This paper analyses the impact of changes in social institutions, i.e. in the informal and formal social security system, on income inequality in China. This study uses an inequality decomposition analysis approach comparing household survey data for 1988 with 1995. Since 1992 was a decisive year for accelerating to increase the role of market mechanism in China, comparing these two periods shows significant changes in social institutions and their impacts on income inequality. It provides meaningful implications for inequality issues in the present China. In a first step the paper looks at the impact of changes in the family based social security system on income inequality. Secondly, the paper investigates the contribution of current social security system reforms as a potential tool to cope with increasing inequality. Three main results emerge from the analysis: first, the family based social security is losing its importance mainly through the changes in employment pattern in a household. This change has a significant impact on income inequality. Second, this study shows that the introduction of new formal social security system helped to equalise the distribution of retired household members’ income in urban areas. Third, however, these changes have only benefited a restricted number of persons. Benefits for rural migrants are low and most of the rural population has still no access to the new system. Important steps forward will be to raise the fund-pooling level, and to include nonfarming workers into the new system.