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Retirement Planning > Retirement Investing

The evolving idea of retirement

By Michael Finke

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A fellow economics professor recently decided to choose a yearlong sabbatical at half pay instead of a half year at full pay. I asked him why.

“I’m amortizing my retirement.”

“How so?”

“I’m OK with working a half year longer before I retire. But I get to take an extra half year of retirement right now. My health is good. I can spend time with my family. And I haven’t taken much time off in the last decade. Why should I wait until I’m 70 when I can spend some of my retirement in my 40s?”

This discussion completely changed the way I think about retirement. I’d become so accustomed to seeing middle age as the era of sacrifice where my most important goal is to save for decades of kicking back after retirement. But what is retirement? Why do we stop working in our 60s? Where did we ever get the ideas that define how we think about working later in life?

Retirement is a 20th century idea. In her careful review of the evolution of retirement, UCLA economist Dora Costa traces changes in the workforce that resulted in a sharp drop in the percentage of employed males over the age of 64. The story of retirement is ultimately a history of trends in labor force participation of older men (since women only entered the workforce in large numbers in the late 20th century). Costa describes how men increasingly retired because they could afford it, because they started believing in a new lifestyle of fun and relaxation, or because nobody would hire them.

Our economist friend who chose to bring more retirement into the present was essentially saying that he wanted to extend his work life in his 60s in order to increase his leisure time in his 40s. It’s better to think of retirement as a tradeoff between labor and leisure. If we’re not working later in life, then we’re going to be spending a lot more time engaging in leisure activities. That’s why, to an economist, the question of when to retire is really about when to take your leisure time over a life cycle.

Costa notes that young adults today can expect to spend a third of their life in retirement. If your first instinct was to wonder why a lazy professor would spend a year avoiding his teaching responsibilities, consider that the average adult is going to spend 25 years away from the workplace in retirement. Three-quarters of the time, this transition from working to retirement is an abrupt end to life employment rather than a transition to part-time work.

Jumping directly into retirement while living longer (and spending more time in school) means that the average percentage of an American male’s life in the labor force has declined from about two-thirds of life expectancy in 1950 to one-half of a lifetime today. And paying for half a life of leisure can get expensive. 

Why Do We Retire at 65?

Behavioral economists have long noted the power of a reference point—a number which serves to anchor decision-making that can have a powerful impact on choice. In the case of retirement, the magical age of 65 has been around for over a century. Pensions were granted at age 65 to Union soldiers in the late 19th century and the first social insurance program in Germany set 65 as the retirement age in 1916. According to the Social Security Administration, in 1935 the Committee for Economic Security proposed 65 as the full retirement age in the U.S., to match not only the newly created federal railroad pension but also the age that was then used in half of U.S. state pensions.

According to a number of committees tasked with determining retirement ages during the early 20th century, 65 was chosen because it represented the age at which men appeared to lose their productive capacities. Period arguments include dubious claims of a loss in mental elasticity or ability to keep up with the rapidly changing technologies of the industrial age. When arguing for railroad pensions that started at age 65, it was noted in Supreme Court arguments that “physical ability, mental alertness, and cooperativeness tend to fail after a man is 65.” It’s good to know that the genesis of the modern retirement age was pegged to the uncooperative stage of the life cycle.

Age 65 also made sense because it wouldn’t place too much of a burden on the rest of society. When the average longevity falls below the average retirement age, this places a modest burden on those who transfer dollars through payroll taxes to fund a pension system. In fact, the initial rate on Social Security that was needed to fund the small minority of Americans 65 or older was 1 percent.

Today about 80 percent of workers live beyond age 65. And those who reach age 65 will live, on average, an additional 16 years. Unless they have a higher income. In one of the most fascinating trends in recent decades, higher income workers have gained an additional five years of longevity compared to lower income workers in the U.S.

