PENSIONS: With an ageing population and the investment climate not so attractive for pension funds, it may be time to rethink our approach to retiring, writes Clare O'Dea

Early retirement has become commonplace and is a fantasy cherished by many workers who are still decades away from the official retirement age of 65. But the workers of today will be retiring in a completely different State with a different set of constraints and the dream of early retirement is unlikely to come true for most.

In fact, things are moving steadily in the direction of later retirement.

Until recently, early retirement has been encouraged and affordable but the situation is beginning to turn and the need to retain people in the workforce longer is becoming greater.

Low pension contribution rates, lower investment returns and the new low interest rate regime are increasing the risk of a pension funding shortfall in the private sector. That's against a backdrop of increasing life expectancy and a changing age structure in society.

The dramatic demographic shift that we are living through cannot be ignored. We are a greying population with a below replacement fertility rate. It's estimated that by 2011, the number of people in the 45 to 64 age category will grow by 197,000, an increase of 24 per cent. At the same time, the numbers of younger people entering the workforce will fall.

Or, to put it in starker terms, there are approximately five people of working age for each person over 65 at present. Projections show that, in 40 years, the ratio could be reduced to less than two to one.

As an economy, one way of addressing that imbalance would be to encourage people to work beyond the traditional retirement age. Another solution might be to change from a fixed retirement point to a more flexible gradual retirement age band.

But it's not just the increasing proportion of older people in the population that will have an impact on pension provision and working patterns, it's also the fact that we are living for longer.

"It's very difficult to conceive of people being able to save enough in a 30- to 35-year career to support themselves for a further 30 years," warns Mr John Feely, chairman of the Irish Association of Pension Funds.

There has been a focus in pensions policy on increasing private pension coverage but the adequacy of those pensions is just as important. In other words, it's not good enough just to have a pension plan, you have got to be putting in enough money.

The sustained move away from defined-benefit or final salary schemes towards defined-contribution pension schemes also has implications for the funding of pensions.

The vast majority of new schemes being set up are defined-contribution schemes, where the investment risk is shifted from the employer to the employee. This is a worrying trend. Contributions paid to defined-contribution schemes by workers and employers are generally lower than to defined-benefit schemes, at 10 per cent versus 12 to 14 per cent. Workers may be disappointed to find that money saved will not be enough to produce a decent pension when the time comes to retire.

So, expectations need to be revised. Mr Feely believes it's not realistic to expect that workers and employees are going to start saving twice as much.

"The question is how are we going to get around it? I think the solution will be to aim for pensions lower than the standard two-thirds of final salary and for people to stay longer in the workforce."

This may sound alarming but it's natural to expect that society will have changed in 30 years and there's a strong case for believing that it will be normal and financially necessary to work for longer.

We have been spoilt by the strong investment climate of the past 20 years, where pension fund investment returns have been 13 per cent per annum above the rate of inflation. With lower interest rates and falling investment returns, it has become much more expensive to provide for people in retirement.

One approach that needs particular examination is the introduction of an early or part-time pension payment linked to semi-retirement or part-time work. This could fit in to a retirement age band, say from 60 to 70, instead of a fixed retirement point.

The system should be able to accommodate different preferences and circumstances. Individuals may not be best served by maintaining the fixed retirement point in a culture of flexible working and growing life expectancy.

The fixed retirement age dates from 1908 when the old-age pension at age 70 was introduced. A fixed retirement age has been a feature of our social policy since then and the current retirement age of 65 has been in place for more than half a century.

The position of the National Council on Ageing and Older People is that flexible retirement would ease the transition from work to retirement for older people, while enabling their skills and experience to be used for a longer period if they so wished.

The Minister for Labour, Trade and Consumer Affairs, Mr Tom Kitt, has said the Government's policy of reducing the tax burden was designed to act as an incentive for older people to continue working, especially those who may wish to supplement their income.

But this is only the beginning. "We need a further detailed examination of the relationship with pensions and benefits to ensure that full pension entitlements and benefits are retained and that there is no financial disincentive to remaining in or returning to work beyond a certain age," Mr Kitt said.

Mr Eamonn Heffernan, president of the Society of Actuaries, argues that there is a need for Revenue to change its practice with regard to phasing in pension payments.

"As things stand, it is not possible for someone approaching retirement to work four and then three days per week and draw their pension for the other days, but there is no good reason why this shouldn't be allowed. The broad message should be that structures need to become more flexible and expectations have to be changed."