The traditional notion of retirement—one day you’re working, the next you’re golfing, traveling and spending time with the grandchildren—doesn’t cut it with a lot of people anymore. These days, many individuals want to keep working—at least part time—while they ease into retirement. And many employers would like to keep older workers on the payroll with a diminished workload, but they haven’t found effective ways to help such employees stick around.
One possible solution is so-called phased retirement, a work arrangement that allows employees near retirement age to make a gradual transition to full retirement.
Laurie Barr, SPHR, employment manager at Oregon Health & Science University, an academic medical center in Portland, Ore., that offers phased retirement, says: “It’s something every organization needs, to be flexible. Our workforce as a whole is aging. There are going to be more people retiring than are available to fill jobs.”
Phased retirement offers pluses for employers and employees alike. Employers get to retain experienced workers—especially those with specialized or technical skills—who are hard to replace. And employees can stay engaged in work and earn income while getting a taste of the retiree’s lifestyle.
Facing the Facts
Employee retention may not seem like a high priority given today’s soft economy and recent mass layoffs, but employers must face the inevitable: As the population ages and baby boomers retire, there won’t be enough workers to fill the gaps, HR experts say. Companies will have to find ways to shore up their staffs, and they’ll have to adopt creative retention strategies.
“Some organizations will have huge drains if they don’t do something,” says Anna Rappaport, a Chicago-based principal of HR consulting firm William M. Mercer Inc.
Retaining older workers, in some capacity, will be key. Without programs like phased retirement, many companies will risk losing their most experienced workers.
Fortunately, older workers seem inclined to continue working. (See “Supply of Older Americans Demands Work,” on page 54.) Last year, almost one-third of the 56.3 million Americans age 55 or older were in the labor force, according to the Bureau of Labor Statistics.
And that share will go even higher, if workers’ expectations are any indication. Sixty-one percent of employees expect to work for pay after retiring, according to a survey report released earlier this year by the Washington, D.C.-based Employee Benefit Research Institute.
But many older employees who want to continue working don’t want to do it full time. “More and more employees, when they think of retiring, think of it in a gradual way. It’s no longer an on-off switch,” says James Delaplane, vice president of retirement policy at the American Benefits Council, a Washington, D.C., association of benefit plan sponsors.
Building the Framework
Not all employers need a phased retirement program to hold on to older workers, but retirement consultants say that more companies should consider them. Twenty-three percent of 232 large U.S. organizations surveyed by the Mercer firm last year had such programs. According to Watson Wyatt Worldwide, a consulting firm based in Washington, D.C., phased retirement programs are most prevalent in higher education and government.
In general, having a phased retirement plan makes the most sense for companies with many older workers who have technical or other hard-to-fill jobs or who have business relationships with key clients, consultants say.
The health care and utility industries may be especially at risk because their workforces tend to be older, says Mercer’s Rappaport. But, she adds, all types of employers will be affected in the long run.
To decide if you should have a phased retirement program and to sketch a framework for it, compare your current workforce demographics with your future labor needs. How many employees are near retirement age? What skills do they have? How difficult will it be to replace them? What are your projected workforce needs? Which business units are especially vulnerable?
Experts also suggest other steps, such as these:
- Try a pilot program in one division before instituting phased retirement for everyone.
- Change payroll and other systems to track hours and new categories of employees.
- Adjust health and other benefits to suit phased retirees.
- Communicate the opportunity to eligible workers.
Who’s on the List?
Phased retirement doesn’t have to be offered to all employees, experts say. It can be targeted so that a firm can align its workforce and budget. For example, a company may want to retain senior engineers but not mail clerks. “You have to draw a rational line between those you offer it to and those you don’t,” says Lawrence Lorber, a partner in the New York-based law firm Proskauer Rose LLP.
He adds that offerings based on job category rather than age aren’t likely to violate the Age Discrimination in Employment Act, which protects workers 40 and older.
Indeed, the complex legal issues that arise with phased retirement have less to do with age discrimination than with pension laws and rules, attorneys say.
