Advisory Council Report of the Working Group on Phased Retirement

November 14, 2000

The Working Group Report, submitted to the Advisory Council on Employee Welfare and Pension Plans, known as the ERISA Advisory Council, on November 14, 2000, was approved by the full body and subsequently forwarded to the Secretary of Labor. The Advisory Council was established by Section 512(a)(1) of the Employee Retirement Income Security Act of 1974 to advise the Secretary with respect to carrying our his/her duties under ERISA.

I. Introduction

"There seems to simply be an increased desire among individuals to stay active and stay involved and do it through the workplace to later years." - Paul Yakoboski, Employee Benefit Research Institute

What is Phased Retirement?

In the broadest sense, phased retirement means a gradual change in a person's work arrangements as a transition toward full retirement. This may involve a change of employers (including self-employment), a change of career or a reduction in the number of hours worked. As the focus is on how and on what terms people continue working after they are eligible for retirement benefits, the re-employment of retirees ­ whether or not it was anticipated when they first retired ­ is also sometimes included in discussions of phased retirement.

This concept is not new. Paul Yakoboski of the Employee Benefit Research Institute (EBRI) reported that the results of the most recent annual Retirement Confidence Survey showed that 25% of those currently "retired" have worked for pay in retirement, and that 67% of current workers expect to work for pay after retiring. A study by Joseph Quinn of Boston College indicates that one-third to one-half of American workers will work on a "bridge job" along the way to total retirement.

For purposes of this report, however, we are focused primarily on an arrangement where an employee reduces his work schedule with the same employer as he/she approaches full retirement. It also includes certain related programs or arrangements whereby employers may encourage workers to continue working when their benefit programs might otherwise encourage them to leave.

Interest in Phased Retirement

The combination of the baby boom generation approaching retirement age and the tight labor market has increased the interest of many employers in retaining their older, experienced workers. The fact that more jobs are in the service industry compared with manufacturing means that employees are physically able to work to later ages. Also, many employees who want to continue working would also like to have a reduced or more flexible work schedule, as they get older. One survey showed that three-fourths of workers would prefer a reduced workload before full retirement rather than to retire abruptly.

Obstacles to Phased Retirement

Plan design: One of the major obstacles to phased retirement involves defined benefit pension plans, which were often designed to encourage retirement at ages before an employee actually wanted to retire. These plans may no longer serve the goals either of the employer or of many of the participants. To maximize the value of their pensions, many employees today choose to retire from their current employer and seek employment elsewhere.

Loss of benefits: Health care coverage is another concern for older workers. By moving from full-time employment to part-time employment, an employee may lose access to company-subsidized health care coverage.

Legal concerns: There are a few other miscellaneous legal obstacles for employers. For example, phased retirement is a gray area under the age discrimination laws.

Current Phased Retirement Programs

A Watson Wyatt survey of 586 large employers indicates that about 16% currently have formal phased retirement programs and another 28% are interested in implementing one in the next few years. Most of the current programs cover academic professionals, where it is easier to adjust teaching loads. For these employees, defined contribution plans are prevalent and phased retirement may be offered to encourage the retirement of tenured staff rather than to retain those who would otherwise leave. They are also often found in the public sector, where rich early retirement subsidies are common and the parties have more freedom to redesign pension formulas than ERISA allows.

Among public sector employers, deferred retirement option plans (DROPs) have become popular. Under the most common version of this option, pension payments commence and are credited to an individual account within the same plan while the employee continues working. After a specified number of years (typically five), the employee retires and receives both his pension plus the value of the individual account that has accumulated (with earnings). This type of plan enables an employee to continue working and still receive the full value of early retirement subsidies in the pension plan.

Another example of a phased retirement program is the National Rural Electric Cooperative Association (NRECA) plan. Under this plan, participating employers may elect to have their plan's normal retirement age set at age 60, 62 or 65 (with various service requirements). When an employee reaches his/her normal retirement age, the pension may start, even if the employee continues working on a full-time or part-time schedule. Upon subsequent "retirement", the employee receives an additional benefit from the additional years of service he/she has worked since his/her normal retirement date. Other benefits, including health insurance, remain in effect during the phased retirement period.

Other phased retirement programs which do not involve defined benefit pension plans may be less complicated and provide for continuation of various benefits (perhaps on a reduced basis) for employees who elect a reduced work schedule. A TIAA-CREF survey of 167 colleges and universities showed that 29 out of 66 who responded had phased retirement programs and almost all allowed retired faculty to teach part-time.

Testimony

We have received testimony from 11 witnesses, which include representatives from employers and employer organizations, retirement plans, researchers and research organizations, consulting firms, the IRS and the legal profession. Although many employee organizations were also contacted, most declined to testify because they did not yet have a position on this relatively new topic. Summaries of all the witness's testimony are included in this report.

II. Issues

It is possible that some people in pension plans, which are based on the participant's final average pay, may lose pension benefits if their final average pay goes down. This reduction in pay often occurs when a person goes from full-time employment to part-time employment. Although current law prohibits a pension from being decreased because of increasing age or service, there is no specific rule which stops a pension from being decreased if final average pay goes down. Although this Working Group heard the IRS position on this issue is that pensions may not be reduced if final average pay goes down, there appears to be a great deal of uncertainty in this area. We heard testimony that pensions have, in fact, been reduced and that court cases have supported the reduction in pension when pay has been reduced. There are many ways a pension plan can define final average pay and some definitions eliminate this problem altogether.

Current regulations do not allow payment of defined benefit pension benefits prior to a participant's normal retirement age unless there is a complete severance from employment with the plan sponsor. A plan may provide that pensions are payable on or after a participant's normal retirement age, even if the participant continues to work (altogether this type of provision is not that common). In comparison, a 401(k) plan may provide for distributions on or after age 59½, even while a participant is employed.

Because of the nature of traditional defined benefit plans, the value (not necessarily the amount) of a participant's pension may actually decrease if he or she continues working past his or her normal retirement age. For plans with subsidized early retirement benefits, pensions may begin decreasing in value (not necessarily the amount) after early retirement age. This provides a strong incentive (which many employers may have originally intended) for participants to retire before they are actually ready to retire, and possibly seek employment elsewhere.

Although this Working Group recognizes the importance of making sure retirement benefits are used for retirement, we see the need for some flexibility in this area to enable employers and employees to work out mutually-beneficial phased retirement programs.

Health care access is a major concern for workers. In many situations, an employee, who goes from full-time employment to part-time employment as part of a phased retirement plan, would lose health care coverage, since most employers do not provide this benefit to part-time employees. Although COBRA coverage is available for up to 18 months following loss of coverage, there is often a gap in coverage between early or phased retirement and Medicare eligibility. Purchase of health care coverage on an individual policy basis at older ages is often very expensive or not available at all because of health conditions.

We have heard testimony that companies are concerned that, if they offer payouts on a phased-retirement basis, they might have trouble passing some of the mechanical income-based nondiscrimination tests for retirement plans, even though the phased-retirement program is, in principle, available to all participants who meet the age and service requirements established for the program. This may occur because, as a general rule, there is a higher concentration of highly compensated employees in the older-age, longer-service categories. It may also be that there are more highly compensated employees within the particular category of workers whose skills an employer wants to retain by offering phased retirement (e.g., engineers).

While this Working Group is concerned that retirement plans operate in a nondiscriminatory manner so that there is no dilution of coverage and benefits for the lower paid employees, we believe it is worth considering whether a facts-and-circumstances safety valve, or some other means of demonstrating compliance with the basic principles of nondiscrimination in this context, would be beneficial. This might entail enabling companies to seek specific IRS approval for their phased-retirement programs, or the establishment of specially tailored tests, like those already applicable to early retirement windows, to accommodate the practicalities of phased retirement.

