Social Security

The public pension system in the United Kingdom differs significantly from its peers in continental Europe.  First, private and occupational pensions play a much larger role in retirement than in the rest of Europe.  Secondly, UK projects that public pension savings will actually decrease as a percentage of GDP (from 4.5% in 2000 to 4.1% in 2050) despite an aging population.  This is due to a decrease in benefit generosity and a push for more individuals to self-insure for retirement.  

Pensions are financed through an 23.8% payroll tax on weekly earnings between £89 and £591 (11% paid by the employee, 12.8% paid by the employer).  In 1968, 80% of males between the ages of 60 and 64 were in the labor force, but now this has dropped by 1996 to just under 40%. 

First Tier: The Basic State Pension

This is a flat-rate contributory benefit payable to men over 65 and women over 60 (gradually increasing to 65 for women by 2020). To qualify for the £73 weekly benefit, individuals must pay into the system for 90% of their working life.  There is no mean-testing for this program, and delaying the receipt of benefits by one year will increase weekly payments by 10%. 

Second Tier: SERPS, Occupational and Personal Pensions

The State Earnings Related Pension Scheme (SERPS) was introduced in 1978 and pays a pension equal to a fraction of an individuals qualifying annual earnings each year since 1978.  Originally it aimed to replace 25% of an individual’s best twenty years’ earnings (up to a limit), but subsequent cuts have move the replacement rate to 20%.

Individuals can elect to opt out of the SERPS program and instead participate in private pensions (an individual retirement account) or an occupational pension.  Occupational pensions currently cover 45% of all workers.  Since 1988, individuals could also leave SERPS and their occupational pension in favor of a private savings scheme.  By the mid-1990s one-quarter of all employees had taken out a personal pension.  Blundell, Meghir and Smith note that “there is a serious issue over the number of older workers who were ‘mis-sold’ personal pensions by financial advisers who wrongly advised them that they would be better off leaving their occupational pension scheme.” It is not surprising that 22% private-sector occupational schemes plans are defined contribution (or a defined benefit/defined contribution hybrid) as compared to only 2% in the occupational schemes in the public sector. 

Other Programs

The state also has a Minimum Income Guarantee program.  This is a flat-rate, noncontributory, means tested program to help those with little income.  All individuals aged 60 and older who are unemployed receive the Minimum Income Guarantee.  The incapacity benefit is for disabled individuals.  One must undergo a medical examination by a general practitioner (GP) and be certified unable to do any work to receive this benefit. 

For the average Spaniard, going into retirement means collecting a public pension and nothing else.  In 1990 less than 5% of the employed population had a private pension; while this figure has risen to 30% in 1999, still less than 1% of the population derives more than 10% of their retirement consumption needs from private savings or private/employer pensions.  Public Pensions expenditures currently account for 9.5% of annual GDP; this compares to 4.5% of annual GDP spent on Social Security in the U.S. in 2002.

The pattern of Labor Force Participation in Spain is similar to that of France, Germany and Italy.  Just under half (46.5%) of the population retires by age 60, although reform efforts have attempted to slowly increase the de facto age of retirement. 

Social Security

There are a variety of Social Security schemes but the largest is the Régimen General de la Seguridad Social (RGSS) which covers about 70% of all workers.  Special programs for specific classes of workers include: Régimen Especial de Trabajadores Autónomos  (RETA) for the self employed, Régimen Especial Agrario (REA) for agricultural workers, and the Régimen Especial de Trabajadores del Mar (RETM) for sailors. 

The RGSS plan is a pay-as-you-go system and contributions are 28.3% of gross income (23.6% paid by the employer and 4.7% paid by the employee).  Entitlement to an old age pension requires 15 years of contributions and is conditional on having reached 65 years old.  Pensions are paid out as follows:

• Pension=a*BR 

‘BR‘ is the base reguladora which is calculated by summing an inflation adjusted measure of earnings in the last 96 months before retirement dividing this number by 112.  Those with more than 15 years of service receive a value of ‘a’ which increases from 0.5 as the number of years of service increases and is capped at 1 for those with 35 or more years of working.  Thus, people who worked over 35 years can expect to have about 85% of their average real earnings replaced through the public pension system–subject to a pension minimum and maximum. 

Early Retirement

Under the RGSS, early retirement is available but individuals are charge a penalty of 8% for each year retired under 65.  Some individuals in hazardous jobs (railroad workers, airline workers, and of course bullfighters) or workers laid off for industrial restructuring can retire at age 60.  These groups represents about 10% of early retirees.  For government workers, the Régimen de Clases Pasivas (RCP) allows workers to retire at age 60 if they have accumulated enough work experience.

