Can the Actuarial Reduction for Social Security Early Retirement Still Be Right?

Monthly Social Security benefits claimed at age 62, rather than 65, are reduced by about 20 percent.  The goal of the reduction is to ensure that early retirement does not result in any additional cost to the system.  When the reduction was set over 50 years ago, a worker claiming at 62 received benefits for about 20 percent longer than someone claiming at 65.  Since then, life expectancy has risen, so that claiming at 62 today means receiving benefits for only 15 percent longer.  How can a 20-percent reduction still be right?

The original legislation creating the Social Security program did not allow workers to claim benefits before the program’s eligibility age of 65.  In 1956, however, Congress gave women the option to retire as early as age 62 on a reduced monthly benefit, so that married women, who were typically younger, could retire and claim benefits at the same time as their husbands.  Congress made the option available to all women, so as not to discriminate against unmarried women.  Congress extended the same option to men in 1961, during a recession that made early retirement an attractive policy response. 

In 1960 the average life expectancy at age 65 was about 15 years; therefore a worker who claimed at 62, as opposed to 65, collected benefits for three additional years or 20 percent longer (18 years /15 years).  If an individual were receiving benefits for 20 percent longer, the only way to keep the cost constant would be to pay 20 percent less each year.  

Life expectancy at 65 has increased significantly in the last 50 years.  It is now 20 years, so the worker who claimed at age 62 instead of age 65 would receive benefits for 15 percent longer (23 years/20 years).  So why shouldn’t the benefits be reduced by 15 percent to keep costs constant?  

The answer is that the cost to the government of providing benefits early is the difference in the present value of expected lifetime benefits starting at age 62 and at age 65.  That calculation means that the cost depends on interest rates as well as life expectancy.  Real interest rates have increased since 1960, and higher rates shrink the cost of a benefit stream claimed at 65 more than a benefit stream claimed at 62. 

The rise in interest rates has largely offset the increase in life expectancy.  Calculating the cost of lifetime benefits using the interest rate the Social Security Administration projects over the long-term, 2.9 percent, the cost of benefits claimed at 62 would be 96 percent of the cost of benefits claimed at 65.  It suggests that the reduction for early retirement is a little high, but not bad. 

In short, the actuarial reduction factor for early retirement, set by Congress over 50 years ago, has proved to be remarkably durable.  Despite rising longevity and changes in interest rates, the cost of lifetime benefits claimed at 62 remains reasonably close to the cost of lifetime benefits claimed at 65.