Why are pensions indexed?

Earnings-related pensions are indexed to

  • help ensure a reasonable starting pension for a new pensioner, considering the income level while still working; and
  • preserve the purchasing power of the pension in payment.

If pensions were not indexed, the starting pension amount could be very modest and the purchasing power of the pension in payment could quickly weaken in the course of retirement.

As of the beginning of 2005, all earnings-related pensions have been determined based on the average earnings of a person’s entire working life. This has made pension indexing during the active period even more important. Calculations show that nearly half of the amount of future starting pensions stems from indexation.

The graph below shows an example of how indexation by the wage coefficient affects pensions. The assumption in the calculations is that the index of wage and salary earnings will rise by 3.2 per cent per year, and that the earnings development at the individual level will follow the development in the index of wage and salary earnings. The pricing level is expected to rise by 1.7 per cent per year. The individual’s starting monthly salary is 1,000 euros.

The person in the example will have accrued a monthly pension of slightly less than 2,700 euros by the age of 65. Without indexation, the monthly pension would be 40 per cent smaller.

The length of time spent in retirement and the price and wage level development significantly affect how large the share of the value of the pension in payment is due to index security (figure above).

If the pension recipient turned 65 between the years 1996 and 2004, his or her descriptor would be placed between the two descriptors in the chart.

 

For example, for a pension that began 30 years ago, the share of pension period index security alone is more than 50 per cent in 2018. In pensions that began already 20 years ago, the share of index security is approximately 30 per cent.

When taking into account index security from the active period as well as the retirement period, the amount of an earnings-related pension that has been running for a long time would amount to only one tenth of the actual amount being paid if index security was not applied.

 

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