A more common means to reach retirement is through unemployment insurance (UI).  The UI program in Spain ranges between 120 and 720 days, however, a special program exists for those aged 52 and above.  This ‘UI 52+’ program includes those who a) would otherwise be eligible for a pension, except for their age, and b) have an income below 75% of the monthly minimum wage.  The benefits are paid until the individual reaches RGSS eligibility at age 65 and are set at 75% of the monthly minimum wage.  Other individuals elect to go on early disability–which involves a complicated set of eligibility rules which will not be discussed here.

While France, Germany and Italy struggle to reform their gigantic old-age pension system, in the Netherlands the problems are not nearly as acute.  The Dutch have a Social Security system, but it is not as large as in the countries to its south.  A large portion of the a Dutch individual’s pension comes from their employer; thus the fiscal strain on the government is not as severe.  On the other hand, the Netherlands ranks only behind Italy in terms of the amount of individuals between ages 56 and 65 who are out of the labor force.  This is mostly due to the fact that workers can leave the labor force and rely on the generous Dutch safety net (Unemployment Insurance, Disability, etc.) to replace the majority of their income until they reach the age for Social Security eligibility.

Pensioen (State Old-Age Pension) 

The Dutch social insurance (sociale verzekeringen) program for its state Old-Age Pension (Pensioen) is a flat rate benefit that all residents receive after they have reached 65 years old.  The rate is generally 1/2 the after tax statutory minimum wage (minimumloon), with supplements for single individuals and for married couples with one spouse who is younger than 65.  This way, all individuals are assured at least a living standard of a minimum wage worker, which is about €1350 per month ($20,700 USD/year).  This pay-as-you-go system is financed through a 17.9% payroll tax up to a maximum and pensioen expenditures account for 5% of GDP.

Other Programs

Although the official retirement age in the Netherlands is 65, a variety of other programs allow workers to retire much earlier.  Disability insurance (DI) “guarantees employees who lost more than 80 percent of their earnings capacity a benefit equal to 70%…of their daily wage (up to a maximum).”  In the 1980s, this program was such a popular means for employers to get rid of less productive elderly workers that the Dutch government had to reduce the benefit (the benefit was 80% of wages before 1985) and increase the stringency of the eligibility requirements. 

Unemployment benefits (UI) are a less desirable means of getting to early retirement, since benefits are of limited duration.  For people aged sixty of above, however, one can expect to receive UI benefits equal to 70% of their prior earnings up to age 65. 

Private Pensions

Almost 80% of Dutch male residents receive a pension from a private employer or occupation group by the time they reach age 65.  In fact, over half of dutch male residents receive a private pension between the ages of 60 and 64.  Early retirement (ER) was common during the 1980s as a means to reduce unemployment, but as the costs of ER plans have increased and unemployment has dropped to 5.8% as of May 2006, flexible retirement plans are more common where benefits increase as the age one chooses to retire rises.

Overall, the Netherlands has a relatively minimal public pension system (compared to other OECD countries), but generous social welfare benefits and private pensions have made early retirement an attractive option for many Dutch. 

Japan is an incredible success story.  After so much suffering in World War II, this country now has the second largest economy in the world and the longest life expectancy of any country in the OECD. This success however, may become a fiscal nightmare in the future. In 1998, 16.2% of the Japanese population was 65 or older (about the OECD average), but by 2050 this number will jump to 32.3%. Spending on public pensions accounted for 9.3% of GDP in 1997 and this number is only expected to increase. The 1994 Pension reform attempted to resolve some of the fiscal problems facing the nation. Benefits were to be reduced 5%, eligibility for KNH (see below) benefits was to increase from age 60 to 65, and wage indexation of benefits was to be terminated. Instituting American-style 401(k) programs have also been proposed.  

While these fiscal issues need to be resolved, longevity should be celebrated. Further, Japan has among the highest elderly labor force participation in the OECD. For those aged 60-64, 74.8% of men are working and 40.1% of women are working. Of all the public pension programs I have examined so far, the Japanese system seems to be the most sensible.

Kiso Nenkin

This is a basic flat rate pension give to all residents age 65 and up. There are no earnings tests or work history requirements needed to receive his benefit, but the pension is not large. Often, this is the only benefit housewives receive.

Kosei Nenkin Hoken (KNH – Private Employees Pension)

This program covers 85% of all workers; the rest are covered by Kyosai Kumiai (Public Employees Pension), but since the programs are very similar I will only discuss the KNH. The pension benefit is calculated as follows:

• Pension=(infl. adj. avg. wage)*(contribution years)*(0.0075)

This means a typical individual who worked 50 years will earn 30% of their career monthly earnings. Factoring in the Kiso Nenkin benefit of a husband and his wife, a typical couple will have a pension of about 50% of their annual wages. The program is financed through a payroll tax of 17.35% split evenly between the employer and the employee.

