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Stretching it out

Written by Charlotte Moore
June/July 2014

There are no easy choices facing European politicians when it comes to planning future pension policy. Increasing longevity means that a larger proportion of the population will be living longer and needing more income in retirement.

European politicians are being encouraged to increase the retirement age to reduce the cost to the state. In particular, the OECD has said the Netherlands must do more to encourage working at an older age to meet growing challenges. And Germany’s EU commissioner criticised his country’s plans to lower the retirement age.

Some countries, however, have bitten the bullet and started to increase the retirement age. The UK has increased the retirement age to 66 in 2022 and plans a further increase to 67 by 2028. Greece and Spain have both agreed to raise their retirement age from 65 to 67 and Portugal has increased its retirement age to 66.

Workplace effect

While a later retirement age is more cost effective for state pension provision, it also has implications for employers for both the impact it will have on occupational pension provision as well as the implications for human resources.

The impact on occupational pensions should be positive.

Mercer senior associate Anne Bennett says: “Higher retirement ages can mean that scheme members save for longer so that will help to improve pension adequacy. It may also help to increase income if the retirement age manages to keep pace with longevity.”

The shift across Europe from defined benefit to defined contribution pension schemes should also help to accommodate the later retirement age. Towers Watson senior consultant Mark Duke says: “DC schemes are much more flexible and it’s relatively easy to adjust these schemes to different retirement ages.”

There will, however, be additional costs for employers as most European DC schemes require employers to contribute to their individual pension schemes. “Individuals will have longer careers which will mean there will be higher contribution levels,” says Duke.

For providers of occupational pensions the challenge is not only that the state retirement age is increasing, it’s also that the attitude towards retiring is changing.

Mercer senior associate Glyn Bradley says: “The tradition of a cliff edge retirement decision of working one day and retiring the next is being eroded.”

Private pensions will need to be able to adjust to changing retirement ages as well as take a more flexible approach to retirement.

Bradley says: “There is a risk that the state pension age is outstripping the age at which people wish to retire.”

Waiting to retire

Bradley argues that there are two groups of people in particular affected by the rise in state pension age. “There is a group of blue collar workers who have relatively low savings who cannot afford to cut down on their working hours until they reach retirement age,” says Bradley.

This group could pose a problem of pension adequacy for employers. “Employers could improve benefits to help this group to retire earlier but they would have to tread carefully around the age discrimination rules,” says Bradley.

But others argue that the UK government’s decision to abolish the requirement to purchase an annuity at retirement will make it easier to bridge the gap for this particular group of employees.

JLT Employee Benefits chief actuary Hugh Nolan says: “Now scheme members have the option to take their defined contribution pot as a cash sum.”

For those on lower income, this is a more efficient use of their cash than having to use it to purchase a meagre annuity.

Nolan says: “This improves their position. If they retire from work before the state pension age, they can use this cash to tide them over until the state pension kicks in.”

“This gives people more flexibility about when they can retire, irrespective of their official state pension age,” says Nolan.

Bradley argues that there is another group that could be affected by the rise in state pension age. “There is a group of white collar workers who have got significant pension savings but there is a gap between the age at which they wish to retire and the scheme retirement age or the state pension age,” he says.

That group of workers is likely to solve that problem through phased retirement where they start to work part-time and use part of their pension savings before they retire fully, says Bradley.

DB and DC mix

Those who have a mixture of defined benefit and DC pensions could use the DC pot to introduce some flexibility about their retirement age, using the DC pot to tide them over until the DB pension kicks in at their official retirement age. “This mix and match approach could work very well,” says Duke.

But many workers may well decide to simply carry out working full time as it’s much more financially rewarding. Duke says: “If you work for a year, you can generate an annual salary where as it would take 20 years of setting aside 5 per cent a year to generate the same amount.”

Flexibility

The UK now has the most flexible system in Europe. “Other European countries are much more focused on long-term income rather than allowing scheme members to cash out their pension - they are much more tightly linked to the insurance market,” Nolan says.

Many European markets are still focused on a single retirement date with regular income paid after that date. That makes them much less able to accommodate a more flexible attitude towards retirement, he adds.

Bennett agrees: “European pension policy is focused on generating pension income that could supplement the state pension payment rather than allowing flexibility.”

In the past, however, European countries have relied on state-sponsored early retirement schemes to ease out employees who no longer want to be there or who were no longer up to the job.

Bennett says: “In the future, employers will no longer be able to rely on this mechanism as governments are cutting back on these types of benefits. That means they will have to find a way to bridge the gap instead.”

This lack of reliance on early retirement highlights an important point: while DC occupational schemes have the flexibility to take account of later retirement, employers still have to cope with the impact on staff management.

“There will be significant challenges posed by having an older workforce. They might require a different work environment and so changes will need to be made,” says Duke.

There are also significant inter-generational issues – employers want to avoid a situation where it’s impossible for younger employees to be promoted because all the positions are still taken by older staff.

“It’s also going to be much harder for employers to force employees to retire with the repeal of mandatory retirement ages and a tougher stance on age discrimination. That could generate a potential legal minefield,” says Duke.

There is little doubt that in the UK, the changes in at-retirement options for defined contribution pensions will herald in a new era of flexibility which will be able to handle further changes to retirement age. But the impact on the management of human resources is less clear cut, as is how other European occupational pension systems will adapt to those changes.

Charlotte Moore is a freelance journalist



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