Retirement: A part-time pension

After more than 25 years on the job, Steve Stephens, 57, wanted to cut back on his hours without jeopardizing his lucrative pension benefits. Luckily for Stephens, his employer, Volkswagen of America, granted his request. He transferred from a high-pressure position, human resources leader, to manage special projects until he qualifies for early retirement next year.

Stephens, who lives in suburban Detroit, is typical of many aging baby boomers looking for more leisure time without completely abandoning their paychecks. Nearly two-thirds of older workers say they would like to work part-time before retiring completely, according to a survey by Watson Wyatt Worldwide. And one in three would be willing to stay on the job past normal retirement age if their employer offered a phased-retirement program.

But two major obstacles may stand in the way. First, most defined-benefit pension plans base benefits on the employee's final three or five years of pay. The second barrier is a federal rule that prevents tapping your pension early if you're still on the job.

But change is coming to encourage phased retirement. A proposed IRS regulation will allow employees who are at least 59 1/2 and who reduce their hours at least 20 percent to collect partial pension distributions while continuing to work. For example, if a 60-year-old worker who is entitled to a $2,000 monthly pension cuts his hours in half, he could collect a part-time salary and a $1,000-per-month pension check.

Under the proposal, which is likely to be adopted later this year, a partially retired worker would continue to earn pension benefits, and benefits earned based on the higher, full-time salary would be protected. Once the worker retired completely, monthly benefits would be recalculated to take into account additional benefits earned and partial benefits already received.

The change would apply only to defined-benefit pension plans, which cover less than 20 percent of U.S. workers. IRS rules already allow participants in the more common defined-contribution 401(k) plans to withdraw money at age 59 1/2 — although some employers forbid distributions while employees are still on the job.

Access to retirement benefits to supplement part-time income could be critical to younger retirees whose earnings restrict their ability to collect Social Security. In 2005, those under the normal retirement age — 65 and six months this year — lose $1 in benefits for every $2 over the earnings limit of $12,000 a year. By supplementing part-time work with partial retirement benefits, older workers could delay collecting Social Security.