One can receive partial pension benefits beginning at age 60 through the Zaishoku program (see below), but full pension benefits do not occur until age 65. After age 65, one can delay pension benefit receipt with some actuarial adjustment.

Zaishoku Pension

The Zaishoku Pension is an earnings tested pension for employees aged 60-64 and is part of the KNH system. If one works between 60-64, an automatic 20% reduction in benefits occurs and other pension benefits are taxed away as earnings increase. Implicit tax rates are: 50% for earnings above ¥220,00 ($1,910) per month and 100% for earnings above ¥340,000 ($2900) per month.

Unemployment/Disability

Unemployment Insurance (UI) is limited to 300 days in Japan. Some people do use UI as a form of early retirement but since benefits are limited to a year, this has a moderate impact on the number of people who retire.

Unlike most European countries, very few Japanese use the Disability program as an interim income support. The rules to qualify for this program are strict and require full disability. Also, the benefits are similar to the KNH program so only the truly disabled generally apply.

Kosei Nenkin Kiken (KNK – Employee’s Pension Fund)

The employer-provided pension program covers about 2/3 of all workers. Workers can choose a lump sum payment or an annuity. Often, the KNK benefit is paid in conjunction with a mandatory retirement at age 60. Due to the seniority system, middle-aged workers are often expensive and firms use mandatory retirement to unload these workers; those who leave their job through mandatory retirement often find other part-time work, but finding full-time work in Japan for those over 60 is often difficult.

Like the French, Germans retire early (on average at between age 59 and 60) and for Germans, this early retirement is  seen as a social achievement.  Some polls, however, show that younger Germans do not believe they will receive an adequate pension in their old age and attempts at reform are underway.

The Germans have had a public pension system for over one hundred years, and their system has often been the model which other countries emulate.  The German pay-as-you-go system in it current form began in 1957 with a pension benefit and a flexible retirement age.  In 1972, the retirement age for old age pension was lowered, and old age disability pensions were created.  The “Century Reforms” of 1992 and 2001 decreased benefits throughout the pension system in an attempt to stem the fiscal problems which occur in an aging society.  The 1992 reform included a variety of changes such as making pensions dependent on pension type (discussed later) and indexing the average pension benefit for the entire system to net wages instead of gross wages as done previously.  The 2001 reform will gradually reduce replacement rates from 72% in 1997 to 64% in 2030.  Let us first look at the private sector:

Gesetzliche Rentenversicherung (GRV)

This public retirement insurance covers 85% of the German workforce and is mandatory with exemptions for civil servants and some self-employed.  Generally this is the only money individuals receive in old age, since individual retirement accounts and occupational pensions do not play a major role in Deutschland.  The program is financed 70% through a payroll tax split evenly between employees and employers (the tax is currently 19.5% of gross wages), and 30% through earmarked indirect taxes (VAT and a gas tax).

The GRV offers flexible retirement, with full benefits occurring at age 63 for most men, but age 60 for women, the unemployed and the disabled.  GRV pays no spouse benefits, but there are survivor’s benefits which are 60% of the deceased mate’s former benefits.  As of 1998, the average replacement rate was 70.5%–meaning one could make almost three-quarters one’s working salary during retirement. 

The formula to determine one’s pension depends on the following four factors:

1. Relative earnings position – computed by averaging average pension contributions over working life
2. Years of Service
3. Pension Type - There are 5 types.  The retirement age/necessary years of service are in parentheses. 
• Normal (65/5), Long Service (63/35), Women (60/15), Older Disabled (60/35), Unemployed (60/15)
4. Average pension for the nation as a whole.

As you can see, from point (3), while retirement is officially at age 65, many people retire earlier.  Two of the most common routes to early retirement are:

• Go on the Unemployment rolls at age 57.  One will be able to collect Unemployment Insurance (UI) for three years or negotiate a severance package with one’s employer. At age 60, an individual will be able to qualify for a pension.
• Go on disability at age 60.  One must prove to be at least 50% physically disabled and pass an earnings test to qualify.    

Civil Servants

Civil Servants receive an even more generous package than those in the private sector.  Replacement rates for civil servants are 75% of gross (pre-tax) wages, compared to 70% of net (after-tax) wages for the private sector.  Benefits are a function of 1) years of service, 2) last gross wage, and 3) a new adjustment factor for early retirement. 

