Retirement Planning

This is a fairly complicated issue that continues to capture the attention of the public. The debate over whether Social Security will be available for the youngest members of the current workforce only adds legitimacy to the necessity of early retirement planning. Mortality studies show that most people will need retirement income for at least 15 years. This, combined with the uncertainty of investment returns and inflation, makes retirement planning a critical topic in today's business and political spectrums.

Eligibility

Although pension plans may be designed to cover all employees, normally an employee must satisfy some conditions to become eligible. Full-time employment, minimum age, minimum length of service, and minimum earnings are common requirements. For instance, a plan may cover all salaried employees at least 20 years of age who earn more than §15,000 and have at least two years of service. Other eligibility rules such as a maximum retirement age may be established. These may not be more stringent, however, than the provisions of the Age Discrimination in Employment Act (ADEA), ERISA, and the IRC. The ADEA generally prohibits employers from forcing employees to retire because of age before 70. The provisions of ERISA require coverage of all employees who are at least 20 years of age and have one year of service. Also, ERISA allows the exclusion, in defined-benefit plans, of employees who are hired within five years of the normal retirement age. The minimum-earnings requirement is designed to integrate private pension plans with Social Security and, at the same time, to avoid the IRS ruling that prohibits discrimination in favor of the more highly paid employees.

Vesting

Vesting is the employee's right, after meeting certain requirements, to the benefits attributable to the employer's contributions if employment terminates prior to retirement. The employee is always entitled to a refund of his contributions as well as any investment earnings on termination. The employee's right to the employer's contribution, however, depends on the extent to which vesting has been attained.

Three minimum vesting standards for pension plans are set forth by ERISA:
- The 10-Year Rule. The employee must be 100% vested after 10 years, with no vesting whatever prior to that time.
- The 5-to-15 Rule. The employee must be at least 25% vested after 5 years; graduated vest-ing continues with full vesting after 15 years.
- The Rule of 45. The employee must be at least 50% vested after 10 years, or when age and service equal 45-whichever is earlier-then 10% a year until fully vested.

Retirement Ages

Pension plans generally have three retirement ages:
- normal,
- early, and
- late.

The normal retirement age is 65. The choice of this age is Influenced by the fact that this is the age at which full Social Security benefits begin. Moreover early retirement with full benefits often produces prohibitive costs. Since 1978, however ADEA has prohibited mandatory retirement by employers before age 70, and this undoubtedly will modify the normal retirement age.

Early retirement on a reduced pension is allowed under qualifying conditions. One such requirement may be that the employee must be at least 55 and have been at least 10 years in the plan. Late retirement may be deferred beyond 70. Increased benefits may then be provided, but most plans simply pay normal retirement benefits as a means of encouraging older workers to retire.

Retirement benefits have been available to some employees of some companies for a number of years. Private pension plans in the United States are a result of the Industrial Revolution in the late 1800s, as the industrial base shifted from agriculture to manufacturing. The Social Security Administration was created in the 1930s as a part of Franklin Roosevelt's New Deal. Shortly after the creation of Social Security, private pension plans grew—offering coverage to millions of employees. In 1962 the Self-Employed Individuals Retirement Act (also known as Keogh plans) was enacted through the efforts of New York Congressman Eugene J. Keogh. This act established tax-deferred retirement plans with withdrawals starting between ages 59 1/2 and 70 1/2. The plan is for the self-employed and those who have income from self-employment on the side (freelancers, moonlighters, etc.). Embezzlement from these plans by trustees led to the passage of and the Employee Retirement Income Security Act of 1974 (ERISA). That same year another entity was formed by the government, the Pension Benefit Guaranty Corporation, which serves as the insurer of many pension plans.

Deferred compensation, defined benefits, and defined contribution plans are common forms of retirement plans. All plans having to do with retirement are considered pension plans. In the 1980s, defined-benefit (DB) plans have lost popularity in favor of defined contribution plans. DB plans are standard retirement accounts which currently require a five-year vesting period. In 1979, 17 % of pension plans were DC. By 1988 this percentage had grown to 34 percent. Labor unions tend to use DB plans extensively, and this may account for some of the decline. A primary Alison for the growth of DC, however, is the emergence of 401(k) plans, in which employers match a percentage of employee contributions; these are generally invested in mutual funds or stock plans. Also, as the workforce becomes more mobile DC plans are preferable because the amount invested can be rolled into another account at another employer. DC plans, however, face scrutiny by many financial advisers for two reasons:

1. the investment decisions made by the company may be too restrictive for the employee to meet individual goals; and
2. many times employees are not educated about the risk and returns available through the given investment vehicles.

In 1990 DC and DB plans distributed $126 billion in lump-sum payments, an amount that was equal to half of all Social Security checks posted mat same year. Rollover activity into similar tax-deferred plans continues to increase as tax laws require a 20 percent withholding (ax to be paid on the lump-sum if it is not rolled over. Merrill Lynch leads the market in attracting this rollover business. In 1993 65,000 new retirement accounts were opened at Merrill Lynch, averaging $100,000 each.

Perhaps the most significant difference between DB and DC plans is the voluntary nature of the DC plan. DB plans are generally automatic, reserved for union and salaried employees. DC plans are fully voluntary, deferred-compensation plans in which an hourly or salaried employee elects to have a certain percentage of money deducted — before taxes — from the paycheck. Adding to the financial pressure of DB plans on employers, nondiscrimination rules have been enacted for 1996. These rules state that public sponsors must offer the same benefits to all employees regardless of their compensation. Many state and local municipalities have moved to DC plans to avoid this new mandate. Similarly, the voluntary nature of DC plans makes detractors wonder if ill-informed employees will have less in their DC accounts at retirement than if the DB plans had been available.

Two possible changes in the laws that govern retirement accounts have recently been the center of debate. Senator Howard Metzenbaum of Maryland introduced a pension reform bill in 1994 that would allow all employees to participate in a company's retirement plan (if the company has one), reduce the term of full vesting to 750 hours, and ease rollover requirements should an employee change employers. The proposed bill also provides for immediate vestment of employer contributions to DC plans. The other change is encompassed in me proposed Retirement Protection Act of 1993. The idea behind me act is that age and service-weighting factors are not in line with nondiscrimination rules. These factors supposedly tend to favor highly-paid employees who can use the DC plans as a tax shield.