Employers will no longer be able to force workers to retire before 65, unless they can justify it.
Pensions changes: Retirement age will be set at 65
The government has announced that firms will be barred from 2006 from imposing arbitrary retirement ages.
Under new European age discrimination rules, a default retirement age of 65 will be introduced.
Workers will be permitted to request staying on beyond this compulsory retirement age, although employers will have the right to refuse.
Trade and Industry Secretary Patricia Hewitt said people would not be forced to work longer than they wanted, saying the default age was not a statutory, compulsory retirement age.
She said employers would be free to continue employing people for as long as they were competent.
'Best of both worlds'
Under age discrimination proposals from the Department of Trade and Industry last year workers were to be allowed to work on till 70 if they wished.
Business leaders had opposed the plan as they said it would be too costly and cumbersome.
The British Chambers of Commerce welcomed the latest proposal.
"This move today is the best of both worlds," it said.
"Employers have the ability to define the end point of the employer-employee relationship and employees have flexibility with a right to request to work past the age of 65."
But Age Concern said imposing a retirement age of 65 was "cowardly" and a "complete u-turn".
"This makes a mockery of the Government's so-called commitment to outlawing ageism, leaving the incoming age discrimination law to unravel," said Gordon Lishman, director general of Age Concern England .
"It is now inevitable that older people will mount legal challenges to the decision using European law."
The decision will have no impact on the age at which workers can collect their state pension, the government has said.