Spain has a defined-benefit system, meaning that the amounts of members’ contributions are determined by law. Employees contribute according to their earnings and the tax category to which they belong. The amount of a person’s pension is determined by a law which says that the amount payable depends on: the duration of the person’s work history, the person’s contributions during the last 15 years of their working life, and other parameters.

The amounts of the social security contributions and benefits recorded in any given year determine whether there will be a surplus (i.e., contributions exceeded benefits) or a deficit (in the opposite case). Over the past few years, the Spanish social security system has reported surpluses, which have been progressively accrued in the national pension reserve fund. This fund is intended to be used when the amount of the contributions is insufficient to finance the pensions payable.

Yet if we take into account that most of the reserve fund’s assets are public debt issued by the Treasury and purchased by Social Security, then we see that the pension reserve fund is actually an accounting convention that would disappear from a consolidated public-sector balance sheet. In other words, the fact is that the funds are not sitting in a piggy bank that we can simply break open when the need arises.

Thus, when the day comes that the aggregate amount of social security contributions is no longer sufficient to pay pensions in payment—and that day will inevitably come—the government will have to draw upon the income deriving from other taxes in order to defray those amounts.

But that is not all. The Spanish pension system is also facing some specific problems of its own. The first of these is the steady decline in population, halted only by the inflow of immigrants, which has slowed considerably as a result of the recession and has also given rise to its own problems of integration. The models we currently work with provide a highly accurate estimation of the number of individuals who will be 65 years old 20 years from now and predict very reliably the amount of the pension benefits the Spanish state will have to pay in the future. Prior to the recession, these models indicated that the first deficits would appear by 2016, but given the economic situation it would not come as a surprise if the initial difficulties were to emerge sooner.

Another peculiarity of the Spanish system is the rapid change in the level of education. Over the past 20 years, Spaniards’ access to secondary education and higher education has risen substantially, which has changed the makeup of the population. People with higher qualifications earn higher wages and contribute more to the social security system when working. However they also have the right to higher pensions, so the change in the level of education also affects the sustainability of the pension system.

Another determining factor is the amount of the minimum state pension. In this area, there are two questions to consider: one is whether the minimum state pension is high or low in absolute terms; the other is whether the minimum pension is high or low in relation to the average pension. This latter point is where we find the relevant problem of sustainability: it is difficult to know how many individuals are receiving a higher minimum pension than they would be receiving, based on their work history and the rules of the pension system, if that minimum did not exist.

In Spain, the minimum pension presents another major problem related to early retirement. The retirement age is currently 65 years, or earlier for some workers (60 for mutual members and 61 for those contributing under the general regime after 1963). Those who choose to retire before turning 65 are subject to a penalty of 8% per year of early retirement. In other words, if a person retires at the age of 60, their pension benefits will be 40% lower; if they retire at 61, it will be 32% lower, and so on.

Minimum pensions, however, are exempt from penalties, and thus remain the same regardless of whether a worker retires at 65, 60 or 61 years of age. Those who know they will receive the minimum consequently opt for retirement at 60 or 61, and thus avoid paying four or five years of social security taxes, while collecting their pensions for four or five more years, thereby increasing the expenditure of the system and reducing both its income and its viability.

Considering the situation, it is quite clear that the viability of the Spanish pension system is in jeopardy and that there is a need for major structural reforms that force us to rewrite the rules of the system, the amounts of the contributions to social security, and the amounts of the pensions paid. The reform proposals most commonly discussed by researchers and experts are two: 1) increase the number of years taken into account when calculating the pension payable; and 2) increase the minimum retirement ages.

1) Increase the number of years taken into account when calculating a person’s pension. Currently, pensions are calculated by taking into account the contributions made during the last 15 years of the person’s working life. This reform proposes to extend the calculation to the last 30 years, or even expand it to cover the individual’s entire working life.

This measure presents certain problems that were not foreseen by other researchers. Generally, the last few years of a person’s working life are when they receive the highest wages, and thus if the formula were to include the years in which they earned less, the amount of the pension to which they are entitled would be reduced—which is precisely the aim of this reform. However, according to the models that we have studied, this reduction would mean that a significant number of workers presently entitled to pensions above the minimum would earn the minimum pension. And since minimum pensions are exempt from penalties for early retirement, many of these workers will exit the labor market on reaching the earliest possible retirement age, thereby considerably increasing the costs of the system. Thus, this reform would only increase the viability of the system if coupled with further measures such as making the minimum pension also subject to penalties for early retirement.

2) Increase the minimum retirement ages. Life expectancy has increased considerably since the public pension system was created. Yet the normal retirement age of 65 remains unchanged. This has led to progressively rising costs for the pension system. We currently have far more pensioners, who collect pensions for much longer period of time, despite having contributed the same as in the past.

If we were to increase the retirement age, the number of years of contribution would increase and the number of pensioners would decrease. According to the models that we have studied, an increase of three years in retirement ages would be enough to ensure the sustainability of the Spanish system up to the year 2050.

Implementing this measure will require a prior study on how to increase the retirement age, since that would need to be done gradually. The best solution may be to increase the retirement age by one financial quarter each year, which would entail a transition period of 12 years for the reform to be fully implemented.