Monday, 26 November 2012

Pensions and Retirement

After years and years of the retirement age remaining stable and citizens being able to compute when they would have been able to retire peacefully without any worries, suddenly countries have decided to alter the retirement age for state pensions. The reasons stated for that were that it is infeasible for the state to pay pensions for so long as the average life expectancy of a person has risen over time. For reasons of comparison, I offer you a list of several EU nations with their respective retirement ages (additional information and more nations can be found in Wikipedia and this Eurostat publication (p.78) ):
I will not argue with the feasibility or not of the pension system in each country. Nevertheless, I would argue with something that is more important in my mind. All of the above retirement ages are fixed to a specific age and not the amount of years a person has worked.

I will illustrate what I mean with a simple example. Take for example the case of Germany:
We have two persons Mr A and Mr B, both aged 18 at the moment. Given that the retirement age in the country is 67 both persons have approximately 49 years of work in front of them. Average life expectancy in Germany is now exactly 80.0 years as quick Google search can show and recent EU projections state that it will rise to 84 years by 2060 when our two friends will retire. 

Thus, both of them are expected to work for 49 years and enjoy their pensions for another 17. The big problem arises when Mr A decides to take up a university degree. As in Germany an academic degree usually takes about 5 years to be completed (with even considering any delays or further study) it would mean that Mr A would in fact work for 44 years and receive a pension for his remaining 17.

Some of you may say that if Mr A gets a higher salary due to his university degree it would be same as if he had worked those extra 5 years. Well, maybe or then again, maybe not. This is not always the case as many people without any degrees have managed to do extremely well, better than others who had graduated from universities. In any case, my point would be this: why not let people select their own retirement age based on the years they have worked?

I am not an actuary, however, it would seem very plausible that people who are essentially working for e.g. 43-44 years should be allowed to choose whether they would like to retire or not. In our example above, Mr B should be free to select whether he would like to retire at any age in the 62-67 range. Based on the value of their stream of payments to the social security system, the last few years' worth of installments would account for much less than the ones in their first years of employment. This essentially means that the last few years of payments would not matter as much to the amount Mr B receives per month as his pension (for a more elaborate view on the subject have a look at the time value of money). Thus Mr B would be free to choose whether he would like to continue work until his 67 years of age or stop at any time between 62-67. As people differ in their ability to work in old age, this would mean that persons who are not strong enough (due to accidents or other health reasons or even by nature) are allowed to retire without being a burden to the system, as they are now being considered whilst those who feel strong enough to continue may do so.

This rationale would work both in a funded as well as an unfunded benefits plan, given that in both cases the amount of pension to be received is to calculated based on the amount of payments one has given into the system. (for differences between plans read this)

The solution described above is much more optimal than those implemented now, as it allows for the person to be judged on his years of service and not by a rule-of-thumb age. It even prevents cases of social injustice as it correlates years of work with the ability to retire without forcing people to be employed when their nature forces them to do otherwise. Nevertheless, as with many ideas, ideological stubbornness does not allow politicians and policymakers to see the forest and not just the tree.

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