company to pay an inflation-adjusted monthly pension and a survivor pension to any beneficiaries. The account holder transfers ownership of the assets to the life insurance company, which assumes both financial and longevity risk. The decision to choose a life annuity is irrevocable once the ownership of the account assets has been transferred to the life insurance company. 3. Temporary Income with Deferred Life Annuity . The account holder contracts with an insurance company to provide temporary or programmed monthly payments until, at some point after retirement, the insurance company starts to pay a life annuity. In this way the account holder retains ownership of the part of the account that remains in the AFP until the life annuity begins. 4. Immediate Annuity Plus Programmed Withdrawals . In 2004, a new option was created, under which a portion of the account balance is used to purchase an immediate annuity and the remainder is paid out as programmed withdrawals. From the account balance, 15 UFs are reserved to cover funeral expenses. In Chile, disability and survivor benefits are financed by a combination of the worker's individual account and private insurance. AFPs are required to purchase insurance policies to finance disability and survivorship benefits on behalf of participants and their surviving dependents through the age of 65. Since 2009, employers have been required to pay the premiums to the AFPs on behalf of their employees. Survivor and disability insurance premiums have recently averaged about 1.49% of payroll contributions. This insurance is used to pay the difference between an annuity financed from the accumulated assets in the worker's account and the disability or survivor pension to which the disabled worker or the worker's survivor (spouse, children, or parents) is entitled. The monthly disability pension is 70% of the worker's base salary (defined as his or her average monthly salary for the previous 10 years) for those entitled to a total disability pension and 50% of base salary for those who are entitled to a partial disability pension. Eligible survivors may include a surviving widow(er) and children younger than aged 18 or aged 24 if a student. There is no age limit for disabled surviving children. Workers may make voluntary additional contributions to certain savings products authorized by the Chilean government, including voluntary savings accounts managed by the AFPs, mutual funds offered by banks, and savings products offered by insurance companies.