years of service for early retirement.
If an employee has less than 30 years
of service, his pension is reduced 5
percent for each year before age 65.
If an employee has 30 years of
service or more, the reduction period
is only until age 62. This means
that Employee A who retires at age
60 with 10 years of service would
face a pension reduction of 25
percent (65-60 = 5; 5 years x 5
percent = 25 percent). Employee B
who also retires at age 60, but with
30 years of service, would face a
reduction of 10 percent (62-60 = 2; 2
years x 5 percent = 10 percent).
Assuming a normal monthly benefit
of $500 for all employees, Employee
A would receive a pension of $375
per month, while Employee B would
receive a pension of $450 per month.

In another form the reduction rate
varies by years of service. For
example, a plan might allow
employees with 25 or more years of
service early retirement at age 50.
An employee whose length of service
is less than 30 years is subject to a
reduction factor of 6 percent for each
year before age 55; for an employee
with 30 years’ service or more, the
factor is 3 percent. Employee A, who
retires at age 52 with 27 years of
service, would face a pension
reduction of 18 percent (55-52 = 3; 3
years x 6 percent = 18 percent).
Employee B, who also retires at age
52, but with 30 years of service,
faces a 9 percent reduction (55-52 =
3; 3 years x 3 percent = 9 percent).
Assuming a normal benefit of $500
for all employees, Employee A’s
reduced monthly benefit would be
$410, while Employee B’s benefit
would be $455.

Early retirement supplements
The age at which a defined
benefit plan participant can take
early retirement is often earlier than
that for collecting Social Security
Tetirement benefits. A few plans
provide monthly early retirement

supplements that generally last until
age 62, the earliest age at which
Social Security retirement benefits
are payable. Some employers use
these supplements to induce older
workers to retire, while other
employers use them to reward
workers for longevity. To receive
these benefits, workers must often
meet age or service requirements
more stringent than those for early
retirement. Ten percent of private
sector workers participated in
defined benefit plans with this
feature; less than 0.5 percent of
public employees had this option."°

Conclusions

Data from the 1993-94 Employee
Benefits Survey show that most
workers participating in defined
benefit pension plans had provisions
for early retirement. The greatest
proportion of workers covered by
such provisions were in plans with
variable early retirement reduction
factors.

Defined benefit plan incentives
have been considered a factor
influencing the early retirement
trend. The decline in the proportion
of workers covered under these
plans, however, could slow down or
reduce the number of early retirees."'

The availability of retiree health
coverage could also influence the
early retirement trend. Existing
research indicates that employer-
provided retiree health coverage
increases the probability of retire-
ment for workers under age 65.'?
Without employer-provided retiree
health coverage, workers retiring
before age 65 face higher outlays,
other factors being equal, than
retirees over 65, many of whose
health care expenses are reimbursed
by Medicare. It should be noted that
the proportion of employees with
medical care coverage who also have
employer-provided retiree coverage
has not changed much in recent
years."? The decline in the propor-

tion of employees with medical care
coverage, however, has reduced the
number of employees in plans with
Tetiree coverage" and could slow or
reduce the number of workers
Tetiring early.

The 1983 Social Security amend-
ments, which made significant
changes in benefit eligibility, could
further reduce the number of early
retirees. Beginning in the year
2000, the normal retirement age for
Social Security eligibility will be
gradually increased until it reaches
67 in 2022. The early retirement
benefit amount, payable at age 62,
will be reduced over this period.
This is because the maximum early
Tetirement reduction will increase
from its present 20 percent to 30
percent for those who reach age 62
in the year 2022 or later. Since it
is likely that many workers reaching
age 62 in the year 2000 or later will
lack the financial resources to make
up this difference," they will
probably have to continue working
in order increase the adequacy of
their retirement resources.

Defined benefit pension plan:
A retirement plan that uses a
predetermined formula to
calculate a participant's
benefits.

Benefits are generally based
on a participant’s salary and
years of service with the
employer sponsoring the plan.

