As baby boomers retire, we are confronted with a dilemma. On the one hand, it will be good for society if more people work later into life. But Social Security, the primary source of retirement income for most U.S. households, originally was designed to encourage people to do just the opposite. It provided incentives for people to get out of the labor force and stay out. Changing those incentives — and the expectations they engendered — is a key challenge over the next decade.
We face two problems. First, many retiring boomers won’t have the savings or retirement benefits to enjoy the level of retirement living that they anticipated. Policies already in place will likely reduce the “replacement rate,” how Social Security payments compare to pre-retirement income, from 38 percent today to less than 30 percent in 2030. Moreover, we will likely make additional changes to the program to shore up its funding, eroding this rate even further.
The second problem is that the labor force will get smaller, relative to the economy, than it is now. As more boomers retire, getting workers will be increasingly difficult.
The nation faced a different problem in the 1930s, when the Social Security Act was passed. Unemployment was high and had been for six years. The Act’s primary objective was to provide at least minimal income for retirees and the disabled. But encouraging people to leave the labor force to open up jobs for others was a major consideration.
To accomplish that, the program established a “normal retirement age” of 65. But it offered a reduced level of benefits at 62. This helped those with physical impediments with an alternative to continued work, an important consideration when many jobs involved strenuous toil.
In addition, a “retirement earnings test” reduced the benefits of anyone who chose to continue working after starting to receive Social Security benefits. At first it applied to anyone younger than 75, but the age limit was lowered to 72 and then 70 before its repeal in 2000. It still applies, however, to anyone who retires before the normal retirement age, now 66 and moving up.
Workers responded to these incentives. The average retirement age declined slowly from 1940, the first year benefits were paid, until the 1980s. Since then it has risen, but only slightly. Later retirement would solve many problems of funding baby boom retirement, but we are not moving fast enough in that direction.
We could incrementally raise the minimum age of early retirement from 62 up to 64 or so. We could sharpen the cut in benefits if they are taken before the normal retirement age. Or we could let market forces determine when people choose to retire.
The issues are complex. Alicia Munnell, a respected economist at Boston College, has written an insightful book, Working Longer: The Solution to the Retirement Income Challenge.
I don’t face the choice for another five years, and my current plans are to continue at least some writing and teaching until I am 70. But if you are interested in learning more about the issues, read Munnell’s work.
© 2008 Edward Lotterman
Chanarambie Consulting, Inc.