Mind the Gap: The Distributional Effects of Raising the Early Eligibility Age and Full Retirement Age

Introduction

This article analyzes the distributional and solvency effects of increasing Social Security's retirement ages. The full retirement age (FRA) is the age at which a beneficiary's full primary insurance amount (PIA), upon which monthly benefits are based, is payable.¹ The current-law FRA varies from age 65 to 67 depending on year of birth. The earliest age at which retirement benefits can start is 62 (the early eligibility age or EEA). Retired-worker benefits claimed between the EEA and FRA are permanently reduced, based on the number of months between the beneficiary's age when benefits are claimed and his or her FRA. Policymakers have proposed increases to the EEA and/or FRA to address increasing life expectancy and Social Security solvency issues.

This analysis compares the following three retirement-age increases suggested by the Social Security Advisory Board in its report, Social Security: Why Action Should Be Taken Soon:²

1. After the current-law FRA reaches age 67, index the FRA to longevity by increasing it 1 month every 2 years starting for those turning age 62 in 2024 (hereafter referred to as the "growing-gap option").
2. Apply the same FRA increase as that proposed under the growing-gap option. In addition, raise the EEA by the same increments as the FRA starting with individuals turning age 62 in 2017 to maintain a 4-year gap between the two ages (hereafter referred to as the "gap-4 option").
3. Apply the same FRA increase as that proposed under the growing-gap option. In addition, raise the EEA by the same increments as the FRA starting with individuals turning age 62 in 2024 to maintain a 5-year gap between the two ages (hereafter referred to as the "gap-5 option").

The distributional analysis presented here is based on projections from the Social Security Administration's (SSA's) Modeling Income in the Near Term, version 6 (MINT6) model, and the results pertain to Social Security beneficiaries aged 60 or older in the years 2030, 2050, and 2070.³ The analysis does not simulate behavior changes in response to increasing the EEA or the FRA, but increasing the EEA would prevent some individuals from claiming benefits as early as they could under current law (that is, they would not be eligible to claim benefits before the new law would allow).⁴ The analysis assumes that anyone who under current law would have started receiving benefits before the new EEA would start at the new EEA under the gap-4 and gap-5 options. The benefits under each option are compared with the benefits scheduled to be paid under current law (scheduled benefits) and the actual benefits that could be paid without any changes to current law (payable benefits).⁵ Solvency estimates are from SSA's Office of the Chief Actuary (OCACT), based on the 2011 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds (2011 Trustees Report).⁶

Major Findings

Although each of the three retirement-age policy options would improve system solvency by similar proportions, their effect on individual beneficiaries would vary across the population, as the following highlights show:

• Benefit reductions are greater under the proposals with more months of early retirement reductions; the growing-gap option results in an 8 percent reduction in median benefits in 2070, compared with a 4 percent reduction under the gap-5 option and a 2 percent reduction under the gap-4 option. The growing-gap option also results in more beneficiaries overall receiving a benefit reduction by 2070: 82 percent, compared with 65 percent under the gap-5 option and 53 percent under the gap-4 option.
• Although the majority of beneficiaries would receive benefit reductions, the gap-4 option would increase benefits for 28 percent of beneficiaries in 2070 compared with scheduled benefits. This occurs because the number of years in which benefits are reduced for early retirement decreases from 5 to 4.
• Up to 6 percent of beneficiaries in the youngest age group (60–69) in 2070 would not receive any benefit under the gap-4 and gap-5 options because some individuals in that group would be younger than the new EEA and no longer eligible for benefits at those ages.
• Poverty rates would increase slightly under all three retirement-age options, with the largest increases occurring for individuals in the youngest age group.

Current Law

The earliest age at which a retired-worker or spousal beneficiary can start receiving benefits is 62 (see Table 1). Beneficiaries turning age 62 in 2012 (born in 1950) have a FRA of 66. For each month that a beneficiary receives benefits before his or her FRA, the benefit is reduced by one reduction factor.⁷ The total benefit reduction for claiming benefits at age 62 increases from 25 percent to 30 percent under current law. An individual who claims retirement benefits at the EEA today would be subject to 48 months of early retirement, or a 25 percent benefit reduction. Starting for individuals born in 1955, the FRA will increase by 2 months each year until it reaches age 67 in 2022 for those born in 1960 or later. Once current law is fully phased in by 2022, the difference between the EEA and FRA will be 5 years. At that time, an individual who claims benefits at the earliest age possible would be subject to 60 months of early retirement, or a 30 percent benefit reduction.

