Work and Retirement

Policy Backgrounders | Social Security

No. 162
Friday, November 03, 2006
by Liqun Liu and Andrew J. Rettenmaier


Introduction

"Funding boomers' retirement benefits will put a severe strain on workers."

In 2006, the first of 77 million baby boomers reached age 60. In two years they will be eligible for early retirement benefits from Social Security. In five years they will be eligible for Medicare. As they retire, the boomers will stop paying taxes to fund America's elderly entitlement programs and begin collecting benefits instead. Over the next three decades, the number of retirees will double. However, due to declining fertility rates, the number of workers contributing to the system will fall from three for each retiree receiving benefits to two for each retiree. This will place a severe strain on working Americans to pay promised benefits to the elderly.

One way to soften the blow of the boomers' retirement is to encourage them to stay in the workforce longer, or at least not encourage them to leave. Increasing work by boomers would also increase income tax revenues. In addition, Medicare's finances would improve because older workers would receive some of their health coverage from employers rather than the government. It also would keep America's most experienced employees in the workplace, boosting economic output.

However, features of the current Social Security program actually encourage older Americans to retire earlier. For example:

  • Social Security withholds a portion of some people's benefits because they earn wages above a certain amount before they reach the normal retirement age (the earnings test).
  • Benefits for those who continue working past the early retirement age do not properly account for the Social Security payroll taxes paid during the additional working years.
  • Americans are spending a longer portion of their lives in retirement, but the normal and early retirement ages have not been fully adjusted to reflect rising life expectancies.

This paper examines several ways to increase the labor supply of older Americans and update Social Security to keep pace with changing life expectancies and labor market conditions. The reforms would give seniors greater freedom and flexibility to time their retirement, provide employers with incentives to retain older workers and increase incentives for older Americans to stay in the workforce longer.

"Social Security gives seniors incentives to retire early."

The reforms will not solve Social Security's long-term financing woes. However, they will reduce the incentives under the current system for seniors to stop working once they are eligible to begin claiming benefits. Fundamental reforms that address system solvency could build on these changes. The three broad measures considered are:

  1. Eliminating the earnings test for early retirees (age 62 to the normal retirement age);
  2. Reducing payroll taxes once a worker is eligible to receive Social Security benefits; and
  3. Accounting for increases in life expectancy by indexing the normal and early retirement ages, and updating the Social Security benefit formula.

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