what is a replacement rate 
a replacement rate is the percentage of a worker s pre retirement income that is paid out by a pension program after the worker retires in pension systems that pay workers substantially different payouts based on their differing incomes the replacement rate is a common measurement that can be used to determine the effectiveness of the pension system more generally a retirement replacement rate is the percentage of a person s pre retirement income that will be needed for the person to maintain the desired standard of living after retiring the calculation should be based on all sources of income including social security pension retirement savings plan and any other sources understanding replacement ratesthe replacement rate also referred to as the income replacement rate serves as a way to measure the percentage of a worker s current income that a particular pension based retirement plan can be expected to produce replacement rates are commonly mentioned in the debate over the u s social security system under social security law replacement rates should target about 40 of the replacement rate for the average retiree 1 as some workers have retirement plans or benefits beyond the social security benefit this replacement rate may only be one portion of the funds available at retirement income replacement needs vary from individual to individual the amount requires an analysis of the standard of living the person wishes to maintain and an understanding of the costs required to maintain that standard for example if two employees earn the same annual pay of 100 000 but one requires 45 000 per year to maintain the desired standard of living while the other requires 60 000 the replacement rates for those individuals will be 45 and 60 respectively replacement rates and pensionspension plans also referred to as defined benefit plans provide a specified benefit to employees often these calculations are based on the number of years each employee has worked for the organization allowing for a certain percentage of replacement rate credit per year of service upon retirement an eligible employee can receive benefits calculated based on the total earned replacement rate as compared to the average annual salary received over a particular period of time while these types of pensions can be offered by a variety of organizations they are more commonly seen today in the public sector such as government employees instead of the private sector 