Reduction coefficient – What is it, definition and concept

The reducing coefficient is a coefficient that indicates the economic penalty suffered by a certain pensioner for having retired early. This, because the pension will be charged for more years, so the amount must be reduced.

When we talk about the reduction coefficient, or the reduction coefficient, we are always referring to the early retirement pension and pensioners. Well, there may be financial assets subject to reducing coefficients, while we can find this coefficient in other fields.

But usually, the reducing coefficient is how economists in Spain call the coefficient that indicates the economic penalty suffered by that person in their pension upon retirement before having reached the legal retirement age.

Retirement pensions are generally received after you have completed your working life. That is, a pensioner can collect it upon reaching the legal retirement age established in each territory, in Spain for example it is 67 years.

But you should know that to receive this pension, this pensioner must have contributed for a certain number of years. For example, if in Spain the pensioner wants to collect 100% of the pension, he must have contributed a minimum of 35 years.

But it may be the case that we have not reached the legal retirement age, but we already have that right to a pension. Let’s imagine a person who started working at 18, continuously, and today is 53.

This person would be entitled to a pension, but they still have 14 years left to reach retirement age. However, given that he has already completed the years necessary to receive a pension, he could retire early, even if he has not reached that legal age.

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In the same way, if the person were forced to retire early involuntarily (due to an accident, for example), this would also have reducing coefficients.

What is the reducing coefficient for in early retirement?

Let’s imagine a person who retires at the legal retirement age (67). This person, taking into account that life expectancy is 82 years in Spain, would be receiving the pension for approximately 15 years.

However, going back to the previous example, let’s imagine that person who retires at 53, and who must collect his pension for 29 years, taking into account the same life expectancy.

Thus, we find two pensioners who would collect 100% of their pension, but one would do so for 15 years while the other estimates to collect said pension for many more years (29).

For this the reduction coefficient is applied. Well, with early retirement, many pensioners could receive larger and unfair pensions if these coefficients do not balance this situation.

The reduction coefficient as a sustainability mechanism

As we have seen in the example, there are many reasons that could motivate a worker, who has already contributed for years to collect a pension, to retire and live with that pension that he receives from the State.

However, life expectancy, which stands at 82 years, grows over time. In the same way that many trades, thanks to technology, allow citizens to work longer and retire later.

If the reducing coefficients were not applied, pensioners could retire early and collect their entire pension, motivating them to carry out this practice. A practice that harms the pension system of a country.

But, since the reducing coefficients are applied, the worker is not motivated to advance his pension. In this way, the worker continues to contribute more years to the system, promising him a more attractive pension upon reaching the legal retirement age.

Reducing coefficients in the anticipated pension

As an example, we are going to see the reducing coefficients applied by Social Security in Spain in a scenario in which a worker retires before reaching the age.

Thus, the following table lists the reducing coefficients, these reflecting the percentage of penalty that is applied based on the characteristics of the worker.

To understand this table, we must know what each column means.

First of all, the first column refers to the pension months that we anticipate. That is, the time that remains to retire at the time we retire.

Let’s imagine that we retire 24 months before our ordinary retirement arrives, which would be 2 years before.

In this case, we see that the penalty is between 14.67% and 11%.

Let’s imagine that we have been trading for less than 44 years. In this case, we must calculate what the 13.33% reduction on the pension is equivalent, and must subtract the result when we obtain it.

As we can see, depending on the years of contributions and the years that we have left to retire, this penalty will be higher or lower.

Therefore, we are talking about a very simple process that, as I said, pursues the objective of making the different pension systems in the world sustainable. Given that, if life expectancy continues to increase and pensions are not reduced, pensions would be increasingly expensive and unsustainable, taking into account the demographic structure shown by most developed economies.