Promised and Actual Benefits in Mexican Social Security for the Transtion Generation

Abstract

This paper provides a set of measurements of the actual benefits and costs of the general old age retirement plan provided to individuals by the Mexican pension system (MPS), which is necessary to evaluate the decisions by workers to contribute to social security (i.e. work in the formal sector) and to retire. The MPS offers two basic plans. One is a defined benefit plan, available only to those registered before July 1997. The other is a defined contribution plan and is the default mandatory plan for all active workers. We compare benefits and costs under each plan. The “promises” of the original legislation (the benefits under a non-hyperinflationary environment) have resulted in extremely high benefit-cost ratios mainly due to the increase in survival probabilities after retirement (we use the 1951 actuarial evaluation to make the comparison). A consequence is that among workers with the option of receiving the benefits of the new or the old laws, very few will choose the new one under a non-inflationary environment. While inflation has historically reduced the benefits of the old law to a very large degree, the levels of inflation and low interest rates associated to the Great Recession mean that benefits under the old law have become very attractive; for the same reason, the tax on earnings after the mandatory retirement age have become so high that any eligible worker is expected to retire as soon as they legally can. Another variable of significance to determine benefits is the density and timing of contributions over the life-cycle; this feature of the old law (which applies roughly to those retiring until 2042 assuming a potential work history of 45 years) may promote a return to the “formal economy” by workers near retirement age in the following decades, with the purpose of “recovering” entitlement to a pension.

Keywords: Mexico, Social Security, Pensions

JEL Classification: J26, H55, O17