Earnings Test, Non-actuarial Adjustments and Flexible Retirement

Abstract

We are grateful to Alexander Ludwig for advice on the computational algorithm. We thank Tabea ABSTRACTIn response to the challenges of increasing longevity, an obvious policy response is to gradually increase the statutory eligibility age for public pension benefits and to shut down pathways to early retirement such as special rules for women. This is, however, very unpopular. As an alternative, many countries have introduced "flexibility reforms" which allow combining parttime work and partial retirement. A key measure of these reforms is the abolishment of earnings tests. It is claimed that these reforms increase labor supply and therefore, also the sustainability of pension systems. We show that these claims may not be true in the circumstances of most European countries.To this end, we employ a life-cycle model of consumption and labor supply where the choices of labor force exit and benefit claiming age are endogenous and potentially separate. Earnings tests force workers to exit the labor market when claiming a pension. After abolishing the earnings test, workers can claim their benefits and can keep on working, potentially increasing labor supply. Our key result is that the difference between exit and claiming age strongly depends on the actuarial neutrality of the pension system and can become very large. Abolishing an earnings test as part of a "flexibility reform" may therefore create more labor supply but at the same time, reduce the average claiming age when adjustments remain less than actuarial, thereby worsening rather than improving the sustainability of public pension systems.

Endogenous Retirement Behavior of Heterogeneous Households Under Pension Reforms

“…As previously mentioned, the adjustment rate, , creates strong incentives for when to retire (Desmet & Jousten, 2003;Gruber & Wise, 2005;Fisher & Keuschnigg, 2010;Börsch-Supan, et al, 2017b). Occasionally, it is referred to as "actuarial adjustment rate," although the term "actuarial" only applies when is introduced in the pension system such that the present discounted value of participating in the pension system for all households is independent of their retirement age, R.…”

“…Studies have shown that wealth and financial incentives have a great impact on retirement decisions (French, 2005;Chan & Stevens, 2008) as well as on the household composition and income status of individuals (Coile, 2004;van der Klaauw & Wolpin, 2008;Gustman & Steinmeier, 2004;Fuster, et al, 2003). The design of pension systems is of great importance for determining the impact on retirement behavior because individuals sometimes react strongly or weakly to changes in incentives and in the framework of pension systems (Gustman & Steinmeier, 2005;Duggan, et al, 2007;Kotlikoff, et al, 2007;Börsch-Supan & Schnabel, 1998;Gruber & Wise, 1999;Börsch-Supan, et al, 2017b).…”