Determinants of retirement timing: theoretical background

People retire at a wide range of ages for a variety of reasons. Fisher et al. (2016) provided a detailed review of literature on determinants of retirement timing, including: physical, financial, demographic, psychological, work, family, cultural, macroeconomic, and institutional factors. In the same vein, Scharn et al. (2018) conducted a detailed literature review and identified 49 determinants of retirement timing that were classified into eight domains.

Decision to retire is one of the most important and complex choices people make during their lives. It is not just a one-time event (discrete choice), but rather a long-term decision-making process (Wang and Shultz, Reference Wang and Shultz2010; Feldman and Beehr, 2011). This process is shaped by two categories of factors: push and pull (Ebbinghaus and Hofäcker, 2013; Hofäcker et al., 2015; Hofäcker and Radl, 2016; Jensen et al., 2020). Push factors are negative conditions that crowd out older workers from employment. Pull factors are positive incentives that make retirement more attractive.

In line with an economic approach, retirement decision is an economical choice; people exchange their time (leisure, recreation) for money (retirement income, consumption) (Laitner and Sonnega, 2012). Individuals (homo economicus) are rational, so tend to work until subjective value of the additional unit of money (possible by work) is offset by subjective loss suffered from giving up leisure and recreation. Moreover, rational people do not consider only the current level of income, but rather make lifetime plans (Ando and Modigliani, Reference Ando and Modigliani1963). Working-period is a time of wealth cumulation, whereas retirement is a time of wealth decumulation. Since people tend to avoid radical changes in the standard of living, they work as long as they collect sufficient resources to smooth consumption after retirement.

In line with a sociological approach, retirement decisions are closely related to norms, values, aspirations, and identities (Guillemard and Rein, 1993; De Tavernier et al., 2019). Those factors modify the impact of financial incentives: therefore, individuals are not affected by economic factors alike. Social stratification and intrinsic value of work play here a crucial role. People with strong work ethics, who build their own identities on professional positions, are less motivated to withdraw from the workforce. Such attitude may be additionally strengthened by negative connotations with retirement, as a social degradation and isolation. In contrast, people with low work ethics, and positive retirement expectations are less motivated to prolong their working life.

De Tavernier et al. (2019) conceptualized different types of retirement, taking into account two dimensions of retirement planning: pension wealth and identity (orientation). They noticed that voluntary retirement takes place when individuals have the required resources to sustain desired standard of living without working, and also have an alternative challenge or identity to enter after workforce withdrawal. If any of these conditions are disrupted, an involuntary retirement occurs. In such case individuals end up with insufficient means to uphold desired consumption level, or/and a lack of prospects or purpose in their retired life.

Retirement timing is shaped not only by personal characteristics, but also by contextual (macro-level) factors (Szinovacz, 2013; Hofäcker and Radl, 2016). It applies especially to institutional settings, which changed radically over the last fifty years. Starting from the 1970s Western countries struggled with a surplus of workforce, which caused so-called demographic unemployment (Wagner, Reference Wagner and Steinmann1984). At that time policy-makers implemented various measures promoting early labour market exit. It established and disseminated “early retirement culture” (Blöndal and Scarpetta, Reference Blöndal and Scarpetta1999; Guillemard, Reference Guillemard2003; Radl, 2014; Ehmer, 2015), In the 1990s, however, as a demographic situation changed, paradigmatic shift in public and political agenda was imposed, from “early exit” to “active ageing” (Zaidi et al., Reference Zaidi, Harper, Howse, Lamura and Perek-Białas2018). It contributed to the fundamental change in the pension system and labour market policy. The welfare state has been redesigned. A number of reforms restrained financial incentives to early workforce withdrawal (thus reducing the impact of pull factors), and also improved employability of older workers (thus reducing the impact of push factors) (Hofäcker and Radl, 2016). Despite many efforts, the situation has not changed everywhere, and as a result, European countries remain polarized between “early” and “late exit regimes” (Hofäcker et al., 2015).

Description of the research problem

Pension reforms set institutional settings and therefore influence retirement timing. According to Hofäcker et al. (2015, p. 208) institutional conditions at the nation-state level frequently set the relevant opportunities and constraints for retirement decisions within a population. Potentially, however, not only the character of changes play a role, but also its number and frequency. It can be presumed that while the recent reforms aim at prolonging working life, the fact of its implementation provides an opposite effect and discourages working beyond pensionable age. Such assumption is based on psychological phenomenon called “the certainty effect”.