We have heard testimony that the age discrimination rules are very broad and very general and that the uncertainty about their application in phased retirement programs inhibits many companies from pursuing phased retirement programs. For example, a recent Court of Appeals decision, which the EEOC has endorsed, held that it is illegal for an employer to provide lesser benefits to Medicare-eligible retirees than it provides for early retirees. Given the overwhelming challenge of comparing health benefit packages and depending on how the courts rule in the aftermath to that decision this may mean that employers must provide the same health coverage to over-65 retirees that they provide to younger retirees. This could make it very difficult for an employer to structure an appropriate and appealing health plan for phased early retirees.

While this Working Group does not want to dilute the protections of older workers under the age discrimination laws, we feel that a clarification of the law that accommodates phased retirement programs would be beneficial. Any such clarification should, of course, make sure that employers cannot use the notion of "phased retirement" as a shield for constructively discharging older workers.

Although Deferred Retirement Option Plans (DROPs) have become popular in the public sector, we are not aware of any in the private sector. (See Background Information on Defined Benefit Plans for a description of DROPs.) Part of the reason may be that pension plans in the public sector are not covered by all of the ERISA rules and related laws and regulations that cover pension plans in the private sector.

This Working Group feels that this type of plan is an attractive way for an employer to retain its older employees who might otherwise leave employment to take advantage of early retirement incentives contained in the plan. The absence of these plans in the private sector may be due to legal obstacles in ERISA or related laws. This Working Group did not have the time to investigate the specific obstacles that might exist for these plans, but we feel further study is warranted.

III. Recommendations

To enhance phased retirement, the ERISA Advisory Council recommends that the Secretary of Labor consult and work with the appropriate government agencies and individuals to accomplish the following:

To alleviate the potential problem of pension loss when final average pay goes down, we recommend:

A change or clarification in pension law or regulations so that a pension cannot be reduced if pay decreases due to phased retirement.

Until the above recommendation is accomplished, employees be notified if a change in their employment status may reduce their pension.

To alleviate the problem of requiring employees to completely sever their employment relationships with their current employer to access their pension benefits prior to normal retirement age, and to encourage employers to make the plan changes that would allow employees to take advantage of phased retirement, we recommend:

Support of the Phased Retirement Act introduced by Congressman Earl Pomeroy and Senator Charles Grassley which will allow pension payments to be made, even while employed, after the earlier of:

1. Normal retirement age
2. Age 59½
3. 30 years of service

Allowing employers to adopt these new rules on a temporary basis, i.e. with a sunset provision.

Clarification that benefits paid after 30 years of service (but before age 59½) not be subject to the 10% additional tax on premature distributions.

Clarification that the bill facilitates early access in the event of phased retirement while restricting other options that might allow voluntary access to funds prior to actual retirement.

To alleviate the health care access concerns of older workers, we recommend consideration of one or both of the following:

Allowing individuals to purchase Medicare coverage between age 55 and age 65 at a rate that is competitive with group insurance policies that provide similar benefits, but without consideration of insurability and pre-existing condition requirements.

Extending the total COBRA period for employees losing coverage after age 55 to the lesser of:

1. Period of time to Medicare eligibility
2. Period of coverage with the employer prior to the COBRA period.

To alleviate situations where the phased retirement provisions in a pension plan cannot pass the mechanical income-based nondiscrimination tests, but where the intent is clearly nondiscriminatory, we recommend:

Permitting a facts and circumstances test for phased retirement provisions in a pension plan, as an alternative to passing the mechanical nondiscrimination test.

Developing safe harbors and/or special rules addressed to phased retirement programs that accommodate their special characteristics.

To alleviate some of the Age Discrimination in Employment Act (ADEA) concerns employers and employees may have regarding phased retirement programs, we recommend that:

The Secretary of Labor collaborate with the EEOC on a review of the application of the ADEA in the context of phased retirement programs, so that guidance can be issued that lets employers and employees know what conditions and boundaries are required for an acceptable phased retirement program. If, in consultation with interested stakeholders in the private sector, they determine it is necessary to modify the law to make such programs feasible and attractive, they should recommend appropriate statutory amendments.

To evaluate the potential to provide private sector employers with the same options and tools available to public sector employers to design pension plans that enable employees to receive more value from their pensions, while continuing to work, we recommend:

The Secretary of Labor organize a task force with other appropriate government agencies and the general public to investigate and study potential ERISA and related rules that may be obstacles to private sector employers in designing Deferred Retirement Option Plans (DROPs) or similar arrangements that protect the value of pensions when employees work past their early retirement ages.

IV. Background Information on Defined Benefit Pension Plans

The traditional defined benefit plan provides a monthly income for the life of the participant (and spouse, unless the participant and spouse elect some other form of benefit). The amount of a monthly pension is determined by a formula which usually takes into account years of service and often pay. An example would be 1% of final average pay for each year of service.

Final Average Pay

Final average pay is often defined as the average over the last 3 or 5 years, or the average pay over the 3 or 5 consecutive years out of the last 10 which produces the highest average. Even in the latter situation, someone's final average pay may decrease if they work several years in a part-time position after working full-time. Current pension law prohibits a pension from going down because of additional age or service, but there is no specific rule that stops a pension from being reduced because pay goes down. Although we have heard that the IRS position on this issue is that pension benefits cannot go down if pay is reduced, additional documentation would be beneficial. Many professionals in the employee benefits community have differing views on the subject and some court cases have supported a reduction in pensions when average pay goes down.

Late Retirement

A participant works past normal retirement age still earns additional pension benefits. However, the longer a person works and delays his or her pension, the fewer years he/she will receive a pension. Therefore, even though a participant's monthly pension benefit may increase through additional years of service, the value of the pension may actually decrease. Some plans provide that, at a minimum, a person who works past his or her normal retirement age will receive a pension whose value is equal to the value of the pension which would have been payable at his or her normal retirement age. This really means that the person has not earned any additional value in his or her pension. Current law permits a pension plan to start paying out benefits at normal retirement age, even if the participant continues working. This eliminates a large portion of the problem of decreasing or non-increasing values in pension benefits after normal retirement age. Both because of its cost and because employers have historically used the pension plan to encourage retirement, this provision is relatively rare.

Early Retirement

Most pension plans provide for early retirement after a person meets a certain age and/or service requirement, e.g. age 55 and 10 years of service. Upon early retirement qualification, a participant may defer distribution until normal retirement age or take a reduced pension payment commencing earlier. The reduction in pension reflects the fact that when a pension is payable early, it will be paid for more years. In many plans, the reduction is smaller (or even zero) than it could be to reflect the longer period of payment. In this situation, we say the plan has a subsidized early retirement benefit. In some cases, the plan also pays a supplemental benefit until age 62 to reflect the fact that Social Security benefits are not payable until that age. At the point a person becomes eligible for a subsidized early retirement benefit, the value of his or her pension increases in value substantially.

After that point, if the person continues working, the value of his or her pension may decrease even though the amount of monthly pension he/she earns still increases. This is similar to the situation where an employee works past his normal retirement date. Under current law a participant must have a complete severance of employment with the plan sponsor to start receiving his/her pension (prior to his/her normal retirement date) and get the full value of the subsidized early retirement. This creates an incentive for some employees to retire from their current job, get their pension, and seek employment elsewhere. Of course, other factors such as health insurance, 401(k) plans, and financial security act to encourage an employee to stay employed.

It should be noted that while cash balance pension plans are technically defined benefit pension plans; the benefit accrual is more like a defined contribution plan. Therefore, much of the preceding discussion does not apply to cash balance pension plans; except for those employees who are grandfathered into the prior plan provisions.

Phased Retirement Liberalization Act

The Phased Retirement Liberalization Act has been introduced by Congressman Pomeroy and Senator Grassley. It allows the payment of pensions while the participant remains employed following the earliest of:

• Normal retirement age
• Age 59½
• Completion of 30 years of service

This would alleviate much of the pressure for an employee to retire to take advantage of subsidized early retirement benefits. It should be noted that this gives a participant the right to receive his or her pension under the above circumstances, only if the employer amends the pension plan to provide for such payment. Since this will be relatively expensive for some employers who have very subsidized early retirement benefits, many employers may not take advantage of this change in law. Also, once an employer makes this change it is not reversible due to the anti-cut back rules. Some employers could be hesitant to make this change since they may want to encourage retirement in the future and they will not have that option if they make this change now. To address the hesitancy that employers might otherwise have to make the change, the provision may be more narrowly defined to include only employees who are currently over a certain age on a specified date.

