If you pay into a pension for so many years, but end up living a long time then you will have likely gone through the principal as well as any interest earned. How do retirement systems fund this if you’ve drawn more than you’ve saved over the years?
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The magic of compound interest.
For every $1000 the company puts away for you in your 20s, they end up with about $30,000 if they just set it in an index fund.
This is metered by the payout formula. If you worked 1 year at the company, they might pay you 1% of your salary, but if you worked 45 years, they might pay you 45%.
So, if you worked 45 years, they’ve made 20-30x whatever they set aside in the first 10 years on investments, and so for 2 years of your pay-in your entire out-take is covered. So, they can decrease your salary by 3% and set it aside.
It should be noted that it decreases *dramatically* and you can do this yourself with a 401k/403b/roth ira. Assuming 8% post-inflation and retirement at 65:
|Age|Money In|Money Earned by Fund|
|:-|:-|:-|
|20|$1000|$31,900|
|25|$1000|$21,700|
|30|$1000|$14,700|
|35|$1000|$10,000|
|40|$1000|$6,800|
|45|$1000|$4,600|
|50|$1000|$3,172|
|55|$1000|$2,100|
|60|$1000|$1,400|
|65|$1000|$1,000|
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Say you make $100,000/year and put $3,000 per year into the fund and work at the company the full 45 years.
The fund with 8% growth has $13,914,202. That’s 139 years of your salary, though you were probably making more by the time you retired, a common payout is ~40%, but even if you doubled to $200k and they paid the whole thing, it’d still be 70 years.
It’s remarkably cheap to fund retirement if you start young. You either need a lot of time or a lot of money. Companies also usually have endowments and just company profit that goes to pensions, but big picture if it wasn’t going to pensions, it’d go to salaries, so it’s a salary reduction one way or another.
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