Why Dutch and Danish retirees sleep well at night

Carefree retirees.
Carefree retirees.
Image: Reuters
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Retirement, a relatively modern concept, is expensive.

No country has figured out how to finance a third of your life out of the labor force. But some countries have better systems than others. The latest annual, Melbourne Mercer Global Pension Index , now in its tenth year, ranks the health and viability of national retirement systems around the world. It has once again awarded the Netherlands a top slot, and Denmark, last year’s winner, is right behind. They rank highly in terms of the level of benefits they supply, their sustainability (the Dutch and Danish don’t worry about their system going bust), and transparency. There are many things we can learn from their success, they show how most countries are on the wrong track.

What makes Danish and Dutch pensions so special?

1. Small government benefits

Denmark offers a basic pension to most Danes age 65 and above (the minimum age increases to 68 by 2030) that’s worth about $11,000 a year. The pension may be reduced for certain income levels and if the beneficiary has meets income tests, it could be increased to as much as $23,000 for a single person. The Netherlands also has a flat basic state pension that pays out about $10,500 a year to Dutch retirees over age 66.

By contrast, the average government benefit in the US, from Social Security, is larger—about $14,000—but it may be as high as $32,000 if you earned more while working. Since the Dutch and Danish state pensions are financed with current tax dollars, their smaller state pensions limits the government’s liability as the population ages. The US also finances Social Security benefits with current tax dollars, but larger, more unpredictable benefits mean more strain on the system.

2. Reliance on the private sector

Denmark and the Netherlands can get away with lower state benefits because they are supplemented with employer retirement plans.

About 90% of Danes also have access to a retirement account through work. It is similar to the US’s 401(k), where employers and employees contribute to an account and employees bear the investment risk. The wide coverage is what makes Danish pensions so special: In the 1980s only 35% had access to a pension account through work. The increase comes from the roll out of new pension accounts that targeted blue-collar workers. Danes contribute between 12 to 18% to their employee pension accounts. Benefits are paid as an annuity after retirement, though sometimes Danes can take it as a lump sum.

Like the Danes  most Dutch—about 94%—also have a pension benefit from work. Unlike Denmark, the pensions are defined benefit plans, where the employer or industry bears the investment risk (though there is sometime some risk sharing through inflation indexation and new collective defined contribution schemes) and pays their former employees a fraction of their salary after they retire. Dutch workers can take their pension to other jobs.

In both countries pension agreements may be with individual companies or industry-wide, through collective labor agreements. Total pension income typically replaces more than 70% of working income, though the actual replacement rate varies.

What makes Argentine pensions so terrible?

Argentina is at the bottom of the rankings, and offers lessons about what makes a retirement system work. It primarily relies on state pension funded mostly by current tax dollars like the other countries, but with erratic tax revenue the funding is not secure. Argentine pensions used to feature individual saving accounts until the state appropriated them in 2008. The Mercer report has concerns about the pension’s sustainability and if it offers enough to the poorest Argentines. It shows how a lack of transparency, unstable institutions, and fiscal pressure can undermine any pension system.

What can other countries learn?

The Melbourne Mercer index offers some critical lessons for policy makers. Some US politicians want to expand Social Security benefits, and enlarge unfunded state program. But this makes long-term sustainability a concern. The report already has concerns about the viability of America’s existing Social Social Security benefits.

Despite the effectiveness, the Dutch or Danish models would be hard to copy, under current US pension laws, in the private sector. Regulations make it expensive for smaller employers to offer retirement benefits, so about 40% American workers don’t have a work-place retirement plan. In the US retirement benefits are usually only offered through individual employers, so the costs of offering pension benefits cannot be shared among entire industries.

Denmark and the Netherlands show that relying on employers and their workers to carry some of the burden can work. While policy makers may debate the merits of defined benefits (Netherlands) versus defined contribution plans (Denmark), those nation’s demonstrate a successful system comes down to execution and adequate funding.