“The government must do something to alleviate the pain of those who have suffered so much,” the socialist president, Ricardo Lagos said in an address to the nation.
“We have to take measures to heal the wounds, not to reopen them.”
Victims stand to receive payments of up to 112,000 pesos ($AUD 243) per month, effectively doubling the pensions of many former victims.
In addition, victims and their relatives will be eligible for free education and health benefits.
The programme, yet to be approved by Congress, will cost an estimated A$89m annually.
President Lagos’s offer comes after he was presented with a new report detailing the testimonies of 35,000 people alleging human rights abuses were perpetrated against them under Pinochet’s military regime.
The investigating commission, chaired by Bishop Sergio Valech, found 28,000 of those claims were credible.
According to human rights campaigners, as many as 3,000 people died for opposing Pinochet’s military regime, which seized control of the country in a bloody coup that overthrew elected left-wing president Salvador Allende.
Mr Lagos said the report showed torture was elevated to the level of a “state-sanctioned institutional practice” and that the brutal violation of people’s rights during Pinochet’s 17 years in power “affected all facets of (victims) lives, as well as those of their family members.”
But the measures have fallen short for some former victims.
“For the reparation process to be complete, the report should not be just put on the internet, but printed and sent to all schools in Chile, to all public libraries,” said Mireya Garcia, a human rights activist whose brother is among 1,200 dissidents still unaccounted for.
“We also want a memorial to the victims and a monument with the motto ‘Never again torture in Chile’.” Ms Garcia said.
Jorge Saez, 51, was arrested in 1974 for his communist activism as a university student.
He said he was repeatedly tortured and forced into exile, only returning to Chile in 1986.
“I feel a tremendous frustration after hearing the president and his proposal,” Mr Saez said.
“Not because of the money, but because we heard nothing about justice, about punishing the torturers, about making sure this will never happen in Chile again.”
Augusto Pinochet, also the subject of an investigation for alleged corruption, has never been brought to trial to face allegations of human rights abuses.
Despite being stripped of immunity from prosecution by Santiago’s appeal court in 2000, Pinochet has evaded legal action claiming to suffer mild dementia which prevents him from mounting a defence.