The Working Group has a concern that the resulting legislation must include provisions that specifically address abuses, other uses, etc. to continue the goal that retirement benefits should, in fact, be retained for retirement.

Under current law, 401(k) benefits may be distributed after age 59½, if the plan so provides. The Phased Retirement Liberalization Act would expand this to allow distributions after 30 years of service.

Deferred Retirement Option Plan (DROP)

DROP is a feature of some public sector defined benefit plans. Under this feature, an employee elects to have his/her pension start on a particular date even though he/she continues to work. Instead of having the pension paid out to the participant, the monthly pension payment is paid to an individual account for the participant within the pension plan. This technically complies with the rule that a pension cannot be paid until the participant terminates employment, but allows the employee to get the benefit of any early retirement subsidy in the plan. The individual account is credited with investment return, and when the participant actually retires, he/she receives the accumulated account balance (in a lump sum or over a fixed period of time) in addition to the ongoing pension.

Typically, the pension benefit, at the time the DROP commences, is frozen and an additional benefit begins to accrue from that time forward. The additional benefit is not paid until the participant actually retires. Note that for final average pay plans, any increases in final average pay after the DROP commences does not apply to the service earned before the DROP commences.

It is also typical to have a fixed maximum period for the DROP to operate (usually 5 years). After that time, the employee is expected to retire. It is also possible to just have the pension payments cease after the DROP period until the participant actually retires.

DROPs and other arrangements, which allow a participant to be credited with or to access his/her pension while still employed, remove one of the incentives for an employee to retire. Another view is that DROPs and other similar arrangements merely put an employee on a financial par with another employee who retires and goes to work for another company which has the same benefit package.

V. Summaries of Testimony

May 8, 2000

Testimony of Paul J. Yakoboski, Ph.D., Senior Research Associate, Employee Benefit Research Institute

Notable Quotes

"There seems to simply be an increased desire among individuals to stay active and stay involved and do it through the work place to later years."

"Because the labor market is very tight, older workers are more in demand as are all workers. They are valuable commodities, so their options are greater and they are able to demand flexibility."

Summary

Paul Yakoboski summarized the results of the annual Retirement Confidence Survey, a telephone survey of about 1000 individuals, of whom about 250 were "retirees." The individuals identified themselves as retirees (there was no specific definition). Among current retirees, 25% have worked for pay in retirement. Of these (multiple answers were allowed):

• 75% say the major reason is they enjoyed working and wanted to stay involved.
• 30% stated having money to buy extras was an important reason.
• 25% cited health insurance or other benefits.
• 21% needed to work to make ends meet.

For current workers, the expectations were:

• 47% expect to retire at age 65 or later.
• 22% expect to retire at age 60 to 64.
• 22% expect to retire before age 60.
• 4% expect to never retire.

67% expect to work for pay after retiring. Of these 64% gave the primary reason as "enjoying work and wanting to stay involved." About 30% to 37% (each) stated that "keeping health insurance or other benefits," "having money to buy extras," and "having money to make ends meet" were reasons to keep working.

In general today's workers plan on working longer than today's retirees actually worked, although for many of those currently retired, early retirement wasn't always by choice or design. It often involved a company's downsizing, a health problem, or a family issue.

Mr. Yakoboski then summarized a study by Dr. Joe Quinn, an EBRI Fellow of Boston College. It is based on "The Health and Retirement Survey" which tracks older (starting in the 50's) individuals over time. The main findings were:

From the end of WWII to the mid 1980's, men have been retiring (leaving the workforce) at earlier and earlier ages. Since the mid 1980's the trend has leveled off and may be increasing slightly. For example, the labor force participation rate for 65 year old males was 72% in 1950, 31% in 1985 and 32% in 1997. For 62 year old males, the figures were 81% in 1950, 51% in 1985 and 53% in 1997.

Labor force participation rates for older women were relatively stable from 1950 to 1985, and has increased significantly after the mid 1980's. This is due to the general increase in the number of women in the workforce.

Current estimates indicate that one-third to one-half of American workers will work on a "bridge job" along the way to total retirement. A bridge job is often part-time, often involves a change of employer (or self employment) and may even involve a change in line-of-work.

Other developments that encourage people to work longer include:

• Abolition of mandatory retirement
• Changes in Social Security (larger increases for late retirement and elimination of the earnings test after age 65).
• More retirement plans are defined contribution plans which do not include age-specific retirement incentives.
• More jobs are in the service sector and less in manufacturing, and so more people are able to work until later ages.
• Individuals want to stay active and involved.
• The labor market has been tight in recent years.

June 1, 2000

Testimony of Scott A. Morris, Vice President and Senior Economist

Working Group for Economic Development

Scott Morris presented the CED's research report entitled "New Opportunities for Older Workers." Mr. Morris pointed out that the aging of the baby boomer generation will have a dramatic impact on the U.S. economy and that U.S. businesses and lawmakers need to address many issues relating to older workers to encourage longer employment.

Some of the findings of the CED include:

Americans are living longer and retiring earlier than ever before. Since 1940 the life expectancy of a 65 year old has increased by 4 to 6 years. The average retirement age has decreased over the past 30 years from age 65 to age 62.

America as a nation is growing older. 30 years from now, 20% of the U.S. population will be age 65 or older, compared with just 12% today.

The ratio of workers to retirees is dropping dramatically: In 1950, there were seven working age persons for every elderly person in the U.S. By 2030, the ratio will drop to less than 3 to 1. This will have a large impact on national savings and investment as entitlement programs become more burdensome and retirees draw down their retirement savings.

Current policies and practices create financial disincentives to continued employment for older workers. These include pension plans that penalize work after a certain age and Social Security earning limits for beneficiaries.

Older Americans face non-financial obstacles to work, including workplace discrimination and limited opportunities for professional development.

More Americans will be willing and able to continue working later in life. Many will work longer out of necessity, but many others want to keep involved for personal fulfillment, or to maintain a higher standard of living.

Older Americans represent a tremendous source of experienced human capital. Employees report that older workers show more judgment skills, demonstrate a greater flexibility in work arrangements, and have a higher degree of loyalty to their employers than younger workers.

Some recommendations presented in the CED report include the following:

• Remove public incentives for older Americans to work
• Eliminate the Social Security earnings test.
• Increase Social Security's normal and early retirement ages to 70 and 65, respectively, over the next 30 years.
• Eliminate the employer first-payer provision in Medicare.
• Reform Social Security Disability Insurance to promote work by the disabled while maintaining an adequate safety net of benefits.
• Amend current federal laws to allow greater flexibility in hiring older workers for contingent and part-time work.
• Reform workplace policies and practices to encourage older workers to continue working.
• Address ways to alleviate the problem of private plans which penalize work after a certain age.
• Consider greater use of cafeteria style benefits to facilitate older workers in flexible work arrangements.
• Pursue phased-retirement as an alternative to standard retirement policies.
• Combat negative stereotypes
• Offer management training and employee workshops to eliminate age related bias in the workplace and educate managers about the value of older workers.
• Ensure that age bias plays no part in hiring, training or retention decisions.
• Promote opportunities for older workers to update their skills
• Ensure that older workers receive the same access to employer provided training as younger workers.
• Encourage older workers to seek training to stay competitive.
• Urge educational institutions to offer expanded job training programs for older Americans.
• Create more recruitment strategies targeting older workers.

The CED believes these recommendations can alleviate the looming economic problems of an aging America, enhance the lives of older Americans, and enable businesses to profit from the talent and resources of their older employees.

