Gliding into the Golden Years


By Ellen Hoffman Many Americans say that instead of retiring full-time, they want to ease into their nonworking years. A recent study by consulting firm Watson Wyatt Worldwide finds that nearly two-thirds of surveyed workers over 50 hope to scale back their jobs or work in a more flexible environment before retiring for good.

Phased retirement is also attractive to many employers. "Workers with niche experience are hard to find," says Lynn Dudley, vice-president and senior counsel for the American Benefits Council, an employers' organization based in Washington, D.C. "Companies, quite frankly, don't want to let go of them too soon." She says that one way to keep these employees on board is to offer them the chance to work less than full-time.

BIG STEP. So, while phasing out of your job might make sense for both you and your employer, there' a catch: the Internal Revenue Service. If you're one of some 16 million workers who still have a traditional pension, you can't start collecting until you terminate your employment. That's a problem if part-time income won't be enough to cover all your expenses. The rule doesn't apply if you have a 401(k) or similar retirement account at work, or if you go to work part-time for another employer. (For rules on withdrawing money from 401(k) and similar accounts, read Publication 590, Individual Retirement Arrangements (IRAs), available from the IRS.

According to an Urban Institute paper written by senior fellow Rudolph G. Penner and others, some employers get around the IRS rule by rehiring workers shortly after they "retire." However, the authors say that the strategy is risky and can result in severe penalties for the employer.

But change is on the horizon due to a proposed regulation that the IRS issued in November, 2004. More than two years after requesting public and industry input, the agency published a new regulation that would allow employees who cut back their working time by at least 20% to start receiving some of their pension benefits. The rule is not effective yet and could be revised, because the IRS has requested comments on it until Feb. 8.

Even if a final rule comes out shortly thereafter, it's unlikely that employers would implement such plans until 2006. But human-resources consultants and employer groups say that the proposal is a big step toward forging a final policy.

NUTS AND BOLTS. If gradual retirement appeals to you and "if you have good benefits and a good job, I would say hang in there," says Anna Rappaport, a principal in the Chicago office of consultant Mercer Human Resources. She points out that once the final rules are set, "your employer may offer new options." Vanessa Scott, legislative counsel for the ERISA Industry Committee, an employer group based in Washington, D.C., says you should also "be talking to your employer so they know what you're looking for in a phased retirement program." That way, the company can develop plans based on what employees actually want and need.

Here's a basic outline of how the system would work under the proposed rule. An employer would be allowed to set up a plan for employees who want to take phased retirement. Participation would be voluntary; to participate, the employee would have to be at least 59 years old and currently a full-time worker.

The employee would have to reduce his or her hours by at least 20% and would receive a prorated amount of the pension -- in regular payments, not a lump sum -- while working the reduced schedule. For example, if hours were reduced by 30%, the employee would be able to collect up to 30% of his pension while still working.

THE BIG PICTURE. If you chose the phased-retirement option, you would continue to earn credit toward your pension, but the IRS warns that when you stop working entirely for that employer, the remaining value of your pension would have to be recalculated, and "early distribution of the employee's [pension] benefit will reduce the benefits available after full retirement." The regulation doesn't address whether the employer would offer medical insurance or any other benefits.

When weighing whether phased retirement makes sense, you should do an analysis of all of your potential retirement finances, including how taxes and Social Security might be affected. Be sure to consider three especially important financial issues. One is that if you plan to start receiving Social Security while working part-time, you could have your benefit reduced if your income exceeds annual limits.

For 2005, the limit will be $12,000 in earnings if you haven't reached your full retirement age. See the Social Security Web site for details. Secondly, combined Social Security benefits and income from a phased-retirement job could also push you into a higher tax bracket. Be sure to check out IRS information about the taxability of Social Security benefits.

BOOMER IMPACT. Finally, if you're close to 65 and Medicare eligibility, you may be better off working full-time until you reach 65. That way, you could keep your employer's health-insurance coverage.

Phased retirement can be an excellent solution for both employers and employees. As baby boomers start to retire, employers are becoming more concerned about losing their experienced workers. And if you're worried about not having enough income or easing the transition from full-time work to full-time retirement, working part-time might be the answer.

If you haven't considered it before, this may be a good time to explore how you would feel about postponing your full-time retirement lifestyle for just a few more years. From both a financial and psychological perspective, you just might find that the tradeoff is worth it. In addition to writing Your Retirement for BusinessWeek Online, Hoffman is the author of The Retirement Catch-Up Guide and Bankroll Your Future Retirement with Help from Uncle Sam. You can contact her through her Web site, www.retirementcatchup.com


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