Three Retirement-Age Options: A Comparison

All three options include the same incremental increase in the FRA by indexing it to longevity over the very long term, although the EEA increases only under the gap-4 and gap-5 options (see Table 2). OCACT estimates that to index the FRA to longevity, it would need to increase by 1 month every 2 years beginning with individuals turning age 62 in 2024. The growing-gap option does not include an increase in the EEA from age 62, thereby continuously increasing the gap and the number of early retirement months between the EEA and FRA. The gap-4 option begins increasing the EEA by 1 month every 2 years for those turning age 62 in 2017 (beginning with the current-law increase in the FRA from age 66 to 67 in 2017); as Table 2 shows, that option maintains a 4-year gap between the EEA and FRA. The gap-5 option does not begin increasing the EEA until 2024, maintaining a 5-year gap between the EEA and FRA. Under all three options, the widow(er) EEA and FRA also increase by the same number of years as the retired-worker EEA and FRA, but for those turning age 60, not age 62, in each year.⁸ The following tabulation shows the corresponding additional early retirement months and benefit reductions associated with increasing the gap between the EEA and FRA beyond the 5 years (or 60 months) in current law, for the growing-gap option:

As previously noted, the increases in the retirement ages occur over a very long period. A midcareer worker born in 1972 and turning age 62 in 2034 would have a FRA of 67 and 6 months under all three options, with an EEA ranging from age 62 under the growing-gap option to 63 and 6 months under the gap-4 option (see Table 2). The growing-gap option would produce the maximum number of early retirement months (that is, 66 months) for this worker, resulting in a benefit reduction of about 32 percent (see the previous tabulation). The effects on benefits for a midcareer worker would not be significantly different from scheduled benefits; however, the effects on benefits would be larger further in the future. An individual born today and turning age 62 in 2074 would have a FRA of 69 and 2 months under each of the options, with an EEA ranging from age 62 under the growing-gap option to 65 and 2 months under the gap-4 option. The growing-gap option would produce the maximum number of early retirement months (that is, 86 months) for this worker, resulting in a benefit reduction of about 40 percent.

Interaction of Retirement-Age Options With Existing Program Rules

Changes to the EEA and FRA would result in additional changes to benefits when they interact with existing program rules. Changes to program rules increase or decrease benefits compared with current law, which may negate, mitigate, or amplify changes caused by the retirement-age options. For example, under current law a beneficiary can earn delayed retirement credits (DRCs) of up to 8 percent a year by waiting to claim benefits until after his or her FRA, up to age 70.⁹ Because the FRA increases under all three options, the number of DRCs earned would decrease because these estimates do not account for changes in claiming behavior. Although the same number of people is estimated to claim benefits in each year under the proposals as under current law, fewer of those individuals would be claiming benefits after the new, higher FRA. This results in lower benefits for some beneficiaries who would have earned DRCs under current law.

Under the gap-4 and gap-5 options, the number of computation years used in the benefit calculation and the age at which earnings are wage-indexed would increase as the EEA increases, based on OCACT assumptions.¹⁰ For example, Social Security benefits are currently based on a worker's 35 highest years of earnings, but if the EEA increases to 63, the options increase the number of earnings years to 36. Because an additional lower or zero-earnings year could be added to the benefit calculation, that change would generally result in lower benefits. In addition, the options would increase the age at which earnings are wage-indexed from age 60 (2 years prior to the current-law EEA) to 61 (2 years prior to the EEA in this example). Because wages typically grow faster than prices, this change would generally result in higher benefits.¹¹

Benefit Reductions Over Time Under All Three Retirement-Age Options

The growing-gap option, which only increases the FRA, would produce the largest benefit reductions among the three retirement-age options.¹² By 2070, the median percentage reduction in individual benefits compared with scheduled benefits would be 8 percent under the growing-gap option, compared with 4 percent under the gap-5 option and 2 percent under the gap-4 option. To put these reductions in context, median payable benefits in 2070 would be 23 percent lower compared with scheduled benefits.