Testimony of Sylvester Schieber and Kyle Brown of Watson Wyatt Worldwide

"Phased Retirement: Reshaping the End of Work"

Mssrs. Schieber and Brown discussed a 1999 Watson Wyatt Survey and report entitled "Phased Retirement: Reshaping the End of Work". They made the following points in their testimony:

The survey of 600 employers, which was conducted last year, was prompted by the increased interest in the issue of phased retirement on the part of both employers and employees. This increased interest reflects to some extent the current tight labor markets, which are projected to become even tighter in the next decade as the size of the workforce continues to shrink.

Sixteen percent of the employers surveyed currently have some form of phased retirement; three-fourths thought that phased retirement could help ease the problems resulting from the tight labor market; and the vast majority of employers surveyed thought that the restrictions on phased retirement should be relaxed.

The two sectors currently using phased retirement most extensively are education and public administration.

About three-fourths of those older workers surveyed were interested in phased retirement, with different attitudes generally related to the nature of the profession or the particular job. As a general matter, there was greater interest in the arts, recreation and finance than in the manufacturing sector.

Although some workers develop a new (shadow) career after retirement, it is often difficult for a worker to get the same level of pay in the new career that he or she was earning previously.

Although benefits provided to phased retirees are stepped-down from their pre-retirement levels, they are typically more generous than those made available to workers who have completely retired.

Most employers surveyed cited the current regulatory restrictions and cost as the major deterrents to the increased use of phased retirement. The major regulatory deterrent is the IRS regulation prohibiting in-service withdrawals in qualified plans. The cost deterrents cited are the salary premium for older workers and the cost of benefits for these workers.

The survey indicated that 15% of men over the age of 65 are currently working, as compared to 8-9% of women over the age of 65. However, workforce participation rates for women of all ages have been increasing.

One trend noted in the report was the significant disparity between phased retirement arrangements in the private and public sectors. In the private sector, these arrangements tend to be ad hoc and limited to selected management employees, while in the public sector, these arrangements are more comprehensive and robust. Employers with formal phased retirement arrangements have reported higher acceptance, with one educational institution reporting a 25% participation rate.

It is in the public sector that the use of DROP plans has become most prevalent. Under these "deferred retirement option plans", a distribution from the employee's retirement plan is credited to an individual account maintained for the employee within the same plan. Interest is credited to the account and accruals under the plan's benefit formula may continue as well. Drop plans are not used in the private sector, possibly because of their expense.

Testimony of Ted Kennedy, Senior Counsel For State Government Affairs, American General Retirement Services

Of the many alternatives for phased retirement in the public sector, most are compensation or benefit based.

Phased Retirement: Possibilities from the Public Sector

Compensation Based

Severance Package

Most of us are aware of the use of severance packages to encourage early retirement, but these packages may also be used as an incentive (bonus) to continue working for a period of time.

Salary Increase

Any increase in salary will provide the obvious incentive to continue working.

Since most retirement benefits are in some way tied to salary, increased retirement income is an additional incentive.

Conversion to Part-time Employee (e.g. job sharing, work at home)

Within limits, the employer no longer pays FICA taxes. These tax savings may be passed on to the employee in the form of a pay increase.

Also within limits, and after age 65, the employee may receive pension income from Social Security and other pension plans in addition to salary.

Conversion to Consultant/Independent Contractor

The two points addressed for part-time employees apply here as well. The employer may pay more for the service since they do not have to fund other employee benefits, yet the employee maintains similar benefits which were vested in prior employment.

Benefits Based

Social Security Limitations

One way to encourage retention of employees is to continue increasing earnings limitations for those converting to part-time or consultant status.

Separately, early payout penalties may be adjusted to encourage or discourage employment.

Accumulated Sick Leave Plans (ASLP)

These plans reduce absences and encourage continued employment by providing retirement income for un-used accumulated sick days. Payment for these accumulations may be made pre-tax by the employer up to sec. 415 limits and post-tax thereafter.

Employers may calculate and pay on an annual basis or upon termination. Since payment is typically based on salary, the employer may encourage continued employment by agreeing to calculate payment upon termination thereby giving the employee the benefit of salary increases.

The caution for these plans is to ensure employer funding to negate the possibility of unfunded accrued liabilities.

Deferred Retirement Option Plan (DROP)

(Began in Louisiana in 1982)

Similar to part-time and consulting arrangements, these plans allow employees to begin payout of pension benefits while continuing to work. The benefits are paid into an employee account until actual retirement removing concerns regarding earnings limitations.

Upon retirement, the employee begins receiving their pension annuity and is granted access to the lump sum accumulated in the employee account together with earnings or interest.

These plans also help prevent inflation erosion of the pension benefit possible in the years just prior to retirement.

Defined Contribution Pension and Voluntary Supplemental Plans

Defined contribution plans (401(a), 403(a), 401(k), 457 and403(b)) by their nature provide incentive for employees to continue working. Unlike defined benefit plans, defined contribution plans grow exponentially in latter years due to the compounding effect of contributions and earnings over time.

The portable aspect of these plans provide workers flexibility in employment so job transfers may be facilitated without loss to retirement accruals.

Employers may modify these plans to further encourage employee retention.

Employers may provide matching dollars to voluntary supplemental plans adding further to the corpus of retirement savings.

Employers may complement a defined benefit pension and defined contribution voluntary supplemental plan with a defined contribution supplemental pension. These supplemental pensions may be applied throughout the career or after a period of years. In the latter case, employers re-direct contributions from the defined benefit pension plan at the point when additional contributions provide minimal increases in retirement income, say 30 years. The vested interest in the DB is frozen and all future contributions flow into a DC plan. The net result at retirement is greater flexibility and income.

In instances where employers use DC plans as primary pension vehicles, options are available.

Employers may allow employees phasing into retirement to work and contribute to the DC pension, but begin withdrawing annual earnings from the plan as well as salary. Upon retirement, the full corpus of the plan is then made available.

In all examples illustrated above, the key to the success of the phased retirement plan is employee education. Employees must be fully informed of their options and educated as to which options best meet and further their retirement goals. For this reason, employers and the vendor community offering these plans must be prepared and committed.

Education is Key!

July 17, 2000

Testimony of Lana M. Keelty, Legislative Counsel, National Rural Electric Cooperative Association

Ms. Keelty began her remarks by providing background on the National Rural Electric Cooperative Association (NRECA). The NRECA is an association of nearly 1,000 consumer-owned not for profit electric cooperatives. It provides pension and welfare benefits to over 130,000 employees and dependents. The NRECA offers a very complex array of both defined benefit and defined contribution plans which are viewed by its member cooperative-employers as an important tool for attracting and retaining employees. NRECA has defined phased retirement as a program of incentives which target older workers to encourage them to remain actively employed. Phased retirement has been offered by NRECA since 1983.

According to Ms. Keelty, phased retirement programs in addition to offering a way to manage the problem of the diminishing pool of new and younger skilled workers, phased retirement programs can reduce and avoid the expense of recruiting and training new employees while retaining the institutional memory of long-service employees. She stated that phased retirement incentives address three specific issues in the NRECA defined benefit plan.

Allows workers to lock in an advantageous interest rate by transferring the lump sum distribution into NRECA's 401 (k) plan or into an IRA

Provides income in order to maintain a comfortable lifestyle while working a reduced schedule

Prevents the loss of the value of subsidized early retirement benefits

Ms. Keelty described the NRECA's defined benefit plan as a multiple employer plan which includes 850 cooperative employers which in turn offer retirement benefits to 50,000 participants. The plan has in excess of $3 billion in assets. Normal retirement age in the plan can be 60, 62, 65 or 30 years of service or age 62, whichever comes first. About 50% of the cooperatives have 62 as normal retirement age; 15%, age 65; and 35% have 30-year/age 62. Less than 1% have selected age 60 as the normal retirement age. Participants may elect to receive benefits in the month in which the employee reaches normal retirement age, while continuing to work. Benefits may be received in a lump sum or as an annuity. Participants in plans with the 60, 62 or 65 normal retirement ages may opt for phased retirement once prior to reaching age 70-1/2 and may elect a second phased retirement after reaching age 70-1/2. Benefit accruals continue until actual retirement.