According to the OECD Structural Policy Indicators paper, France has one of the highest implicit tax rates on continued work during its old age pension in the entire OECD.  In 1998, the implicit tax was over 80%.  Subsequent reforms have reduced the implicit tax to about 50% in 2003; yet only Luxemburg and the Netherlands have higher implicit tax rates on working while receiving old age pension than does France. 

Thus, it is not surprising to find that the average age of retirement in France is 59 years of age, and only 53% of individuals over between 55 and 59 are labor force participants.  According to the OECD Observer, these numbers are much lower than in Denmark, where the average retirement age is 65 for men and 62 for women.  It may be sensible that 86.2% of individuals over 65 receive some public benefits, but it is surprising that 23.7% of people aged 55-59 receive public benefits. 

There are two major reasons why retirement occurs at such an early age.  First, in 1983 France lowered the age for Social Security eligibility from 65 to 60.  Secondly, generous Unemployment Insurance allows older workers to leave the labor force even earlier than age 60.  Let us now examine the programs which make up France’s old age pension plan.

Social Security

This is the largest program in France.  The pension amount is calculated according to the following formula:

• Pension=a*[max(N,T)]/T*[infl. adj. avg. wage of best max(N,T) years]

N is the number of months an individual has been employed over their career, with T being a maximum cutoff.  The ‘a‘ term is determined by 1) the age of retirement and 2) N; and ranges between 0.25 and 0.50.  A later retirement date and more years of service moves ’a’ closer to 50%.  There was a maximum monthly pension of €2353 as of 2002.  In the 1970s and early 1980s, the benefits were indexed to average wage growth, but this was subsequently replaced with a price inflation measure in the mid 1980s.

Complementary Schemes

These plans are defined contribution plans (but not fully funded) and are organized by the private sector.  Workers receive a pension equal to:

• Pension=Sum{c(t)*w(t)/PP(t)}

c(t) is the contribution rate and w(t) is the gross wage each year.  PP(t) is the purchase price of a ‘point’ (salaire de rèfèrence) of pension benefits.  The Complementary Schemes are organized by occupation and benefits are limited to a maximum amount.  Executives belong to one organization (Association Gènèrale des Institutions de Retraite des Cadres – AGIRC) and non-executive employees belong to another organization (Association des Règimes de Ratraite Complèmentaire – ARRCO). 

Civil Servants have a separate pension system in which individuals can receive a full pension at age 60 as long as they have had 15 years of service.  There is also a mandatory retirement age of 65 for these workers.

Unemployment Insurance and the FNE

Most individuals who qualify for Unemployment Insurance (UI) receive declining benefits as the duration of their unemployment spell increases.  For workers over 58, however, this is not the case.  For these workers, they receive full UI benefits until the age they are eligible for Social Security.  This makes applying for UI prior before age 60 a very attractive option. 

Further, the state has set up the Fonds National pour l’Emploi (FNE) to actually increase the rate of retirement among elderly workers.  If a firm agrees, the state will give additional benefits to elderly workers who are laid off.  While this seems nonsensical (why is the state paying firms to fire workers), the government claims that the FNE will open up positions for younger workers.  According to the 1 July 2006 Economist article (“Output Demand and jobs“), the unemployment rate in France was 9.3%, so finding positions for younger workers is a significant problem (see problems with the Contrat de Première Embauche).

In Denmark the official retirement age is 65, but on average most people retire at age 61.  Around 8%-9% of GNP is spent on government income transfers to the elderly.  Among men between the ages of 55-65, only Sweden, the U.S., and Japan have higher labor force participation (LFP) rates.  Why do we see such high LFP in Denmark (which is generally seen as having a very generous social insurance system)?

The reason for this is that pensions generally range from 40%-70% of average prior wages (adjusted for inflation).  The proportion is closer to 70% for low wage earners and closer to 40% for high wage earners.  Thus, we see the earliest retirement among people in the manufacturing and service industries who generally have lower wages. 

I will now briefly describe the retirement programs in Denmark:

Old Age Pension (OAP)

This is a pay-as-you-go system which has a residency and age criteria as its only requirements.  At first this program gave a base amount to everyone 67 years and older but “from 1993 forward, this amount has been means tested against earnings from work, but not against capital income.”  OAP is financed from general tax revenues.

Social Disability Pension (SDP)

This is a disability program in which eligibility depends on health criteria, although these eligibility rules have become more flexible over time.  Individuals enrolled in SDP automatically switch to the OAP program once they reach 67 years of age.  Like OAP, this program is financed from general tax revenue. 

