Ten Steps to Reforming Baby Boomer Retirement
Thursday, March 23, 2006
by John C. Goodman, Devon Herrick, Matt Moore
Table of Contents
- Executive Summary
- Step 1. Improving Traditional Pension Plans
- Step 2. Improving 401(k) Plans
- Step 3. Expanding IRAs
- Step 4. Removing Penalties on Work
- Step 5. Repeal the Social Security Benefits Tax
- Step 6. Using the Roth Method of Taxation
- Step 7. Making Health Insurance Portable
- Step 8. Tax Relief for Post-Retirement Health Insurance
- Step 9. Creating Health Savings Accounts for Seniors
- Step 10. Paying for Long-Term Care
- About the Authors
Step 4. Removing Penalties on Work
One of the great accomplishments of the Contract with America 26 was the abolition of the Social Security retirement earnings test for people who reach the normal retirement age of 65. Such people no longer lose Social Security benefits if they earn wage income. The problem remains, however, for those below the normal retirement age.
The normal retirement age is rising for workers born after 1938. It began rising in 2003 by two months every year and will continue until it settles at age 67 for workers born in 1960 and later. People who receive Social Security benefits before normal retirement age are subject to an earnings test if they continue to work. In 2006, Social Security will withhold $1 in benefits for every $2 of non-Social Security earnings in excess of $12,480. While the benefits are restored later, some individuals may view the withholding as a tax.27
"The earnings test penalizes retirees who keep working."
Oddly, the earnings test applies only to wage income. One can receive millions of dollars per year in interest, dividends and capital gains without losing a penny of Social Security benefits. But someone who invested in human capital rather than financial capital is punished when he or she seeks a return on that investment by continuing to work.
Under current law, people can take “early retirement” and begin collecting reduced Social Security benefits as early as age 62. They can also delay their retirement and receive enhanced benefits up to age 70. Until relatively recently, the terms of this choice were not actuarially fair. They encouraged early retirement and discouraged delayed retirement - thus costing the nation by lowering output and costing the Treasury by increasing Social Security benefit payments.28 Today, however, the tradeoff is thought to be actuarially fair for a healthy individual.29 Furthermore, from the normal retirement age until age 70, there is no requirement that individuals actually be retired in order to receive Social Security benefits. So the decision to work (and how much to work) can be independent of the decision to draw benefits.
Accordingly, the Social Security earnings test is unfair and counterproductive. A recent study from the National Bureau of Economic Research concluded that the earnings test reduces the number of married men between 62 and normal retirement age in full-time work by 10 percent.30 To encourage people to remain in the workforce longer and better prepare for their own retirement, Congress should repeal the earnings penalty for everyone who collects Social Security benefits.