Rethinking earnings and consumption through life

In the United States, many people are re-evaluating the traditional model of working and saving through life. The traditional model is that you get an education and then work full-time until you exit the workforce entirely and live on a pension, Social Security, and/or savings. In recent years, the Financial Independence / Retire Early (FIRE) movement has encouraged discussion of alternative ways to think about work and earnings. At the same time, economic research has started to address ways in which policies and regulations have started to change incentives in how people work (or not). Specifically, working later in life, whether part-time or full-time, is much more financially attractive than in the past. This is a result of changes in Social Security and the transition from traditional pensions to 401(k)s and IRAs. Transitioning from full-time work to part-time work and staying in the workforce longer is a scenario more people should consider.

Traditional pensions (so-called defined benefit or DB plans) provide a specific amount of retirement income, typically based on the number of years that you have worked and an average of your highest-income years. Working longer typically increases the retirement benefit because you have more years of service but reduces the number of years you will be in retirement (obviously). If, for example, you have been employed for 30 years, adding one more year adds 1/30th to your retirement income, but you have lost 1/N of your expected lifetime retirement income, where N is the number of years that you expect to live in retirement.

With 401(k)s and IRAs and similar defined contribution (DC) plans, the economics are very different. Delaying retirement reduces your number of years in retirement, but increases your wealth because your portfolio has more years to grow. You do not lose 1/N of your expected lifetime retirement income because you will have the option to draw a higher level of income in retirement because you have delayed retirement and/or you will have more wealth to leave to your kids or to causes that you support.

Traditional pensions create incentives to work until a full retirement age and then to retire while self-directed retirement plans open up all sorts of new ways to shape earnings and savings. Consider, for example, the increasingly common scenario is which someone saves aggressively in their younger years and then downshifts to work fewer hours for some number of years. By doing so, they delay claiming Social Security and drawing from retirement savings. Saving more in your younger years gives your money more time to grow until you need it. Working part-time rather than abruptly ceasing all paid work reduces the amount of retirement savings that you would need to accumulate to support a traditional retirement. In addition, there is a disproportionate benefit to claiming Social Security later.

Another benefit of part-time work in later years is that you maintain your skills and other human capital. Continuing to work part-time in a field in which you have some expertise makes it far more likely that you will be able to scale up the amount that you work if circumstances require. Someone who has consulted in their field for even ten hours a week is much more employable, one imagines, than someone who fully retired a decade ago.

The old idea that people will work traditional full-time jobs for 30+ years and then retire abruptly to a life of zero work is neither terribly attractive nor practical for many Americans. People are living longer and have more productive years available to them, but these additional years can be spent in a variety of ways. Public policy makes it increasingly beneficial for people to work part-time for longer. The future of paid work is quite different than the past and I expect to see much greater variety of options for employment.