Understanding the Pension System in Chile: Key Features and Benefits
The Beginning of the Work of Unaffiliated Workers
According to the provisions of Article 2 of Decree No. 3.500, the start of the work of an unaffiliated worker generates automatic membership to the system and the obligation to contribute to a Pension Fund Administrator.
What Does Membership Mean?
According to Article 2, paragraph two, affiliation is the legal relationship between a worker and the Pension System of Aging, Disability, and Survivorship, which incurs rights and obligations established by law, particularly the right to benefits and the obligation to contribute.
What Characterizes the Affiliation?
The membership system is unique and permanent, continuing during the lifetime of the insured, whether or not they remain active, engaged in one or several simultaneous or successive jobs, or changing institutions within the system.
What Constitutes Individual Capitalization?
Individual capitalization means that each participant has an individual account where their pension contributions are deposited, capitalized, and earn investment returns that help administer the resources of the funds. At the end of their working life, this capital is returned to the member or their surviving beneficiaries in the form of some type of pension. The pension amounts depend on the amount of savings, establishing a direct relationship between personal effort and the benefit obtained.
Private Management of the Funds
The pension system is administered by private entities called Pension Fund Administrators (AFP). These institutions are corporations whose sole purpose is to administer a pension fund and other activities strictly related to pension money, in addition to granting and administering allowances and benefits provided by law. Administrators collect pension contributions, deposit them in the personal account of a participant, and invest resources to provide the benefits accruing later. Additionally, they take insurance to finance disability and survivorship pensions for their affiliates. For their handling of Pension Funds, the Managers are entitled to remuneration established based on commissions paid by the members. The fees are set freely by each Administrator, on a uniform basis for all its members.
Characteristics of the System
Legal Insurance
The Pension System Individual Capitalization is mandatory for all dependent employees and optional for workers who were in the old system when the reform was implemented, as well as for independent workers.
Participants and Contributors
The category of affiliate includes any worker who joins the individual capitalization pension system, losing this status only if they meet all legal requirements, decide to disenroll, and reassert themselves in the old pension system. All workers, whether dependent or independent, can join, with no distinction between the activities they develop or the employers they serve. When subscribing to an administrator, the employee is incorporated into the pension system, even when changing jobs, becoming unemployed, or leaving the labor force.
Financing System
Old age pensions are financed by individual contributions of 10% of salaries and taxable income up to a maximum of 60 UF, plus the cost savings gained by the staff. In case of disability or death of the participant during their working life, individual savings are complemented by disability insurance and survivor benefits that the AFPs hire from Life Insurance Companies. This insurance and the cost of system administration are funded by an additional contribution to the 10% mentioned above, also expressed as a percentage of taxable income.
Separation Between AFP and Fund
The Pension Fund is a heritage property separate from the Administrator, meaning the resources accumulated by pension funds are owned in the fraction that corresponds to each of the members of the system. Additionally, the Administrator must keep separate accounts of the Heritage Fund. The assets and rights that comprise the assets of the Pension Funds are indefeasible.
Pension Arrangements Provided for in Decree No. 3,500
The affiliates that meet the requirements for pension benefits for any of the causes identified can avail themselves of the balance accumulated in individual accounts and choose one of four pension arrangements established by law:
- Scheduled Withdrawal (Article 61 of DL 3500): This mode allows the member to withdraw annually from their individual account an amount of money defined, funded with an annuity paid in twelve monthly installments. The programmed withdrawal is characterized by being essentially revocable, meaning the participant may elect at any time for any other of the pension arrangements.
- Immediate Annuity (Article 65 DL 3.500): This form involves a contract between the member and a life insurance company, obliging the beneficiary to transfer their pension funds (or a part to be determined) to the insurer of their choice, which pays a monthly pension at UF from the moment the contract is signed until their death, and subsequently, a survivor’s pension to their beneficiaries or successors. This option is irrevocable, and the member ceases to control their pension funds, as they are transferred to the insurance company in exchange for the annuity contract. The value of the pension remains constant over time as agreed at UF.
- Temporary Income Deferred Annuity (Article 64 DL 3.500): This type of pension is a mixture of the two. The affiliate contracts with a life insurance company to pay a pension at a definite future date (deferred annuity), transferring the agreed premium amount while retaining sufficient funds in their individual capitalization account for the Pension Fund Administrator to provide a temporary income until the deferred annuity begins to be paid by the insurance company.
- Immediate Annuity with Programmed Withdrawal (Article 62 bis DL 3.500): This form of pension involves the affiliate contracting with an insurance company for immediate annuities, using some of the individual account balance, with the remainder benefiting a scheduled withdrawal. The pension will be the sum of the amounts received in each mode. This option is available only to those members who can obtain an immediate annuity equal to or greater than the guaranteed minimum old-age pension.
What Constitutes Excess Freely Available?
Free disposal of surplus corresponds to the sum remaining in the individual capitalization account after the participant becomes effective in any of the pension arrangements explained.
How Much is the Compulsory Contribution?
The compulsory contribution (Article 17 DL 3.500) corresponds to 10% of the remuneration that members should find in their individual capitalization accounts (Article 41 and 44 of the Labor Code in relation to Articles 14, 15, and 92 DL 3500). Additionally, according to Article 17, an extra contribution is also mandatory for the financing of the AFP, including the payment of insurance premiums. There are exceptions for participants who are not required to make these contributions, such as those who have attained the age for old-age pension. If they wish to disenroll, it is done voluntarily (Article 69 of DL 3500), with the only requirement being contributions for health as provided in Article 84.
What is the Remuneration and Income Using the DL 3500?
For pension purposes, remuneration means the consideration paid in cash and additional in-kind valued in money, to be paid to the worker’s employer according to the employment contract and for monthly taxable income, which is declared monthly by the self-employed AFP to serve as a basis for the calculation of contributions, which may not be less than the minimum wage.
Other Types of Savings Associated with Pension
- Voluntary Savings Account (Count Two) (DL 3500, Article 21): Members can make deposits in the AFP they are members of, which are not contributions for tax purposes, aimed solely at encouraging savings. These deposits are paid into a personal account for each affiliate, independent of individual capitalization accounts.
- Deposits Agreed (Article 20, inc. Third, DL 3500): The member can deposit amounts agreed upon with their employer in their individual account to gather sufficient balances to fund an early pension or increase the amount of their pension. These amounts are not paid for any legal effect and are not considered income for tax purposes.
- Voluntary Pension Savings Account: This consists of sums allocated by the member to pension savings plans VCT offered by authorized institutions (DL 3500, Article 20 ff. and Law 19,768 of 2001), promoting savings to improve the balance to fund the pension.
What Constitutes the Pension Reform?
The Pension Reform refers to the creation of a supportive system of old-age pensions and disability, known as the