1. The pension of a retired person as a proportion of income when in employment. The higher is the replacement ratio the stronger is the incentive to retire. Conversely, a worker may postpone retirement if the current replacement ratio is too low. A target replacement ratio is used as a guide in pension planning.

2. The income of an unemployed worker as a proportion of income when in work. If this ratio is too high it gives a disincentive to accept job offers: allowing for the cost of travel to work and other working expenses, and the value of leisure, a replacement ratio below 1 is needed to maintain incentives to work. Too high a replacement ratio may perpetuate unemployment, while too low a ratio inflicts suffering on the unemployed and their families. In practice replacement ratios vary widely, as income support for the unemployed is based on family size while wages are not.