Working a few years longer has a much bigger impact on improving retirement income security for older workers than boosting 401(k) contributions during the last decade of work, according to new research published by the National Bureau of Economic Research.
In fact, working a little longer and postponing the start of Social Security benefits can raise annual retirement income by as much as a modestly higher saving rate over several decades of work, according to NBER, a prominent nonprofit public policy research organization.
The biggest impact of the working-longer strategy applies to older workers because the benefits of traditional retirement strategies, such as increasing savings or switching to a lower-cost portfolio, diminish with age.
For example, a 36-year-old who boosted his 401(k) contributions from 6% to 7% of his pay (assuming a 3% employer match and 5% annual return) would get nearly four times more benefits from his increased contributions and earnings over 30 years than a 56-year-old who increased his savings by a similar percentage over 10 years.
By contrast, a 56-year-old worker who decides to work just one month longer at the end of his career could get the same increase in retirement income as he could by boosting his retirement saving rate by one percentage point over 10 years.
"The results are unequivocal," researchers Gila Bronshtein of Cornerstone Research, Jason Scott of Financial Engines, John Shoven of Stanford University and Sita Slavov of George Mason University wrote in their joint paper, "The Power of Working Longer." "Primary earners ages 62 to 69 can substantially increase their retirement standard of living by working longer."
Social Security benefits are based on the top 35 years of indexed earnings and the age at which you start receiving benefits. If you work less than 35 years, the Social Security Administration plugs in a zero for any year without earnings, creating a lower benefit. But each year you continue to work, even after reaching full retirement age, adds to your Social Security earnings record, possibly increasing future benefits.
Social Security retirement benefits are available as early as age 62, but are reduced by 25% to 30% compared to claiming at full retirement age, which ranges from 66 for those born from 1943 through 1954 to 67 for those born in 1960 or later.
Those who are willing to delay claiming Social Security get a big payoff. Benefits increase by 8% per year for every year an individual postpones claiming beyond full retirement age up to age 70, increasing monthly Social Security payments by up to 32%. For example, the difference between claiming benefits as early as possible at age 62 versus waiting until age 70 results in a 76% increase in Social Security income for life for someone whose full retirement age is 66.
There are several reasons working longer has such as positive effect on retirement income. Additional months or years of work allow workers to contribute more to their retirement accounts and delaying withdrawals from those accounts allow more time for them to grow.
But the biggest factor is the increase in Social Security benefits that results from claiming later A 66-year-old-worker who works one year longer and claims Social Security one year later sees a 7.75% rise in his overall inflation-adjusted retirement income, 83% of which comes from the rise in Social Security benefits, the study found.
The Social Security effect is highly progressive. The study noted that the lower one's income, the larger the gain in Social Security benefit from additional earnings. For example, a lower-wage worker needs to work only 2.1 months longer to equal the benefits of saving an extra one percentage point of income over 30 years, while a higher-wage earner has to work 4.4 months longer to get the same benefit, the study found.
The longer one works, the higher the retirement standard of living. For example, a 62-year-old working eight additional years will increase his or her retirement income by at least 40%, and in some cases, more than 100%, the researchers concluded.