Occupational pension schemes, voluntarily provided by employers, are common in many OECD countries. This section shows detailed results on the value of these pension entitlements for four countries: Canada, Denmark, the United Kingdom and the United States. These four countries were chosen for three reasons. First, coverage of occupational pensions is broad: around one third of employees in Canada, a little under half in the United Kingdom and the United States and around 80% in Denmark.1 Secondly, occupational pensions play an important role in providing retirement incomes. Thirdly, data are available on the rules and parameters of different employers’ plans for these countries.2, 3
The analysis of the four countries that follows is presented in the same format as the country studies that discuss mandatory pension systems. These provide detailed descriptions of the rules and parameters chosen for the representative pension plan and the justification for that choice. The table below offers a cross-country summary of these provisions for the three countries where defined-benefit pension systems have been modelled. In Denmark, occupational pensions are of the defined-contribution type.
It is also important to note that defined-benefit occupational plans often have more generous rules for age of retirement than do national programmes. For comparison with other countries and with the results of mandatory pensions only, it is again assumed that people retire at the normal pension age of the public scheme. In practice, earlier retirement will result in lower benefits because of the smaller number of years over which pension accrues.
Parameters and rules for defined-benefit occupational pensions
Canada United Kingdom United States
Earnings measure Final salary (70%) Final salary (95%) Final salary (55%)
Vesting 5 years’ service 2 years’ service 5 years’ service
Pension age 65 65 65 (47%)
Accrual rate 2% a year (70%) 1.25% a year (65%) 1.5% a year
Integration method 1.3% accrual up to public ceiling – –
Pre-retirement preservation None Price inflation None
Post-retirement benefit adjustment Half price inflation Price inflation None
II. VOLUNTARY, OCCUPATIONAL PENSIONS
Notes
1. See OECD (2001), Table 6.2 and Johnson (1998), Table 3.3.
2. The data for Canada come from OECD (1995). For the United Kingdom, data are drawn principally from the National Association of Pension Funds annual survey. The Government Actuary’s survey is published with a huge delay, with 1995 data only available in 2001. Disney and Whitehouse (1994, 1996) provide simulations of pension entitlements for a range of different scheme rules and parameters. Data for the United States come mainly from Mitchell and Dykes (2000), which is based on a survey of schemes by the Department of Labor; see also Department of Labor (1999).
3. In other countries with broad coverage of occupational pensions – such as Germany, Japan and Switzerland – there have been no surveys of employer pension plans. It is impossible, therefore, to model with any degree of certainty the rules of a “typical” scheme.
II. CANADA
Canada
O
ver 40% of the Canadian workforce are members of occupational pension schemes, known as retirement pension plans. Around 45% of this total are members of public sector schemes. This gives a coverage rate in the private sector of around 30% compared with nearly 100% coverage among public-sector employees.There was a shift to defined-contribution schemes in the 1980s and 1990s in the private sector, but these plans still account for just 13% of total members (including hybrid plans with defined-benefit and defined-contribution elements). Over 60% of members are in final-salary defined-benefit schemes, with 10% in schemes with an average-salary formula and 20% in plans that provide a flat benefit for each year of membership. Most schemes cover the entire workforce, but 20% of members are in schemes reserved solely for members of trades unions.
Most occupational schemes – covering 90% of members – are compulsory for people eligible to join. Typically, eligibility is determined by years of service (to a legal maximum of two years). Vesting rules vary by province, but are generally two years of membership or five years’ service. Some also depend on age. Pensions can be transferred to another occupational scheme or a personal plan when a worker changes jobs, or “preserved” in the old occupational scheme until an employee reaches pension age.
Pension age is generally 65, but a significant minority of public-sector members can claim their pension at 60. The accrual rate in public sector schemes is nearly always 2% of earnings for each year of service. The earnings formula is usually based on the best five years. In the private sector, 2% is also the most common accrual rate, accounting for nearly half of members. But almost a third have accrual rates between 1½ and 2% and another 10%
between 1 and 1½% per year of service. There has been a shift towards the norm of 2%
accrual, partly because this is the maximum allowed by income-tax regulations.
Most schemes are integrated with the public earnings-related scheme, giving a lower accrual rate (usually 1.3 to 1.5%) on the slice of earnings up to the ceiling for the second-tier pension. Lump-sum benefits are not permitted.
In 1989, post-retirement indexation was automatic for 70% of members of public-sector schemes, but only for 7.5% in the private public-sector. However, only 28% of public public-sector members were guaranteed full inflation uprating. Most large schemes, however, provided for ad hoc increases that compensate for about half of inflation.
II. CANADA
Pension modelling results with voluntary schemes: Canada
Source: OECD, based on information provided by the countries.