Early retirement: The point at
which defined benefit pension
plan participants can retire and
receive all accrued benefits less
a reduction for the years prior to
their normal retirement age.

Normal retirement: The point
at which defined benefit
pension plan participants can
retire and receive all accrued
benefits.

Compensation and Working Conditions December 1996 16

. tp


Exhibit 1. Early retirement reduction differing by life expectancy at age of retirement

Replacement Annual Percent of oon
Retirement age rate benefit normal benefit] per year
(percent)
55. 10.42 $3,128 39.90 6.01
56. 12.03 3,609 46.09 5.99
57. 13.64 4,092 62.24 5.97
58... 15.24 4,572 58.35 5.95
59... 16.84 5,052 64.49 5.92
60. 18.42 5,526 70.55 5.89
61. 20.00 6,000 76.60 5.85
62. 21.56 6,468 82.57 5.81
63. 23.11 6,932 88.50 5.75
64. 24.62 7,386 94.30 5.70
65. 26.11 7,833 100.00 0.00
Exhibit 2. Earty retirement reduction differing by age bracket
Percent Annual Percent of
Retiroment age reduction benefit normal benefit
65 oO ‘$6,000 100
64 3 5,820 7
63 3 5,640 94
62 3 5,460 9
61 3 5,280 88
60 3 5,100 85
59 5 4,800 80
58 5 4,500 75
57 5 4,200 70
56 5 3,900 65
55 5 3,600 60
were in plans with variable reduction _ final compensation was $30,000, the public workers were subject to this
factors. The most frequent variation employee would receive an annual provision.

was according to age. One common
form is the actuarial method which
is based on the employee’s life
expectancy at the age early retire-
ment is taken. This type of reduction
was applicable to 28 percent of
private employees and 35 percent of
public employees with early retire-
ment provisions.

An example of a reduction
schedule varying by age at time of
retirement is shown in exhibit 1. It is
assumed that employees will receive
a normal retirement benefit at age 65
if they have at least 10 years of
service. Employees with 10 years of
service can, however, opt for early
retirement at age 55.

If an employee with 10 years of
service retires at age 65, the annual
benefit would be equal to 26.11
percent of final compensation. If

retirement benefit of $7,833. An
employee with 10 years of service
and $30,000 final compensation who
retires at age 55, however, would
receive an annual retirement benefit
of $3,126. This benefit is 39.90
percent of the normal benefit and
represents an average reduction of
6.01 percent for each of the 10 years
before normal retirement age. An
employee with the same service and
compensation who retires at age 60
would receive a pension of $5,526
which is 70.55 percent of the normal
benefit and represents a reduction of
5.89 percent per year.

Another reduction factor is one
that differs for age brackets instead
of changing each year. (Sce exhibit
2.) Among employees with early
retirement provisions, 26 percent of
private workers and 20 percent of

15 Compensation and Working Conditions December 1996

In the example, normal retire-
ment age is 65, but early retirement
can begin at 55 if an employee has
10 years of service. The reduction
factor is 3 percent a year between
ages 60-64 and 5 percent a year
between ages 55-59. An employee
retiring at age 61 would receive 88
percent of the normal benefit [100 -
(4 years x 3 percent)], while an
employee retiring at age 56 would
receive 65 percent of the normal
benefit [100 - (5 years x 3 percent +
4 years x 5 percent)].

Reduction varies by service. In
some plans, an employee's years of
service is a factor in the early
retirement reduction. In one form,
the reduction period varies by years
of service, For example, a plan may
require a minimum of age 55 and 10



“Information from “Trends in Labor Force
Pastici pation of Major Population Groupe, 1965.
1992" Boreas of Labor Saisie Division
Labor Force Statistics, July 1995(anpobied)
sod Employment and Earning 5, January 1996,
p. 160.

