Pension Benefits in a More Realistic Setting

Earnings-related pensions are computed according to the years of contributions, a certain number of last (or best), earnings and an accrual rate, i.e. the percentage of valorized earnings awarded as pension for each year of service. Indexation of existing pensions can be anchored either to wage or to CPI growth. Earnings-related pensions tend to award higher internal rate of returns (IRRs) to short and dynamic careers than to long and flat ones. Intra-generational unfairness is mitigated when applying lower accrual rates to higher income brackets, as in the U.S. system. Personal Accounts ensure fairness by computing the first annuity dividing the account balance at retirement by a ‘divisor’ reflecting retiring workers’ life expectancy, while anchoring indexation to the system’s rate of return ‘net’ of the frontloading factor.