Impact of unemployment breaks on pension entitlements
Many individuals have interrupted careers because of unemployment and delaying entry into the labour market. Pension credits as well as residence-based pensions and minimum pensions help to cushion the impact of unemployment breaks. This indicator shows how this affects future pension entitlements. Male workers with average earnings and having five years out of the labour market due to unemployment will have a pension equal to 94% of that of a full-career worker on average across the 38 OECD countries with substantial cross-country variation. Benefits are not affected in Colombia, Ireland, New Zealand, Spain and the United States, whilst Australia, Iceland and the Slovak Republic have a future benefit at 88% of the full-career worker as there is no mechanism to cushion the impact of the break.
Most OECD countries aim to protect at least the initial periods of absence from the labour market due to unemployment. On average five years of unemployment will result in a pension of 94% of that of a full-career worker for the average-wage case. With 10 years of unemployment after a five-year delay to beginning the career this falls to 78%, with both scenarios leading to a higher retirement age in a few countries. For low earners, the impact of these two career breaks on their pension benefits is lower, with a relative pension of 96% and 83%, respectively, compared with the full-career case.
For the average-wage worker, pension shortfalls relative to someone with a full, unbroken career varies widely across countries. They are generally larger for longer duration of career absence and for high-earners. In the Slovak Republic the pension loss after a five-year unemployment break is around 12% as there is no instrument to cushion the impact of the unemployment shock on pension. In Latvia there is only minimal protection for the first year. In Australia and Iceland, although there is no protection in the DC pension schemes, both countries have basic pensions that are gradually withdrawn against other income, so whilst this does not provide protection for the five-year case it does cushion the impact of the longer unemployment break scenario.
However, in other countries, pension rules can offset the fallout from spells of unemployment. This applies for example in Ireland, Spain and the United States. In Spain and the United States, this is because total accrual rates and the reference wage used to compute benefits are not affected – for example, pension entitlements stop accruing in Spain and the United States after 38.5 and 35 years, respectively. In Ireland, this is because such a break does not affect the basic pension level. In New Zealand as well periods of unemployment do not affect the basic pension as it is entirely residence based. The Netherlands’ residence-based basic pension affords some protection against unemployment, while the occupational pension is sharply reduced by unemployment breaks.
In Greece, Luxembourg and Portugal the benefit upon retirement will be high but the individual needs to work one, three or one year longer, respectively, to get a full pension (i.e. without penalty). For Greece and Portugal this is also because the indexation of benefits in payment to the full-career worker is below wage growth. In Luxembourg contributions at later ages result in a slightly higher accrual with a long career. Average-wage workers have to retire later to benefit from a full pension after experiencing a five-year unemployment break in France and Slovenia as well due the required contribution rules.
There are countries which afford low-paid workers better protection against long-term unemployment than average earners, because minimum pensions and resource-tested schemes play a crucial role in some of them – Australia, Belgium, Canada, Chile, Colombia, Iceland, Mexico, Norway and Poland. Where there is no or limited pension credit provision – in Chile, Estonia, Israel, Korea, Mexico and Turkey, for example – pension losses are more substantial for average-wage earners with effects felt most keenly in countries whose compulsory pension programmes link pensions and earnings closely – e.g. Chile – and at higher earnings levels. By contrast, lower earners in Germany are more affected by the longer unemployment break than average earners, as low earners lose their entitlement to the supplemental component of the pension, due to their shorter contribution period.
In Colombia and Mexico low earners even with long-career breaks meet the criteria to receive the minimum pension, as is the case for full-career low earners, and thus their pension entitlement is not affected by the career break.
Definition and measurement
For the unemployment career case, men are assumed to embark on their careers as full-time employees at 22 or 27 for the late entry case, and to stop working during a break of up to ten years from age 35 due to unemployment; they are then assumed to resume full-time work until normal retirement age, which may increase because of the career break. Any increase in retirement age is shown in brackets after the country name on the charts, with the corresponding benefits for the full career worker indexed until this age. The simulations are based on parameters and rules set out in the online “Country Profiles” available at http://oe.cd/pag.
Note: Figure in brackets refers to increase in retirement age due to the career break. Individuals enter the labour market at age 22 in 2020. The unemployment break starts in 2033. Low earners in Colombia, New Zealand, the Slovak Republic and Slovenia are at 66%, 60%, 53% and 55% of average earnings, respectively, to account for the minimum wage level.
Source: OECD pension models.
Note: Figure in brackets refers to increase in retirement age due to the career break. Individuals enter the labour market at age 27 in 2025. The unemployment break starts in 2033. Low earners in Colombia, New Zealand, the Slovak Republic and Slovenia are at 66%, 60%, 53% and 55% of average earnings, respectively, to account for the minimum wage level.
Source: OECD pension models.