An Optimal Choice among Pension Systems: Evidence from Colombia

Abstract

This paper examines how Colombian workers choose between two pension regimes, pay-as-you-go (PAYG) and individual account (IA), in a context marked by widespread labor informality anduneven wage distributions. Drawing on a discrete choice framework, we hypothesize that there exists acritical wage threshold above which the higher replacement rate offered by PAYG outweighs the loweraccessibility constraints. In contrast, while below this threshold, the IA system’s more generous lumpsum payouts become more appealing for individuals who may struggle to meet minimum contributionrequirements. The model is calibrated to the data and then subjected to Monte Carlo simulationsto gauge consistency with observed system preferences. Findings indicate that PAYG tends to favorhigher earners through regressive subsidies and stricter qualification criteria, whereas IA proves moreaccommodating to low-income earners. The results underscore the need for nuanced policy reforms thatacknowledge these distributional imbalances and address the challenges of labor informality.