old couple model standing on money coins saving for concept investment mutual fund finance and pension retirement

Late retirement - possible for many, but not for all

Europeans are living longer, and are staying healthy for longer. That in itself is a positive development, but in combination with low birth rates it threatens the financial sustainability of pension systems and the welfare state as a whole. Finland was quick to respond to demographic aging. What lessons can be learned from Finnish pension reforms?

By Kati Kuitto

Despite massive popular opposition and bypassing parliament, the French government recently pushed through a gradual increase in the retirement age. The reason: There are fewer working-age taxpayers and contributors, and increasing numbers of pensioners and elderly people in need of care. France is certainly not alone in facing this problem. In a total of 18 out of 41 industrialized countries surveyed by the Bertelsmann Stiftung's Sustainable Governance Indicators (SGI), the ratio between older people and the working population has become critical. Extending working lives has therefore become one of the central sociopolitical goals of recent years.

After Japan, Finland is the country which is most and most rapidly affected by demographic aging. The record low fertility rate of not even 1.4 children per woman in recent years and low net immigration reinforce the negative trend and threaten the financial sustainability of the welfare state. In Finland, however, policymakers reacted relatively early and looked for solutions - and some results of the reforms are already showing.

Reforms and corrections

In almost all European countries, opportunities for early retirement from the labor force have been abolished or at least severely restricted. The retirement age has also already been raised in most countries, or is set to rise in the future. In a total of ten European countries, retirement age is linked to life expectancy. The idea behind this is that the ratio of the average number of years expected to be spent in retirement to the number of years spent in working life should remain roughly the same, in order to avoid placing an excessive burden on future generations in terms of pension financing.

In Finland, the central goals of the last two pension reforms in 2005 and 2017 were later retirement and extending working lives. Early and unemployment pensions, which had made it possible to retire before the standard retirement age until 2005, were gradually abolished. In addition, a financial incentive was introduced, rewarding those who work beyond the age of 63 with a higher pension accrual rate. However, this tended to benefit higher earners and, in the longer term, this measure would have contributed to growing socioeconomic disparities in pension levels. Corrections were therefore made in the next major pension reform in 2017.

The flexible retirement age of 63 to 68, introduced in 2005, was replaced in the 2017 reform by a minimum and target retirement age, which are linked to life expectancy and increase depending on the year of birth. Only when the target retirement age is reached is the full pension paid. Each month of early retirement from the minimum pension age reduces the pension by 0.4 percent. Those who have no earnings-related pension at all, or only a small one, receive a tax-financed so-called national pension on a pro rata basis. If the earnings-related pension exceeds 1,500 euros per month, there is no longer any entitlement to an additional national pension. Model calculators offered by the pension system enable citizens to calculate their own retirement age and the retirement pension they can expect. This creates transparency for the individual effects of the pension reforms and allows personal planning of retirement and income thereafter.

Not everyone can - or wants - to work longer

A successful pension policy is closely linked to a government's ability to develop policies strategically and with the participation of all relevant groups, and to monitor them continuously after implementation. Evaluations of Finnish reforms, show that more people are actually staying in work until retirement. It is of note that this positive development occurred especially among workers with lower levels of education. For ordinary workers, unemployment was often a path to early retirement before the 2005 reform. The abolition of the unemployment pension thus had an effect. This led to a narrowing of socioeconomic disparities in the exit of the labor market. The increase in the retirement age in 2017 also had the hoped-for effect of making working lives longer overall.

Despite a general increase in the retirement age, there are still many people in industrialized countries who cannot - or do not want - to work longer. As a result, there are still significant socioeconomic differences in many nations when it comes to retirement. In Europe, people with low levels of education leave the labor market an average of 2.8 years earlier than those who are highly qualified. This gap is smallest in Sweden, Germany and Finland. Research is still needed to determine which pension, education and labor market policy factors contribute to reducing education-related differences.

Support needed throughout people's lives

Education and lifelong learning are essential building blocks for stable labor market participation. Prevention is becoming increasingly important, as more and more people are becoming temporarily or permanently disabled early in their working lives due to mental or physical problems. Sufficient provision of early education, childcare and care for elderly dependents are important for gender equality in labor market participation, as the example of the Scandinavian welfare states shows.

Flexible solutions in terms of working hours and organization can make it easier for older workers to stay in the workforce longer. Employers' appreciation of older workers also plays an important role. Fortunately, a survey of employers in Finland found no evidence of the age discrimination in employers’ attitudes that is often assumed in public debates. Whether this positive result is actually reflected in recruitment behavior and efforts to retain older workers remains to be seen.

Pension policy must continue to keep in mind the diversity of individual life courses. Many people are still fit and willing to work at the age of 70, while others’ ability to work reduces far earlier. The welfare state must ensure an adequate retirement income for all. The measures needed to deal with demographic aging in a financially and socially sustainable way extend far beyond pension policy.

Kati Kuitto is a senior researcher at the Finnish Center for Pensions in Helsinki. She conducts cross-country research on pension systems and policies and is a member of the Bertelsmann Stiftung's Sustainable Governance Indicators (SGI) expert network.

Translated from German by Jess Smee.