Ed Dolan's Econ Blog

Let’s Not Make it Any Harder to Retire; It’s Getting Harder All the Time as it is. (Part 1)

Last week the Business Roundtable came out with a position paper entitled “Social Security Reform and Medicare Modernization Proposals.” Its centerpiece is an increase to 70 in the eligibility for Social Security and Medicare. According to Gary W. Loveman, Ph.D., Chairman, CEO & President, Caesars Entertainment Corporation, and Chair of the Roundtable’s Health and Retirement Committee, the purpose is to modernize the programs in view of “new demographic realities.”

Raising the eligibility age is a bad idea. It is based on the false premise that, since Americans are healthier and living longer, they can and should assume greater individual responsibility for their retirement. Unfortunately, the reality is that for all but the wealthiest Americans, self-financed retirement is becoming harder, not easier. A higher eligibility age would only make it still more difficult.

The real demographic realities

First, let’s take a closer look at those “new demographic realities.” Yes, Americans on average are living longer, but the increase in life expectancy has strongly favored higher-income Americans who are less dependent on Social Security to begin with. Social Security benefits account for just 18 percent of income for the most affluent fifth of retirees. By comparison, Social Security benefits contribute more than 80 percent of retirement income those in the bottom two-fifths of the distribution.

The following chart shows just how skewed increases in longevity have been. Taken from a study written for the Social Security Bulletin by Hillary Waldron, the chart compares the life expectancy at age 65 of male Social Security recipients from various birth cohorts in the top and bottom halves of the income distribution. If we compare the life expectancies of men who reached age 65 in 1977 (the 1912 birth cohort) with those who reached that age in 2006 (the 1941 birth cohort), we see that those in the bottom half of the income distribution gained just over one year of life expectancy, whereas those in the upper half gained six years.

Another way to look at the same numbers is to ask by how much a 3-year delay in eligibility reduces the number of years of benefits. The average lower-income man now receives about 14 years of benefits, if he takes full benefits starting from age 67. That would decrease to about 12 years if full benefits started at 70, a 22 percent reduction. For higher-income men, the reduction would be from about 19.5 years to 16.5, a reduction of just 15 percent.

Either way you look at it, the demographic reality is that an increase in the eligibility age would have a regressive impact on the income distribution of older Americans.

To be fair, the Business Roundtable proposal recognizes the regressive impact of raising the eligibility age and recommends offsetting it with other measures. It suggests setting a new minimum benefit that would be high enough to raise low-income recipients above the poverty line, and at the same time, means-testing benefits for wealthy recipients.

Both ideas are should be adopted on their own merits whether or not the eligibility age is changed. The real worry is that needed adjustments to minimum and maximum benefits would fall by the wayside during Congressional negotiations. Increasing the eligibility age without adjustment of benefit formulas would leave low-income retirees worse off in both absolute and relative terms.

The Financial Realities

Distributional considerations aside, raising the eligibility age for Social Security and Medicare shares a problem that is common to all proposals for shifting the burden of retirement saving from the federal budget to individuals. That is the fact that self-financed retirement has already become significantly more difficult, even without further changes to entitlement programs.

A recent policy brief from the Center for Retirement Research at Boston College succinctly outlines the reasons. Here are the main points, each of which is supported by charts and data in the brief itself:

  • As noted above, life expectancy has increased. The increase is not quite as great for women as for men, but then, women lived longer and had lower average incomes to begin with, so it was already harder for them to accumulate enough wealth to last them through their retirement years.
  • Changes in private pensions have made retirees more dependent on their own accumulated wealth. As recently as 1983, 62 percent of workers with pension coverage had defined benefit plans, often paying a set fraction of the retirees former salary, and sometimes protected against inflation. Such plans have now largely been replaced by defined contribution plans, under which retirees’ income depends on the earnings from funds deposited in a 401k or similar individual account. By 2010, just 19 percent of workers were fully covered by defined benefit plans, with another 13 percent having plans with mixed features. Over the same period, the number of workers covered only by defined contribution plans rose from 12 percent to 69 percent.
  • Out-of-pocket medical costs have risen. For example, between 1983 and 2010, copayments under Medicare Part B, the program that covers physician services, rose from 7.5 percent of the average Social Security benefit to 17.0 percent. That increases the amount of wealth you need to accumulate by the time you retire in order to maintain a given standard of living.
  • Real interest rates are falling. (The real interest rate is the nominal rate earned on retirement savings minus the rate of inflation.) In 1983, the real rate was around 8 percent. Since then it has fallen steadily. By 2010, it was effectively zero. The lower the real interest rate, the more you need to save during each year of employment, or the more years you need to work, in order to accumulate a given amount of wealth by the age of retirement. What is more, the lower the real interest rate, the lower the monthly income produced from a given accumulation at retirement.