The two Social Security reference points—age 62 for initial eligibility and age 65 (now 66) for full retirement age—have had a powerful impact on when people retire. Among men born between 1930 and 1934, 57 percent claimed their benefit at age 62 during the 1990s. This has recently fallen to just 45 percent of men born between 1943 and 1944. Claiming at or before full retirement age remains a popular strategy for many Americans.

The defined benefit pension system often provided a strong incentive for workers to retire. Many formulas reduce the actuarial value of an annuitized income stream with each additional year worked (since longevity is decreased by a year and pension income rises only modestly), and led to a two-year difference in retirement age between workers with and without a DB plan. In the 1990s, the number of workers who retired at age 55, when many pension systems first allow retirement, spiked. Many employees who continue to participate in defined benefit plans, for example public sector workers, face choices about early retirement that are not available to private sector workers saving in defined contribution plans.

Despite big increases in life expectancy, many remain fixated on retirement age reference points established during the Jazz Age. The percentage of men aged 65 and older who are working fell from 75 percent at the turn of the century to less than 25 percent today, despite spending more years in retirement.

Both average retirement age and labor force participation rates, however, have increased slightly in recent years, in part because of the transition to defined contribution plans. There’s every reason to believe that baby boomers will retire later than their parents. Clients, however, may continue to focus on the reference point. The reality is that funding a longer retirement out of savings calls for considering new, later retirement ages that match up better with increases in life expectancy. Otherwise they’ll be socking away a big chunk of income to fund a long retirement, or they’ll have to cut back on their lifestyle to make their nest egg last over a longer and more active retirement period. 

Workforce Changes

In the defined contribution era, what would convince a worker that giving up a job makes sense? Economists see this as a simple comparison of the value of work and leisure. You could spend another year at the job earning an extra year of salary, but you’d give up a year of joy in retirement. When is it worth it to keep working?

Think of the retirement decision as a scale. On one side you have a year spent traveling, spending time with friends, catching up on home projects and playing golf. On the other side you have a year spent hanging out with colleagues, solving work problems, dealing with your boss and making an additional year’s worth of salary. Which would make you happier?

Economists have found evidence that if you tip the scales of the balance, you can see predictable changes in the likelihood of retirement. Are you in a technology-intensive field in which workers have to maintain complex skills to continue making a high salary? If so, that tends to tip the scale in favor of retirement. Do you like your job? If so, you’re more likely to spend another year in the office (it’s often hard to push academics into retirement).

One significant change is the amount of wealth modern retirees have by the time they hit retirement age. Most American households end up accumulating wealth by accident—they build up home equity through their mortgage and they create an annuitized nest egg through the forced savings plan called Social Security. Rising rates of home ownership and increases in asset accumulation mean that today’s retiree has more than six times the wealth of a 65-year old in 1917. Having enough wealth means that we have the luxury to decide that we’ve had enough of work and, therefore, a life of leisure doesn’t sound all that bad. A 19th century 65-year old didn’t have that option.

In addition to rising wealth, a big reason that we consider retiring early is because it sounds like a lot of fun. The elderly first started migrating in significant numbers to warmer climates in the early 20th century. Retirement started to be seen as a reward for a lifetime of hard work—a chance to kick back in newly created retirement communities that provided a lifestyle of carefree recreation.

New research by Charlene Kalenkoski at Texas Tech provides some evidence that many retirees, particularly those in the top wealth groups, are able to maintain active retirements with significant travel and other active pursuits that tend to correlate with life satisfaction. Others who are more constrained tend to watch a lot of TV and engage in other passive activities that don’t show up on retirement brochures. If the purpose of retirement is leisure, then at least consider what kind of leisure you can afford when choosing a retirement age.

When thinking about when to retire, it’s also good to think back to the wise economist who decided to delay retirement in order to live better early in life. Many of us don’t have the option to take a year off, but we do have the option to take full advantage of vacation time and spend more on our leisure today instead of buying more in the future. When you decide to enjoy the limited time we all have on this earth is your choice. Don’t let anyone, especially a Depression-era government commission, guide when the transition makes sense to you.

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