Work and Retirement
Friday, November 03, 2006
by Liqun Liu and Andrew J. Rettenmaier
Table of Contents
Updating Benefit Adjustments
If the normal and early retirement ages rise with increases in life expectancy, the age-specific adjustments in the Social Security benefit formula must also change to maintain the program's actuarial fairness.
"Adjustments to early and delayed retirement benefits could keep Social Security actuarially fair."
Benefits are actuarially fair, or equal, if they provide similar expected lifetime benefits regardless of the age at which workers start claiming them.22 The following discussion outlines changes already taking place under current law, which provides a model for how future benefit adjustments could be structured to keep pace with the new normal and early retirement ages discussed in the previous section.
Benefit Changes under Current Law. Beyond the normal retirement age, benefits are increased for every year an individual delays claiming Social Security. Payments are reduced for individuals who claim benefits before reaching normal retirement age. For example, if people who turn 62 this year start claiming benefits on their 62nd birthday, they will receive a monthly check equal to 75 percent of their full benefits.23 If they wait until age 66, they will receive the full 100 percent of their benefits. And if they wait until 70 (or later) to claim benefits, they will receive 132 percent of their full benefits - a 32 percent bonus.24
There is disagreement about whether the current rates at which Social Security benefits are reduced or enhanced are actuarially fair.25 If the adjustments yield lower expected lifetime benefits for delaying retirement, they may encourage retirees to claim benefits early, and if they yield higher expected lifetime benefits for delaying retirement, they may encourage workers to work beyond the normal retirement age.
The 1983 reforms are gradually changing the normal retirement age and the adjustments for early and delayed retirement.26 [See the sidebar: "Actuarial Fairness under Current Law."] Figure VII demonstrates the effects of these changes:
- Benefits for individuals born in 1924 to 1937 are adjusted at the same rate before the normal retirement age of 65, but diverge above it.
- The reward for delayed retirement rises from 3 percent per year for those born in 1924 to 6.5 percent for those born in 1937.
- The bonus for each year of delayed retirement after the normal retirement age will rise to 8 percent for individuals born after 1942.27
"The bonus for delayed retirement is increasing."
The horizontal shifts in the delayed retirement schedules illustrate the effects of raising the normal retirement age - ultimately to 67 for individuals born in 1960 and later.
Note the 1983 reforms did not raise the early retirement age from 62. As the number of years between 62 and the normal retirement age increases from three years to five years, the benefits paid to these earliest retirees will fall from 75 percent to 70 percent. Thus, individuals born between 1943 and 1954 who start claiming benefits at 62 will receive 75 percent of their full benefits while those born in 1960 will receive 70 percent.
"Benefit adjustments for early and delayed retirement could be indexed for increasing longevity."
The adjustments made by the 1983 reforms described above provide a model for how the penalty-reward adjustments can be further shifted to provide incentives for longer workforce participation.
Indexing Bonuses and Penalties for Early and Delayed Retirement to Longevity. Indexing the early and normal retirement ages to account for increasing longevity requires changing the rate of benefit adjustments for early retirement and delayed receipt of benefits. This could be done by shifting the scheduled adjustments for individuals born in 1943 to 1954 to hold the ratio of retirement to work years constant as the normal retirement age increases. Figure VIII shows these shifts using the schedule for those born in 1943 to 1954 as a guide. For workers born in 1960, the new adjustments would be identical to those under current law with two exceptions:
- The early retirement age would be increased to 63, and
- The 8 percent delayed retirement credit would be extended to the age of 71.
Thus, the adjustments would begin at the early retirement age - four years before the normal retirement age (67 - 4 = 63) - and end four years after the normal retirement age (67 + 4 = 71).
However, for these adjustments to be actuarially fair, regardless of the year in which a worker was born, life expectancies at the new early retirement ages would have to be similar. Figure IX presents adjustments for several birth years based on the new normal and early retirement ages, assuming a 3 percent real discount rate.
- Workers born in 1960 would receive 75.2 percent of their full benefits at the initial early retirement age of 63, full benefits at 67 and if they delay retirement benefits until age 71, a 38.1 percent bonus, or 138.1 percent of their full benefits.
- Workers born in 1980 would receive 74.5 percent of their full benefits at the initial early retirement age of 64, full benefits at 68, and a maximum for delaying retirement benefits until age 72 of 139.6 percent of their full benefits.
- Workers born in 2000 would receive 73.9 percent of their full benefits at the initial early retirement age of 65, full benefits at 69, and a maximum for delaying retirement benefits until age 72 of 141.3 percent of their full benefits.
"After all the adjustments, Social Security benefits would be actuarially fair."
The initial benefit levels are all essentially equivalent to the 75 percent for early retirees shown in Figure VII. The annual bonuses for delayed retirement after the new normal retirement ages for future retirees are greater than the current 8 percent per year.