Medicare, Retirement Costs, and Labor Supply at Older Ages

Richard W. Johnson

WP#2002-8

Abstract

When workers retire, they forego the wages and many of the benefits they received while employed. By providing subsidized health insurance coverage to virtually every American at age 65, Medicare reduces the cost of retiring for workers who receive health benefits from their employers, especially when those benefits do not continue after retirement. As a result, an increase in the age of Medicare eligibility may lead many workers to delay retirement. This paper examines how a potential increase in the age of Medicare eligibility might affect retirement behavior by relating the health insurance costs of retirement to labor supply decisions. The insurance cost of retirement is the increase in health insurance premiums that workers face after they retire, relative to what they pay when working. We measure the effect of insurance costs on labor force withdrawals by including the net present value of premium costs in a multivariate model of retirement. We then simulate the impact of changes in the Medicare eligibility age by re-computing premium costs under the assumption that individuals could not receive Medicare coverage until age 67. We find that health insurance costs significantly discourage retirement, and that an increase in the age of Medicare eligibility would reduce retirement rates.