The paper studies the effects of introducing individual retirement accounts (IRA) as an alternative to the employer-based, pay-as-you-go public pension system in Japan. Without any reform, the projected demographic transition implies a massive increase in government expenditures in the magnitude of 40% of total consumption expenditures at the peak. Gradually shifting the earnings-related part of pension towards self-financed IRA, expenditures can be reduced by 20% of total consumption, providing a major relief for the government budget. The reform generates a significant rise in capital, as individuals save more for retirement, which is invested over many years. As a result, wage, output, and consumption are also higher, leading to a sizeable welfare gain in the intermediate and long run. Current generations, however, can face a large welfare loss depending on how the transition is financed.
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