A Supersized Pension System

A fortunate step was taken half a century ago when the foundations were laid for the pension system we know today. Through foresight, Icelanders have managed to build up a nearly fully funded pension system through fund accumulation, and we are one of the few nations where the vast majority of pension liabilities are funded. Most of our neighbouring countries chose the pay-as-you-go route, where the taxes of those in the labour market are used to fund the pensions of those who have reached retirement age.

The strength of the Icelandic system is therefore beyond doubt. However, its size and scope have created problems that it is time to address.

Mandatory savings too high

The aim of the pension system is to ensure people's financial security in their later years. To this end, individuals pay a mandatory contribution to pension funds of 15.5%, of which 11.5% comes from the employer and 4% from the employee. The rate of mandatory saving is nowhere higher within the OECD. In addition, employees can build up supplementary pension savings, where employees contribute 4% against a matching contribution from the employer of up to 2%. Pension savings can therefore amount to as much as 21.5% of wages.

Mandatory saving carries an opportunity cost. People's needs are, after all, not the same at different stages of life. Younger people are generally more indebted and often face substantial expenses when setting up a home and having children. As life progresses, debt generally falls and various major expenses become a thing of the past.

Despite this, employees pay the same proportion of their wages into mandatory savings throughout their working life. An individual with average earnings who makes full use of supplementary pension savings and achieves a 3.5% real return can expect pension payments during the first fifteen years of retirement to be around a quarter higher than wages at the peak of their career, and more than 50% higher than wages at the end of their working life.

Many eggs in one basket

High mandatory savings and extensive participation mean that pension fund assets amount to around 187% of GDP. Despite the size of the funds, legislation restrains their foreign investments through a statutory cap on their holdings in foreign currency. As a result, the funds have a substantial presence in domestic asset markets.

Greater risk diversification, including through foreign investments, can better protect the nation's pension savings against shocks confined to Iceland. It is preferable for the pension funds themselves to determine their own risk diversification, rather than the government deciding what constitutes an acceptable split of assets between currencies.

Managing these savings is also costly. The total cost of the pension system, i.e. the funds' operating costs and investment fees, amounted to around ISK 47 billion in 2025, or 0.54% of assets. This cost has been rising in recent years, mainly due to increasing investment fees, at the same time as investment costs have generally been falling abroad.

Who controls the savings?

Pension fund boards are generally made up half of representatives from employers' associations and half from trade unions. Ordinary fund members therefore have no direct involvement in who controls their savings.

Trade union membership is not a condition for contributing to a particular fund. Those who sit on the board therefore do not need to be representatives of the relevant fund members' trade union. This can create a principal-agent problem, where those managing other people's money do not fully share the same interests as the owners of that money.

Four steps towards a better system

Four reforms should be made to the pension system in order to address the challenges outlined above. First, the mandatory contribution should be reduced from 15.5% to 12%, and a cap set on the amount of wages against which the mandatory contribution is calculated. Second, fund members should be allowed to elect the boards of their pension funds. Third, the foreign currency cap should be abolished, giving the funds greater scope for risk diversification beyond Iceland's shores. Finally, oversight and transparency around costs should be increased, among other things so that fund members can better compare the costs and performance of funds.

These proposals would help ensure a better balance between a carefree retirement and living standards in younger years, while also giving employees a greater say in how their own savings are managed.

Birta Karen Tryggvadóttir, economist in Viðskiptaráð's policy division

This article first appeared in Morgunblaðið on Thursday, 20 August 2026.

This article was automatically translated from the Icelandic original.