Originally certainty effect was discovered by Maurice Allais in 1953, and hence is broadly known as “Allais paradox”. Kahneman and Tversky (1979, p. 265) described it as a decision-maker’s tendency to “overweight outcomes that are considered certain, relative to outcomes which are merely probable”. They confirmed empirically that action eliminating the probability of harm (i.e. from 1 percent to zero) is valued more than same-range action, which only reduces this probability (i.e. from 2 percentages to 1 percent). In their research (Tversky and Kahneman, Reference Tversky and Kahneman1981), respondents were asked to choose one of the following options: (A) a sure win of $30, or (B) 80% chance to win $45. Expected value in option A (1*$30=$30) is lower than in option B (0.8*$45=$36), but still it was chosen more often (78% respondents preferred option A, 22% preferred option B). It proves that most people favor risk-free options even when providing much lower outcomes (in monetary value). They usually prefer a smaller-certain gain over a bigger-uncertain one, just as in old catchphrase “A bird in a hand is worth two in the bush”.

Retirement decisions can become uncertain in two ways. First: people cannot effectively assess their future financial needs, especially regarding very old age, when they will become frail and dependent. Neither the level nor the period of expenses is known. Secondly, the reliability of the pension system may become a source of uncertainty. Recently implemented pension reforms radically modified institutional settings along with fundamental principles and entitlements. The aim of those changes was to uphold sustainability of social security system under demographic shift. However, solutions favorable on macro-scale (i.e. increasing retirement age, reduction of pension entitlements) were usually harmful on micro-scale (for individuals). Such turbulent environment naturally undermines trust in the system and increases uncertainty.

Theoretically, if the pension system is stable workers can make effective retirement plans. After reaching pensionable age, they may choose whether to end up career early and get lower benefits or to postpone retirement and get higher benefits. In such case extending working life is a risk-free option. However, if the system is unstable, workers reaching official retirement age make decision under uncertainty. They have to choose whether to retire earlier and get lower, but certain benefits, or rather to postpone retirement and get only “potentially” higher benefits. The more the pension system is unstable, the more risky is extension of working life.

The aim of the article is to verify whether stability of the pension system influences retirement timing. Basing on the certainty effect it can be presumed that high instability of retirement rules demotivates to extent working life. In countries with relatively stable pension systems, people are more likely to postpone retirement, whereas in countries with relatively unstable pension systems by contrast, they tend to retire as soon as possible. We provide empirical verification of this assumption. For this purpose, we put together two measures: (1) retirement timing, and (2) instability of pension system. None of these measures is evident, so require detailed discussion and clarification.

In our study, we analyze macro-level variables (with countries as units), constructed on the basis of OECD’s biennial report “Pensions at Glance” (2009, 2011, 2013, 2015, 2017, 2019, 2021), We take into consideration 21 European countries with available data: Austria, Belgium, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Luxemburg, Netherlands, Poland, Portugal, Slovak Republic, Slovenia, Spain, Sweden, and UK. The period covered by the study is 2009-2020.

Retirement timing: source of data

Retirement timing may be analyzed at two levels: micro and macro. At the micro-level (an individual), it refers to the age at which an individual withdraws the workforce. At the macro-level (a country), in turn, it refers to the average age of all individuals withdrawing workforce in a given period. Such a collective approach is called “effective retirement age” or “effective age of retirement”.

In most international studies effective retirement age is calculated using labour force survey data, with moving out of the labour market treated as a proxy for retirement. As such, people above a specific age that are not in the workforce at the time of the survey are treated as retired. Such simplification facilitates the analytical process but also causes some methodological issues. First of all, such approach includes as “retired” also people who never worked or are not able to find a appropriate employment. In turn, people who have already removed from their main job, and feel “retired”, are considered as “workers” just because they still perform some form of paid work to supplement their old-age pension benefits. Anyway, Scherer (2002, p. 7) noticed that

In general, women withdraw from the workforce earlier than men, as shown in Table 1. However, this is not the rule everywhere. In 2020 the gap between the effective retirement age of men and women was the biggest in Greece, Hungary, and Poland (respectively: 2.8, 2.4, and 2.1 years). On the other side, in Estonia, Luxembourg, Finland, France, Ireland, and Germany women worked longer than men (the gap in those countries was 1.3, 0.9, 0.6, 0.5, 0.2 and 0.1 respectively).

Table 1. Effective and normal retirement age in chosen EU countries (both sexes; 2014, 2016, 2018, and 2020)

Notes:Effective retirement age is calculated as a weighted average of (net) withdrawals from the labour market at different ages over a 5-year period for workers initially aged 40 and over. In order to abstract from compositional effects in the age structure of the population, labour force withdrawals are estimated based on changes in labour force participation rates rather than labour force levels. These changes are calculated for each (synthetic) cohort divided into 5-year age groups.Normal retirement age assuming labour market entry at the age of 20, and contributing in every year from that time. In countries where there are different retirement-income programs for different group of workers, the data relate to the main, national scheme for private-sector workers. It does not take account of earlier retirement ages or more favorable treatment of, for example, public-sector employees or workers in specific hazardous or arduous occupations. If pension ages differ with women’s marital status or the number of children that they have, pension ages are shown for childless, unmarried women.Source: (OECD, 2015, 2017, 2019, 2021).