Ms. Keelty emphasized the need for legislation that would allow defined benefit plans to make in service distributions to any employee who has reached some combination of age and service and would allow in-service distributions in the form of a lump sum as well as an annuity.

She indicated the NRECA strongly supports the Phased Retirement Liberalization Act introduced by Rep. Earl Pomeroy (D-ND) and Sen. Charles Grassley (R-IA), which is aimed at the core problems of implementing phased retirement programs.

Ms. Keelty concluded her remarks by offering the thought that phased retirement is an option that will allow employers in a tight and aging skilled labor market to attract and retain an increasingly finite resource-workers.

Testimony of James Klein, President, Association of Private Pension & Welfare Plans

James Klein is president of the Association of Private Pension and Welfare Plans, an information exchange for benefits professionals. Shortly after the passage of ERISA, they were refashioned as a 501(c)(6) advocacy organization. Their main mission is to advocate on behalf of their diverse membership, made up principally of large employer plan sponsors, as well as service providers who help plan sponsors administer their retirement and health plans. These benefit plans cover more than 100 million Americans. Mr. Klein feels phased retirement is of keen interest.

He stated that he realizes they're at the very beginning stages of understanding the parameters in examining phased retirement programs, how companies are dealing with them, and the motivations of both the employers and the employees. He feels one of the things that's obviously very important to them are the realities of the labor force, the demographics that show falling fertility rates and increasing life expectancies, all of which would seem to indicate a more flexible policy toward how they define work in retirement.

One of the clear problems they see are these impediments to both the company and the individual being able to have a variety of different options as to how they want to deal with continued work, depending on the nature of the retirement plan under which they may be covered and their ability to get in-service distributions while continuing to work on a full-time or part time basis; a variety of those kinds of issues. Just the opportunity, to be able to balance work and retain the kind of income that's necessary to pursue individuals' interest.

One of the anomalies that their members frequently see with regard to these impediments on the in-service distribution restrictions, is that individuals can get around those rules by leaving their company's employ, taking their distribution, and then go to work for the competitor down the street. From the company's perspective, it's a tough thing to see your most experienced, valued employees leave because they want to avail themselves obviously of supplemental payments available under the plan.

Often they end up working for a competitor when they would just as soon prefer to continue working for their original company. Mr. Klein states that is something that he thinks needs to recognized as a real problem.

Their member companies have essentially looked at four different approaches to attempt to design phased retirement programs, to deal with the current legal constraints and some of the present barriers.

The first one relates to the in-service distributions from a defined benefit plan. Companies have looked at the issue of simply amending the normal retirement age to the earlier of age 65, or some combination of the lower age and some period of employment service.

Needless to say, doing that can prove to be very costly as all employees are eligible for the full benefits at this new lower age, which then becomes adopted. It also can create issues, frankly, on the nondiscrimination rules as well.

In-service distributions under 401(k) plans is sort of a variation on this theme, with the employees over age 59½ 401(k) plan, rules would permit withdrawals while the employee is still working, but the law does not permit in-service withdrawals in the absence of a hardship. That becomes a real question when the employee wishes to phase down their employment at some age which is less than 59½.

Some companies have looked at the issue of simply terminating and subsequent rehire, and determining whether a certain period of time has to pass for this to be a bona fide retirement before either the company approaching the individual or the individual approaching the company about coming back to work.

That seems to be an overly cumbersome and not terribly efficient way of trying to ensure that everyone is remaining on the right side of various rules that currently are in place.

Then, of course, there are a whole host of issues about part-time employment. Employers who wish to eliminate less favorable treatment of part-time employees under the plans in the case of older employees who are phasing down, could frankly inadvertently and sometimes regrettably cause the affected plans to run afoul of various technical rules if they try this.

For example, in a final average pay plan, if the company would like to deem the individual to be earning at the full rate so that their ultimate retirement benefit won't be lower, then you could see where that might create some nondiscrimination rule of qualification problems there, because those part-time employees would be deemed to be at this higher rate.

Clearly, that's the kind of thing that is an impediment to the company. It's not beneficial to the individual because no one is trying to do the right thing for the individual.

According to Mr. Klein, in terms of their public policy recommendations, a general principle they believe applies here, as they think it applies throughout the voluntary employee sponsored benefit system overall, is flexibility - flexibility on the part of the employer to establish phased retirement plans, to modify these plans, and to terminate them, if necessary. Voluntary participation on the part of the employees in terms of their choice to avail themselves of a phased retirement opportunity is also required.

Mr. Klein stated that he thought everyone was aware that last week, Congressman Earl Pomeroy and Senator Charles Grassley introduced some legislation called the PRLA legislation, the Phased Retirement Liberalization Act. He said he commended them for what they're doing for drawing attention to this issue. He supported this effort which basically would allow employees, either upon reaching 30 years of service, or age 59½, to be able to "set those new triggers", if you will. He said they were still evaluating whether those numbers are the appropriate triggers to have.

For example, is there a large group of individuals who would want to avail themselves of phased retirement programs who are somewhere between the age of 55 and 59½, just to pick a number.

Mr. Klein said another related issue is whether the 10 percent early distribution tax should apply to these newly permitted in-service distributions. The Grassley-Pomeroy legislation does not really address that issue. Also, whether or not these penalty-free distributions should really be permitted from individual retirement accounts earlier than under law, in order to conform with the new rule for qualified plans, is also a related issue that he thinks would benefit from further reflection.

Properly conceived, he says, a phased retirement program should not favor either higher or lower paid employees. Nonetheless, a program could violate certain mechanical nondiscrimination rules that are applicable under the Internal Revenue Code. On the other hand, facts and circumstances, not a discrimination rule, would permit a phased retirement program while, in his view, prohibiting any abusive programs that primarily benefit the highly-compensated employees.

The addition of a facts and circumstances standard to a nondiscrimination rule is part of the bipartisan pension legislation that has now passed Congress a few times in various iterations. Mr. Klein says they recommend its enactment as a means of facilitating phased retirement as well.

Mr. Klein stated that they do commend the Advisory Council for holding this set of hearings. If the Labor Department is able to explain for the benefit of all who listen the importance of encouraging phased retirement as something that is very positive for employers, for the workers, and then it turns out that the main legal impediments are the ones that enshrined in the Internal Revenue code, then political process will simply have to do its will. But, he concluded, the Advisory Council has made a valuable contribution to a better understanding of it without stepping over a jurisdictional line.

August 15, 2000

Testimony of Lawrence Lorber, Esq., Partner, Proskauer Rose, LLP, Attorneys at Law

Mr. Lorber made the following significant points in his oral testimony:

He is an expert on employment law issues, particularly the Age Discrimination in Employment Act (ADEA).

Our Nation's employment policies and law are heavily influenced by tax considerations.

Many of our basic employment law principles are based on outdated assumptions about how the workplace operates and a narrow view of the employment relationship.

For example, the age 65 normal retirement age reflected in the Social Security program and in private pension plans is a throw back to an age when few people lived to that age. In contrast, the ADEA prohibits discrimination based on age at any age above 40 without a cap.

For example, telecommuting and home-work are increasing alternatives to the traditional workplace.

The law should reflect the economic realities of new employment structures. The law is somewhat hostile to phased retirement programs. The law should allow employers and pension plans the flexibility to design and operate effective phased retirement programs that make economic sense to the employer and the employee.

An important issue for phased retirement is the continued availability of health insurance. Employees will be very reluctant to engage in a phased retirement if it means loss of health insurance. Yet, there are issues about whether employees who work part-time under a phased retirement program would be eligible for coverage under the employer's health plan. COBRA coverage, which is limited to 18 months, might not be sufficient and is costly. The Medicare Secondary Payor requirements should also be taken into account in designing a phased retirement program. The employer's health plan will be the primary coverage, and Medicare secondary coverage, for employees who continue to work beyond age 64.

