Retiring like a Turkish sultan
ERDEM AKTUĞIf you save 900 Turkish Liras per month for 10 years, how much money will you have in your bank account if the annual rate of return is 12 percent? The answer is about 207,000 liras (not bad). However, if you convince your firm and start a private pension plan, inputs remaining the same, the total amount in your bank account in 10 years will be 460,000 liras! This is because a 9 percent contribution is matched by your employer with an 11 percent rate and some compounding. Well, Turkish regulators just sweetened the deal for employers too, and said the state would match this plan with 5 percent, so the contribution required by employers drops to 6 percent. With 20 years of savings, the results are even more dramatic: You will have about 2 million liras in your bank account. If the old lira was still in use today, you could be a trillionaire! The numbers are right, and all of this is not magic but “compounding,” the largest force in the universe according to Albert Einstein.
Let me add that the concepts of financial literacy and prudential investment are not very well established in Turkey. According to Pension Monitoring Center, the average age that workers start their private plans is 33.5 as of 2011. In addition about 60 percent of the entrants to the system see the plans as a means of saving some money in the short-run, rather than planning for some additional income during their retirement. Recently, the penalty for exiting the system prematurely has been lowered as well. All of these factors together might help explain why the average duration of these plans is only about five years.
Concerning public pensions, which are defined as benefit plans guaranteed by the government, things do not look very good as well. The average number of years a Turkish pensioner spends in retirement is about 34 years, compared to an average of about 18 years for Americans and Germans, and about 25 years for Italians and Greeks. The time spent in retirement is clearly too long for Turks, and pension expenditures accumulated to a deficit of about 7.8 percent of gross domestic product (GDP) as of 2012; compared to a less than 5 percent deficit in the “troubled” U.S. system with a much older population and lower fertility rates.
Current efforts to lower the burden of the public pension deficit on government finances are mainly threefold; a gradual increase in retirement ages, a fight against the informal sector, and stronger incentives toward private pension (defined contribution) plans. Even though the private pension system recorded very high growth rates over the last decade (since October 2003), pension fund assets stand at about 2 percent of GDP in Turkey. We can compare this with the U.S., a market-based hybrid system in which pension fund assets constitute about 73 percent of GDP. OECD average for pension fund assets is about 72 percent, the U.K. stands at 87 percent, and Germany, a more socialist system, is at 5.2 percent.
As I mentioned at the beginning, with the new regulations taking effect in January 2013, the incentives are amplified to set up private plans. Currently, there are about 3.1 million participants in the system, and 0.5 million people are expected to join during 2013. Therefore there is a big potential for growth. However, foreign investors and local contributors have to be very careful in their choices. For investors, the volatile nature of Turkish markets and changing regulations can be challenging. For contributors, the challenge is to choose the right plan provider and the right portfolio. As of 2011 the average annual return for private pension funds was about 7 percent for the latest three years, with a range of about -20 percent to +20 percent annual returns in 2011. The contributors should also be careful about management fees (recently reduced to about 2.5 percent annually) and administrative charges, as the fees might be a drag on their savings.