2 For more information see Employee Ben-
efits in Medium and Large Private Establish-
ments, 1993, Bulletin 2456, Buseau of Labor Sta-
tistics, 1994, and Employee Benefits in State and
Local Governments, 1994, Bulletin 2477, Bureau.
of Labor Statistics, 1996,

100 workers). Because of low coverage rates (only
15 percent of full-time workers participated in a
efined benefit pension plan) and high nonresponse
fates in the 1994 survey, detailed provisions of
defined benefit pension plans were not reported.
For more information see Employee Benefits in
Small Private Establishments, 1994, Bulletin
2475, Bureau of Labor Statistics, 1996.

Barly retirement trends have been examined
in previous research using Employee Benefits
Survey datn For more information see Olivia S.
Mitchell, “Trends in Pension Benefit Formulas and

Benefits Administration, 1992, pp. 177-216.

“ While 65 is the normal retirement age for
current Social Security retirement recipients, 52
[percent of defined benefit pension plan participants
‘in medium and lange private establishments could
retire before age 65 and still receive normal

92 percent. When plans permit normal retirement
before age 65, they usually impose a minimaura
service requirement, for example, 10 years of sex-
vice at age 62.

— Endnotes —

5 For more information about the Employee
Retirement Income Security Act of 1974 see What
You Should Know About Your Pension Rights,
U.S, Department of Labor, Peasion and Welfare
Benefits Administration, 1995.

For more information see Kristen Phillips,
“State and Local Government Pension Benefits,”
in Turner and Beller, eds., pp.341-392.

7 Participants in plans with a sum of age plus
service of with a service requirement only could
be eligible to retire at or before age 55 if they joined
the plan at a relatively young age. If these partici-
Pants are included, 89 percent of private employ-

than 80 percent of what he would have received
at age 65. This is because the benefit computa
tion made at age 65 would most likely be based
on a higher salary and more years of service than
at age 61.

* Olivia Mitchell's examination of earlier EBS
data uncovered the same pattern, She found that
in 1989 two thirds of all workers in medium and
large private establishments covered by a uniform
carly retirement reduction factor faced benefit re-
ductions less than 6 percent. See Tumer and
Beller,

"Data from the 1988 Employee Benefits Sur-
‘vey were used to examine supplemental retirement
payment provisions in defined benefit pension
plans. For more information see William J.

Wiatrowski, “Supplementing Retirement Until
Social Security Begins,” Monthly Labor Review,
1990, pp, 25-29,

In 1993, 56 percent of full-time employees
in medium and large private establishments par-
ticipated in a defined benefit pension plan, down
from 63 percent in 1989. The proportion of State
and local government employees participating in
defined benefit pension plans was similar in 1990

17 Compensation and Working Conditions December 1996

and 1994, 90 percent and 91 percent, respectively.
8 See Alvin E, Headea, Jr, Robert L. Clark, and
‘Linda Shumaker Ghent, “Retiree Health Insurance
and the Retirement Timing of Older Workers,”
(Unpoblisied) Augut 1995 and Lyon A. Karly
and Jeannette A. Rogowski, “The Effect of Ac-
een Pot scene Vest Ingurascs onthe
Decision to Retire Early,” Industrial Relations
Review, VolA8, No, 1 (October 1994), pp. 103-

123.

14 Ym 1993, 40 percent of employees in me-
ium and large private establishments who had
health insurance were in plans that had retiree
coverage, either fully or partly financed by their
employer, slightly lower than the 42 percent in
1989. In 1994, 60 percent of public employees
‘with health care coverage had (fully or partly)

‘compared

lasge private establishments with medical care
‘coverage was 82 percent in 1993, down from 92
percent in 1989. ‘The proportion of public em-
Ployees with medical care coverage was 87 per-
cent in 1994, down from 93 percent in 1990. Itis
difficult, however, to determine the impact of these
declines on eventual setiree coverage because itis
possible that some of these workers may have de-

/ashington DC, Employee Benefit Re-
search Institute, 1990, pp. 13-23.
TM For more information see Paul Yakoboski
and Celia Silverman, “Baby Boomers in Retire-
ment: What are Their Prospects?” in Dallas L.
Salsbury and Nora Super Jones, eds., Retirement
inthe 205 Century. Ready or Not.. Washing-
ton, DC, Employee Benefit Research Institute,
1994, pp. 1-62,



Early Retirement
Provisions in Defined
Benefit Pension Plans BY ANN C. FOSTER

ost workers participating in defined benefit pension plans had provisions for
early retirement. The greatest proportion of these workers were in plans with
variable early retirement reduction factors.

