How much pension do you get for your pension contributions? Comparison between Finland, Sweden and Germany
The question of how much pension one gets for one's contributions is often raised in the Finnish pension debate. The new country comparison in a recent analysis by the Finnish Centre for Pensions provides one way of examining the relationship between statutory pension contributions and old-age pensions. According to the comparison, the lowest old-age pension is about half of the contribution, while the highest old-age pension is almost one and a half times the contribution.
Antti Mielonen, Special Adviser at the Finnish Centre for Pensions, closely monitors and analyses pension systems in various countries. Together with Mathematician Meeri Kesälä and Liaison Manager Mika Vidlund, he recently completed an analysis of the relationship between statutory pension contributions and old-age pensions in Finland, Sweden and Germany. The analysis uses examples of middle-income men and women of different ages who have contributed to their earnings-related pension in 2020. We asked Mielonen how Finnish, Swedish and German citizens fared in the pension comparison.
One of the main principles of the earnings-related pension scheme is the link between insured earnings and the pension received. How much return do Finnish citizens get on their pension contributions?
Although there isn’t a direct link between pension contributions and pensions in the Finnish pension system, the relationship can be assessed using cash flows of contributions and benefits. In Finland, the ratio between contributions and pensions varies considerably between different age groups. For a Finnish 60-year-old woman, the ratio is the highest in the analysis at 1.42 – she receives almost half as much pension as she pays in contributions.
For a middle-aged Finnish man, the ratio of contributions to pension is about one, that is, he receives about the same amount of pension as he has paid in contributions.
However, younger people receive much less for their contributions. For example, the ratio for a 30-year-old man is 0.74.
What exactly is measured by this ratio?
In this analysis, the ratio measures how much a person pays in pension contributions in 2020 compared to how much they will receive as an old-age pension in the same year.
If the ratio is 1, the person’s pension and pension contribution are equal. If the ratio is less than 1, the contribution is higher than the pension. And if the ratio is greater than 1, the pension is higher than the contribution.
Let’s take the example of a person who earns 40,000 euros a year and contributes to their pension in 2020. In Finland, this person’s comparable pension contribution is 21.7 per cent of their annual income, which amounts to 8,670 euros. If they are a 60-year-old woman, they will receive a total pension of 12,301 euros in present value from the pension accrued in that year. The ratio is calculated by dividing the pension accrued by the pension contribution paid: €12,301 ÷ €8,670 = 1.42. This means that she will get back 1.42 times what she has paid in pension contributions.
It is important to note that this is a theoretical analysis, and the assumptions made have a significant impact on the results. In this scenario, the pension is not an investment instrument whose returns fluctuate with market movements. It is an insurance policy designed to provide a stable income throughout a person’s retirement.
What is the ratio between pension contributions and old-age pensions in Sweden and Germany?
In Sweden and Germany, the ratios are lower, which means that pension contributions yield less pension than in Finland.
In Sweden the ratios are between 0.70 and 0.90. Sweden has a system based on contributions, which leads to more consistent ratios than in Finland. It is important to note that this comparison is limited to the statutory earnings-related pension scheme and does not include other pension schemes.
In Germany, the ratio of pension contributions to benefits is low for all age groups, ranging from 0.57 to 0.90. The ratios in Germany reflect the ageing of the population and the lack of funding reserves in the pension system.
The interest rate selected has a significant impact on the results of the analysis. What does changing the rate mean?
In this analysis, the future pension has been converted to its present value using a discount rate of two per cent, in addition to adjusting for inflation. Statistics Finland also uses a two per cent discount rate to calculate pension liabilities.
Changing the discount rate to zero per cent shows how sensitive the calculations are to changes in interest rates. With a zero per cent rate, the highest ratios are found in the younger age groups. For example, a 30-year-old woman in Sweden and Finland would have a pension/contribution ratio of up to 2.15. Conversely, the lowest ratio is for a 60-year-old man in Germany, where the ratio is 1.04.
A higher ratio reflects greater risk and uncertainty about the future. A young person’s pension will be paid out over a longer period and its present value decreases with higher interest rates.
Apart from the discount rate, what other factors affect the ratio between pension contributions and benefits?
Aside from the discount rate, many factors influence the ratio between pension contributions and benefits. These include the duration of pension payments, the determination of pension amounts, indexing of pensions, and the overall contribution levels of the pension system. In Finland, the life expectancy coefficient reduces monthly pensions as life expectancy increases. Additionally, in 2020, pensions for a 60-year-old accrued at an unusually high rate due to transitional provisions following the pension reform of 2017.
In Germany, an automatic stabilization mechanism adjusts pensions to maintain the financial balance of the system. Sweden now has a fully contribution-based system with fixed contribution levels. The analysis also uses estimates of average life expectancy and projections of retirement age and other pension system parameters.
Gender significantly affects the comparison. Women have a higher life expectancy, resulting in higher ratios than men in all countries.
The analysis uses a so-called comparable old-age pension contribution, which is obtained by multiplying the total pension contribution by the share of old-age pension expenses in total expenses. The total pension contribution is supplemented by any tax revenues or other sources of funding used to finance pensions. In Germany, for example, the state finances more than a quarter of the pension system through tax revenues.
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