The Impact on Retirement Decisions

The option of early retirement is a highly prized, but at the same time highly costly, social achievement in Germany. With an increasing aging population and the precarious financial state of the public pension system, these costs are once again the focus of discussion about pension reform. Since the 2004 reform has kept the retirement age largely untouched, the reform discussion is shifting once again to the pivotal retirement age of currently 65.

This is particularly attractive as an increase in the age of retirement will boost the number of contributors to the system whilst simultaneously reducing the number of beneficiaries. Bearing increasing life expectancy in mind, raising the age of retirement would also appear to be a rather natural reform option. What is more, there is no sign that an increase in the age of retirement is likely to be prevented by deteriorating health.

This paper provides an econometric estimate of the long-term impact of various reform options on retirement decisions in Germany. "Long term" is here defined as the state of play after all transitional regulations have taken effect. In context of the reform discussion, for example, the following question arises: How does the actual retirement age increase if the normal pension age is increased from age 65 to 67? This kind of question is of great interest as not all persons will delay their retirement entries by these two years but instead prefer a disability pension or accept adjustment costs. In order to predict these behavioural changes, a model is considered that relates the actual retirement decisions of older workers, as observed in the data provided by the 1984-1997 German Socio-Economic Panel (GSOEP), to the relevant statutory pension rules. We then use this model to predict future retirement decisions under reformed pension rules.

As a reference scenarion, we examine the pension reforms already implemented in 1992 and 1999, which, however, will only take effect after a long transitional period (see figure). We then examine different reform proposals: (a) All the age limits reached after the transition period shown in the figure are increased by an additional year or alternatively by additional two years. (b) As opposed to adjustment factors of 3.6 per cent per annum that are valid under the 1992 and 1999 reform, adjustment factors of 4.5 or alternatively of 6 per cent per annum are introduced. (c) Finally, we model the transition from the current defined benefit system to a notional defined contribution (NDC) system.



Based on the status quo estabilisehd by the 1972 reform the full implementation of the 1992 and 1999 reforms would lift the average male retirement age by almost 2 years, from 61.2 to 63. An upward shift in the entire fabric of age limits by 2 years increases the average effective retirement age for men by a further 9 months, from 63 to 63.7 years. The introduction of higher adjustment factors also has a very distinct impact on retirement decisions. Deductions of 4.5 per cent per annum increase the average retirment age by 9 months, from 6 to 63.7 years. Deductions of 6 per cent have a considerably stronger incentive effect and even lift the average retirement age to 64.9 years. As opposed to men, women respond less flexible and less strongly to the investigated pension reforms.

The results illustrate that an increased actuarial adjustment factor and an increased retirement age based on higher remaining life exectancy offer major potential for postponing the effective age of retirement. From an economic perspective, therefore, these policy options offer suitable measures to help put the German pay-as-you-go public pension system on a path on which it can regain its financial sustainability

more information:

Renteneintrittsentscheidungen in Deutschland: Langfristige Auswirkungen verschiedener Reformoptionen
MEA Discussion Paper: 031-03 Barbara Berkel, Axel Börsch-Supan