The Swedish pension system
The purpose of a retirement system is to generate income for people after retirement. By giving up a part of the income, and possible consumption, during the years of work, one hopes to gain insurance. An insurance of enough income to continue living a comfortable life also after retirement.
In January 1999, the reformed Swedish pension system was introduced and was fully implemented in 2003. One reason for the reform was to make the pension system fairer (Proposition 1993/94:250). Going from a system based on defined benefit (DB), where the pensions were based on how high your salary was, to base it on defined contribution (DC), how much money you have contributed to the system. However, the system was mainly reformed to become more financially stable, meaning a system that could better withstand and follow the economic and demographic change.
The demographic challenge is that we have an aging population. The proportion of people contributing to and withdrawing from the pension system is shifting. More people might need the support, while less can contribute. The reformed system was built to follow this change from a cost perspective. If the amount paid into the system becomes more than what is withdrawn, a break would be activated and lower the pensions paid out until the pension system is in balance again. From the benefit perspective, they relied on people’s ability to decide. They did put a lot of faith in that people would choose to work longer and retire later to increase their pension.
The Swedish retirement system is mainly a two-pillar system containing public and occupational pensions. The public pension is the central part, and the one most people rely on. It is based on a person’s taxable income throughout his life, where 18.5 percent is deducted from the yearly income to the public pension system. The public pension contains two parts. The first part of the public pension, and the most substantial part (16 percent of the 18.5 percent), is a pay-as-you-go system (PAYG), which means that a person’s contribution is directly paid out to the pensioners. The contribution is then booked on the individual’s account with the expectation that the next generations will pay it. It is not funded, meaning there is no actual money saved on the individual’s account regarding this part. It instead relies on transfers between generations to back it up. The expected amount that a person will receive during retirement is mainly based on how much has been contributed, where the number of years a person has worked is essential, and the general life expectancy. This is then adjusted, so the person receives a higher monthly pension at the beginning of retirement. The monthly pension then decreases with a specific rate. As the life expectancy at age 65 has increased, the number of years a person will have to distribute the pension wealth over has increased too. An effective way to increase the expected monthly pension would be to work longer and retire later, as it increases the contribution and simultaneously decreases the expected number of years the pension needs to provide for.
The second pillar is the occupational pension, a supplement to the public pension. Around 96 to 97 percent of employees in Sweden get provisions for an occupational pension (ISF, 2018). It is not only common to have an occupational pension, but it has also become a more significant part of the total pension for many. It is now around 28 percent of the total pension and will likely keep increasing (Swedish Pension Agency, 2021).
In Sweden, there are mainly four substantial occupational pension schemes that are all based on agreements between labor unions and employer associations. Two are for workers in the private sector and are divided up into blue- respectively white-collar workers. The other two are for people either employed by the municipality and the region or people employed by the state. A person can have more than one occupational pension if he has had multiple employments with other occupational agreements.
The amount contributed to these schemes is between 4,5 to 6 percent of the salary depending on which scheme the employer belongs to. For people with salaries above the threshold for contribution to the public pension, the contribution rate for the occupational pension can be higher; this rate is typically around 30 percent of the salary and makes the occupational pension more vital for high-income earners.
The occupations pension for the municipality and regional workers
The occupational pension scheme in focus in this thesis is KAP-KL, which belongs to employees of the municipal and regional sectors. KAP-KL was introduced in 2006 and replaced an earlier occupational pension agreement. Since 2014 KAP-KL only includes municipality and regional workers born before 1985. Those born after 1985 belong to the AKAP-KL agreement, which was introduced in 2014. KAP-KL will be the only agreement of interest here, as people born in 1985 and after have not started withdrawing their pension.
KAP-KL has two parts, one is a defined benefit (DB), and the other one is a defined contribution (DC). Not everyone in KAP-KL is entitled to the DB KAP-KL; only those with a salary above 7,5 income bases are.3 The income for this part is then calculated as a rate of the salary one has in the final years of employment. The employer is responsible for the DB KAP-KL, and it gets paid out at retirement.
In contrast to the DB KAP-KL, everyone in KAP-KL is entitled to the DC KAP-KL. It can be earned from age 21, and the contribution rate is 4,5 % of the salary. The DC KAP-KL is a funded system where the pension wealth is invested and taken care of by a pension company. From the age of 55, it is possible to apply to withdraw the pension income from the DC KAP-KL part. The withdrawal options are either to withdraw it in a fixed term, ranging from 5 to 20 years, or as an annuity. If the occupational pension has not been withdrawn before age 67, it will automatically be paid out as an annuity. This « automatic payout age » changed in 2018 from 65 to 67, meaning that if you wished to withdraw the pension at age 65, you had to apply.
