May 26, 2022

The Role of Life Expectancy in Retirement Age Around the World

An increasing number of governments are pegging retirement age to life expectancy, but it comes with consequences.

Reported by Anna Gordon

Pegging retirement age to life expectancy is a growing topic of conversation around the world. The Organization for Economic Cooperation and Development recommends the practice, but most countries still choose a seemingly arbitrary number to set as the minimum retirement age.

Picking the right retirement age continues to be a hot-button political issue around the world. A debate over whether to increase France’s retirement age of 62 gripped the country’s presidential election last month. In Argentina, a government reform that increased the retirement age to 70 for men and 63 for women led to mass protests in 2017.

Retirement age and longevity impact pension systems directly: The longer plan participants live in retirement, the more money they collect from the pension system.

Pegging Retirement Age to Life Expectancy

While most plan sponsors understand that the stability of any type of defined benefit plan depends on a feasible retirement age, many governments continue to ignore the OECD’s recommendations of pegging retirement age to life expectancy.

Life expectancy estimates fluctuate every year, and the number can change due to current events. The COVID-19 pandemic, for example, brought down life expectancy in the United States by more than 1.5 years. As of 2020, the average U.S. life expectancy is 77 years, compared to 78.8 years in 2019.

Currently, seven OECD countries peg minimum retirement age to life expectancy. They are Denmark, Estonia, Finland, Greece, Italy, the Netherlands and Portugal.

Sweden may also join that list soon. The Swedish retirement system uses a form of defined contribution plan to fund its citizens’ retirements; thus, unlike the defined benefit pensions in other countries, retirement age isn’t a matter of fiscal importance.

“In Sweden, if people retire early, there is no impact on pension finances. If people retire early, they will just get lower pensions,” says Hervé Boulhol, a senior economist at the OECD. “It’s not a public finance issue. It’s really more about encouraging people to work more and build up larger pension savings.”

In 2019, the Swedish government passed a law that would peg retirement age to life expectancy and gradually increase the retirement age from 61 in 2019 to 67 by 2026.

Pegging life expectancy to retirement age can help plan sponsors by making it easier to predict their total liabilities and decreasing the likelihood of situations where an unexpected increase in life expectancy suddenly compromises their funded ratio. However, it also comes with consequences.

Determining the Right Work-to-Retirement Ratio

Once a country does decide to peg retirement age to life expectancy, it faces several attendant issues. In Denmark, which already pegs its retirement age to life expectancy, policy makers are debating just how strong this link should be.

Currently, retirement age in Denmark changes at a one-to-one ratio with life expectancy. However, some say that instead of increasing retirement age by one year per each year of additional life expectancy, the government should set a formula so that retirement age increases a by a smaller proportion with each additional year. The retirement age would thus be set so that every individual spends the same proportion of life in both work and retirement.

For example, if a country set the ratio of work-to-retirement years to 0.75, the retirement age would shift to accommodate that ratio if life expectancy changed. If the average person works for 45 years and retires for 15 years, the retirement age could be set to 65 with a life expectancy of 80 years old. But if life expectancy were to increase by four years to 84 years old, the retirement age would increase by only three years, to 68 years old, and beneficiaries could anticipate 16 years of retirement benefits instead of 15.

Denmark’s retirement age is 65, and there are plans to gradually increase the age to 68 by 2030.

The Inequality Problem

Despite the argument for pegging retirement age to life expectancy, some economists advise against it.

“The motivation to peg life expectancy to retirement age is mostly to cut benefits, because on average life expectancy is going up,” says Teresa Ghilarducci, an economics professor at the New School for Social Research who specializes in retirement security.

Ghilarducci says that pegging retirement age to life expectancy often adversely impacts groups of people with shorter life expectancies.

“The distribution of longevity is wildly unequal,” says Ghilarducci. “Even though the average might be going up, there is tons of evidence all over the world that people who have had good jobs and higher socioeconomic status are the ones that are getting most of the gains.”

Boulhol agrees with Ghilarducci that this could be a serious issue for many countries.

“The U.S. is one of the countries in which life expectancy inequality is increasing, at least according to some models,” says Boulhol. “You want to be careful about making retirement age changes in countries with high inequality.”

Nevertheless, Boulhol and the OECD still recommend life expectancy as a useful tool in determining retirement age because it directly determines the average amount of time a person will spend in retirement. Ghilarducci, however, is more skeptical of the idea.

“If you just index retirement age to longevity, in the guise of science you are abdicating the responsibility,” says Ghilarducci. “The retirement age should not be indexed to something arbitrary, like average longevity. The full retirement age should be set according to the conditions of the country.”

While Ghilarducci does not have a one-size-fits-all solution, she thinks that for governments trying to curb inequality, creating different retirement ages for different types of workers could be a start.

“If you care about helping people have about the same amount of retirement, then you can have blue collar and lower status people claim earlier and higher status people work longer for their benefit,” says Ghilarducci.

However, while Boulhol agrees that inequality can be a big problem, he cautions against creating different retirement ages for different demographic groups.

“Theoretically you can think about it, but in actuality it is very hard to define the right group of people,” says Boulhol. “It’s also politically questionable.”

Boulhol warns that focusing too much on inequality of life expectancy could mean that women, who live on average longer than men in nearly all countries, would see higher retirement ages.

However, he is open to the idea of reducing inequality by considering difficult working conditions.

“You can assess people’s health and choose to make them eligible for disability pensions,” says Boulhol. “But that’s an individual assessment, which is not defined by other factors like education and income.”