Pension systems: Who pays whose pension

Every month, part of your salary goes to retirement. But where exactly does that money go?

There are two main answers. And they tell completely different stories.

The first is called pay-as-you-go. The money you pay in today pays today's retirees.

It is not set aside for you. It goes straight from one generation to the next.

In exchange, you get a promise: when you retire, the people working then will pay for you.

So everything depends on one ratio: how many workers for each retiree.

For the example, say a pension equal to half the salary. With two workers per retiree, each pays in a quarter.

If it falls to one and a half workers per retiree, the contribution rises to a third of the salary. For the same pension.

It is the heart of the debate in ageing countries. Fewer births, longer lives, and the ratio falls.

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The second answer is funded pensions. Your money is invested, in your name, and grows until you leave.

Here, no dependence on the next generations. But another one: on markets and compound interest.

A crisis just before retirement, and the pension melts. Pay-as-you-go carries a political risk, funding a market risk.

Many countries mix the two. A pay-as-you-go base, and a funded layer on top.

There is also a way of counting rights: points. Each euro paid in buys points.

Take values for the example: a point costs twenty euros, and pays one euro forty a year in retirement.

Two thousand euros paid in a year is one hundred points. Forty years, four thousand points.

Four thousand points times one euro forty: five thousand six hundred euros of pension a year.

But careful: these two values are not set in stone. They are fixed every year.

If the point value falls to one euro thirty, the pension falls to five thousand two hundred euros. With nothing else changed.

The conversion rate is the real hidden lever of a points system.

That leaves the big political question: age and length. Leaving later, or paying in for longer.

Both come to the same thing: more years paying in, fewer years of pension. That is why it is so hotly debated.

To balance a system, there are only three dials: pay in more, receive less, or leave later.

Every reform moves at least one. Knowing which one tells you what it costs you.