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Abstract

About one-quarter of workers age 51 to 55 in 1992 developed health-related work limitations and about one-fifth were laid off from their jobs before age 62. Although late-career health and employment shocks often derail retirement savings plans, Social Security’s disability insurance, spouse and survivor benefits, and progressive benefit formula provide important protections. In fact, health shocks increase Social Security’s lifetime value, primarily because the system’s disability insurance allows some disabled workers to collect benefits before age 62. However, if the system’s disability insurance program did not exist, the onset of health-related work limitations would substantially reduce Social Security wealth.

Introduction

Health and employment shocks are fairly common at older ages and often derail retirement savings plans. About 19 percent of adults age 51 to 61 in 1992 were laid off from their jobs at some point before 2002, and about one-third developed serious health problems that limited their work ability over the 10-year period (Johnson, Mermin, and Uccello 2005). People who lose their jobs in the years leading up to retirement or are forced by health problems to reduce their work hours generally have less money available for retirement savings than people who remain at work until their planned retirement age. Job loss between the ages of 51 and 71 reduces household financial and housing wealth by about 33 percent for single people, when other factors are held constant, and the onset of work disability reduces wealth by about 42 percent (Johnson, Mermin, and Uccello 2006). The estimated effects are smaller but still substantial for married people.

Social Security may provide some protection from health and employment shocks at older ages. The system’s disability insurance provides some people whose health problems limited their work histories with more generous retirement benefits than they would otherwise receive. Additionally, Social Security allows those with limited earnings to collect benefits based on their current, divorced, or deceased spouse’s work history. Various features of the benefit formula, such as the provisions that base benefits on only the highest 35 years of earnings or replace larger shares of pre-retirement lifetime earnings for those with low income than those with high income, also favor those with limited employment histories and lifetime earnings. As a result, health and employment shocks in the years leading up to retirement may have smaller effects on future Social Security benefits than on financial wealth holdings.

Traditional employer-sponsored pension benefits, however, may be especially vulnerable to health and employment shocks in the years immediately prior to benefit take-up. Most traditional plans tie benefits to years of service and nominal earnings received near the end of the career. As a result, pension wealth tends to grow rapidly in the years just before people qualify for benefits. An additional year on the job increases future benefits not only by adding an additional percentage of pay, but also by raising the value of previous accumulated benefits by a combination of real wage growth and inflation. Thus, many people lose substantial pension wealth if they are laid off from their jobs just before qualifying for benefits or are forced by health problems to retire early.

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The nonpartisan Urban Institute publishes studies, reports, and books on timely topics worthy of public consideration. The views expressed are those of the authors and should not be attributed to the Urban Institute, its trustees, or its funders.

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