Demand for Phased Retirement Programs on the Rise, But Challenges Still Exist

by George W. Zobrist

Note: This article is intended to be educational only and should not be considered to be legal or financial advice.

More and more, professionals nearing retirement age are opting to continue working in some form. Many are choosing one of several phased retirement options, which enable them to keep working part time. Among the most popular “phasing” options are temporary, seasonal or part-time employment; extended leaves of absence; and variations of an option commonly referred to as a deferred retirement option program (DROP).

Phased retirement is about more than money. According to a March Watson Wyatt (a global consulting firm specializing in human capital and financial management with an office in Washington, D.C.) survey, 42 percent of working professionals who phase into retirement do so because they enjoy working and want to continue to do so, not because they have to. Another 25 percent continue working because they need the income, and 15 percent work for extra income. Furthermore, in 1999, 16 percent of the employers surveyed offered phased retirement programs, but more recent data suggest that more employers are beginning to offer such alternatives as flexible work schedules, job sharing and telecommuting (www.watsonwyatt.com/us/pubs).

Employers and Employees Gain

Employers and employees both enjoy advantages associated with phased retirement. Employers who offer phasing programs can retain trained and qualified individuals; reduce costs associated with training new employees who replace retiring professionals; and lower their salary and benefits expenses. At the same time, employees who choose a phased retirement path enjoy generally flexible work arrangements; can make a more gradual transition to full-time retirement; can supplement their retirement income; and can increase future benefits through deferral.

Challenges Exist

At the same time those who offer or participate in phased retirement programs tout their value, challenges to the concept exist. According to Watson Wyatt (August 2002), the Internal Revenue Service (IRS) is concerned about the effect of phased retirement on the pension system. The practice also raises concerns in the workplace. Among the concerns are:

• Defined benefit plan costs could increase
• “Double dipping” can create tensions among coworkers
• Phasing programs may affect spousal benefits

Barriers Related to Pensions and Phased Retirement

In the Internal Revenue Code’s rules for defined benefit (DB) plans, the main regulation states that DB plans cannot begin distribution until an employee has terminated employment or reached normal retirement age.

Legally, DB plans are structured so that professionals who “ease” into retirement will see their retirement amounts diminish, since most DB plans use their last several years of employment as the benefit basis. The Supreme Court recently ruled that workers who retire early and receive benefits while continuing to work another job can’t have their benefits reduced. This ruling primarily affects multi-employer pensions such as those offered by unions in certain industries, but Karen Ferguson, of the Pension Rights Center in Washington, D.C., said the ruling is important for all workers (USA Today, 8 June 2004). The Pension Rights Center is the country's only consumer organization dedicated solely to protecting and promoting the pension rights of American workers, retirees and their families.

Potential Regulatory Solutions

Experts have proposed these potential regulatory solutions to the phased retirement barriers:

• Notify employees that their DB plan benefits would be reduced with phased retirement
• Adjust in-service distribution to permit distributions to employees who have reached a certain age, completed a specified amount of service, or a combination of the two
• Review and amend age discrimination laws related to gradual retirement programs
• Allow employers to modify eligibility rules

Proposed Legislative Solutions

Legislators are also considering a number of possible solutions, including:

• Lowering the normal retirement age for DB plans
• Eliminating subsidies that encourage early retirement
• Encouraging or allowing two-tiered DB plans, which would enable employees to receive part of their pension early and part when they reach retirement age
• Allowing phased retirement pay to be annualized, crediting half-time employees with a half-year of benefit accrual

Florida’s DROP Program

A National Association of State Retirement Administrators report titled “Phased Retirement Overview: Summary of Research and Practices” (K. Brainard, October 2002) discusses some of the factors associated with phased retirement, including:   Employers are seeking ways to keep experienced employees; Employees are working longer; Social Security retirement age is increasing; Congress approved the earnings test for Social Security recipients over age 65; and Retirees are facing financial limitations.

Florida offers a DROP option to all state employees, including university and public school employees. In the DROP program, retirement benefits are deferred and deposited into a separate account. When a participant terminates (usually within five years), he or she can receive a lump sum payment for the deferred benefits and can start a pension annuity. Other states offer variations of Florida’s DROP program.

IEEE-USA Efforts

In December 2002, IEEE-USA's Career Policy Committee sent comments concerning phased retirement to the IRS, in response to IRS Notice 2002-43, IRS Bulletin 2002-26, page 38 (08 July 2002). The Committee’s comments addressed two concerns of U.S. IEEE members: retirees are contemplating continued part-time work after retirement from their primary employer, owing to declines in retirement asset values; and the Employee Retirement Income Security Act of 1974 requirements governing defined-benefit plans that have made it impossible for many professionals to continue part-time work. This latter concern affects employers as well, as they lose access to the intellectual capital developed over many years when professionals must retire. (IEEE-USA’s detailed comments are available at www.ieeeusa.org/forum/policy/2002/02dec31.htm.)

Demand for Phased Retirement Programs Will Grow

The demand for phased retirement is likely to increase in the coming years, as more workers decide they want to work in a more flexible environment as they reach retirement age. And as the demand increases, employers who do not offer phased retirement options may face a competitive disadvantage.

For More Information

For more information about phased retirement, visit:

• www.watsonwyatt.com
• http://was4.Hewitt.com
• www.urban.org
• www.workforce.com
• www.ieeeusa.org

Dr. George W. Zobrist is professor emeritus at the University of Missouri-Rolla, Department of Computer Science, and IEEE-USA's Member Activities editor.