This article analyzes the variables that must be taken into account when deciding to increase the contribution base, considering its calculation for the retirement pension.
The decision to increase the contribution base is important at the age at which it begins to be included in the pension calculation.
How much contribution should be made to Social Security is one of the great dilemmas of the self-employed. The peculiarity of this group (each person can choose their base between a minimum and a maximum) leaves the difficult task of determining the amount of retirement savings they wish to make in the hands of the worker themselves. The dilemma is obvious: pay more now to collect a larger pension in the future or save and rely on private coverage as a complement.
Given that the system allows individual free choice of contribution bases, the decision is not easy: not only how much (between the minimum and the maximum that the Government sets each year) but also at what age one should start contributing more to try to maximize future collection.
All these decisions imply "a very high degree of uncertainty", according to the recent report by Cunef and Fedea entitled Contribution and pension regulations for self-employed workers in Spain: Are life cycle savings encouraged? The choice of the amount, these experts conclude, "requires a large amount of information and the ability to predict the future evolution of numerous individual variables (future income and expenses of the activity) and aggregate variables (pension variables, interest rates)." .
Collect a higher pension: at what age does the base change?
A large part of the self-employed contribute for the minimum base. According to the Fedea report "the minimum contribution base is, by far, the base most commonly chosen by our self-employed workers (regardless of their sector of occupation or personal characteristics)." Data from the Ministry of Labor indicates that their 86% chooses the minimum base, which in 2019 stands at 944.40 euros per month.
Up to a certain age, "there is no incentive to contribute above that minimum base," states the Fedea study. That is, the decision of how much to contribute begins to be decisive from the age at which the basis chosen by the self-employed begins to be included in the regulatory basis for calculating the pension. This is what the Fedea report calls “optimal age for first listing.” But what is the optimal age for self-employed people? It depends on many factors, including the worker's current age, when he or she wants to retire, and what public pension he or she aspires to receive. And that is why this age is individual and will be different for each of the workers. (See table).
According to this study, "there is nothing that rewards contributing above the minimum base in the years that are not taken into account to calculate the pension." That is, it would be optimal for all self-employed workers to contribute for the minimum base in the years that are not included in the regulatory base of the pension (those far from retirement age). Contributing for higher bases at these ages “leads to paying higher social contributions but has no impact on the pension.” Thus, if a person plans to retire at age 67, this means that they should begin to consider higher bases starting at age 42.
But it must be taken into account that since 2011, the age limit at which the self-employed can freely choose their contribution is 47 years. In addition, the legal retirement age is gradually being raised until it reaches 67 years in 2027. And the number of years included in the regulatory base is also being expanded, which will be 25 years in 2021. All of this complicates the calculations of the self-employed: theoretically, between 42 and 47 years is the age at which you should decide when to raise the base.
As an example, a self-employed worker who is 35 years old in 2019 (he was born in 1984) must first consider what age he wants to retire. If you aspire to retire at 67 (legal age when your turn comes), you should keep in mind that your Social Security payments will be included in your pension from the time you turn 42. Although you will have until the age of 47 to be able to freely change your base.
Even so, "there are few self-employed workers who choose high contribution levels" at age 47 and many economists "have attributed this to a rational strategy based on the minimum pension." And he attributes this to the worker's expectation that the minimum pension will rise more than the minimum bases. That is, there is a range of contribution bases above the minimum base in which contributing an additional euro "reduces the self-employed person's life cycle wealth."
The normal thing, the report points out, is that "there is no incentive to increase the contribution, since contributions in excess of the minimum do not increase the pension." Furthermore, the minimum pension is high enough to generate “very high implicit rates of return (the highest in the system).”
Until the 2011 Social Security reform, the strategy for the self-employed "was really simple", given that they could freely change their contribution base until they turned 50. Therefore, the optimal age to start contributing above the minimum base (in case you wanted to collect a higher pension) was similar for everyone, and coincided with those 50 years (the result of combining 65 years of retirement age with the retirement period). 15 years that the regulatory base of the pension was taken into account). The best way to optimize was to "contribute most of your working life for the minimum base and change to the highest possible contribution in the years included in the regulatory base."
Collect the 100% pension: how many years should you contribute?
Another question that the self-employed person must ask themselves is how many years they must work to be able to collect the 100% pension. In this aspect, the self-employed worker is no different from the salaried worker.
Firstly, to receive a contributory pension, the worker must have contributed for at least 15 years. But with that period, the pension collected is very low: a 50% is applied to the regulatory base.
This is because the amount of the retirement pension is the result of applying a percentage to the regulatory base based on the years that the worker has contributed. Thus, for the first 15 years of contributions, the 50% will be applied and from year 16 of contributions, 0.19% will be added for each additional month. For those that exceed month 248, 0.18% is added.
In this way, for example in 2019 it will be necessary to have contributed 35 years and six months to be able to retire with the 100% of the public pension at the legal age, that is, 65 years and eight months. If you want to retire at 65 years of age, you will need to have contributed for 36 years and 9 months.
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