Pension puzzle

© David Rooney

Governments have to reform pensions, not just to make them affordable, but sustainable and adequate as well. A major challenge, but there are solutions.

When Antonio Todde died in 2002, he was preparing to celebrate his 112th birthday. Then the oldest man in the world, Mr Todde claimed his longevity was the result of hard work and a daily glass of local red wine. His homeland of Sardinia is known for its concentration of centenarians: both Mr Todde’s parents had lived well into their 90s, and his four children were all alive at the time of his death.

Populations are ageing not only in Sardinia, but all over the world. According to OECD projections for the year 2050, on average across the OECD area, 100 people of working age will have to support 137 children and people over 65; for the EU, the ratio will be even worse: 100 workers will have to support 142 inactive people. The task for policymakers is enormous as they try to keep retirement income provisions adequate and sustainable over the next few decades, faced with such rapid population ageing.

Reforming pensions in light of these demographic changes, with the twin objectives of adequacy and sustainability, has become one of the biggest challenges for social policy. Allowing in more immigrant workers, encouraging more women to work, and taking measures to increase productivity—all of this can certainly help to finance pensions in the short term, but it is not enough. Reforms that reduce public pension liabilities, diversify the sources of income in retirement and lengthen the working life seem inevitable, ending the early retirement trend of past decades.

Most countries have woken up to the need to plan for an ageing society. But reforms are far from easy. They involve long-term policy decisions under uncertain conditions, and often the likely impact of these decisions on the well-being of pensioners today and tomorrow is not spelt out clearly. Pension reform often brings people out onto the streets, and forces governments into retreat. Getting reforms right, therefore, demands involving the public, and that means current as well as future pensioners.

Is there a perfect pension system? Unfortunately, the answer is no. Pension systems are moving targets. They need to adapt to changing economic and social conditions, while at the same time keeping promises that were made to workers in the past. Getting a grip on pension systems and identifying best practices is not easy. Benefits and retirement income depend on a wide range of factors, such as retirement ages, required years of service, and benefit calculation methods. Also, life expectancy at retirement differs from one country to another, making it hard to compare generosity and affordability across countries.

Much policy attention to date, including at the OECD, has focused on the fiscal aspects of the ageing problem, for example, how ageing would affect public expenditures and how much tax burdens would grow. Much less attention has been paid to the impact of reforms on the adequacy and distribution of pensioner incomes, particularly in view of preventing pensioner poverty.

The OECD has developed a framework to assess these impacts. Pension benefits are projected for workers at different levels of earnings, covering all mandatory pension systems for private-sector workers, including minimum pensions, basic and means-tested schemes, earnings-related programmes and defined-contribution schemes. For the first time, these projections also look at the effects of the personal income tax and social security contributions on living standards in work and in retirement.

Social adequacy

Our analysis shows that workers on average earnings in OECD countries can expect their post-tax pension to be worth just under 70% of their after-tax earnings. Even the countries with the lowest earningsrelated payments (the UK and the US) pay a net replacement rate of around 50% at average earnings. High-income workers at twice average earnings will receive less than 60% net. This means that, on average, fullcareer workers earning average or higher incomes can expect to receive adequate pensions, considering that retirees do not have work-related expenses to cover and that many of them own their homes.

But what about poorer workers, those earning low wages or working part-time? The role pensions play in guarding against poverty in old age cannot be overstated. Low-income workers are a particularly vulnerable group when it comes to retirement income, since they are less likely to have additional private pension arrangements or other personal assets to cash in. The average OECD low-income worker (earning half of average earnings) will receive a net replacement rate of about 85%. At first sight, this looks rather good. But to measure social adequacy, individual pension entitlements are better expressed as a share of average economy-wide earnings.

Using this latter measure, pensions for low income workers look less adequate in some countries. In Mexico, the Slovak Republic and the US, for example, pension benefits can be worth 20% or less of average earnings. In Germany, pensions for low income, full-career workers are worth less than a quarter of average earnings. However, all OECD countries have safety nets in place to protect pensioners from old age poverty. These programmes offer an average minimum retirement benefit for full-career workers of about 30% of average earnings. Pension reforms that cut benefits further for low-income workers will thus result simply in more pensioners having to take up the means-tested programmes, hence robbing Peter to pay Paul in terms of public spending.

Financial sustainability

Are the pensions promises made to future retirees affordable? To answer this question, consider the outcome of the OECD’s new comprehensive “pension wealth” indicator, which works out the lump-sum equivalent of all the pension income a worker can expect to receive, taking into account pension level, retirement age and life expectancy in the respective country.

By this count, Luxembourg has the highest pension wealth. For a worker on average wages, it amounts to 18 times those earnings for men and nearly 22 times for women, reflecting their longer life expectancy. This means that if the government gave each pensioner an upfront payment, it would have to fork out an average lump sum of $587,000 on retirement. That is quite a pension bill to take on. Pension wealth for Luxembourg is nearly treble the average for OECD countries. The lowest levels are found in Ireland, Mexico, New Zealand, the UK and the US, where it is less than six times average earnings.

Two crucial factors for pension wealth are pension age and life expectancy. Clearly, pensions would be more affordable if eligibility ages were higher. The official pension eligibility age in most OECD countries is 65, though it is less than that in the Czech Republic, France, Hungary, Korea, the Slovak Republic and Turkey. The ages at which workers actually retire, however, are much lower in most countries, due to special early retirement programmes, disability schemes, or other paths out of the labour market. Reforms to make pensions more affordable must therefore address not only the standard retirement ages, but tackle the early retirement problem as well.

