The Wall Street Journal, December 19, 2009, Saturday

The Wall Street Journal

December 19, 2009, Saturday

The Wall Street Journal

A Gradual Exit
'Phased' retirements are becoming more popular. Here's how to do it right.

By ANNE TERGESEN
If all had gone according to plan, Annis and Ernie Fuller would be retired by now.

But after consulting with their financial planner late last year, the Gurnee, Ill., couple decided to stay on the payroll—and take a "phased retirement" instead.

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Under the program rolled out in 2008 by the Fullers' employer, Abbott Laboratories, the couple "gets the best of both worlds," says Ms. Fuller, age 57. By remaining on the job (the Fullers now hope to retire in 2011), they continue to earn income, accrue pension and Social Security benefits, and funnel savings into their beaten-down investment accounts. But in return for taking a 10% reduction in pay, they also receive five extra weeks of vacation each year, boosting the total to nine weeks.

"It's going to be hard to use all those days," jokes Ms. Fuller, who says she and her husband, 57, plan to travel and spend time with grandchildren.

Amid the economic turmoil, interest in phased retirement is on the rise. For employees, these programs offer a way to ease rather than plunge into retirement, which can pay psychological and financial dividends. Many employers, like Abbott, are introducing phased-retirement programs to prepare for mass retirements among baby boomers, an eventuality the recession has only delayed. The goal: to persuade near-retirees to stick around long enough to teach colleagues how to do their jobs.

Other employers are implementing these programs to pare payroll costs while minimizing layoffs. In a survey released in July, the nonprofit Families and Work Institute in New York found that 77% of 400 employers contacted had taken steps to reduce their labor and operation costs during the previous 12 months. Of those, 7% said they were relying on phased-retirement programs.

Clemson University in Clemson, S.C., is one such employer. Hit by a $38 million drop in state funding since July 1, the school has unveiled several cost-cutting measures, including a phased-retirement program for faculty meeting certain service and age requirements, says Michelle Piekutowski, associate chief human-resources officer. So far, a handful have expressed interest.

"The budget cuts were one motivator" for adopting the program, Ms. Piekutowski says. But so was the fact that "some employees who are ready to retire now, with the economy the way it is, want to keep working."

If you're interested in phased retirement, the first step is to ask your employer whether it's possible to work something out. Only 6% of employers have a formal phased-retirement policy, according to a 2009 survey by the Society for Human Resource Management in Alexandria, Va. (Even then, most require employees to obtain a supervisor's approval.)

But many more employers, some 45%, offer these arrangements to select employees on an informal basis, according to Hewitt Associates, a consulting firm in Lincolnshire, Ill. Since human-resources departments usually don't publicize these opportunities, "employees may not even know phased retirement is a possibility," says Jamie Hale, a Dallas-based practice leader at Watson Wyatt Worldwide, a benefits consulting firm.

Before entering into such an arrangement, consider how flexible it is. Like many employers, Abbott imposes no deadline by which phased retirees must leave the payroll. It also allows those who obtain a manager's approval to return to full-time status, says Tim Richmond, divisional vice president of compensation and benefits. In contrast, under a program American Express Co. introduced last year, phased retirees are generally expected to leave the company within a year, says Kerrie Peraino, the company's chief diversity officer. Clemson has a three-year deadline.

Clarify how your role will change. Will you, like Annis Fuller, shift some responsibilities to colleagues? Or will you move to a position suited to working fewer hours? "You have to strike a balance between being able to phase down and making sure you don't get marginalized," says Alan Glickstein, a senior consultant at Watson Wyatt.

It's also important to research the impact of phased retirement on your benefits, including those—like Social Security or a pension—you may be counting on to supplement your reduced salary. In a worst-case scenario, those who cut back on their hours may wind up with permanently reduced pension benefits or bare-bones health insurance. Here's what you need to know before you make a decision.

Social Security Benefits
If you are 62 or older, you may decide to tap your Social Security benefits to make up for the smaller paycheck you'll earn while phasing into retirement. But be aware that Social Security penalizes those who continue to earn an income before reaching full-retirement age. (For those born between 1943 and 1954, that age is 66.)

In 2009 and 2010, for every $2 above $14,160 a Social Security recipient younger than full retirement age earns, the Social Security Administration reduces his or her benefits by $1. In the year in which the recipient reaches full retirement age, Uncle Sam deducts $1 in benefits for every $3 above $37,680.

Starting in the month in which beneficiaries reach full retirement age, the deductions cease. Benefits are then raised by an amount designed to compensate the recipient—over an average life expectancy—for what was withheld earlier.

401(k) BENEFITS
Another way to supplement a reduced paycheck is to take withdrawals from a tax-deferred retirement account, such as a 401(k). The good news: Many employers allow those on the payroll to tap these accounts. (Of course, they have to pay ordinary income tax on withdrawals and, if younger than 59½, there is usually a 10% penalty, as well.)

But if you work fewer hours, your contributions are likely to decline. "If you cut back your hours, but keep the percent of salary you contribute the same, then you will save fewer dollars, and your employer's match will fall too," says Mr. Glickstein of Watson Wyatt.

Once an employee's hours fall below a certain threshold—often, 1,000 hours per year—some 401(k) plans eliminate matching contributions or prevent participation altogether. Check your plan's "summary plan description," available through your human-resources department.

Pension Benefits
Yet another way to supplement a phased-retirement salary is to begin taking your pension benefit early. In 2006, Congress enacted legislation that gives those still on the payroll access to their pension checks starting at age 62—instead of the "normal retirement age" many plans define as 65. But employers don't have to amend their plans to make this possible, says Chantel Sheaks, a principal at Buck Consultants in Washington, D.C.

Perhaps an even bigger concern is whether a decision to phase down will permanently reduce your pension benefit. In calculating benefits, most employer-sponsored plans weigh factors including an employee's salary and years of service. Problems can arise when, instead of looking at an employee's highest three or five years of pay, a plan considers earnings in the "years just before retirement," says Robert Hutchens, a professor of economics at Cornell University. In such a situation, an older person who, for example, "chooses to work half time at half pay could lose as much as half of all future pension benefits," he says.

Ask your employer whether you'll continue to accrue pension benefits. Under federal law, pension plans are required to give employees who work 1,000 hours or more per year credit for that year of service. But some allow employees who work fewer hours to earn credits.

To encourage employees to retire early, many companies provide incentives in the form of subsidies that increase pension payouts. However, if you draw a pension while still on the payroll, you may not receive such a subsidy, says David Certner, legislative policy director at AARP.

Other Benefits
Employers often provide part-timers with less generous benefits. As a result, "you want to go through all of your benefits and understand how phased retirement will affect each one," says Mr. Glickstein.

In some instances, you may lose access to benefits. In a survey of 950 employers Prof. Hutchens published in 2003, 34% of those that allow phased retirement said phased retirees receive no health insurance. Some other employers defray a smaller portion of the cost of benefits for phased retirees.

At Noblis Inc., a Falls Church, Va., nonprofit that provides scientific consulting services, employees receive life- and accidental-death-and-dismemberment insurance that amounts to two times salary. But since phased retirees often work fewer hours, their salaries are lower—and so is their coverage.

— Ms. Tergesen is a staff reporter for The Wall Street Journal in New York. She can be reached at encore@wsj.com.