Japan’s pension system: a fragile equilibrium between tradition and contemporary challenges

Japan, one of the most developed countries in the world, is facing a silent yet profound crisis: the sustainability of its pension system. Global trends such as an aging population and declining fertility rates have brought the country to a major dilemma that calls for urgent solutions. While these issues are not unique to Japan, they are more pronounced there than anywhere else.

History of the scheme

Japan’s pension system dates back to 1942, with the introduction of a retirement scheme for workers, motivated by post-war reconstruction and the needs of industrialization. This initial scheme was salary-based and only covered employees.

In 1954, a major reform was introduced: benefits and contributions became proportional to income. Then, in 1961, a new milestone was reached with the creation of the National Pension System, which expanded coverage to all citizens, including self-employed workers, farmers, students, and non-working spouses.

In 1970, spurred by post-war economic growth and a high fertility rate, the government adopted the PAYG (Pay-As-You-Go) financing system for pensions. This meant that contributions paid each year were used to finance the benefits of retirees for that same year. As a result, the system did not accumulate large reserves, and the state functioned primarily as a redistributor. At the time, the number of contributors was steadily increasing, and it was assumed that the system’s sustainability would naturally follow.

In 1985, the government officially established a three-pillar system, which was further refined with a 2004 reform that indexed benefits to Japan’s economic and demographic conditions.

A Three-Pillar System

Like Switzerland, Japan has a three-pillar system, with the first being the most redistributive and the third based entirely on personal savings.

First pillar – Kokumin Nenkin (Nation Pension System)

The first pillar is mandatory for everyone. Citizens enter the system at age 20 and remain until they are 60 years old. The population is then divided into three categories: self-employed or non-employed individuals, employees, and non-working spouses. Self-employed workers pay their contributions through a flat monthly rate, billed directly. Employees’ contributions are included in the second pillar. Non-working spouses are already covered by the system thanks to their working spouse’s contributions. There is a possibility for low-income citizens to be exempt, with a 10-year buyback plan.

The benefits of the first pillar are the most redistributive possible. Everyone receives the same amount, ¥69,300 per month (~CHF 400) for 40 years of contributions, adjusted otherwise. Half of the benefits are financed through the pillar’s contributions, and the other half is supported by the State.

Second pillar – Kosei Nenkin (Employees’ Pension system)

The second pillar is only financed through the contributions of the current year. All employees are covered up to age 60, after which participation becomes optional. The standard retirement age is 65, but workers can stop working at 60 or continue until 70. This will decrease or increase the pension they receive at retirement, as is also the case in the Swiss system. The contribution is 18.3% of gross salary, with half paid by the employer.

The benefit can be claimed at age 65, in addition to the first pillar income. The amount depends not only on the number of contribution years but also, unlike the first pillar, on the income earned during the person’s working life.

Third pillar – Private savings pension system

The third pillar in Japan is similar to its Swiss namesake. Contributions are optional, and the benefits are only calculated based on what the individual has saved during their life. This system is considered “fully funded”, because unlike the PAYG system, the benefits are based on capitalized reserves. This means there is no risk of losing one’s money, since it is not redistributed each year.

The main difference between the Swiss and Japanese schemes is that both mandatory pillars in Japan are based on the PAYG system, whereas the Swiss LPP is fully funded. Otherwise, both systems are quite similar.

Main challenges of the scheme

1. Aging of the population

The fact that both mandatory pillars are PAYG systems means that the country has nearly no reserves. This makes the scheme highly social, but also extremely dependent on demographic trends. Currently, 30% of the population is aged 65 or older. This trend shows no sign of reversal, as the fertility rate, 1.3 children per woman, is far below the replacement level of 2.1. In fact, the Japanese government estimates that elderly people will represent 40% of the population by 2055. This is a major issue because the system is mainly supported by active workers. The consequences are already visible: when Japan adopted the PAYG system, the dependency ratio was 5 workers for 1 retired person. Today, it is about 2 for 1, and within 25 years, it will be 1 for 1. This means there will be more and more beneficiaries and fewer contributors to support them, which makes the current scheme unsustainable in the long term.

2. Japan’s economic environment

It is evident that social expenditures in Japan are increasing. In 1991, they represented 11% of GDP. Today, they account for around 22%. This rise is due to increasing life expectancy: as people age, they require pensions and costly medical care for a longer period, heavily subsidized by the state. To finance this, and because of the shrinking number of contributors, Japan’s public debt is now the highest among OECD countries, representing over 300% of its GDP.

Another challenge lies in the economy itself. Japan has experienced a long period of low inflation or deflation since the 1990s. In fact, the country’s GDP has remained stagnant over the past twenty years. Prices are not increasing, nor are wages, which limits the contribution capacity of the active population. When an economy faces deflation, other problems emerge: people expect prices to fall further and prefer to save money rather than spend it. Japan is already in a liquidity trap, making monetary and financial policies less effective in restoring the pension scheme’s sustainability.

Figure 1: Public dept (% of GDP)

Figure 2: Proportion of populations over 65 years old

Reforms and possibles solutions

1. Increase the age of retirement

Japan has already implemented some reforms. Among them, the retirement age was raised from 60 to 65 in the 2000s, and the change has been fully enforced since April 2025. From a pragmatic standpoint, this measure appears effective: if people retire later, they contribute longer. This reduces the financial burden on the state while increasing the number of contributors. Nevertheless, this reform may raise ethical concerns, as people must work five additional years to avoid reductions in their future benefits.

2. Transition to a funded scheme

Another potential solution would be to shift from a PAYG system to a partially or fully funded model. On paper, this appears to be the most sustainable option, but it would require substantial financial resources to carry out the transition. To finance such a shift, Japan would need to raise additional contributions from the population or increase its public debt to compensate for the lack of reserves for future beneficiaries.

3. Stimulate the working population

Finally, Japan could aim to boost participation in the pension system by encouraging higher employment rates. This could involve making part-time work more accessible, incentivizing employment beyond the age of 65, or facilitating immigration to address the growing shortage of contributors.

Conclusion

Japan finds itself in a delicate situation. Although its pension system has historically been effective, it is now under pressure from demographic, economic, and political forces. While some reforms have already been implemented, they will likely not suffice to ensure the system’s long-term sustainability. A transition to a more funded model, combined with stronger efforts to increase participation in the workforce, could help revitalize the pension system in the years to come.

Nicolas Steiner