Effective retirement age differs across countries and over time. In the period 2009-2020 it decreased in average by 0.2 year in case of men, and increased by 0.3 year in case of women. In 2020 average age of workforce withdrawal in all analyzed countries was 62.5 for men, and 61.8 for women. However, particular countries differ greatly in this respect. Men retire the earliest in Luxembourg (59.2), and the latest in Sweden (65.8). Women retire the earliest in Greece (58.1), and the latest in Estonia (65.4).

Each country sets some official threshold beyond which people are allowed to apply for full old-age pension benefits. This threshold is called “normal retirement age”, and is defined as the age of eligibility to all components of the pension system. Usually this threshold is clearly defined in national legislation. However, it is composed differently and varies greatly from country to country (OECD, 2011). Some countries give the opportunity to retire earlier, before reaching normal age, if only certain contribution requirements are met. Some other countries (e.g. Finland, Sweden), in turn, do not set up a “normal” retirement age at all, but instead define a range of ages at which the pension may first be drawn.

Table 1 presents a variety of normal retirement ages across countries and over time. Between 2009 and 2020 it changed in most analyzed countries. In 12 of them it increased, in some cases radically, such as in Belgium (+5 years for both sexes), Slovenia (+3.7 for women, and +3.3. for men) or France (+3.3 for both sexes). In one case (Portugal) retirement age decreased (-0.7 for both sexes). In Poland, in turn, initially retirement age increased, but eventually the pension reform was reversed and retirement age decreased to original level.

People may withdraw from the workforce at a different age. As such, at the macro-level, effective retirement age may differ from normal retirement age. As shown in Figure 1 and Figure 2, the averageFootnote ² gap between these two measures varies, in case of men from 1.8 in Slovenia to −3.1 in Spain, and in case of women from 1.8 in Estonia to −3.9 in Belgium. Generally, in most analyzed countries, people withdraw from the workforce before reaching statutory age. This is particularly evident in Belgium and Spain. By contrast, in Estonia, Slovenia (only men), Portugal (only men), and Austria (only women) effective retirement age is considerably higher than the normal retirement age. In those countries workers tend to postpone retirement beyond the official threshold.

Figure 1. The average gap between normal and effective retirement age (men, 2009-2020).

Source: Own elaboration based on OECD data (OECD, 2015, 2017, 2019, 2021).

Figure 2. The average gap between normal and effective retirement age (women, 2009-2020).

Source: Own elaboration based on OECD data (OECD, 2015, 2017, 2019, 2021).

Instability of the pension system: source of data

From the very beginning of its existence, the pension system has been subjected to numerous modifications. It is so also today. Policy-makers are forced to implement pension reforms to ensure fiscal sustainability and social efficiency. Although the scope of current changes is unprecedented, there are still new ideas for a radical system reorganization.

Every pension reform makes the system unstable, because it interferes with the construction and institutional settings (rules, principles, procedures). The level of this instability varies from country to country. In some cases changes are rare and evolutionary, but in the other cases changes are more frequent and revolutionary in nature.

The level of (in)stability of the pension system can be measured in various ways. One of them is simple summing up the number of pension reforms that have been implemented in a specific country, in a specific time. This score presents how frequently the system was modified. As such, the higher is the number, the more unstable is the pension system. Such an approach is advantageous for its simplicity, but it does not give a whole picture. Moreover, in some cases it may create misleading impressions. This is because pension reforms are diverse: from minor modifications, to structural reconstructions. Each of them may have a radically different impact on the stability. Therefore, it may turn out that the pension system in one country, where several minor reforms were implemented, is much more unstable than in another country, where at the same time only one reform was implemented, but of fundamental importance.

Comprehensive measurement of the (in)stability of the pension system requires taking into account two components: (1) the scope of pension reforms (How many changes are being done?), and (2) the impact of pension reforms (How serious are those changes?). Therefore it is necessary not only to calculate the number of pension reforms, but also to assess their significance.