As the EEA and FRA increase over time, benefit reductions and the percentage of beneficiaries who have benefit reductions would increase. As Chart 1 shows, there would be no change in median benefits in 2030 compared with current law because less than a quarter of beneficiaries would be negatively affected under each of the options. As more beneficiaries are affected by the changes in the EEA and FRA each year (see Table 3), the median benefit reduction compared with scheduled benefits increases over time. For example, under the growing-gap option, the percentage of beneficiaries who would have benefit reductions increases from 13 percent in 2030 to 82 percent in 2070. This option also has the largest percentage of beneficiaries who would have benefit reductions by 2070 (82 percent, compared with 53 percent and 65 percent for the gap-4 and gap-5 options, respectively).

Effects of Increasing the EEA

Increasing the EEA would raise benefit claiming ages because beneficiaries could no longer claim benefits at their current law EEA. As noted previously, beneficiaries under current law who claimed benefits before the new, higher EEA would claim them at the new EEA under the gap-4 and gap-5 options. That provides a "lower bound" estimate of the increase in the median claiming age that would result from raising the EEA. As shown in Table 4, the median benefit claiming age would not change under the growing-gap option compared with scheduled benefits, but would increase under the gap-4 and gap-5 options.¹³ For example, under the gap-4 option, the median benefit claiming age would increase 2 years and 4 months for spousal and worker beneficiaries. Under the gap-5 option, there would be a smaller increase in the median benefit claiming age for some groups because the EEA increase would start later (for example, there would be a 1 year and 5 month increase for spousal and worker beneficiaries). Although the median claiming age would increase under the gap-4 and gap-5 options for most beneficiaries, the increasing FRA under all three options would result in additional early retirement months and therefore benefit reductions.

Retired-Worker Beneficiaries and Benefit Reductions Under All Three Retirement-Age Options

All three options would reduce benefits for retired-worker beneficiaries by increasing the number of early retirement months. Under each of those reform options, beneficiaries would be subject to a different number of early retirement reductions based on the increasing FRA and the increases (or lack of increases) in the EEA. In 2070, the median claiming age for retired-worker beneficiaries under scheduled benefits would be 64 and 1 month (see Table 4), while the median FRA would be 67. That results in 35 months of early retirement reductions, or a 20 percent benefit reduction. Under the gap-4 option, the same group of beneficiaries would have an increased median claiming age of 64 and 10 months and an increased median FRA of 68 and 6 months. That results in 44 months of early retirement reductions and an increase in the reduction for early retirement from 20 percent to about 23 percent. Meanwhile, under the growing-gap and gap-5 options, retired-worker beneficiaries would have the same median claiming age (64 and 1 month) as under scheduled benefits, but a higher median FRA (68 and 6 months). That would result in 53 months of early retirement reductions and an increase in the benefit reduction to about 27 percent. As Chart 2 shows, the median number of early retirement months would increase under all three retirement-age options, resulting in benefit reductions for retired-worker beneficiaries compared with scheduled benefits (see Table 5).¹⁴

Beneficiaries Experiencing Little or No Effect on Benefits Under All Three Retirement-Age Options

Some beneficiary groups would have similar early retirement reductions under the options as they do under current law. For example, under the gap-5 option, a spousal and worker beneficiary would have a median increase of 1 additional month of early retirement (from 56 to 57 months (see Table 4)), increasing their median benefit reduction from 28 percent to about 29 percent.

As shown in Table 5, disabled beneficiaries would not receive benefit reductions at the median under any of the retirement-age options. That is because disabled beneficiaries convert to retired-worker beneficiaries at their FRA and are therefore not subject to early retirement reductions. However, disabled beneficiaries could be affected by these options if they receive auxiliary benefits as an aged spouse or survivor. For example, under the growing-gap option, 10 percent of retired disabled beneficiaries (older than their FRA) would receive a benefit reduction and 4 percent of disabled-worker beneficiaries (younger than their FRA) would receive a reduction.

