Optimal retirement with disability pensions

Abstract

This paper develops a general equilibrium life-cycle model with endogenous retirement that focuses on the interplay between old-age pensions (OAP) and disability pensions (DP) in Germany. Germany has introduced a phased-in increase of the normal retirement age from age 65 to 67 (Reform 2007) and closed off other routes to early OAP retirement. This reform was followed by a phased-in expansion of future DP benefits (Reform 2018). Our simulation results indicate that the first reform will induce a shift toward DP retirement, while the Reform 2018 will even neutralize the financial and economic gains of the Reform 2007 if current DP eligibility and benefit rules remain unchanged. We therefore highlight the increased relevance of DP when reforming the retirement system and retirement incentives in an aging society. Securing the financial stability of public pensions requires activation and rehabilitation of sick elderly in the workforce and tight access to disability benefits.