How much will you earn when you retire? This is how the replacement rate works to know your pension

Being able to plan your retirement well depends in part on knowing how much you will receive in your pension.

Oliver Thansan
Oliver Thansan
15 May 2024 Wednesday 10:27
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How much will you earn when you retire? This is how the replacement rate works to know your pension

Being able to plan your retirement well depends in part on knowing how much you will receive in your pension. To have a clue of the amount, there is the replacement rate, which compares the salary with the benefit and shows what income one will live on when leaving working life behind.

“It is the proportion in which the first pension replaces the last salary received,” details José Antonio Herce, founding partner of the Longevity firm.

According to data from the Organization for Economic Cooperation and Development (OECD), today in Spain the replacement rate provided by the public system is 80.4%. It is for an average income and in gross terms. "The worker who retires has to take into account that on average Social Security will give him 80% of his pension in relation to his salary."

80% is an average. Some will receive more, others less. The rate is higher the lower the last salary: the minimum supplements compensate for any deficiencies that may exist upon retirement. The previous example could be rescued: anyone who earns 1,000 euros will have a pension very similar to that figure. On the other hand, due to the limits of the system, the replacement rate is lower the higher the last salary is. “Today the maximum pension is slightly above 3,000 euros (3,175.04 euros per month). In people who were earning 5,000 euros, 6,000 or something more per month, the replacement rate can be 40%-50% or less,” he exemplifies. The OECD specifies in the case of Spain that those who double the average salary have a rate of 49.6% when they retire.

Are they high numbers? In comparison with the public systems of the EU, Spain stands out by far. With an average of 49.5% for the 27 as a whole, in Belgium the replacement rate is 43.5%, in Germany 43.9%, in France 57.6%... If we are going to Italy is closer (76.1%) and the only one with similar rates is Greece (80.8%), according to the same source.

These are generous figures. “The replacement rate of the Spanish public pension system is considerably higher compared to our surrounding countries,” explains Raúl Leyenda, director of pensions at Nationale-Nederlanden. The last pensioners of the general regime to enter the system do so by collecting 1,592.42 euros, according to the most recent data from Social Security, from March. The figure reached 1,760.80 euros in January and varies throughout the year, but presents an upward trend if we take a look at the history since 2005.

Although the amount of new pensions is increasing, the replacement rate usually remains at similar levels, since salaries are also updated and the result is readjusted.

With the 80% reference one has to do the math, consider whether it is a lot or a little for your expenses when you retire. Logically, the standard of living that was financed by the salary, if it was spent in its entirety, becomes more difficult to cover. In this case, you can choose two paths: adjust expenses to the new reality or choose to supplement the pension. The latter is something that must be started sooner, “as soon as possible…”, Heras emphasizes.

“It is highly advisable to have savings plans aimed at complementing our public pension, whether individual or through the company, with the aim of maintaining the standard of living in the retirement stage,” says Leyenda. “Many have mandatory complementary savings systems that make the difference between the last salary and the retirement amount closer,” she points out. Today, in any case, for the vast majority of retirees the public pillar is the only one.

With the private contribution, the income collected up to now could even be exceeded. “Let's imagine someone who wants to dedicate their retirement to start traveling, spending more than they earned before. That has to be paid for,” says Herce. He believes that pedagogy should be done on the need to plan for retirement, urging the expansion of pensions promoted by companies, which today only have about 2.5 million employees out of 17 million, she details. “The complementary pension must be generalized. Social Security is exhausted, it cannot do more or better, although it is not going to go bankrupt,” she explains.

In other European countries such as Denmark, the Netherlands or Sweden, the complementary contribution via mandatory business plans makes a difference. For example, the Danes go from a replacement rate of 30.2% on the public side to 73.1% when adding the business side, which reaches 116.6% at lower salaries. In the Netherlands it went from 29.1% to 74.7%. And in Swedish lands from 49% to 62.3%, always with OECD data.