Another important issue is income maintenance. Can an employee in phased retirement receive compensation and pension benefits at the same time?

Most employment law practitioners would discourage their employer-clients from using targeted incentives that tend to favor one group of older employees over other older employees or younger employees because of uncertainty over application of the ADEA.

"In many respects [phased retirement] is a safety valve. If in fact it were possible, if an employer could make a rational employment decision that it needed somebody's technical skills, but perhaps not their full time effort, for whatever reason, can they use those people in that regard? Can the benefit structure be at a point where they can still be productively utilized and employed, but employed and utilized at a lower level? Certainly conceptually it can be done. I think as a practical matter, any employment lawyer will tell an employer don't do it."

There is also an issue under the Older Workers Benefits Protection Act whether a phased retirement program would have to comply with the notice requirements of that Act.

A phased retirement program must take into account the effect, if any, of a lower salary on the pension benefits of the employee. Where pension benefits earned over a career are based on the employee's final salary or final average salary, a reduction in salary under a phased retirement program could cause the employee to lose pension benefits.

Testimony of Norman Stein, Professor, University of Alabama

Professor Stein teaches employee benefits and federal tax law at the University of Alabama (UA). UA's retirement program matches employee contributions up to 5% of compensation to TIAA-CREF. UA employees also participate in the Alabama Teachers Retirement System's (TRS) defined benefit plan. It credits employees with 2% of final pay per year of service. Retirement age is 65, but employees working 25 years can retire at any age with full benefits.

Pension payments stop for retirees earning over $17,000 annually from a university, college or state agency. This prohibits moving from full time employment to substantial part-time employment, because neither reduced University pay nor early retirement benefits are sufficient to support the workers. Because TRS is a final pay plan, moving to part-time employment reduces future retirement benefits. Phased retirement is effectively prohibited. Because it is a state pension system, this plan is not governed by ERISA. Plans of this type have the following disadvantages:

They discourage phased retirement by prohibiting receipt retirement pay while working part-time. Phased retirement would allow younger employees to advance. Plans like UA's limit employees to choosing full-time employment or full-time retirement ­ a stark choice of complete and sudden retirement or working fulltime.

These plans allow employees to retire at any age after working 25 years. It is poor tax policy for the government to provide tax-subsidizes for retirement systems that begin paying benefits so early.

It is poor retirement policy to allow retirees in their 50's to switch to full-time work for a new employer thus reducing resources earmaked for supporting people after they leave the job market.

It is poor labor policy to encourage those who truly retire at an early age to exit the job market so young, especially given the currently tight labor market.

Professor Stein favors phased retirement. Both employers and older employees contemplating retirement would gain if employees began receiving retirement benefits while continuing work on a reduced, but substantial, basis. Phased retirees would be shortchanged if they didn't continue accruing additional retirement benefits so transition from phased retirement to complete retirement was not financially dramatic.

Some fear this proposal because of the potential drain on retirement plan assets. Stein, however, believes it can be designed to be revenue neutral.

Professor Stein's Principles for Phased Retirement are:

To be tax-subsidized, retirement systems should support people whether in full or phased retirement.

Employers should end accelerated early retirement programs on a prospective basis, except for people unable to work, due to disability or otherwise.

Despite point #2, it is unfair to eliminate early retirement programs for current employees who have relied on them in retirement planning.

Employers should permit employees who reach a genuine retirement age such as 60 to draw retirement benefits and work part-time.

Employees who elect phased retirement should continue to earn additional retirement accruals.

Employees who elect phased retirement should receive detailed disclosure comparing the value of their phased retirement benefits with benefits they would receive (i) if they retired immediately, and (ii) if they continued to work full-time.

Employers should not be able to pay retirement benefits ­ periodic or lump sum ­ to employees who continue to work full-time, except employees who reach social security's retirement age.

Employers should boost the ultimate benefits at normal retirement age of employees who forgo early retirement, but those benefits should not start until employees actually retire or begin phased retirement.

Professor Stein listed bad ideas from some pension consultants. They would:

Let business use retirement plan assets for non-retirement purposes.

Undermine the important reliance protections of Internal Revenue Code section 411(d)(6).

Weaken solvency of the social security trust fund.

One industry idea would permit employers to pay lump sums from pension plans to induce employees not to take a subsidized early retirement benefit to which they are entitled. This is bad because lump sums aren't treated as retirement savings by the employees, but as bonuses to employees the employer wants to retain. They are likely to be consumed prior to retirement age. Employers want the ability to use pension funds to pay cash bonuses to favored employees, but this abuses the central idea of tax-subsidized retirement systems, which are designed to help employees build security for when they leave the workforce.

A better approach would permit employers to increase benefits at normal retirement age if the employee forgoes early retirement, so the benefit at normal retirement age would become the most valuable benefit under the plan. If employers want to pay immediate cash bonuses, they can but with after-tax dollars.

If this bad industry concept became law, top-heavy pension plans of many small businesses would turn into revolving tax-deferred savings accounts ­ to be drawn on whenever business wanted to and for any purpose, thus changing these plans into naked tax shelters and drains on the US Treasury.

The consulting industry wants to end Social Security's earnings test for employees under 65. Actuarially, reduced age-62 social security benefits have a higher value than age-65 social security benefits. This bad idea would increase the expense of the Social Security system. Workers should not be encouraged to take pre-age 62 benefits. Those benefits are not necessary for employees to take phased retirement. Phased retirees should derive adequate income from the combination of retirement benefits and current compensation. Social Security benefits should be saved until employees actually retire or reach Social Security retirement age. Current law permits an employee to earn $10,500 before benefits are reduced. This adequately aides low income employees who want to take phased retirement.

Professor Stein opposes the consulting industry proposal that employers are allowed to offer benefits, then retract them even after employees have earned them, in order to permit "experimentation" in "phased retirement" benefit programs.

Professor Stein proposes these law changes:

The law should prohibit major reductions in pension benefits already earned for employees in their 50's who cut their working hours due to health reasons.

The law should mandate an employer's affirmative duty of complete disclosure to avoid the situation where GTE tricked employees into taking lump sum benefits less valuable than normal benefits.

September 11, 2000

Testimony of Pamela C. Scott, on behalf of the U.S. Chamber of Commerce

Pamela Scott is an attorney with the benefits consulting firm Towers Perrin, but testified on behalf of the U.S. Chamber of Commerce.

Ms. Scott noted that phased retirement is not a technical term. For her presentation, she focused on situations where an employee voluntarily reduces the amount of hours worked in anticipation of full retirement. Most of the issues addressed involve private sector, single employer plans under section 401(a) of the Internal Revenue Code.

Some practical problems associated with phased retirement include:

Existing defined benefit plan designs may encourage workers to retire fully to receive subsidized early retirement benefits.

Existing plan designs do not allow flexible draw-downs of retirement plan benefits. For example, an employee may wish to receive a smaller benefit while working part-time and then a larger benefit after full retirement.

After normal retirement age, employees may lose some of the economic value of their defined benefit plan by not retiring, and often do not earn meaningful additional benefits if they continue working.

The legal issues associated with addressing these problems include:

Distributions from qualified defined benefit plans are not permitted prior to the earlier of termination of employment or the attainment of normal retirement age under the plan. The IRS has ruled that if in-service withdrawals (prior to normal retirement age) are permitted, then benefits are not considered "definitely determinable" and therefore the plan is not a pension plan. Reduction of hours worked does not constitute a severance of employment. It may be possible for an employee to terminate employment, receive his/her pension and then be rehired as a part-time employee or a contract employee, but the plan risks disqualification if the IRS rules there was no bona fide termination of employment. Under profit sharing plans, distributions may be made (if the plan allows it) after contributions have been in the plan at least two years or the employee has been a participant for five years. 401(k) contributions cannot be withdrawn until age 59½, except in the case of hardship.