Nonetheless, “the more handpicked [the program] becomes, the more likely you are to encounter discrimination issues,” warns Valerie Paganelli, a senior retirement consultant for Watson Wyatt.
How It Works
The most common arrangement for phased retirees is to work part time, typically 20 to 30 hours per week. Hours are often limited so as not to run afoul of pension-plan rules. Other arrangements include special assignments, temporary work, consulting and job sharing. (See “Options in Phased Retirement,” above.)
The length of the phase is also flexible. No formal end date is required. Employers can set a term of, say, three years. Usually, though, things are left loose to accommodate both the employer’s need to flex staff up or down and the employee’s desire to control how much longer to work before full retirement.
In fact, most firms that offer phased retirement do it informally, with employees and their supervisors negotiating the details, experts say. Occasionally, an informal program morphs into a formal one, but most arrangements are individualized, surveys show.
Some organizations have found, however, that informal programs lead to problems. For example, the Aerospace Corp.—a research and development firm in El Segundo, Calif., that employs 3,200 people—began a formal phased retirement program in 1985 to bring more structure to the rehiring of retirees.
“People were retiring and the next week they’d come back and get hired as consultants—often at higher pay,” says Charlotte Lazar-Morrison, the company’s principal director of HR. “There were all sorts of different deals. It was starting to get out of hand.”
Under the company’s program, Aerospace workers who are 55 or older can choose from several options, including part-time work, consulting and a three-month unpaid leave of absence that lets employees “try out” full retirement—to see if they like it. If they don’t, they can return to full-time employment without loss of benefits. The most popular option is to become a “retiree casual.” With managers’ approval, these workers retire—with pension and medical benefits—and then are rehired to work up to 999 hours per year, the maximum for retaining pension benefits.
“We have retiree casuals who are 75, 80 years old and still working. They want to stay involved. They love the company,” Lazar-Morrison says. “It allows us to have people ready and available to work when we’re in a surge mode. We can call people in, but they don’t have to be on the payroll.”
About 500 retiree casuals are available at any given time, and about 200 are at work, she adds. Thousands of retirees have participated in the program over the years. (See “ Ease on Down the Road.”)
Concerns That Can Stand in the Way
If phased retirement is such a good idea, why aren’t more companies using it? There are two chief drawbacks that may limit use of such programs: health care and pension regulations.
Health coverage is employees’ chief obstacle to phased retirement plans. At companies that don’t offer retirees health insurance, older workers often conclude they must work full time to retain their coverage—at least until they become eligible for Medicare at age 65.
Some organizations, such as Oregon Health & Science University, offer health benefits to all part-time employees, including phased retirees. Others offer benefits but charge higher contributions. Neither of these solutions helps workers who phase into retirement as consultants and therefore are ineligible for benefits.
A Mercer survey, “Phased Retirement and the Changing Face of Retirement,” released in May found that 35 percent of employers offer no health benefits to older workers on modified work schedules; 35 percent provide such workers the same benefits available to other employees, with the same contributions; 20 percent offer the same benefits but with higher contributions; and 10 percent offer different benefits.
Even colleges and universities, which customarily provide generous benefits, are less generous with retirees than they are with full-time employees. Although 80 percent make retirees eligible for health coverage, only 58 percent help pay for it, according to a survey of more than 600 colleges and universities.
The other major obstacle to phased retirement is the federal regulatory structure for pensions. In effect, the rules discourage people who haven’t reached the “normal retirement age”—usually 65—from working full time or part time for a company while receiving pension benefits from that company.
The resulting bind: Some phased retirees can’t supplement their lower earned incomes by drawing on their pensions. The rules are stricter for defined-benefit plans than for defined-contribution plans, though both have limits. Says the American Benefits Council’s Delaplane: “There are some legal impediments and gray areas. Companies offering phased retirement have had to jump through hoops.”
Until Congress changes the law—not a high priority at this time, benefits lawyers say—employers that want to use phased retirement will have to “get around” the legal impediments by adopting certain employment strategies.
