How does the pension system work in Spain

We explain how public pensions work in Spain

The public pension system in Spain works under five principles:

1. Allocation principle: the social security payments of active workers finance the benefits that exist at that time.

2. Contribution proportionality principle: the amount of the benefits will be directly related to the amounts contributed to the public system and to how long the contributions are carried out for.

3. Universality principle: Anyone who has not contributed to the system will be able to access the non-contributor level of benefits in order to cover the most basic needs.

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4. Public management principle: The Social Security system will be managed and financed by public institutions.

5. Adequacy of benefits principle: The amount of the benefits must be sufficient to ensure the protected needs.

The body responsible for managing this system is the Social Security Institute, which also safeguards the assistance for workers that have lost their employment or that cease work due to illness or disability. Let's see in more detail how pensions are organized and distributed in Spain.

A mutual fund for all workers

Welfare benefits, such as the public retirement pension, are recognized and protected by article 41 of the Spanish Constitution: “The public authorities shall maintain a public system of Social Security for all citizens, which guarantees sufficient assistance and social security benefits in the event of situations of need, particularly in the event of unemployment. Supplementary assistance and benefits shall be unrestricted”.

To maintain this right, unlike other countries in which each worker makes monetary contributions to their own private and individual pension plan, in Spain the public pension system is funded by contributions from all workers; they contribute, through their Social Security payments, to a so-called ‘Single Deposit’ from which the money comes to pay for the contribution-level public retirement pensions of workers that are already retired. It is this inter-generational solidarity, to which we must add the inter-regional solidarity, that guarantees that all the citizens of Spain have the right to their retirement pension, regardless of the region they live in.

Access to the public retirement pension

When it comes time to retire, which in Spain as of 2016 is at the age of 65 years and four months (65 for workers who have less than 36 years of contributions), the worker becomes eligible for a lifetime monthly pension of an amount that will depend on the base amounts on which they have made contributions in the final years of their working life (the last 19 years in 2016 and the last 25 years from 2022 onward), as well as the years of contributions and the kind of retirement (standard, early or deferred).

This happens as long as you meet the eligibility requirements for this pension:

1. Proof of at least fifteen years of social security contributions.

2. Proof of a minimum of two years of social security contributions in the fifteen year period immediately prior to retirement.

It is important point out that the standard retirement age will change in the coming years, following a legislative reform that will be gradually increasing the age from 65 years and four months to 67 years by 2027. Anyone that can prove at least 38 years and 6 months of social security contributions will still be able to retire without any penalty at 65 years of age.

The reason behind this is to do with the sustainability of the system, which, as we have seen, is based on the number of active workers, the number of welfare beneficiaries and the amount of contributions and benefits, and more.

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Sustainability of the system

Put simply, in order to keep the public pension system sustainable, there must be more active workers than there are pensioners — the continuity of the system relies heavily on the population pyramid. However, in recent years the number of workers has reduced as a result of the high rate of unemployment, while the number of pensioners has increased. This, together with an evolution of the population in which the trend indicates that there will be increasingly more elderly people and that they will live longer, has cast doubt over the sustainability of the system.

Similarly, newly retired people are eligible for a higher average pension because they have made contributions based on higher incomes, while new contributors join with lower incomes.

A clear example of this situation can be seen in the Social Security Reserve Fund, which is a "piggy bank" that has been holding the Social Security surplus since 2000. This fund has been used in the last five years due to the fact that the system is spending more than it receives, that is, the active workers alone can no longer sustain the public pensions.

Therefore, current workers are contemplating a future in which their quality of life in retirement based on their public pension may be poorer than anticipated. As such, savings and investment products such as pension plans can be an appealing option to bump up your retirement income.

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