Workers, especially men, have
been retiring earlier in recent years.
This is shown by the steep decline in
the labor force participation rates of
men 55 and over. In 1970, 83
percent of men age 55 to 64 were in
the labor force, but by 1995 this rate
had decreased to 66 percent. Among
women age 55 to 64, however, the
participation rate grew somewhat,
from 43 percent in 1970 to 49
percent in 1995. Among those age
65 and over, 27 percent of men and
10 percent of women were in the
labor force in 1970; by 1995,
participation rates had dropped to 17
percent for men and 9 percent for
women."

This article focuses on early
Tetirement provisions in defined
benefit pension plans for full-time
workers in medium and large private
establishments (those employing 100
workers or more) and State and local
governments. These private estab-
lishments are comparable in size to
most State and local governments.
The data used are from the 1993 and

Ann C. Foster is an economist in the Division
of Compensation Data Analysis and Planning,
Bureau of Labor Statistics. Telephone (202) 606-
6222.

ACKNOWLEDGMENT: The author wishes
to thank James N. Houff, senior economist, Divi-
sion of Compensation Data Analysis and Planning,
Bureau of Labor Statistics, for his helpful com-
ments.

1994 Employee Benefits Survey
(EBS) which studies the incidence
and characteristics of employer-
provided benefits.” Early retirement
Tequirements, reductions, and
supplements form the core discus-
sion of the article.>

Background
Defined benefit pension plan

incentives are one factor influencing

the early retirement trend. Most
workers participating in defined
benefit pension plans can retire
before the normal retirement age and
receive a reduced pension.’ Data
from the 1993-94 Employee Benefits
Survey show that among workers
with defined benefit coverage, 95
percent of those in medium and
large private establishments and 87
percent of those in State and local
governments participated in plans
with early retirement provisions.
While early retirement is preva-
lent, specific plan provisions vary
between the public and private
sectors. The Employee Retirement
Income Security Act of 1974
(ERISA) sets minimum standards
for pension plans in private industry.
It does not, however, require pension
plans to provide early retirement
benefits. Private plans can establish
their own eligibility criteria.
Nevertheless, ERISA does require

that early retirement benefits be at
least the actuarial equivalent of a
plan’s normal retirement benefits.>

In contrast, State and local
government plans are not regulated
by ERISA. Although many attempts
have been made to bring them under
Federal jurisdiction, these plans are
regulated only by individual States
and local governments.®

Early retirement requirements

The most common early retire-
ment requirements are age and
length of service. Almost 3 out of 4
Private sector workers were in plans
permitting early retirement at age
55. Table 1 shows early retirement
eligibility requirements for full-time
workers in defined benefit plans with
such provisions.

The greatest proportion of
private employees (34 percent) were
in plans permitting early retirement
at age 55 with 10 years of service,
but substantial proportions were in
plans permitting early retirement at
age 55 with 5 years of service (21
percent) and age 55 with 15 years of
service (13 percent),

The most common age and
service requirements for public
workers were age 55 and 5 years of
service (12 percent), age 55 and 25
years of service (10 percent), and age
55 and 10 years of service (9

Compensation and Working Conditions December 1996 12

rr 7


‘Table 1. Requirements for early retirement, full-time employees by establishment type, 1993-94

