Between 2000 and 2050, the proportion of the world’s population aged over 60 is expected to double. It will rise from 11% to 22%, or in absolute figures, from 605 million to 2 billion. Some countries, like Russia and China, are growing older before they become rich. At the same time, extended families and other traditional ways of supporting the old are weakening world-wide. The result is a looming old-age crisis that threatens not only the elderly but also their children and grandchildren. After all, they are the ones who must shoulder – directly or indirectly – much of the increasing burden of providing for retirees.
Alongside concerns about retirement income, rising healthcare costs are adding to the pressure on states and individuals. The accessibility and affordability of health cover is a major concern in Europe, the USA, Latin America and Asia. It all adds up to an urgent need for pension and healthcare reform across the globe. Formal systems, such as government-backed pensions, are proving both unsustainable and very difficult to restructure. Reforms are challenging and controversial because they involve long-term planning by governments faced with numerous short-term pressures. In addition, reforms are often accompanied by heated ideological debates and conflicts of interest between the various stakeholders.
Pension reform – is there one right answer?
While demographic challenges are comparable around the world, the ways of facing them are as different as each country’s own social security, tax and welfare system. Government action often depends on market conditions and cultural attitudes. In addition, politics, upcoming elections, and the demands of international institutions can have a major impact on the efficiency and effectiveness of pension reforms. The European market with a long pension history experiences currently the highest level of pension reforms world wide. Hence, in the following four broad categories of pension reforms are outlined and illustrated with European country examples.
Adjust tax incentives
Tax incentives are commonly used to support and strengthen pension systems. However, several countries are currently reducing such tax incentives in response to pressures on government finances:
- The Dutch coalition government has introduced new tax legislation that will significantly decrease tax incentives for pensions.
- Ireland lowered the tax relief threshold on pension pots of EUR 60,000 per annum from January 2014.
- In Denmark lump-sum pensions ceased to be tax deductible at the end of 2012.
Raise the retirement age
Increases in the retirement age have already taken place in many developed countries. In some countries this has gone smoothly, but others have witnessed negative reactions from the population. Currently, the pension age in most OECD countries is 65. In contrast, the average pension age in the APAC region is 59 for men and 57 for women. China recently announced proposals to gradually increase the retirement age for men and women to age 65 by 2045, in order to slow the drop in the size of the workforce and control the associated rise in labour costs.
An increase of the retirement age is under discussion in several countries:
- Germany, UK and USA have announced a further rise in the pension age to 67.
- In Belgium, an increase in the retirement age was rejected in 2013. However, measures were introduced to discourage early retirement through increasing the age for early retirement and the minimum contribution period.
- The debate on retirement age in Finland continues, where it is currently flexible between 63 and 68. In addition, the part-time pension age has been increased from 60 to 61, and people retiring at 62 are no longer allowed to take an actuarially reduced pension.
Increase contribution rates and reduce benefits
Several governments have increased contribution rates and cut benefits in order to repair pension systems under pressure since the financial crisis.
- In Portugal, state pension benefits have been reduced – however, this has not led to higher supplementary pension savings. Further cuts of up to 10% are expected.
- In Switzerland, there is a new government proposal to address the problem of minimum conversion rates. The intention is to reduce the rate by increments from 6.8% to 6% over four years.
- France has set up a new pension steering commission to focus on solving the growing deficit in the first pillar pension system. This has recommended increased contribution periods and rates, tax rises for pensioners, a limit on pension indexation, and a new calculation method for civil servant pensions.
Make key changes to the pension system
Some countries are making further important modifications to their systems, often accompanied by an increase in the amount of regulation:
- The Polish government has adjusted the 2nd pillar, made the system voluntary, and banned investments for pension funds in government bonds.
- In the UK, auto-enrolment has been hailed a success, with the UK’s largest employers revealing opt-out rates of just 3% to 6%.
- The Spanish government has proposed new sustainability measures for state pensions in order to cap spending and curb the deficit. These are subject to social partner agreements.
There is no one way to reform pensions
While most pension systems face severe challenges, it is difficult to draw a uniform picture of ongoing reforms. There is no single right answer. The progress of implementation and the measures taken vary significantly from country to country. At the same time, states are broadly moving in the same direction. All the reforms are aimed at lowering state pension benefits and increasing government income in order to manage the pension burden. In other words, there is a definite shift from the state to the private sector. As a result, we expect that retirement savings co-financed by employers and employees will continue to gain in importance and will play an increasingly vital role in responding to the demographic challenges of the future.
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