2.5 Proportion of economy-wide average earnings
Individual earnings, proportion of average earnings
Net and gross relative pension levels Net
Proportion of economy-wide average earnings
Individual earnings, proportion of average earnings
Taxes paid by pensioners and workers Worker: total
Proportion of income
Individual income, proportion of average earnings
Gross replacement rate
Proportion of individual earnings
Individual earnings, proportion of average earnings
Net and gross replacement rate
Proportion of individual earnings
Individual earnings, proportion of average earnings
Sources of net replacement rate Taxes/contributions
Proportion of net replacement rate
Individual earnings, proportion of average earnings
Gross Net Gross
II. CANADA
Pension modelling results: Canada, with voluntary occupational plans
Men Individual earnings, multiple of average
Women (where different) 0.5 0.75 1 1.5 2 2.5
Gross pension level 44.1 56.1 70.3 94.6 118.9 143.2
(% of average earnings)
Net pension level 59.4 75.5 94.6 114.4 129.0 145.6
(% of average net earnings)
Gross replacement rate 88.2 74.8 70.3 63.1 59.4 57.3
(% of individual earnings)
Net replacement rate 108.9 96.4 94.6 78.8 68.8 63.7
(% of individual net earnings)
Gross pension wealth 6.5 8.2 10.2 13.5 16.8 20.1
(multiple of average earnings) 7.5 9.5 11.8 15.6 19.4 23.2
Net pension wealth 8.7 11.0 13.7 16.3 18.2 20.4
(multiple of average net earnings) 10.1 12.7 15.9 18.9 21.1 23.6
II. DENMARK
Denmark
D
efined-contribution schemes are agreed between the social partners. Coverage is almost universal. Contributions to these schemes are typically between 9% and 17% of earnings. Benefits are usually withdrawn as an annuity, although some schemes allow for lump-sum payments. Annuity calculations are based on an assumed interest rate, which is 1.5% for recent contributions and schemes (although was previously 4.5%). However, the schemes operate on a “with-profit” or “participating” basis. This means that pension increases depend on the investment performance of the fund and the mortality experience of its beneficiaries. Since 2000, all negotiated schemes must use unisex life tables for calculating pension values.The modelling assumes the lowest contribution rate of 9% and calculates a price indexed annuity based on a real discount rate of 1.5%.
Pension modelling results: Denmark, with voluntary occupational plans
Men Individual earnings, multiple of average
Women (where different) 0.5 0.75 1 1.5 2 2.5
Gross pension level 56.7 63.7 70.8 84.8 102.2 122.4
(% of average earnings)
Net pension level 68.5 75.5 82.4 96.1 109.9 124.2
(% of average net earnings)
Gross replacement rate 113.3 85.0 70.8 56.6 51.1 48.9
(% of individual earnings)
Net replacement rate 125.0 96.9 82.4 72.5 66.6 62.8
(% of individual net earnings)
Gross pension wealth 9.3 10.2 11.2 13.1 15.6 18.6
(multiple of average earnings) 10.4 11.3 12.3 14.2 16.1 19.1
Net pension wealth 11.2 12.1 13.0 14.9 16.8 18.9
(multiple of average net earnings) 12.6 13.5 14.4 16.2 18.0 20.1
II. DENMARK
Pension modelling results with voluntary schemes: Denmark
Source: OECD, based on information provided by the countries.
2.5 Proportion of economy-wide average earnings
Individual earnings, proportion of average earnings
Net and gross relative pension levels Net
Proportion of economy-wide average earnings
Individual earnings, proportion of average earnings
Taxes paid by pensioners and workers Worker: total
Proportion of income
Individual income, proportion of average earnings
Gross replacement rate
Proportion of individual earnings
Individual earnings, proportion of average earnings
Net and gross replacement rate
Proportion of individual earnings
Individual earnings, proportion of average earnings
Sources of net replacement rate Taxes/contributions
Proportion of net replacement rate
Individual earnings, proportion of average earnings
Gross Net Gross
II. UNITED KINGDOM
United Kingdom
D
efined-benefit occupational pension schemes provide a pension usually related to years of membership of the scheme and some measure of final salary when covered by the plan.Most public-sector schemes pay 1/80th of earnings per year of membership, plus 3/80ths as a lump sum. So the benefit after a full, 40-year career would be half of final salary as an annuity plus 1½ times final salary as a lump sum. Private-sector schemes are more diverse.
Around 60% pay 1/60th of final salary. But taking a lump sum (known as commutation) reduces the annuity value. Around a fifth of plans are more generous than this, while around 7% pay less than 1/60ths or 1/80ths plus a lump sum.
More than a quarter of private occupational schemes are “integrated” with the state scheme, reducing benefits to take account of state pensions received. Most cut the pension by the value of the basic state pension or the lower earnings limit (which are broadly similar by law). Other methods of adjustment are more complicated. For someone on average earnings in a 1/60ths scheme, integration will typically reduce a full-career pension by around a fifth.
The example defined-benefit pension that has been modelled pays an accrual rate of1/80th – the minimum required to contract out of the state second pension – but it is not integrated with the state scheme.
Benefits after retirement must be “limited price indexed”, that is to a ceiling of 5%.
However, all public-sector, and many private-sector plans are fully price indexed.