The first step to assess (in)stability of the pension system is to evaluate the scope of the pension reforms. Although this element seems to be easy to calculate, in fact it is quite problematic and requires several crucial assumptions. This is because the term “pension reform” is not strictly defined and can be understood in various ways: either broadly, as any system change, or narrowly, as a series of comprehensive changes leading to an improvement of the system. Such a lack of clarity generates certain complications. Firstly, a radical (structural) reorganization of the pension system may be treated either as several separate reforms (broad approach) or as one complete reform (narrow approach). Secondly, changes of the pension system are evaluated either as favorable (constructive, functional) or unfavorable (destructive, dysfunctional). Changes that are considered as unfavorable may be taken into account as a reform (broad approach) or not (narrow approach). Under the narrow approach, the reform must have a modernizing character (improvement), otherwise it is not treated as reform, but as a deform or anti-reform.

In order to avoid such misunderstandings, in our study we use a broad approach. Pension reform is any change made by policy-makers that interferes with institutional settings, modifies the organizational structure, or changes the way the pension system operates. As such, every change is a reform, regardless of positive or negative assessment. In our research the number of changes matters, not their quality (reform or anti-reform).

One more problematic issue needs to be solved. Let us assume the following situation. In one country a radical (structural) reconstruction of the pension system has been carried out, including modification of several elements, e.g. official retirement age, level of contribution, and the formula for calculating benefits. All these changes were implemented simultaneously. In another country the same changes were made, but they were implemented sequentially, as separate reforms spread over time. At the beginning retirement age was changed, then level of contributions, and at the end the formula for calculating benefits. After all, the same changes were made in both countries, but the number of reforms was different. In the first case only one complex reform was implemented, while in the second case three simple reforms. To avoid potential misunderstandings, we assume that reform is a single change of the pension system. So if the reconstruction is complex (modifies several elements at once), then each change is calculated separately as a single reform.

We propose to distinguish five essential domains in which pension reforms are implemented, as presented in Figure 3. The domain “structure” includes changes of the pillar composition, with such elements as: the method of financing (funded, PAYG), a formula of benefit calculation (defined contribution, defined benefit), and character of participation in the system (voluntary, compulsory). The domain “entitlements” includes changes in eligibility criteria, such as: retirement age or contribution requirements. Domain “benefits” includes changes in calculating old-age pension benefits, such as: valorization process, supplements, the minimum benefit level. Domain “taxation” includes all changes in broadly understood fiscalism in regard to pension system (e.g. contribution level). The last domain “others” contains all changes in the pension system that were not included by the previous domains.

Figure 3. Domains of the pension reforms.

Source: Own elaboration.

The second step to assess (in)stability of the pension system is to assess the impact of the pension reforms. Reforms may have different “firepower”. Particular changes range from minor (e.g. annual freeze of benefit valorization) to major (e.g. reconstruction of the pillar system). Each of them differs in terms of undermining system’s stability.

Evaluating the impact of pension reforms is more complicated than calculating its number. This is because the scope is a qualitative feature that can be objectively measured, whereas impact is a qualitative feature that (due to its nature) is difficult to measure. However, impact is an ordinal feature, so pension reforms can be ranked from the least to the most “powerful”. Such spectrum between two extremes can be divided into categories that contain reforms of similar significance. In our study we adopted the division into three ordinal categories:

1. 1) minor: a slight change or correction of the pension system, affecting a selected or/and relatively small group of citizens (e.g. temporary change in indexation, or one-off additional pension benefit),

2. 2) moderate: a serious change that is crucial to the functioning of the entire pension system or at least its essential part, affecting all citizens or the vast majority (e.g. changes in contribution level, or modification of early retirement entitlements),

3. 3) major: a fundamental change of pension system, of key importance, with a large impact on all citizens (e.g. modification of the pillar composition, or changes in pensionable age).

Basing on reports “Pensions at Glance” we collected the data on all pension reforms implemented between 2009 and 2020 in 21 European countries. Next, this data was modified in accordance with established requirements. Complex reforms were divided into simple elements, and assigned to appropriate domains. Subsequently, each simple reform was assessed in terms of significance, and classified into the ordinal category. The obtained results are presented in Table 2.

Table 2. The number of pension reforms (overall and by category) in 21 European countries, 2009-2021

Source: Own elaboration based on OECD data (OECD, 2013, 2015, 2017, 2019, 2021).

European countries differ in terms of stability of the pension system. In 2009-2021 the lowest number of pension reforms was implemented in Luxemburg, Austria, and Slovenia, and the highest number in Finland, France, and Greece. It is not easy to distinguish any geographical or socio-economic feature combining countries with a similar levels of (in)stability. For example, among Scandinavian countries, in Sweden system was relatively stable, whereas in Finland it was relatively unstable. Among post-Soviet countries, in Slovenia it was relatively stable, whereas in Poland by contrast, relatively unstable.