At last week’s White House economic conference there was considerable discussion of the need to reform Social Security. The primary reasons given were to improve fairness for younger workers and put the system on a sound financial footing. As important as these things are, however, I think there is an even more important reason to reform Social Security: to keep older workers in the labor force.
The problem is that the first baby boomers turn 62 in 2008. At this age, one becomes eligible for early retirement under Social Security and can begin drawing benefits. Historically, benefits at age 62 were 20 percent less than those available at age 65, the full retirement age. To be actuarially fair, these benefits should have been less. As a consequence of the over generousness of early retirement, far too many people took it.
In 1960, when early retirement was introduced, just 10 percent of workers retired at age 62. Another 8 percent retired before age 65, with 35 percent retiring at age 65 and 47 percent retiring later. By contrast, in 2002, 56 percent of workers retired at age 62 and another 23 percent retired before age 65. Only 21 percent waited until at least the normal retirement age. As a consequence, the average age of retirement has fallen from 66.2 in 1960 to 63.6 in 2002.
Over this same period, life expectancy has risen sharply. In 1960, a 65-year-old male could expect to live another 13.2 years and a female could expect 17.4 more years. By 2003, a man of 65 could expect an additional 16.7 years of life and a woman that age could anticipate 19.5 more years. Thus, people have been retiring earlier even as they are living longer.
The trends toward earlier retirement and longer life mean that people are condemning themselves to a lower standard of living in old age than they would have if they had waited a couple of years to begin drawing Social Security benefits. I think some people may not even realize that the lower benefits they get at age 62 last a lifetime. They may be under the erroneous belief that their benefits will be bumped up at age 65. They won’t.
In future years, early retirees will be getting an even worse deal. Benefits as a share of what’s called the primary insurance amount is being phased down from 80 percent for those born before 1938 to just 70 percent for those born in 1960 or later. That is, those retiring at 62 will get 30 percent less than those who wait for the normal retirement age.
Furthermore, I suspect that only a very tiny number of retirees know that if they had waited past age 65 to draw benefits, that they would be getting more. At present, those delaying retirement past the normal retirement age will get 7 percent more for each year they wait until age 70. Future retirees will get 8 percent for each year they delay drawing benefits past the normal retirement age, which is in the process of rising from 65 to 67 for those born in 1960 or later.
This delayed retirement credit can have a very dramatic effect on one’s benefits. Those born between 1943 and 1954 will get 76 percent more each month if they retire at age 70 than if they retire at age 62. The former will be getting 32 percent more of the basic retirement benefit one qualifies for at the normal retirement age; the latter will get 25 percent less.
Early retirees suffer in another way as well. Once one begins drawing benefits before the normal retirement age there are restrictions on how much wage income one may earn without losing benefits. Next year, one can only earn $12,000 before losing benefits. And the reduction is severe. Benefits are cut by $1 for every $2 earned over the maximum allowed.
Until 2000, a similar rule applied to all retirees on Social Security below the age of 70. But Congress concluded that the de facto 33 percent marginal tax rate imposed by the earnings test was unfair and discouraged a significant amount of work, so the rule was abolished. Those above the normal retirement age may now earn as much as they want and still draw full benefits. However, an earnings test was left in place for early retirees.
Because the normal retirement age is rising to 67 the earnings test will apply to more and more retirees in future years. If they take early retirement in the numbers we have seen and the test is unchanged, then we are going to see a massive withdrawal of older workers from the labor force beginning in 2008. The nation may not be able to afford it.