Retirement: Early Retirement Incentives

Early retirement programs that are available to workers for a specified period of time are often called window plans. Such plans offer special terms for retirement, but the worker must accept the offer and retire by a certain date; the retirement window opens and then closes. These plans have taken many forms but are often linked with an existing defined benefit plan. For example, the plan might state that if the worker retires within the window, pension benefits will be calculated by adding three or five years to the worker’s actual age, or by adding three or five years to the worker’s years of service, or both. Obviously, retirement benefits will be higher under the terms of the window plan, thus providing the worker with an incentive to retire now rather than waiting. Window plans were widely used by large corporations in the 1980s and early 1990s in efforts to downsize their workforces. Switkes provides a detailed assessment of the effectiveness of window plans offered by the University of California.

Workers respond to these special retirement incentives by moving up their retirement date and leaving the firm sooner than they had planned. Firms typically introduce window plans when they are attempting to reduce the size of the labor force. By downsizing, firms reduce the cost of active workers; however, pension costs are increased. This may not be considered a problem if the pension is overfunded, so that new contributions are not required to support the cost of the window program. These plans are less cost effective if the company is trying to address imbalances in the age or skill mix of its workforce at the same time higher payments to retirees are coupled with additional wage payments to persons hired to replace the departing workers.

Companies that adopt early retirement window plans are usually large firms seeking to reduce the size of their labor force and, thus, their labor costs. These offers have to be generous enough to alter the retirement decisions of workers. One problem often associated with these plans is that high-quality workers (the ones the company would like to keep) are often the first to leave because they can take the ERI from their current firm and find employment with another company. Workers with fewer employment opportunities (lower-quality workers) may be less likely to accept the ERI. Because of this incentive, some organizations have attempted to target their window plans to certain divisions or workers with below-average pay.