All might be well if people were increasing their efforts to save in step with the greater need to save, but that is not happening. The following chart from the CRS brief shows that from 1983 through 2007, wealth as a percentage of income showed no strong trend for any age group. That in itself is disturbing because Fed’s measure of wealth, on which the chart is based, excludes the value of defined benefit plans but includes accumulations in defined contribution plans. To maintain equal preparedness for retirement as workers became more dependent on defined contribution plans, the wealth ratio would have had to rise steadily from one survey to the next, something that did not happen.

The 2010 data are even more disturbing. Whereas the 1983-2007 data show no discernible trend, the 2010 wealth ratios lie well below the central tendency of previous experience. Notice also that the 2010 survey shows that people in their 50s were less well prepared for retirement than people already in their early 60s. The Fed conducts its survey of consumer finances every three years. If the cohort who were in their late 50s in 2010 continue to lag behind in the 2013 survey, the situation will begin to look really grim.

The Bottom Line

The bottom line is that people are more dependent on their own retirement savings now than in the past, but low real interest rates have made saving harder. At the same time, income disparities have become wider for those who are still working. Raising the eligibility age for Social Security and Medicare under these conditions is one of the cruelest budget balancing ideas out there.

We need to look for better ways to strengthen a retirement system that is not working well, and that will come under even greater strain as the ratio of retirees to workers rises. That will be the subject of the next post in this series.

Follow this link for Part 2 of this series on retirement

20 Responses to “Let’s Not Make it Any Harder to Retire; It’s Getting Harder All the Time as it is. (Part 1)”

David WishartJanuary 21st, 2013 at 12:52 pm

The current discussion surrounding social security focuses far too much on the financial outlays of government for these programs in the future, but ignores the real resource issue. Government can always finance the cost of social security by crediting the accounts of recipients by keystroking the money in to their account. The US government can't run out of US dollars. The real problem is that as more people enter retirement, the labor force shrinks and the ability and productivity of the remaining workers may not be sufficient to meet all of the demands seniors will have. So in this case, keystroking money in to seniors accounts against a capacity constrained economy would likely lead high inflation. This would reduce the real rate of return to savings.

What we should be talking about is the types of investments we can make today to help labor be more productive in the future so that health related costs stop eating up so many resources going forward. Given health related spending is one of the areas where price increases are most acute, investments in this area that help lower costs will cause the value of seniors savings in real terms to rise.

David WishartJanuary 21st, 2013 at 12:53 pm

Ironically, if the private sector tries to save more to offset the increase in the age of eligibility and the steady loss of defined benefit plans, through the paradox of thrift, aggregate demand will fall, unemployment will rise, tax receipts will fall and the deficit will widen.

kevin rocheJanuary 21st, 2013 at 1:27 pm

Not clear to me why the eligibility age shouldn't be raised to be the actuarial equivalent of what it was when social security was started. People are healthier now than they were then. I am very puzzled by why that makes it harder to retire, since people presumably might continue to work longer, which would likely mean they could actually save more retirement. Working, at anything, has also been shown in numerous studies to improve elderly persons' sense of worth and sense of meaning in life. If the eligibility age had just continually been raised along with the increases in longevity, we would not have the problems we have now. The spread in wealth, at whatever age, is largely due to the fact that our society has fractured into those who were born into relatively stable two-parent homes where education and work were emphasized and those who are born into or early in life begin to live in single-parent households, often where there is no guiding person to nurture and help them attain success in life. And as they become adults they tend to be highly irresponsible in most key areas of life, from work to health, which tends to create a reinforcing downward cycle. Not sure how making the first group pay for the misfortunes of the second group makes the country as a whole better off. Without strong incentives to change behavior, we will have an ever-increasing segment of the population which becomes more and more dependent and expensive to maintain, and we need to figure out how to interrupt that cycle. So far all we are doing is reinforce it.

Bryan WillmanJanuary 21st, 2013 at 2:35 pm

Mr. Wishart raises issues I have raised in the past, and hopefully Mr. Dolan will address in his next post.

I'd like to also suggest that changes in the system to always encourage rather than discourage gainful effort should be a main focus. Both because it will tend to increase the capacity of the economy, and because it will tend to encourage individuals to maximize the fulfilment of their lives.

