Pension reform: What other countries do

As the debate intensifies about the reform of pension provision in the UK, BBC News looks at the different approaches taken by other countries to the pensions crisis to see what lessons might be learned.

Most developed countries face the same demographic problem as the UK: fewer workers are having to support more retired people as people live longer and birth rates decline.

But unlike Britain, many other developed countries have more generous state pension systems, and face the problem of how to fund them in the future.

Other countries have also sought to boost savings by introducing a greater element of compulsion into private savings for retirement.

THE US: PRIVATISING SOCIAL SECURITY

The United States faces some of the same demographic pressures as the UK.

Attention has been focused on how to pay for future commitments for the US earnings-related state pension system, known as social security, after the “baby boomer” generation retires starting in 2010.

The social security system is projected to become insolvent by about 2040, despite earlier reforms which gradually increased to 67 the age at which payments became due, reduced benefit levels, and raised social security taxes.

President Bush has suggested that the best way to deal with the crisis is to partly privatise the system, allowing younger workers to opt out of their social security taxes and put the money into private accounts instead.

The idea is that these private accounts, which could include shares and bonds, would earn a higher rate of the return and so give a higher standard of living to future retirees.

But the plan has run into a firestorm of criticism, both for the huge transition costs, and fears that private stock market accounts would be inappropriate and expensive for low-income workers.

Since social security is funded on a pay-as-you-go basis, the money lost when people opt out would have to be replaced from general taxation, at a cost of up to $3 trillion (£1.7 trillion).

It seems unlikely that Congress will take up Mr Bush’s proposals this year.

Meanwhile, many defined benefit company pension schemes are in difficulty.

Large firms such as General Motors and Delta Airlines are struggling to reduce their pension payouts to aid their return to profitability – and the government pension guarantee scheme is likely to be pushed deeper into deficit as a result.

Many companies have now switched to defined contribution schemes, known as 401(k), which attract tax relief.

But company contributions to such schemes vary considerably, and the type of investments made by individuals (mainly in mutual stock market funds) may not secure them an adequate retirement income.

GERMANY: REDUCING STATE PENSIONS

Germany was the country that first introduced old age pensions – as a bulwark against socialism – under Bismarck in the 1880s.

But the modern pension system – which relies on a partnership between employers, employees and the state – is increasingly seen as unsustainable.

Workers and employers currently contribute about 20% of salary, while the state adds another 10%, to produce a final salary pension that can be up to 70% of earnings.

Under the Social Democrats, pension reform was started, including the raising of the national pensionable age from 65 to 67, an increase in employee pension contributions, and ending the link between pensions and gross earnings.

Angela Merkel, the new Chancellor, is expected to try to push through further reforms to reduce the cost of the pension bill, which has a major impact on Germany’s 35bn euro (£24bn) budget deficit.

These could include encouraging employers to offer defined contribution (money purchase) schemes rather than final salary schemes, and accelerating the move to a later age of retirement.

The OECD has recently urged Germany to encourage more workers to stay in the workforce.

It points out that only 40% of the population between ages 55 and 65 is in the workforce, well below the average of many other countries.

JAPAN: COMPANY PENSIONS UNDER PRESSURE

Japan faces one of the biggest demographic problems of all developed countries, with 28% of its population projected to be over 65 by 2025, compared with 15% in Britain and 12% in the US.

The increase in the elderly population has been caused not only by Japan’s exceptional longevity, but also by very limited immigration and a low birth rate.

As a result, both state and company pension schemes are under pressure to reduce benefits and increase contributions.

Traditionally Japan has depended on its large, export-oriented companies to provide decent pensions for its workers – often funded directly out of corporate earnings rather than put aside in separate funded schemes.

But the hollowing out of the Japanese corporation, with much production switching to other sites in Asia, means that fewer workers are now covered by such schemes.

Japan was late in establishing a state pension system – it was not put into place until the 1970s, but when it was set up its benefit levels were extremely generous.

The prime minister, Junichiro Koizumi, made pension reform one of the keynotes of his recent election campaign.

In 2004 the government announced that pension system contributions would rise every year until 2017, when they will stand at 18.3%. Presently, the figure is 13.58% of a person’s income. Benefits, on the other hand, will be slashed to 50.2% of income from 59.3% over the same period

However, experts believe that further changes will be needed to keep the system solvent.

Until people feel secure about the future of the pension system, they are likely to maintain the high rates of saving that are impeding Japanese economic recovery.

AUSTRALIA: COMPULSORY PRIVATE PENSIONS

Australia has been one of the pioneers of pension reform.

Like the UK, it has a basic state pension – which is means-tested, and pays a modest income to retirees that was introduced in 1909.

But, unlike the UK, the Australian government in the 1990s introduced compulsory private pensions for everyone earning more than A$479 (£191) a month.

At-a-glance

The required contribution rate – paid by employers – has been gradually raised from 3% of salary to 9%, with tax incentives for employees to contribute 2-3% more themselves.

The size of the “superannuation funds” – many of which are run on an industry-wide rather than company basis – has risen from A$30bn to A$600bn.

And 95% of employees are members of such a pension scheme, including 75% of part-time workers.

The compulsory pension deal was initially implemented with the support of the trade unions, who agreed in national pay bargaining to forego wage increases in return for pension contributions.

But some observers believe that the accumulated pension contributions are not big enough to provide an adequate retirement income – and even the government says that after 40 years of saving 12% of their income, workers will retire on less than half their average salary.

There have also been questions raised about the management and accountability of the superannuation funds, whose investment strategies are relatively lightly regulated.

NEW ZEALAND: AUTOMATIC SAVINGS ACCOUNTS

New Zealand has unexpectedly become a model for the reform of the UK pension system, despite having a very different pension system.

There are few big companies; there are no tax advantages for occupational pension schemes; fewer than 15% of workers are in company schemes; and personal pension schemes have grown strongly.

But now the government has embarked on a bold new reform to encourage savings for retirement, called KiwiSaver, which comes into effect in 2007.

The idea is that all workers will be automatically enrolled in a government-run savings scheme which invests their money in personal accounts.

Workers will then be able to take their own personal KiwiSaver account with them from job to job.

Contributions, at either 4% or 8% of salary, will be deducted from salaries by the Inland Revenue, using the country’s existing PAYE tax system.

The Revenue will keep the money for the first eight weeks during which time the saver can decide where the money should be invested, or whether to opt out.

The aim is to save for retirement, so funds will be locked in until the age of 65 (with some exceptions).

Existing employer schemes will have the option of merging with the KiwiSaver scheme.

And members of occupational schemes will be able to choose to join KiwiSaver instead of, or in addition to, their current pension scheme.

However automatic enrolment will NOT apply to workers where their employer already provides a pension fund that is transferable to another scheme, open to all employees and has a total contribution rate of at least 4%. –Steve Schifferes, BBC News economics reporter