In this Note, we highlight:

• Global population aging is challenging pension systems globally and will challenge them even more in the future. Setting a target replacement rate is the first step to strengthening their benefits and sustainability, for the following reasons:

1. To create a benchmark for assessing the adequacy of pensions,
2. To adjust society’s expectations and encourage an active role for workers,
3. To facilitate parametric adjustments required by pension systems and
4. To generate better communication with workers regarding the construction of their pensions and the decisions they can take to correct any shortcomings in their stated objectives.

• The replacement rate is the relationship between pension amounts and workers’ income during working life. There are several pension amount and income alternatives to the considered. There is no unanimity regarding the methodology for calculating the replacement rate; for example, whether income should be adjusted for inflation, or how periods with no contributions should be considered for calculating the average income. These definitions are very important for Latin America, due to its inflationary history and high informality rates.
• The target replacement rate defined by each country must be consistent with the parameters of its pension system (so as not to generate false expectations) and should not be considered an enforceable individual promise or guarantee, but rather an estimate of the average pensions that workers will receive, which will vary depending on the savings habits and work history of each individual.
• The target replacement rate and the main parameters of the pension system must be established in a broadly participatory process, with strong technical support, to achieve social and financial sustainability.
• Knowing the replacement rate of the average worker in the country will not suffice for individual members. They would rather know their expected replacement rate, hence the mandatory PAYGO or individually funded savings system should inform them of their progress in constructing their pensions.