Biggest Help for Middle Income Boomers is Social Security Changes

A new study by a Washington, D.C. social policy research group concludes that changing the income thresholds for taxing Social Security benefits would be the biggest help to middle income baby boomers in retirement.

Urban Institute researchers Barbara A. Butrica, Karen E. Smith, and Eric J. Toder, in a paper prepared for the Center for Retirement Research at Boston College, also point out, however, that changes in retirement plan contribution limits and shifts in tax rates on capital gains and dividends will give the most profound boost to the highest income boomers.

“Tax policy directly affects the amount of wealth individuals can accumulate during their working years and, for a given amount of wealth, the living standards they can enjoy in retirement,” the researchers wrote. “Traditionally, Social Security benefits, tax-favored defined benefit plans and retirement saving accounts, and savings accumulated outside of tax-favored accounts have been viewed as the ‘three-legged stool’ of sources of retirement income. How tax policies evolve in the future will affect retirement income from all three sources.”

For more stories like this, sign up for the PLANADVISERdash daily newsletter.

Butrica, Smith, and Toder reach their conclusions after studying three possible tax law changes and the retirement income effects they would have on Boomers at age 67:

  • tax preferences for deferred contribution plans,
  • the taxation of equity investment income (capital gains and dividends) outside of retirement plans, and
  • the income tax treatment of Social Security benefits.

When it comes to changing plan contribution limits, the researchers find that restoring the pre-2001 contribution limits (indexed for inflation) mostly affects high-income retirees (who were high earning workers), but has very little effect on their after-tax incomes because, even at high incomes, very few workers are currently constrained by the limits.

Extending the tax cuts on dividends and capital gains enacted in 2003 past their expiration date (the end of 2010) would have larger aggregate benefits for older boomers (born between 1946 and 1950) and smaller aggregate benefits for younger boomers (born between 1960 and 1964) than increasing contribution limits, but the benefits would also be concentrated among higher-income retirees, who have the most capital gains and dividends (and had the most gains and dividends in their working years).

Finally, shifting the thresholds for taxing Social Security benefits mostly affects middle-income retirees. Specifically, the researchers examine indexing the thresholds for taxing benefits to changes in the CPI through 2017 (and to wages after 2017) and eliminating the thresholds completely and taxing all benefits. Both changes have less effect on low-income and high-income than on middle-income retirees. Low-income retirees do not benefit much from indexing because most of them do not pay tax on their benefits even with the unindexed thresholds.

Younger boomers have up to 18 years longer than older boomers to accumulate wealth prior to age 67, so policies that raise or lower after-tax returns on saving affect them relatively more, the researchers said.

Indexing Social Security thresholds for inflation also affects younger boomers more than older boomers because younger boomers reach age 67 later, after indexing has had more years to change threshold amounts before taking benefits. The proposal to tax 85% of all benefits with no thresholds, however, increases taxes more for older boomers than for younger because under current law, which does not index thresholds, a larger share of younger boomers’ benefits will already be taxable over time, making a move to full inclusion less of a change for them.

“As policymakers are forced to confront shortfalls in Social Security financing, they could consider income tax changes as an alternative to or in conjunction with reducing benefits or increasing payroll taxes,” the researchers conclude. “Different income tax changes, however, will have substantially different effects on the income distribution of future retirees.’

The paper is available at http://crr.bc.edu/images/stories/Working_Papers/wp_2008-3.pdf.

Increasing Health Care Costs Preventing Retirement

A new study from the Center for Retirement Research (CRR) at Boston College indicates that one result of increasing health care costs is workers deciding to delay retirement.

The study report concluded the increase in health care premiums for individuals who stop working before age 65 and the expected out-of-pocket health care costs after age 65 substantially delay retirement. The increase in premiums after retirement also includes loss of spousal coverage for workers who insure their spouses with their employer-sponsored health plan.

The CRR report noted retirement patterns differ by health insurance coverage. Workers whose employers offer retiree health benefits are more likely to retire than workers with employer-sponsored health benefits that do not continue into retirement. The median retirement age is about 62 for workers with retiree health insurance and 63 for workers with no retiree health benefits. Those with no health benefits from their employers are also more likely to remain in the labor force past age 65.

Never miss a story — sign up for PLANADVISER newsletters to keep up on the latest retirement plan adviser news.

Using data from the Health and Retirement Study in 1994 of respondents age 52 to 63 who were employed full time, CRR researchers found the own premium cost of retirement before age 65 significantly reduces retirement probabilities for both older men and older women. When calculated using a 3% discount rate, a $1,000-increase in the own premium cost of retirement lowers the likelihood that both men and women retire by about 0.1 percentage points. However, the data indicated the spousal premium cost of retirement before age 65 does not significantly affect retirement decisions for either men or women.

The data also showed the present discounted value of expected post-65 health care costs reduces retirement probabilities.

The researchers’ simulations showed that men with relatively low premium costs of retirement before age 65 – set equal to the median value among those with employer-sponsored retiree health insurance – retire about nine months earlier than men with relatively high premium costs. For women, the difference was 11 months.

Men with expected post-65 health care costs equal to the 90th percentile of the overall distribution retire 11 months later than those with health care costs equal to the 10th percentile of the overall distribution (64 years, 1 month versus 63 years). For women, the difference is 12 months.

The report said when the researchers used an annual discount rate of 3%, the mean value of own premium cost of retirement is $11,983 (in 2004 dollars) for men and $13,512 for women. The 1994 present value of expected future out-of-pocket health care costs after age 65 when computed using a 3% discount rate is about $82,000 (mean) for men and about $66,000 for women.

The report, “Do Out-of-Pocket Health Care Costs Delay Retirement?”, is located here.

«