I suggest that at all levels, the total state/federal implicit (taxes/benefits) marginal tax rate must be addressed. I also suggest that the "floor effective labor cost rate" is too high.

Ed Dolan EdDolanJanuary 21st, 2013 at 2:57 pm

"I'd like to also suggest that changes in the system to always encourage rather than discourage gainful effort should be a main focus"

I agree, and I will try to address this point. However, I may differ from Mr. Wishart in that I think that saving is gainful effort. I think some MMT folks overwork the paradox of thrift to reach the conclusion that policies that encourage saving necessarily make us poorer. I think the retirement problem requires simultaneously managing aggregate demand for full employment and shifting the composition of demand toward more saving and investment.

YildoJanuary 22nd, 2013 at 12:28 am

You do realize that "actuarial equivalent" is not the same thing as "life expectancy", right? It hasn't risen nearly as much as life expectancy. Life expectancy stats are skewed by many infancy and childhood diseases having been eradicated. People who have already lived to 65 are not necessarily going to live much longer than their parents' generation did.

Ed Dolan EdDolanJanuary 22nd, 2013 at 1:01 am

I'm a little hazy on the distinction. Can you spell it out? The data in my chart are life expectancy from age 65–is that actuarial equivalent or something else? Obviously not skewed by childhood diseases, tho.

Graham CoxJanuary 22nd, 2013 at 5:48 am

For the long term outlook, need for all to sort out the problem in English of investment being used to cover say the purchase of a Treasury bond through to a company or business angel investing in a risk investment . The personal/micro and macro effects can be very different.

If everyone saves to buy TBs that fund ever increasing deficits or corp bonds to fund share buy backs via extra gearing, the country is in trouble. If they all save to expand the capital available for national account type investing, it can produce a win win.

The paradox (Wishhart) is valid but only for the short term as we go through the deleveraging crisis. it is the coin flip of interest rate cuts pushing on a string.

David WishartJanuary 22nd, 2013 at 11:45 am

I think the paradox of thrift is particularly valid right now while in an economic slump where the desire to save is dwarfing the desire to invest. Savings does not always equal investment. Savings is important for households and businesses because we live in an uncertain world and savings lets us smooth out the impact of adverse events and generally frees us from the cyclicality of the job market. I don't want to come across as demonizing savings. All I'm getting at is that ultimately savings is a liquidity drain that needs some counterbalancing force, which will generally be government deficits when the business sector is under-investing (which is almost always since businesses also save).

Real (non-financial) asset investments create income, so more investment will lead to more income. Savings is generated from income, so we need more investment in order to increase our savings. Whereas more saving because of a reduction in social security will lower aggregate demand and subsequently lower the incentive for private businesses to invest.

kevin RocheJanuary 22nd, 2013 at 11:57 am

I have a lot of experience with actuarial work and I don't know how what you are referencing is relevant. The percent of the population in their 80s and 90s is the fastest growing subsegment and the average health of this segment has continually improved over the last three decades. On average, people are certainly more than capable from a health perspective of working longer.

Kim B. StakingJanuary 22nd, 2013 at 12:19 pm

I think that this is an excellent article. I would add that there is an additional dimension that is not captured by demographics alone. While many of us are able to continue working in interesting, non-physically demanding jobs for several years beyond a normal retirement age, this is not true for many who are involved in physically challenging occupations. The body does wear out and many older individuals are challenged to find any kind of employment beyond age 60. These also tend to be individuals that have het lower life expectancies. As a social insurance program, we have to recognize that some individuals need social security more than others for physical as well as financial reasons.

Scott PlantierJanuary 22nd, 2013 at 12:22 pm

The proposed changes are largely at the behest of the wealthy in anticipation of changing demographics, not fairness, and one of the richest Americans, Warren Buffett, replies to that notion:
“There’s class warfare, but it’s my class, the rich class, that’s making war, and we’re winning.”

NLCJanuary 23rd, 2013 at 2:06 pm

Absolute rubbish. When Social Security was initiated in 1937 the life expectancy was 58 for men and 62 for women. Today, US life expectancy is over 76 for men and 81 for women. This is an increase of about 20 year apiece or almost 30%. When SS was introduced the average pensioner collected for around 5 years. Today, some pensioners collect for more years than they ever worked.

There is no practical tax regime that will support an economically unproductive sector of the population that will soon total over 20% in addition to the other 20-25% of economically unproductive people at the other end of the age spectrum.

