Financial Incentives Affect Retirement Decisions

Titled, “Nonparametric Evidence on the Effects of Financial Incentives on Retirement Decisions,” the paper investigates the extent of responsiveness in retirement entries to a financial incentive that operates along a dimension that is independent of age.

The authors investigate a nationally mandated rule for employer-provided retirement in Austria. The employer-provided benefit system in Austria is largely independent from the rules of the public pension system, which allows the authors’ to study it in isolation of complicated social security rules. 

The eligibility rule in Austria is: workers will receive a lump-sum benefit (i.e. a severance payment) from their employer at entry into retirement. The amount of this payment depends on the tenure in a step-wise function. Individuals are first eligible upon completing a tenure of 10 years, and further increases in benefits occur at thresholds of 15, 20 and 25 years of tenure. If an employee has accumulated at least 10 years of tenure with his employer by the time of retirement, the employer must pay one third of the worker’s last year’s salary. This fraction increases from one third to one half, three quarters and one at 15, 20 and 25 years of tenure.

Statistics show the median retirement age is 58.5 year-old, which reflects that most individuals retire through disability or early retirement. Years of employment and annual earnings in the last year before retirement are slightly higher for workers with longer tenure and these workers also have lower years of unemployment. 
By analyzing the data, the authors found there are discontinuous spikes in the number of retirements at the tenure thresholds. There are also dips in the number of retirements just before the tenure thresholds. A seasonal pattern illustrated by small spikes in the number of retirement at each integer value of years of tenure at retirement.

The seasonality can be explained by a relatively large fraction of job starts in January and corresponding retirement  exits in December. Also, even though there are decreases prior to the thresholds, the frequency of retirements  never goes to zero just prior to the thresholds. This shows that there appears to be a substantial number of individuals who are unresponsive to the severance pay system at retirement. 

The authors also investigate whether individuals time the beginning of new jobs so they can retire at the Early Retirement Age (ERA) (55 for women and 60 for men) and also claim severance payments at the time of their retirements. The evidence showed no discernible change in job starts at any age prior to the ERAs. While there is evidence that some individuals delay their retirements to qualify for larger severance payments at retirement, there is no evidence individuals adjust their labor supply or participation at earlier ages in response to the sizeable anticipated incentives from the severance payments.

Heterogeneity related to health status was also observed. It was found that unhealthy individuals are not very flexible in the timing of their retirements. Retirement patterns are similar across age and gender groups, except for men retiring prior to age 60. 

The authors’ estimation results indicate relatively low labor supply elasticities that are driven primarily by individuals delaying their retirement dates to qualify for larger severance payments. The estimated elasticities suggest older workers and prime-age workers are similar in that both groups appear to be relatively inelastic in their labor supply decisions. 

The results are policy relevant as they suggest while financial incentives do affect retirement decisions, it may be difficult for policy to alter observed patterns by age using only financial incentives as a policy instrument.

Click here to view this paper in its entirety.