How is the amount of income pension determined?
As implied by the name, income pension is based on an individual’s income and the amount of pension contributions (16 percent of pension-qualifying salary) paid in throughout the individual’s working life. For every krona paid in contribution to the system by or for an individual, that individual receives the same amount of pension credit. The value of these pension credits are indexed every year, not by the rate of return on the AP funds’ assets, as many people believe, but by the income index, an interest rate equivalent to growth in the average income in Sweden.
In other words, the amount of income pension is determined mainly by the amount of income earned over the individual’s working life and changes in the average income in Sweden over the period until pension is drawn. But the stability of the pension system is also of importance.
How has system stability been ensured?
When the new pension system was designed, one priority was to ensure its long-term stability. The system was therefore equipped with a built-in mechanism known as automatic balancing. If the assets of the pension system fall below its liabilities, the balance mechanism is activated to prevent disbursements from exceeding the long-term capacity of the pension system. In the event of automatic balancing, the pension credits are indexed at a rate lower than the income index, which means that pension benefits will increase at a somewhat lower rate until the situation improves.
Are the AP funds the only assets in the system?
No, the latest figures from the Swedish Social Insurance Agency (at year-end 2007) show that the combined assets of the AP funds make up less than 13 percent of total assets in the pension system. The largest asset is the contribution asset, i.e. the value of future net contributions to the system.
How important is the contribution asset for future pensions?
It is critical, since it makes up nearly 87 percent of the pension system’s assets.
What affects the size of the contribution asset?
The size of the contribution asset is determined mainly by the employment rate in Sweden, as well as the number of years worked. Two other key factors are the birth rate and immigration. Political decisions that affect these factors therefore influence the size of income pension benefits.
What role do the AP funds play?
The AP funds represent a minor share of total assets in the pension system, around 13 percent. But although the funds’ assets are modest in relation to the total pension liability, the returns of the AP funds influence the level of pension benefits. The higher the return generated by the funds, the lower the risk of a deficit in the pension system and probability that the balance mechanism will be activated. For individual years, such as 2004 and 2005, return on the buffer fund assets can be decisive in determining whether or not automatic balancing is activated.
Will the balance mechanism be activated in 2010?
At the time of the previous measurement (year-end 2007) the surplus in the pension system was very small, at only SEK 18 billion, compared to the system’s total liabilities of SEK 7,000 billion. In view of developments in both the financial market and real economy in 2008, the Swedish Social Insurance Agency has calculated a balance ratio of 0.974 for 2010, which means that the pension balance mechanism will be activated.
Status of the pension system at the latest reporting date (end of 2007)
How does balancing work?
If balancing occurs, pension disbursements will be reduced and indexation of earned pension credits will be lower than the normal rate of indexation by the income index. How much lower depends on the degree to which pension liabilities exceed assets. If liabilities exceed assets by 1 percent, the rate of indexation will be 1 percent lower than it would otherwise have been.
Will automatic balancing affect everyone?
Anyone who has ever been employed in Sweden has pension credits in the system and would therefore be affected by balance. Current pensioners will receive somewhat lower pension benefits and the pension credits of those still working will be indexed at a somewhat lower rate than if balance had not taken place. Indexation of pension rights and benefits will be re-established at the normal level when system balance is restored.
What are the implications for the average pension in 2010?
It is impossible to say, since figures from the Swedish Social Insurance Agency are not available yet. But based on the assumptions made by the National Institute of Economic Research in its December forecast:
- an average salary/wage growth rate of 0.5 percent in 2009
- pension system liabilities exceeded assets by 2.6 at year-end 2008
For a pensioner with an income-based pension of SEK 12,000 per month, the amount of benefits will be reduced by an estimated SEK 132 per month even if the balance mechanism is not activated. With balancing, the reduction will instead be SEK 444 per month.
In other words, the amount of reduction is due partly to the negative return on the AP funds’ assets, but also to a very low anticipated rate of income growth in Sweden during 2009.