The only practical, moral and just solution is to:

– Increase the retirement age (prolonged retirement is bad for retirees health anyway)
– Restrict benefits (means testing)
– Increased taxes

The 'progressive' solutions of job-splitting, mandatory retirement, lowering retirement age to increase youth unemployment have been tried in the social democracies of the EU and only an academic or ideologue could possibly argue that they have been anything but a complete disaster.

David WishartJanuary 24th, 2013 at 8:46 am

The practical, moral and just solution you suggest will cause economic growth to slow and put more people out of work. Higher taxes lowers spending, lower benefit payments lowers spending, higher retirement age increases savings and lowers spending. An economy with more idle labor isn't going to make the fact that the dependency ratio is rising go away.

Isn't the practical solution to begin investing in ways to lower the amount of non-financial resources retirees consume, such as sophisticated medical technologies that keep seniors out of hospitals, better research on diseases affecting the elderly, as well as ways to make the gradually shrinking labor force more productive so it can meet the demands of a rising share of dependents.

maggiemaynotJanuary 29th, 2013 at 3:27 pm

why don't we increase the income thresholds to tax all income. Not up to a limit of $110,000 (or so).? This would solve the entire problem and not make old people work longer and miss some of the time they have left for real retirement enjoyment. Just asking?

Ed Dolan EdDolanJanuary 29th, 2013 at 11:38 pm

I'm not really up on these numbers, but from what I understand, raising the limit would help but not be enough to solve the entire problem.

Someone out there please correct me if I am wrong about that.

McWattFebruary 9th, 2013 at 2:26 pm

Are you people kidding me? Do you realize what raising the retirement age for Soc. and Medi means in real terms? Anybody paying their own health insurance over the age of 60 on this site? How about 1500.00 per month! It was just raised because I just turned 60. If you are employed and your employer currently pays your benefits, how about getting fired sometime in your 50's because you are getting "too expensive" benefit wise for your employer to keep up. This is a major ploy by corporations to keep extracting money from the largest demographic bump in the history of the world. The government has the ability to pay these meager benefits for forever. They are choosing to raise the age to qualify in order to hand you over to the rentiers for a few more years of "extractions". Soc. and Medi are something that you have paid for and earned, now they want to take a significant portion away from you so you can pay the highest rates possible for the last few years of your life, after you are no longer employable, but before you are eligible. WAKE UP!!!!!!!
"Catch-22 says they can do anything we can't stop them from doing."

JR1February 12th, 2013 at 9:59 am

There are a LOT of McWatts out here in the real world where people don't read Ed Dolan's econ blog, or anyone else's for that matter. The millions of McWatts are beginning to get it. They worked, paid their taxes, raised their kids, did their share of patriotic shopping for imported goods, bought a house and kept it up, saved what they thought would be enough for old age, helped care for their own aging parents, helped out the kids when they needed it. And then a criminal cabal crashed the financial system, wiping out much of what they worked for all their lives. Trillions in losses of savings, investments, and real estate values in the blink of an eye. Then their employers, lulled by the corporate wisdom cult into believing that maximizing profit is the only thing that counts, "down-sized-right-sized-streamlined" or whatever. Living wage jobs for people over 50 are scarce and for those over 60, practically non-existent. regardless of education and experience. Some of the creeping despair has been diverted into animosity toward women, minorities, gay people, Liberals, and assorted other bogies. But that can only go so far. We are falling, falling, falling. Screaming that people in Europe are worse off, that the biggest thing to fear is Socialism, that we've lost our moral compass: none of this will keep you out of the ever longer lines at the local food pantry.
Not long before he died, George Carlin laid it all out for America and he said, 'Now they're coming for your Social Security. And they're gonna get it.' Figure out what you're going to do with your rage when that happens. Think about it now because revenge is a dish best served cold and living well is probably no longer a realistic option. Pack up your psychological bug-out kit because to be unprepared for what's coming at you makes you a victim. Sure, you could keep showing up for a job if anyone would hire you. But they won't. Yet even when there are no jobs there is a lot of work to be done. But as McWatt points out, you have to WAKE UP.

Retirement planningSeptember 24th, 2013 at 5:26 am

It is a bit frightening, although not that surprising, that so few people are saving for their retirement and are saving so little. How is it that people who know how little they might get from social security and would have to live on can't make the connection? The answer is that they "can't afford" to save for the retirement that they know they will enter into at some stage. I guess they'll figure out they have enough from social security to "live" on if there is no other resource. Or perhaps they expect that the benevolent federal government will come up with some magic money to make life better. Some adults must still believe in Santa Claus or the Fairy Godmother!