{in percent)
Medium and ‘State and
Requirement large private local
establishments governments
Total with early retirement provision .... 100 100
Less than age 55..... 9 2
No service requirement .. ¢) .
Service requirement
5 years .. 1 8
6-9 years Y )
10 years: 2 1
15 years 1 1
20 years 1 5
25 years 2 1
30 years () 3
Age 55..... 72 46
No service requirement 2 -
Service requirement
Less than 5 years 1 3
5 years .. 21 12
6-9 years ¢) 1
10 years 34 9
11-14 year 0) :
15 years 13 5
20 years 2 3
25 years () 10
30 years : 2
Age 56-59... 1 :
No service requirement () :
Service requirement
10 years ) -
15 years 0) .
20 years 1¥) .
25 years 10) :
30 years 1 -
Age 60..... 7 3
No service requirement () :
Service requirement
5S years 2 iv)
10 years 3 1
15 years 1 -
20 years ¢) 2
Age 62... 3 0
No service requirement ¢) -
Service requirement
5 years QO -
10 years 2 ()
More than 30 years .. ¢) -
Service requirement only’ 5 26
Less than 30 years 0) 16
30 years ... 4 9
More than 30 yeai () fu)
‘Sum of age plus service 3 3
2 3
1 iv)

‘Less than 0.5 percent.

NOTE: Because of rounding, sums of individual items may not ‘equal totals. Dash indicates no employees in this

category.

13 Compensation and Working Conditions December 1996


Table 2. Early retirement reduction, full-time employees by establishment type, 1993-94

(in percent)
Medium and State and
Early retirement reduction large private local
establishments governments

100 100

KJ 3

2 3

4 9

1 ()

5 1

1 4

8 ail

°) -

al 9

2 ()

() 10)

Q 1

64 60

a] 55

28 cI

26 20

10 4

iv) 2

Average uniform percentage reduction? 48 46

‘ Less than 0.5 percent.

? For all covered workers; averages exclude workers:
in plans without uniform percentage reduction provisions.

percent). Twenty percent of State
and local government employees
could retire before age 55 with
varying lengths of service compared
to 9 percent of private employees.
Public employees were more apt
to participate in plans with a
“service requirement only” than
were private employees. Twenty-six
percent of State and local govern-
ment employees participated in such
plans, compared to 5 percent of
employees in medium and large
private establishments. Regardless
of sector, almost all of these employ-
ees were in plans with service
requirements of 30 years or less.
Under some plans, workers could
retire early if their age and years of
service equal a specified sum, such
as 75 or 80. Such plans usually
require an employee to be a specified
age. For example, a plan may allow
an employee, who is at least age 55,
an early retirement option if the sum
of the employee’s age and length of

NOTE: Because of rounding, sums of individual

ployees in category.

service equals or exceeds 80. This
means that a 60-year-old employee
with 20 years of service would be
eligible for early retirement. In
1993-94, few workers participated in
plans with these requirements.”

Early retirement benefits

A worker who takes early
retirement will receive benefits over
a longer time period than if benefits
had begun at the normal retirement
age. This is why, all factors being
equal, such a worker usually receives
a smaller pension than one who
retires at the normal retirement age.
Early retirement benefits are
generally based on the normal
retirement benefit to which a
reduction factor is applied.

Uniform percentage reduction.
Some plans have a uniform percent-
age reduction for each year between
the actual and the normal retirement
ages. For example, a plan has a

items may not equal totals. Dash indicates no em-

normal retirement age of 65 and an
early retirement reduction factor of 5
percent for each year below normal
retirement. A person retiring at age
61 would receive 80 percent [100
percent - (4 years x 5 percent)] of the
normal benefit.*

A uniform percentage reduction
factor was used in plans covering
approximately 36 percent of private
employees and 39 percent of public
employees in plans with early
Tetirement provisions. (See table 2.)
Of those employees subject to this
factor, nearly two-thirds faced
benefit reductions smaller than 6
percent per year. Six percent is often
considered a roughly actuarially
neutral early retirement reduction
factor. This indicates that employers
using reduction factors of less than 6
percent are subsidizing some of their
employees’ early retirement benefits.”

Reduction varies by age. The
greatest proportion of employees

Compensation and Working Conditions December 1996 14

1]