Pension modelling results: United Kingdom, with voluntary occupational plans
Men Individual earnings, multiple of average
Women (where different) 0.5 0.75 1 1.5 2 2.5
Gross pension level 39.4 49.1 58.7 78.0 97.4 116.7
(% of average earnings)
Net pension level 50.3 60.3 70.1 89.8 108.5 127.0
(% of average net earnings)
Gross replacement rate 78.8 65.4 58.7 52.0 48.7 46.7
(% of individual earnings)
Net replacement rate 90.3 77.5 70.1 62.2 57.5 55.7
(% of individual net earnings)
Gross pension wealth 5.9 7.3 8.8 11.7 14.6 17.5
(multiple of average earnings) 6.7 8.4 10.1 13.4 16.7 20.0
Net pension wealth 7.5 9.0 10.5 13.4 16.2 19.0
(multiple of average net earnings) 8.6 10.3 12.0 15.4 18.6 21.8
II. UNITED KINGDOM
Pension modelling results with voluntary schemes: United Kingdom
Source: OECD, based on information provided by the countries.
2.5
Proportion of economy-wide average earnings
Individual earnings, proportion of average earnings
Net and gross relative pension levels Net
Proportion of economy-wide average earnings
Individual earnings, proportion of average earnings
Taxes paid by pensioners and workers Worker: total
Proportion of income
Individual income, proportion of average earnings
Gross replacement rate
Proportion of individual earnings
Individual earnings, proportion of average earnings
Net and gross replacement rate
Proportion of individual earnings
Individual earnings, proportion of average earnings
Sources of net replacement rate Taxes/contributions
Proportion of net replacement rate
Individual earnings, proportion of average earnings
Gross Net Gross
II. UNITED STATES
United States
T
he majority of occupational pension schemes in the United States are final-salary defined-benefit schemes. These cover 56% of occupational pension members, with 23% in flat-rate defined-benefit plans (which pay a fixed amount for each month of coverage), 11%in average-salary schemes and 6% in defined-contribution plans.
The definition of “final salary” varies, but the most common formula is the best consecutive five years’ earnings, accounting for 65% of members.
Accrual structures are complex, with only 37% in schemes having a single accrual rate, the most common being between 1.25 and 1.75%. In 41% of schemes, the accrual rate varies with the level of earnings and in another 8%, with the number of years of service.
Around half of plans are integrated with social security, usually by using an “excess formula” that applies a lower accrual rate to earnings covered by social security.
The most common normal pension age is 65, although a number of plans only allow retirement once a minimum service level has been achieved.
Following a series of regulatory changes, nearly a third of schemes now have no minimum age or service requirement for eligibility to join the plan. Another third have a minimum service requirement of one year or less and a final third have a minimum entry age of 21 and a one-year’s-service requirement. Schemes are voluntary, but participation rates are high, averaging nearly 80% of full-time employees. Vesting is now most commonly achieved with five year’s membership: these schemes account for 85% of members.
Post-retirement indexation of benefits is rare: just 3% of members are promised automatic cost-of-living increases and only 4% of schemes have granted discretionary increases in the last five years. Fewer than one in four schemes allow any of the pension to be taken as a lump sum.
II. UNITED STATES
Pension modelling results with voluntary schemes: United States
Source: OECD, based on information provided by the countries.
2.5 Proportion of economy-wide average earnings
Individual earnings, proportion of average earnings
Net and gross relative pension levels Net
Proportion of economy-wide average earnings
Individual earnings, proportion of average earnings
Taxes paid by pensioners and workers Worker: total
Proportion of income
Individual income, proportion of average earnings
Gross replacement rate
Occupational Earnings-related Proportion of individual earnings
Individual earnings, proportion of average earnings
Net and gross replacement rate
Proportion of individual earnings
Individual earnings, proportion of average earnings
Sources of net replacement rate Taxes/contributions
Proportion of net replacement rate
Individual earnings, proportion of average earnings
Gross Net Gross
Pensioner: total
Occupational Earnings-related
Worker: income tax
II. UNITED STATES
Pension modelling results: United States, with voluntary occupational plans
Men Individual earnings, multiple of average
Women (where different) 0.5 0.75 1 1.5 2 2.5
Gross pension level 43.4 59.7 75.9 105.8 130.9 156.0
(% of average earnings)
Net pension level 56.3 73.7 91.9 125.4 151.0 175.2
(% of average net earnings)
Gross replacement rate 86.9 79.6 75.9 70.5 65.5 62.4
(% of individual earnings)
Net replacement rate 105.7 96.1 91.9 89.3 84.2 80.6
(% of individual net earnings)
Gross pension wealth 5.7 7.7 9.8 13.5 16.6 19.7
(multiple of average earnings) 6.6 8.9 11.3 15.6 19.1 22.6
Net pension wealth 7.4 9.5 11.9 16.0 19.1 22.1
(multiple of average net earnings) 8.5 11.0 13.7 18.5 22.1 25.4
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