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Actuarial deductions for early retirement

Published online by Cambridge University Press:  01 March 2021

Markus Knell Open the ORCID record for Markus Knell [Opens in a new window]
Markus Knell*
Affiliation:
Oesterreichische Nationalbank, Economic Studies Division, Wien, Austria
*
*Corresponding author. E-mail: Markus.Knell@oenb.at
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Abstract

This paper studies how the rates of deduction for early retirement have to be determined in pay-as-you-go (PAYG) systems in order to keep their budget stable. The derivation of these deductions requires the use of a multiperiod intertemporal budget constraint that involves assumptions about the retirement behavior of past, present, and future cohorts. In general, it is not possible to calculate budget-neutral deductions from the budget constraint of a single individual who retires before the target retirement age—an approach that dominates the related literature. Only for specific cases one can use this second approach but then one has to adjust the discount rate to the assumption about collective retirement. If there is only one deviating individual, then the right choice is the market interest rate while for a stationary retirement distribution it is the internal rate of return of the PAYG system. In this case, the necessary deductions are lower than under the standard approach. This is also true for retirement ages that fluctuate randomly around a stationary distribution. Various long-run developments (e.g., increases in life expectancy or permanent changes in the average retirement age) might cause challenges for the sustainability of the pension system. These developments, however, can only be dealt with by adequate adjustments to the basic pension formulas and not by the use of deduction rates.

Keywords

Demographic changefinancial stabilitypension system

JEL classification

J18: Public Policy J1: Demographic Economics H55: Social Security and Public Pensions J26: Retirement • Retirement Policies
Type
Research Paper
Information
Journal of Demographic Economics , Volume 87 , Issue 2 , June 2021 , pp. 141 - 167
Copyright
Copyright © Université catholique de Louvain 2021

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