Net pension replacement rates
Whilst the gross replacement rate gives a clear indication of the design of the pension system, the net replacement matters more to individuals, as it reflects their disposable income in retirement in comparison to when working. For average earners with a full career, the net replacement rate from mandatory pension schemes at the normal retirement age averages 61.4% across the OECD, which is 10.7 percentage points higher than the average gross replacement rate. This reflects the higher effective tax and social contribution rates that people pay on their earnings than on their pensions in retirement, mostly due to the progressivity of tax systems, some tax advantages to pensions and lower social contributions on pension benefits. Net replacement rates vary from under 35% in Australia, Estonia and Lithuania to 90% or more in Greece, the Netherlands, Portugal and Türkiye for average-wage workers. For low earners (with half of average worker earnings), the average net replacement rate across OECD countries is 73.2% while it is 52.8% for high earners (200% of average worker earnings).
The previous indicator of the “Tax treatment of pensions and pensioners” showed the important role that the personal tax and social security contribution systems play in old-age income support. Pensioners often only pay health contributions and receive preferential treatment under the income tax. Tax expenditures and the progressivity of income taxes coupled with gross replacement rates of less than 100% also mean that pensioners have a lower income tax rate than workers. As a result, net replacement rates are generally higher than gross replacement rates.
For average earners, the net replacement rate across the OECD averages 61% for mandatory schemes, from a low of under 35% in Australia, Estonia and Lithuania to a high of 99% in Portugal and over 90% in Greece, the Netherlands and Türkiye (Table 4.4). Moreover, the pattern of replacement rates across countries is different on a net rather than a gross basis.
On average, for average earners, the net replacement rate is 11 percentage points higher than the gross replacement rate (Figure 4.4). The difference is 25 percentage points in Hungary, Portugal and Türkiye with Belgium, the Netherlands, the Slovak Republic and Slovenia around 15-20 percentage points higher. In Hungary, the Slovak Republic and Türkiye, pension income is neither liable for taxes or social security contributions, whilst in Belgium and Portugal they are much lower because of either higher tax allowances or much lower contribution levels.
For low earners, the effect of taxes and contributions on net replacement rates is slightly more muted than for workers higher up the earnings scale. This is because low-income workers typically pay less in taxes and contributions relative to average earners. In many cases, their retirement incomes are below the level of the standard reliefs in the personal income tax (allowances, credits, etc.). Thus, they are often unable to benefit fully from any additional concessions granted to pensions or pensioners under their personal income tax. The difference between gross and net replacement rates for low earners is nine percentage points on average. Belgium, Portugal, the Slovak Republic, Slovenia and particularly Hungary have much higher replacement rates for low earners on a net basis than in gross terms.
The net replacement rate for workers earning 200% of the average is highest in Türkiye at 104%. The lowest replacement rates for high earners are found in Canada, Estonia, Ireland, Israel, Korea, Lithuania, New Zealand and Switzerland where workers earning 200% of the average will receive net pensions that amount to less than 30% of their net earnings when working. In addition to the higher contribution levels in the occupational system for higher earners in Sweden, the net replacement rates are furthermore affected by the fact that pension income and work income are taxed differently and at different rates.
Definition and measurement
The net replacement rate is defined as the individual net pension entitlement divided by net pre-retirement earnings, taking account of personal income taxes and social security contributions paid by workers and pensioners. Otherwise, the definition and measurement of the net replacement rates are the same as for the gross replacement rate. Details of the rules that national tax systems apply to pensioners can be found in the online Country Profiles available at http://oe.cd/pag.
Source: OECD pension models.
Source: OECD pension models.