Overcoming Pension Barriers
There are ways to offer phased retirement and comply with the rules for tax-qualified pension plans, although no solution is ideal.
“I’m not aware of a lot of loopholes if you have a defined-benefit plan. If you have a 401(k), you have more latitude,” says attorney Lorber.
Here’s the rub: Enabling older employees to work part time and supplement their incomes with partial pension payments is difficult for a few reasons.
First, many defined-benefit plans reward long service by basing retirement benefits on average pay during the final few years of work. If older workers go part-time at the end of their careers, their incomes go down—and so do their benefits. That’s hardly an incentive to participate in a phased retirement program.
Although federal law prohibits decreasing pensions because of higher age or service, there are no rules against letting benefits shrink if final average pay is less than expected, according to a report by the U.S. Department of Labor’s Working Group on Phased Retirement. The group is part of the Labor Department’s Advisory Council on Employee Welfare and Pension Benefit Plans. The council’s 15 members, appointed by the secretary of labor, are private-sector experts in retirement benefits, investing, insurance and other financial specialties. The solution for employers is to use a full year’s full-time pay to calculate pension benefits, says Rappaport.
Second, rules for defined-benefit plans prohibit “in-service distributions”—payments to people still on the company’s payroll—before “normal retirement age,” which many plans set at 65. For 401(k)s and other defined-contribution plans, no pension payments are allowed until age 59 1/ 2 unless an employee retires fully. There’s also a 10 percent tax on distributions before age 59 1/2.
The effect of these rules, contained in the federal tax code and the Employee Retirement Income Security Act of 1974, is to force employees to retire completely or to retire with a pension and go to work elsewhere—perhaps for your competitor.
As things stand, there are a few ways for companies to employ retirees and pay them pensions at the same time. The simplest strategy is to not allow phased retirement until workers reach the pension plan’s normal retirement age.
But that can prompt the departure of a lot of valuable people in their late 50s and early 60s who want to scale back their working hours and start tapping their retirement benefits.
One company that has created a phased-retirement path for employees is the Washington, D.C.-based National Rural Electric Cooperative Association. The organization’s employees and members who participate in its defined-benefit plan can enter phased retirement at 62, the normal retirement age, or after 30 years of service. They can work part time and draw partial pension payments. “They end up having 100 percent of salary on a reduced schedule,” says Lana Keelty, the association’s benefits counsel.
Other options, according to retirement experts, are to:
- Lower the plan’s normal retirement age. A lower age allows more people to work part time and collect pension benefits. The downside for employers is that everyone on staff can leave with a full pension at an earlier age—a potentially costly design that many employers probably would be unwilling to adopt. But Watson Wyatt’s Paganelli suggests that higher pension costs could be offset by retaining some senior employees—and saving money on replacement costs.
- Retire and rehire. Under this arrangement, employees can retire fully before normal retirement age and get rehired after a bona fide break in service. If they’re hired back as consultants or contractors, pension payments are no problem. If they’re hired back as part-time employees, they also can collect full or partial pension benefits, depending on what the plan allows. What constitutes a legal break in service is unclear because federal rules set no specific time frame. The Mercer study on phased retirement found the mean separation time to be 5.2 months.
What is clear is that “you can’t have a preconceived arrangement to keep working,” says David Wolfe, a lawyer at Gardner, Carton & Douglas, a Chicago law firm. “If you decide to leave and I don’t have any obligation to rehire you, and there’s a meaningful period [of separation], then that could work.”
A Tool Whose Time Has Come
Despite the obstacles, phased retirement is a retention tool more employers should consider and use, retirement experts say. In the long run, it could help employers seize the productivity of older, experienced workers without having to hire and train younger, new recruits right away.
Deborah Russell, senior program coordinator for economic security and work issues at AARP, says: “Turning your back on older workers with the attitude that they’re sitting around waiting for retirement won’t fly. Companies that continue that mind-set will find themselves left behind in the competitive market.”
Carolyn Hirschman is a business writer based in Rockville, Md. She has written for a variety of business publications and has covered workplace issues since 1991.