Higher life expectancy means that pensions have to be paid for a longer time. All things being equal, countries with lower life expectancy—Hungary, Mexico, Poland, the Slovak Republic and Turkey—can afford to pay men a pension that is 10% higher than, say, in Germany or Italy.

France is a good example of the problem in hand when the two factors come into play: French gross replacement rates are below the OECD average for workers who earn between 75 and 200% of the average, yet the pension wealth indicator exceeds the OECD average because the pension eligibility age of 60 is low and French life expectancy is high.

Another strong message from the evidence we have collected is that many OECD pension systems are just not transparent. People do not understand how they work, and often they do not know how to figure out their entitlements. In Sweden, for example, a white-collar worker on around average earnings at end-career could receive as many as five different pensions: an income-tested public pension, an earnings related public pension, a defined contribution personal pension, and two different kinds of occupational pensions. Sweden, to its credit, has taken steps to make things clearer, and other countries are following suit.

There is a particular need to have younger generations understand pension systems better, since their future pensions may depend on the quality of their own financial decisions. Also, a reasoned discussion about pension reform is impossible without clear information. Financial education is now being promoted by the OECD, partly with this new future in mind.

The urgency is greatest for today’s 40-50 year-olds since their entitlements are being scaled down, but they have fewer years to adapt to the new systems than younger generations. If you are one of them, and if you hope to beat Mr Todde’s longevity record, prepare yourself to work longer, and start planning for your retirement income now. And don’t turn your nose up too quickly at that daily glass of red wine.

References

OECD (2005), Pensions at a Glance: Public Policies across the OECD, forthcoming.

©OECD Observer No 248, March 2005




Economic data

GDP growth: +0.6% Q2 2018 year-on-year
Consumer price inflation: 2.9% Sept 2018 annual
Trade: +2.7% exp, +3.0% imp, Q4 2017
Unemployment: 5.2% Sept 2018
Last update: 13 Nov 2018

E-Newsletter

Stay up-to-date with the latest news from the OECD by signing up for our e-newsletter :

Twitter feed

Suscribe now

<b>Subscribe now!</b>

To receive your exclusive paper editions delivered to you directly


Online edition
Previous editions

Don't miss

  • Globalisation will continue and get stronger, and how to harness it is the great challenge, says OECD Secretary-General Gurría on Bloomberg TV. Watch the interview here.
  • OECD Secretary-General Angel Gurría with UN Secretary-General António Guterres at the 73rd Session of the UN General Assembly, in New York City.
  • The new OECD Observer Crossword, with Myles Mellor. Try it online!
  • Watch the webcast of the final press conference of the OECD annual ministerial meeting 2018.
  • Listen to the "Robots are coming for our jobs" episode of The Guardian's "Chips with Everything podcast", in which The Guardian’s economics editor, Larry Elliott, and Jeremy Wyatt, a professor of robotics and artificial intelligence at the University of Birmingham, and Jordan Erica Webber, freelance journalist, discuss the findings of the new OECD report "Automation, skills use and training". Listen here.
  • Do we really know the difference between right and wrong? Alison Taylor of BSR and Susan Hawley of Corruption Watch tell us why it matters to play by the rules. Watch the recording of our Facebook live interview here.
  • Has public decision-making been hijacked by a privileged few? Watch the recording of our Facebook live interview with Stav Shaffir, MK (Zionist Union) Chair of the Knesset Committee on Transparency here.
  • Can a nudge help us make more ethical decisions? Watch the recording of our Facebook live interview with Saugatto Datta, managing director at ideas42 here.
  • The fight against tax evasion is gaining further momentum as Barbados, Côte d’Ivoire, Jamaica, Malaysia, Panama and Tunisia signed the BEPS Multilateral Convention on 24 January, bringing the total number of signatories to 78. The Convention strengthens existing tax treaties and reduces opportunities for tax avoidance by multinational enterprises.
  • Rousseau
  • Do you trust your government? The OECD’s How's life 2017 report finds that only 38% of people in OECD countries trust their government. How can we improve our old "Social contract?" Read more.
  • Globalisation’s many benefits have been unequally shared, and public policy has struggled to keep up with a rapidly-shifting world. The OECD is working alongside governments and international organisations to help improve and harness the gains while tackling the root causes of inequality, and ensuring a level playing field globally. Please watch.
  • Checking out the job situation with the OECD scoreboard of labour market performances: do you want to know how your country compares with neighbours and competitors on income levels or employment?
  • Trade is an important point of focus in today’s international economy. This video presents facts and statistics from OECD’s most recent publications on this topic.
  • The OECD Gender Initiative examines existing barriers to gender equality in education, employment, and entrepreneurship. The gender portal monitors the progress made by governments to promote gender equality in both OECD and non-OECD countries and provides good practices based on analytical tools and reliable data.
  • Interested in a career in Paris at the OECD? The OECD is a major international organisation, with a mission to build better policies for better lives. With our hub based in one of the world's global cities and offices across continents, find out more at www.oecd.org/careers .
  • Visit the OECD Gender Data Portal. Selected indicators shedding light on gender inequalities in education, employment and entrepreneurship.

Most Popular Articles

OECD Insights Blog

NOTE: All signed articles in the OECD Observer express the opinions of the authors
and do not necessarily represent the official views of OECD member countries.

All rights reserved. OECD 2018