There are problems with reducing the normal retirement age in an ongoing plan (to permit earlier distribution of benefits while still working). These involve benefit accrual rules, nondiscrimination tests and higher plan costs. Legislation introduced by Senator Grassley (S.2853) and Representative Pomeroy (H.R. 4837) on July 12, 2000 would allow in-service distributions from defined benefit plans at the earliest of (a) the attainment of age 59½, (b) completion of 30 years of service, or (c) attainment of normal retirement age. This would put defined benefit plans on a par with 401(k) plans where in-service distributions may be allowed at age 59½, and would alleviate some of the problems associated with phased retirement.

There is a 10% additional tax on distributions before age 59½ which may be a barrier to some phased retirement plans. This tax does not apply if the employee has separated from employment after age 55, if the distribution is rolled over to another qualified plan or IRA, or if the distribution is part of a distribution over the participant's life expectancy (or joint life expectancy) provided that the participant has separated from service when any of the annuity payments are made. Note that these exceptions do not allow any participant to access his retirement funds (without paying the 10% additional tax) before the age of 59½ if he/she is still working for the same employer.

Plan rules on forms of distribution often limit the flexibility of an employee to tailor his/her retirement income to his/her needs during phased retirement. Typically a single election as to the form and timing of the benefit payment applies to the total benefit and is irrevocable. Under a defined contribution plan (including a cash balance pension plan) more flexibility is often available, subject to spousal consent rules and minimum distribution requirements under code section 401(a)(9). There are ways for defined benefit plans to provide more flexibility, but it is very rare, probably because of difficulties in administration and communication.

Pension plans that provide special options for phased retirement programs must pass various nondiscrimination tests. Also, if special options are only available for employees under a phased retirement program, there cannot be too much employer discretion in determining the eligibility for the program. Also, under a phased retirement program, an employer may not offer a choice between additional cash and a benefit under a qualified defined benefit plan.

If an employee continues working past the normal retirement age, the plan may allow payment of pensions (which eliminates the problem of a participant losing economic value if he/she continues working). However, many plans do not pay benefits until actual retirement. Under these circumstances various suspension of benefit rules come into play.

Some employers try to avoid some of these phased retirement problems by rehiring a retiree as an independent contractor (or consultant). However, there are specific rules to determine a bona fide independent contractor status. One of these rules is that the employer must no longer have the right to control and direct the details of the work performed. Except for some professional or technical employees, this type of arrangement is very difficult to structure.

In a question and answer session, the following issues were discussed:

To Ms. Scott's knowledge, the U.S. Chamber of Commerce has not taken a position on the legislation proposed by Senator Grassley and Representative Pomeroy.

Phased retirement programs may be easier to design around cash balance pension plans than traditional defined benefit pension plans since the benefit accrual is more similar to a defined contribution plan.

How a pension plan defines final average pay may be a problem for phased retirement programs if a reduction in pay reduces a participant's pension.

Testimony of Paul Shultz, Internal Revenue Service, Director of Employee Benefit Plans, Rulings and Agreements

Mr. Shultz testified before the Phased Retirement Working Group on September 11, 2000. He was accompanied by his associate from IRS, Roger Kuehnle. Mr. Shultz raised the point that he was before the Council to provide information regarding existing laws and interpretations and that neither he nor the Internal Revenue Service has yet taken any position on phased retirement issues. He characterized the title of "Barriers to Phased Retirement" concerning which he had been asked to testify as presuming implicitly that barriers might be undesirable.

Barriers to phased retirement exist primarily under defined benefit plans, but not defined contribution plans.

Mr. Shultz explained the Internal Revenue Code and ERISA statutes overlap in many but not all instances, there being analogs in ERISA to IRC provisions. He noted that the enforcement under reorganization for these matters is exclusively with the Internal Revenue Service. Hence, in a practical matter the Internal Revenue Service is the leader or primary agency on this issue.

Mr. Shultz pointed out that the "barriers" to phased retirement, included concerns arising from the lack of further or adequate future retirement benefits, and the restraints on in-service distributions, arise not directly from the Internal Revenue Code or ERISA, but rather from long-standing IRS interpretations of the Internal Revenue Code to the effect that pension requires "retirement" and you can't work and collect retirement benefits, etc.

Questions from the Working Group members suggested that barriers to phased retirement should consider not only partial retirement/partial work, but even continuing to work full-time and receiving pension benefits.

This would be particularly applicable to early retirement subsidies, which are very common under defined benefit plans. Mr. Shultz pointed out that the problems of phased retirement conflicting with the IRS's view of in-service distributions at least below "normal" (usually age 65) retirement age, may be viewed as having an adverse impact on the societal desire to obtain on a full-time or on a part-time basis the continued productivity of mature workers.

Interestingly, the Phased Retirement Liberalization Act introduced in Congress accepts the basic premise of the IRS that "pensions" requires retirement and cessation of same employment with only specific exceptions to it, rather than re-evaluating the non-statutory bar to in-service distributions.

Working Group members raised questions, namely the common 1,000 hour per year for pension credit requirement in contrast with the IRS's view that working even 500 hours still disqualifies one from the receipt of benefits before plan defined normal retirement age and concerns regarding the health insurance coverage for persons working under phased retirement and their dependents.

Testimony of Diane Oakley, Vice President, TIAA-CREF, Phased Retirement Arrangements at Colleges and Universities

Normal retirement age in the defined contribution plans that colleges and universities provide for their faculty and staff employees functions more as a target age. Most plan documents specify age 65 as the normal retirement age and colleges select plan contribution rates to provide an adequate pension income at age 65. In 1979, 42% of TIAA-CREF participants starting to draw their lifetime income benefits did so at age 65. Twenty years later in 1999, the percent of those starting income payments at age 65 dropped to 12% while those starting income at age 70 or later jumped to 38%. Retirement rates for faculty dropped with the elimination of mandatory retirement and that today about 50% of the faculty who choose to work beyond age 70 are still employed three years later. This figure increased from 10% in the years before 1994.

Over the past several decades, the administration and faculty at major research universities as well as smaller colleges utilized both voluntary retirement incentive plans and phased retirement options to help balance faculty positions with student enrollment. A study prepared for the National Center for Educational Statistics (NCES), indicated that the opportunity to continue working part time at a college or university was an important consideration in a professor's willingness to retire. While 27.7% of all faculty surveyed were willing to take an early retirement incentive, 46.0% were willing to consider a phased retirement arrangement. Phased retirement has an increasing appeal among the older cohorts: 52.6% of faculty 55-64 and 61.4% of faculty over 65 would consider phased work arrangements.

According to a TIAA-CREF survey of 167 colleges and universities, conducted in 1998, almost all of the 66 colleges responding reported that they allow retired faculty to teach part time. The survey also noted twenty-five colleges and universities with phased retirement arrangements and four more with a combination of an incentive plan with phased retirement. While the length of the phased period varied, three to five years was the most popular duration. Eligibility provisions required faculty to be at least age 50 or 55 or have worked 10, 15 or 20 years before they can take advantage of the phased retirement option. Salaries paid for part-time teaching reflected a pro rata amount of full-time earnings, but some colleges added incentives such as added salary and the continuation of benefits based on the former full-time salary. In certain states, public retirement systems contained restrictions on the level of part-time employment that were incorporated into the phased agreements.

When colleges and universities decide to offer faculty phased retirement arrangements, they can amend their plan documents to allow participants in the phased program to start income benefits from their 403(b) pension plan while they continue to teach part time. Starting to draw pension income at an earlier age under a defined contribution plan means a lower level of income benefits. The phased retirement program often includes continuing pension contributions while employees draw a portion of their benefits to supplement part-time earnings. Starting retirement income from only part of a TIAA-CREF account has grown in popularity; 30.5% of participants who started an income stream for the first time in 1999 did so.