The retirement age
The Swedish pension system does not have an official retirement age. In the public pension, you can start to take it out at the age of 62, and you can collect pension wealth for as long as you work. Most occupational pensions can be withdrawn from the age of 55, except for government works occupational pension, which can be taken out from 61. Most people have and are still taking out their public pension at age 65. However, the withdrawal age has spread out. From the start of the reformed pension system, it has gone from around 80 % to around 50 % that start to withdraw the public pension at the age of 65 (Swedish Pension Agency, 2021). A similar pattern for the withdrawal age can be seen for the occupational pension. More and more people are taking it out before or after 65, but most people still take it out at 65. In 2018 it was around 66% that took out their occupational pension at the age of 65 (AMF, 2018).
The Swedish Pension Agency estimates that the combination of working one more year and at the same time withdrawing the public pension one year later would increase the public pension income at retirement by 7 to 8 percent (Swedish Pension Agency, 2021). For the occupational pension, it is usually not as beneficial to continue working as it does not provide additional pension wealth, but later withdrawal does have a positive effect on the retirement income.
Similar to the findings of Seibold (2022), there are significant spikes at age 65 also in Sweden. Even do the retirement age in Sweden is not as fixed to the age of 65 as it used to be, it is still used as a reference age in many ways. For most occupational pension agreements, the retirement age was set to 65, which is why the automatic payout has been set to that age.
The definition of timing of retirement is not clearly defined. It is common among economists to either refer to it when a person starts to claim pension benefits or the time a person exits the labor market. In many situations, there is a transition time combined with withdrawing some pension and working fewer hours. In this thesis, I will simplify by not extinguishing between fully retired and partly retired. However, I will investigate the influence of the default option on both the timing of withdrawal and the timing of exiting the labor market.
This thesis, therefore, consists of two hypotheses. The first one is that the default option of the automatic payout influences people’s timing of the occupational pension withdrawal. If the default option was used to nudge people to retire at age 65, then changing the default option from age 65 to 67 should decrease the number of people withdrawing their pension at age 65 and increase the number of people withdrawing it later.
The second hypothesis is that the default option of the automatic payout can influence people to stop working earlier than if they did not receive the automatic payout. The automatic payout can influence the decision by signaling that it is time to retire or by increasing the perceived opportunity cost of working. Similar to the first hypothesis, a change of the default option from age 65 to 67 should positively affect retirement. In this case, the change should increase the number of people working after age 65 compared to if the default option was not changed.
Because of the data limitations, the first hypothesis will be analyzed and discussed with the help of data from a report released by AMF, which is one of the largest pension companies managing occupational wealth. This analysis and discussion will take place in the next chapter.
The second hypothesis, which is the main focus of this thesis, will be tested by conducting a difference-in-difference analysis. This chapter will focus on the difference-in-difference method and the data I will use for this study.
Method and identification strategy
The difference-in-difference method is a commonly used approach in economic research. The reason for its popularity is that it is a well-suited strategy to capture the causal effects of a change in the economic environment or government policy. The most straightforward difference-in-difference approach includes two groups and two time periods. One group is affected by the change in the economic environment or the government policy and is called the treated group (T). The second group should work as a control group (C). As to how the treated group would have developed if it had not been treated, it is therefore essential that this group is not affected by the change.
The two time periods should be divided so that one time period represents the time before (B) the treatment occurs, and the second time represents the time after (A) the treatment has occurred. The estimation will compare the change between the treatment and control groups between the two time periods. The change between the two time periods, before and after, for the treated group should capture the effect of the change in the economic environment or the government policy. However, other external effects might influence the treatment group’s development between the two time periods. The change for the untreated group, the control group, should therefore capture all external effects and not the effect of the change. Subtracting the change for the control group out of the change of the treated group should adjust for the external effects and result in only the effect of the change of interest. Equation 1 represents the difference-in-difference method and how it captures the difference-in-difference effect (DD). 𝐷𝐷=(𝑇𝐵−𝑇𝐴)−(𝐶𝐵−𝐶𝐴) (1).
Table of contents :
3.1 The Swedish pension system
3.2 The occupations pension for the municipality and regional workers
3.3 The retirement age
4.1 Method and identification strategy
4.2 Data and variables of interest
4.3 Descriptive Statistics
4.4 Econometric modeling
Result and discussion
5.1 Timing of retirement
5.2 Timing of withdrawal