Post Employment Wage program (PEW) or Efterlhn

The goal of this program was to allow elderly workers to retire early to open up jobs for younger workers.  In reality, the PEW program has become one of the major means by which Danes are able to take early retirement.  On can enter the PEW program at age 60 as long has the individual has a minimal employment attachment when they apply. 

Other Programs

The Transitional Benefits Program (TBP) gives an early retirement option for workers aged 55-59 who are members of an Unemployment Fund and who have been unemployed for 12 of the last 15 months.  In 1994, this benefit was extended to individuals 50-54 years old as well.  

Public Employees have a Public Employee Pension (Tjenestemandspension) which is a defined benefit program as well. 

The Special Pension Program was enacted in 1999 in which 1% of wages go towards a defined contribution fund.  The program currently represents a small portion of the overall retirement needs of the elderly but may grow in importance in the future. 

How to get to retirement?

• If you are under age 50, your only option is to apply for disability through the SDP program. 
• Between 50 and 59 years old, one can still apply for disability (SDP) or an individual can apply to the TBP program if they meet the requirements. 
• Between age 60 and 66, retirement is popular because 1) one can enroll in the PEW program and 2) many labor market pensions give their employees benefits beginning in this age range.  This is the route most people take; the average age of retirement in Denmark is 61.
• At age 67, nearly all individuals in Denmark are retired.  All citizens and most residents are eligible for the OAP program once they reach age 67.   

In Chapter 2 of Social Security Program and Retirement around the World, economists Michael Baker, Jonathan Gruber and Kevin Milligan look at Canada’s Income Security Programs (IS).  According to their research, total expenditures on the three largest elderly transfer programs in Canada cost $22.7 billion in 1998-1999 or 20% of the federal budget.  Also, like most OECD countries, Canada has an aging population.  In 1975, contribution per capita towards public pensions exceeded these pension benefits per capita by $200.  By 1998, benefits exceeded contributions on a per capita basis by about $200.  The authors also note a trend for workers to retire earlier despite increased life expectancy.  In 1960, 87% of men aged 55-64 were labor force participants, but by 1999 this figure had dropped to 61%. 

Below I will discuss the major Canadian programs which transfer money to the elderly:

Old Age Security (OAS) System

Begun in 1952, this is the oldest federal social security program in Canada.  The program replaced means-tested, provincially-administered social security programs which were established in 1927.  The OAS program originally transferred cash to the elderly over 70 years of age but this age limit was later reduced to 65.  A uniform grant of about $420 (in 2000) is given to all who meet certain minimal residency and work requirements.  Since 1972, the OAS benefit has ben indexed to inflation (CPI).  This income is taxable and there is a clawback of 15% for high income individuals.

Canada Pension Plan/Quebec Pension Plan (CPP/QPP)

This is the largest of Canada’s IS programs.  It is financed through a payroll tax of 3.5% on all income between $3500 and the Year’s Maximum Possible Earnings (YMPE) which was $42,100 as of July 2006.  CPP/QPP averages an individual’s earnings between ages 18 and 65 after excluding 1) time spent on disability, 2) time caring for small children, 3) the remaining 15% of eligible months with the lowest earnings.  These amounts are then adjusted for inflation by multiplying eligible earnings by [(YMPE: year earnings accrued)/(average last 5 years YMPE)].  Once an inflation adjusted monthly income is calculated, individuals receive 25% of their previous income subject to a maximum. 

After 1987 for the CPP (and 1984 for QPP) individuals could claim their benefits at age 60 with an actuarially fair reduction in monthly payments.  Fifty percent of Canada’s citizens do claim their benefit early.  Benefits are paid at an individual level, but widows and surviving children under age 18 are entitled to the benefits of the deceased family member.

Guaranteed Income Supplement (GIS) 

This program is intended for OAS recipients with low incomes.  Individuals who wish to qualify for GIS must re-apply every year in order to receive the program’s income guarantee of about $500 per month for married families and $325 per month for single households.

Spouse Allowance (SPA)

For spouses aged 60-64 who are married to OAS recipients or widows of the same age, the SPA program gives them a cash transfer.  The benefits, however, are taxed away at 75% if the individual begins to work. 

Analysis 

Baker, Gruber and Milligan use the Statistics Canada Longitudinal Worker File data set to analyze retirement patterns in Canada.  Their major findings are that the IS system as a whole increasingly provides disincentives to work after age 61.   More specifically, while the present discounted value (PDV) of IS benefits decreases if one continues to work age 61; at age 69, working an extra year would reduce the PDV of IS benefits by 43%!  Reforming the IS system would be one way to induce more elderly individuals to continue to work.