TIAA-CREF supports the legislation introduced by Senator Grassley and Representative Pomeroy would allow certain participants in qualified money purchase plans and retirement plans to draw benefits from their pensions without requiring that they terminate employment. We encourage them to expand the eligibility criteria, since many colleges and universities offer phased retirement opportunities to faculty members once they attain age 50 or 55 and complete as few as 10 or 15 years of service.

Furthermore, individuals age 55 and over who draw their pensions as a series of income payments are not subject to the 10% early withdrawal tax penalty only if they have separated from service. Amending this section of the tax code to not penalize younger participants in phased retirement arrangements would enable these individuals to draw less in monthly income from their pension plan, since the 10% excise tax would no longer apply. TIAA-CREF also supports the proposal in the Grassley/Graham and Portman/Cardin pension bills that would raise the Section 415 percentage of compensation limit to 100%. Enacting this could help enable employers to make pension contributions on full salary to participants in pension phased arrangements.

TIAA-CREF, through its Institute, is working with the higher education community to obtain more comprehensive data on phased retirement arrangements. A survey of 1,300 colleges and universities is in the field and will be finalized in early 2001.

VI. Exhibits and Written Materials Received

2000 Index

Advisory Council on Benefit Implications of Phased Retirement

(Actual Transcripts/Executive Summaries for the Council's full meetings and working group sessions are available ­ at a cost ­ through the Department of Labor's contracted court reporting service, which is Executive Court Reporters at (301) 565-0064/(301) 589-4280 fax.)

For the Advisory Council's 2000 Term:

May 8, 2000: Benefit Implications of Phased Retirement

1. Agenda
2. Official Transcript
3. Executive Summary of Transcript
4. Strawman Discussion Paper/Scope Outline
5. Packet of testimony from the April 3, 2000 Hearing of the Senate Committee on Aging.
6. Several news stories including "Older Workers Should Be Encouraged to Remain, Panel Told" by Ismail Turay, Jr., for the April 3, 2000 Cox News Service; "Congress Looks to Help Older Workers" by Alice Ann Love, Associated Press.
7. "Retirement Patterns and Bridge Jobs in the 1990s", by Joseph F. Quinn, Boston College and a Fellow of the Employee Benefits Research Institute, February 1999, an issue brief for EBRI. (Remarks from the study were contained in Dr. Paul J. Yakoboski's appearance before the working group).

June 1, 2000: Benefit Implications of Phased Retirement

1. Agenda
2. Official Transcript
3. Executive Summary of Transcript
4. May 8, 2000 Follow up Letter from Dr. Paul Yakoboski, EBRI, regarding tabulations from the Retirement Confidence Survey, 1999, which he referenced in his May appearance.
5. "Empty Pipeline: The Federal Employment Crisis, Retirement Wave Creates Vacuum" by Stephen Barr, Washington Post, May 7, 2000.
6. "New Opportunities for Older Workers" executive summary prepared by the Committee for Economic Development.
7. "Phased Retirement and 401(K) Plans", by Martha Priddy Patterson, from the 401(K) Handbook, Thompson Publishing Group, May 29, 2000.
8. "Phased Retirement: Possibilities from the Public Sector", Outline Prepared by Ted Kennedy, Senior Counsel for State Government Affairs, American General Retirement Services, for his presentation at the working group session.
9. "Phased Retirement: Reshaping the End of Work" a 1999 survey report prepared by Watson Wyatt Worldwide.

July 17, 2000: Benefit Implications of Phased Retirement

1. Agenda
2. Official Transcript
3. Executive Summary of Transcript
4. Written Testimony of Lana Keelty, National Rural Electric Cooperative Association.
5. Written Testimony of James A. Klein, President of the Association of Private Pension and Welfare Plans, as well as a news release issued by APPWP about his testimony before the working group.
6. A copy of the Phased Retirement Liberalization Act, introduced by Sen. Charles Grassley in the Senate and by Rep. Earl Pomeroy in the House of Representatives as well as news releases about the bill by both of their offices and others issued by the National Committee to Preserve Social Security and Medicare and by the APPWP on July 12. Also included are the remarks made by Rep. Pomeroy as he introduced the bill in the House as well as a BNA Pension and Benefits Daily news story, "Rep. Pomeroy, Sen. Grassley Set to Introduce Phased Retirement Legislation, Aides Say," July 10, 2000.
7. Written Testimony by Jonathan Barry Forman, a law professor the University of Oklahoma, "Making Federal Pension Policy Work" which is to be published in a forthcoming North American Actuarial Journal.
8. "Firms Find More Profit From Retirement Funds" by Ellen E. Schultz, Wall Street Journal, June 20, 2000.
9. "A New Generation Redefines Retirement" a feature from Workforce Online, May 5, 2000.

August 15, 2000: Benefit Implications of Phased Retirement

1. Agenda
2. Official Transcript
3. Executive Summary of Transcript
4. Written Testimony of Norman P. Stein, Professor of Law, University of Alabama, Tuscaloosa.
5. Written Testimony of Jack McCarthy, Vice President of Human Resources, Varian Medical Systems, Palo Alto, California submitted August 2, 2000.
6. Two Wall Street Journal articles written by Ellen Schultz on July 27, 2000, entitled "Companies Find Host of Subtle Ways to Pare Retirement Payouts" and "Phased Retirement - Option for Workers Is Mainly Boon For Their Employers".
7. "Phased Retirement Gains in Workplace Popularity" by Diana Kunde, Dallas Morning News, February 4, 2000.
8. "Employers Turn to Phased Retirement As Workers Age and Labor Shortages Increase: Trend Predicted to Intensify Over Time", from watsonwyatt.com/homepage/us/new/pre dated March 29, 2000 as well as "Responding (Again) to the Hype: Phased Retirement", July 7, 2000; "Phased Retirement: Reshaping the End of Work", September 9, 1999; "Choosing Retiree Benefit Options: What Constitutes Informed Choice?" July 1, 2000; "Taking the Subsidy Out of Early Retirement: One Story Behind the Conversion to Hybrid Pensions", July 2, 2000, and "Don't Miss the Forest for the Trees", June 2, 2000.

September 11, 2000: Benefit Implications of Phased Retirement

1. Agenda
2. Official Transcript
3. Written Testimony of Diane Oakley, Vice President TIAA-CREF as well as a survey of Changes in Faculty Retirement Policies.
4. "Technical Barriers Under the Internal Revenue Code to Implementing Phased Retirement Programs" by Pamela C. Scott (written testimony of her appearance).
5. "Labor Day 2000: EPF Predicts Size of Labor Shortage, How to Prevent It", a news release issued by the Employment Policy Foundation.
6. 1) Watson Wyatt's Reshaping the End of Work ­ overhead slides.
7. "Older Workers: Trends in Employment and Retirement", July 26, 2000, by Patrick J. Purcell, specialist in Social Legislation, Domestic

October 12, 2000 Benefit Implications of Phased Retirement

1. Agenda
2. Official Transcript
3. Summary of Transcript

VII. Members of the Working Group

1. Carl T. Camden, Chair of the Working Group, Kelly Services, Inc.
2. Richard Tani, Vice Chair of the Working Group, William M. Mercer (retired)
3. Rose Mary Abelson, Vice Chair of the Advisory Council, Northrup Grumman Corp.
4. Evelyn Adams, IBM Global Services
5. Eddie C. Brown, Brown Capital Management
6. Judith Calder, Abacus Financial Group, Inc.
7. Janie Greenwood Harris, Firstar Corporation
8. Michael J. Gulotta, Chair of the Advisory Council, Actuarial Sciences Associates, Inc.
9. Catherine Heron, Capital Group Companies (CGC)
10. Timothy Mahota, Integral Development
11. Judith Mazo, The Segal Company
12. Patrick McTeague, McTeague, Higbee, Case, Cohen, Whitney & Toker
13. Rebecca Miller, McGladrey & Pullen, LLP
14. James S. Ray, The Law Offices of James S. Ray
15. Michael J. Stapley, Deseret Mutual Benefit Association