Working for a Good Retirement

Number 06-03 in The Retirement Project Discussion Paper series

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Executive Summary

When people work longer, they produce additional goods and services for the economy. They also earn more income, usually save some of that income, allow their assets to grow, and increase their annual Social Security benefit by withdrawing money over a shorter period of time. At the same time, they lower Social Security deficits by delaying receipt of government benefits and, quite importantly, pay more taxes-which bolster other government programs.

The broader positive ramifications of additional work have yet to be fully examined. For instance, the Social Security Administration does not report effects of proposed policy reforms on general revenues. To examine these complex interactions, we estimate the effect of increased work using the Urban Institute's Dynamic Simulation of Income Model (DYNASIM3). Among other items, DYNASIM calculates retirement wealth from earnings, pensions, and Social Security. It also calculates payroll tax and federal and state income tax at the individual and family level from 1992 to 2050. These projections account for the dramatic heterogeneity of individual demographic and economic circumstances and how they evolve over time.

At the individual level, we calculate the change in net wealth and annual future consumption made possible by additional work. At the macro level, we calculate the change in total earnings and in the Social Security deficit due to additional work. We also look at the changes in general revenue that could be used to support other government spending (including spending on the elderly).

Key findings include the following:

• Workers could increase their annual income by an average of 5 percent from age 50 onward for one additional year of work and 25 percent for five additional years of work. The additional net wealth from one more year of work, if annuitized at retirement, could increase consumption by 9 percent per year. Five additional years of work could increase annual consumption at retirement by 56 percent per year.
• Lower-income workers have the most to gain from their additional labor. Workers in the bottom lifetime earnings quintile could increase annual consumption at retirement by 16 percent with one additional year of work and by 98 percent with five additional years of work. Workers in middle-income quintiles also gain relatively greater percentage increases in annual income from additional work than do the richest workers.
• At the macro level, the Social Security earnings generated from just one additional year of work are almost equal to the entire 2045 Social Security shortfall (of benefits from taxes) projected under the baseline scenario. A share of those earnings is paid to the government in the form of taxes, including Social Security taxes. The additional Social Security taxes generated by five years of work alone offset more than half of the Social Security shortfall in 2045. Furthermore, if one takes into account the additional income tax revenues, the government's gain to its unified budget is far greater than the size of the Social Security deficit.
• Looking more narrowly at just the additional Social Security payroll tax, even five more years of work is not enough to close the Social Security funding gap by itself. Some additional reform, such as an increase in the normal retirement age, will likely be required. However, the added payroll tax from the additional work can reduce the size of any benefit cuts or tax increases needed to achieve solvency.
• There is a striking contrast between reforms that simply reduce benefits and reforms that increase work effort while partially reducing benefits. Work-inducing reforms clearly require less benefit cuts to achieve solvency because of the additional revenues. Perhaps more striking, workers on average achieve significantly higher net incomes when additional work is involved-the earnings increases can easily more than offset any benefit cut-and significantly lower net incomes when only benefit cuts are involved.

Note: This report is available in its entirety in the Portable Document Format (PDF).

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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