The last decade has seen most countries in the rich world raise the retirement age in order to improve the sustainability of their pension systems at a time when people are living longer, healthier lives. The policy is moving in the right direction, but it has one key flaw -- current policies are too rigid.

Retirement should not be a one-size-fits-all system where those who work longer or retire earlier are penalized. Provided they get it right, governments and citizens have much to gain from a more flexible pension system than exists in most countries today.

According to a study published last week from the Organization for Economic Cooperation and Development, the average retirement age for men across OECD member states is set to go up to 65.8 years from 64.3 years today. This follows a gradual increase in the recent past: Over the last decade and a half, the average age at which workers left the labor market has gone up by two years. That said, there is a great deal of variation, from Korean men who leave the labor market, on average, at 72, to French men, who retire at 60.

There are two reasons why governments in advanced economies are forcing workers to retire later. The first is the overall increase in life expectancy: On average, a man aged 65 can now expect to live five years longer than he could four decades ago. The second is to correct the mistake most governments made in the 1970s and 1980s in introducing early retirement schemes in an attempt to bring more youth into employment. As a result, the average labor market exit age today is still lower than it was four decades ago, when people could expect to live much less.

This combination had made pension systems across the rich world unsustainable, forcing governments to shut down early retirement routes and raise the pension age. The trouble with the new approach, however, is that it often fails to give workers adequate flexibility over their retirement choices.

The OECD finds that the flexibility to retire fully before the statutory pension age is strongly restricted in more than half of the member states. In countries such as France, Spain and Israel, workers even face financial penalties if they want to continue working after retiring. In France, for example, a working pensioner continues to pay contributions but does not earn any additional pension entitlements. In Europe, only about 10 percent of workers aged between 60 and 64 or 65 to 69 combine work and pensions, according to the study, far below the OECD average where about half of workers over 65 do part-time work.

As the OECD study notes, giving people the freedom to retire when they want would benefit both individuals and the state. The government can clearly benefit from letting people work for as long as they want to, since this means higher taxes and economic output. Many individuals want the satisfaction of being part of a work environment, or the added income well past the usual retirement age. Those who are willing to continue working should be allowed to do so, while those who want to retire earlier should be able to, provided they have set aside enough money.

There are several challenges facing politicians who want to let people retire earlier. Giving people more freedom over when to stop working means risking that they will not earn enough to fund a long retirement, and end up falling back on the state’s safety net. There should be a minimum level of pension contributions before a person is allowed to retire to avoid this. Just as private-sector pension plans penalize early withdrawal, public-sector plans could do the same as a way of nudging workers to think hard before drawing from savings.

That may mean overcoming trade-union resistance; unions tend to want to reduce the effective pension age, but oppose penalties for workers who choose to retire earlier. A good example is Italy: The Italian government has recently injected some flexibility into the pension system, allowing all workers to retire up to three years and seven months earlier in exchange for a lower pension.

Putting pension systems on sound footing -- a necessity for financial stability and preserving intergenerational equity -- doesn’t have to mean perpetuating rigid structures or old norms about when retirement should begin. Greater flexibility can have enormous social and economic benefits, too. It is hard to argue against the idea of giving people more control over their lives.


By Ferdinando Giugliano

Ferdinando Giugliano writes columns and editorials on European economics for Bloomberg View. -- Ed.


(Bloomberg)