Reducing the Gap Between the EEA and FRA From 5 Years to 4 Years

If the gap between the EEA and the FRA was reduced by 1 year, about 30 percent of beneficiaries would have benefit increases. Reform options that increase the EEA and/or FRA generally reduce benefits, but the gap-4 option would increase benefits for 28 percent of beneficiaries in 2070 (see Table 3). This would occur because the fully phased-in current-law gap of 5 years (starting in 2022) would decrease to 4 years, reducing the maximum number of early retirement reductions.

Table 6 shows how some beneficiaries would receive benefit increases under the gap-4 option. For example, retired-worker beneficiaries who have a higher benefit under the option would receive a 6 percent median benefit increase in 2070 compared with scheduled benefits. Under current law, that group would have 59 months of early retirement reductions, compared with 48 months under the gap-4 option (that is, the benefit reduction for early retirement would decrease from about 30 percent under current law to 25 percent under the option). In general, the beneficiaries who would have benefit increases under the option are those who would claim benefits as early as possible, and therefore would have the greatest number of early retirement reductions, under current law.

Beneficiaries Who Would Not Receive Benefits Under All Three Retirement-Age Options

Up to 6 percent of beneficiaries in the youngest age group (60–69) would not receive a benefit under the options. As noted earlier, under the gap-4 and gap-5 options, beneficiaries who would have claimed benefits at age 62 under current law would no longer be eligible for a benefit (a 100 percent benefit reduction) when they are younger than the new EEA in 2070. However, once those individuals reach the new EEA and claim benefits, they would have fewer months of early retirement under the gap-4 and gap-5 options than they would under the growing-gap option.

As shown in Table 7, 6.3 percent of beneficiaries in the youngest age group would completely lose their benefit under the gap-4 option, while 3.1 percent would completely lose their benefit under the gap-5 option.¹⁵ No beneficiaries in the older age groups (70–79, 80–89, and 90+) would lose their benefits if the EEA increases because they would already be older than the new, higher EEA. Under payable benefits, no beneficiaries would lose their benefits completely because this option would reduce the monthly benefit calculated under current law for all beneficiaries proportionally based on what incoming payroll tax revenues could fund.

Increases in the Poverty Rate Under All Three Retirement-Age Options in 2070

Each retirement-age option would increase the overall poverty rate of 1.2 percent under scheduled benefits by 0.2 to 0.3 percentage points (see Table 8). Poverty would increase more under payable benefits because the median benefit reductions needed to achieve system solvency would be much higher than under the options (see the next section for more information on system solvency). Poverty increases under the three options would be larger for beneficiaries in the younger age groups because they include those beneficiaries who temporarily lose their entire benefit, as discussed previously. For example, under the gap-4 option, the poverty rate would increase by 0.7 percent for beneficiaries aged 60–69 in 2070, compared with a 0.1 percent increase for those in the other age groups.

Improving System Solvency

Each of the three retirement-age policy options discussed in this article would improve system solvency about 17–20 percent by reducing scheduled benefits (see Table 9). The 2011 Trustees Report estimates that Social Security has a long-run deficit equal to 2.22 percent of taxable payroll. This means that restoring the system to solvency would require benefit reductions, tax increases, or a combination of the two that would be equal to 2.22 percent of taxable wages over the next 75 years. The growing-gap option would improve the long-range actuarial balance of -2.22 percent to -1.78 percent of taxable payroll, while the gap-4 option would improve the actuarial balance to -1.77 percent and the gap-5 option would improve it to -1.85 percent. The early retirement reductions in benefits under current law are actuarially fair.¹⁶ This means that regardless of the age at which benefits are claimed, the present value of lifetime benefits would be the same for a person living to his or her normal life expectancy. All three options would have similar effects on Social Security solvency because the reductions for early retirement under those options would continue to be actuarially fair. However, as modeled by OCACT, the gap-5 option includes a hardship exemption that would account for the slightly smaller effect on solvency. (The hardship exemption was not modeled for this analysis to make comparisons with the other options more straightforward.) Although all three options would improve system solvency by similar proportions, their effect on individual beneficiaries would vary across the population. This fact highlights the importance of distributional analysis to understanding the impact these varying reforms would have on Social Security beneficiaries.