RETIREMENT PLANNING

The vast majority of individuals and couples in the United States can look forward to their retirement—that period later in life when they are no longer working full-time and are supported by financial resources accumulated during their working years. The average retirement age in the United States, based on data from the 1998 Survey of Consumer Finances, is 62.7 years. At this age, in 1998, life expectancy in retirement for an unmarried male was 16.4 years; while for an unmarried female life expectancy at this age was 19.8 years; and for a married couple it was 23.9 years. This means that the typical American needs to be able to fund spending needs for about twenty years of retirement living. Since life expectancies are increasing with advances in medicine, younger generations will have even longer retirements to contemplate. The main implication of this is that longer life expectancies can represent an increase in the risk of a shortfall in financial resources, or in the risk of outliving one’s resources. The risk of shortfall can be greatly reduced with proper financial planning.

The idea that it is never too early to begin planning for retirement is a reasonable one. For example, one should identify employer-provided retirement plans as part of the job selection process. Starting to plan while younger allows one to plan a long-term strategy that can be maintained and adjusted over time. In a world that is uncertain and volatile, retirement planning must be an ongoing process, with decisions made and reviewed as conditions and life circumstances change.

Retirement planning, broadly conceived, means preparing for one’s retirement years, which could extend for two or more decades of later life. This includes consideration of issues such as long-term care and the provision of an estate to one’s heirs. Planning for retirement comes down to a comparison of needs and resources. The main goal is to ensure that one is able to meet annual spending requirements as well as any one-time expenses that may arise. This is done by not only considering resources such as Social Security and defined benefit pension plans, but also considering personal savings. Defined benefit pensions, also known as formula-based pensions, are typically fixed annual payments based on years of service and salary level. Personal savings may include an individual retirement account (IRA) and 401(k), 403(b), or Keogh plans. Due to high administrative costs and maintenance, many companies have opted for, or converted to, defined contributions plans such as a 401(k). These plans allow an employee to make tax-deferred contributions through a payroll deduction. In some of these types of employer-provided plans, the employer may match some level of the employee’s contributions, which provides a guaranteed return. However the investment assets selected or asset allocation must be decided, at least in part, by the employee. This places the responsibility on the employee to not only elect how to fund the account, but also to determine how the account will be invested—which may or may not be advantageous, depending on the individual level of investment knowledge.

Timing retirement

One factor that distinguishes retirement planning from other aspects of financial planning (such as risk management) is that the timing can be, in most cases, anticipated. While some individuals experience early retirements due to health reasons, the majority of Americans have some measure of control over retirement age. This provides an advantage for planning purposes, since a specific horizon is known for asset allocation. Further, it allows one to anticipate what other resources may be available. In fact, the timing of retirement is often related to the timing or availability of Social Security or any defined benefit pensions.

Social Security retirement benefits have gone through some changes, one of which is that the age of eligibility for full retirement benefits is scheduled to increase for most recent birth cohorts. As of 2001, an individual can elect to take a reduced benefit as early as age sixty-two. Thus, it is no surprise that the average retirement age is just over sixty-two. For anyone that retires prior to age sixty-two, there will be some period during which there is no Social Security benefit. This is certainly an issue that should be considered when choosing a retirement age.

Eligibility benefits from other defined benefit pensions adds an additional element to the timing issue, since these plans may lessen the financial impact of retiring prior to age sixty-two. Since eligibility is (as well as benefits from) typically based on years of service, an individual who was first covered by this type of plan in his or her twenties could be eligible for benefits at some point after age fifty. Some people might retire earlier as a result, while others might retire from their current careers but still work elsewhere.

Retirement adequacy

One’s desired annual spending in retirement is a more ideal choice for determining annual needs in retirement. Some methods argue for use of an income replacement rate, but this assumes that a single percentage would work for a large number of households and individuals. Instead, a planner can help a client think through this situation. There are several ways this is done. One such approach, from economic theory, assumes that households seek to smooth consumption across changes in the life cycle and that ideal annual spending is equal to average annual income—taking into account issues such as taxes and interest rates. Another approach is more introspective. This method begins with an existing and comprehensive income and expenditure statement. This process involves examining each expense and determining how it might change in retirement. Examples might include a mortgage being paid off, children who become independent, or increasing health care costs. Additional considerations for retirement spending needs include ties to family, obligations to children and parents, whether to continue some type of employment, creative use of leisure time, and community service. What a person will do once retired is at least partly a question about identity and meaning, but financial implications will affect such decisions.

One should also try to anticipate the impact of taxes. Even though there are some tax advantages for retirement savings and Social Security benefits, taxes will still be owed on all tax-deferred assets as distributions are taken. This is important because spending estimates show how much after-tax income is required for a household. However, distributions from most retirement plans will face taxation when withdrawn and as such, one should consider what pretax amount should be withdrawn to provide the after-tax spending requirement.

Resources expected to continue in retirement, such as defined benefit pension plans and Social Security, are used to help meet desired annual spending needs. For many households, this would still mean that there is an annual spending gap, which represents the amount of one’s desired annual spending not covered by continuing resources such as Social Security. The annual spending gap represents the amount of annual spending needs that is to be provided by investment proceeds and distributions from retirement savings. This gap is likely to be considerably higher for those who have enjoyed higher incomes throughout their working years. This is because higher income tends to indicate higher spending, and the income replacement rate of Social Security retirement benefits diminishes with higher levels of income. However regardless of a person’s pre-retirement level of living, Social Security is not likely to be sufficient as a sole resource for retirement spending needs. This makes investing for retirement essential for all households.

The annual spending gap estimation can be complicated by several issues. Since the starting age for benefits such as pensions and Social Security may differ, there may be different stages of retirement where different resources are available. For example, a husband and wife may retire in different calendar years, resulting in more than one annual spending gap. Other situations where there might be multiple planning periods include retiring before Social Security benefits are available and working during the early retirement years. Each of these stages should be considered and accounted for by discounting the annual spending gap for each year, up to the day of retirement.

The determination of retirement planning adequacy can then be thought of as comparing the annual spending gap with income from investments accumulated during the preretirement years. This comparison can be done by comparing the total value of the annual spending gap for all retirement years, adjusting them downward to reflect the future compounding they would have during retirement. The appropriate discount rate would be the expected portfolio rate of return for investments during retirement, based on asset allocation. The expected value of investments should be based on historical returns for the asset types. Calculations should consider that the asset allocation is likely to change over time. While average returns are most appropriate, some planners may also include an estimate based on a more pessimistic return for those who would like to be prepared for the worst case. If expected investment levels are equal to or greater than the discounted annual spending gaps, then the current investment strategy is adequate.

In the event of inadequacy, there are two potential courses of action that can be taken to improve the situation. The first possibility is to increase investment contributions to the required levels. However, this is only possible if the investor has additional investment capital and is not currently maximizing tax-advantaged contributions to retirement savings. If tax-advantaged contributions are already at the maximum allowed levels, then the investor may also use nontax-advantaged accounts. The second option would be to increase the aggressiveness of the portfolio, if prudent to do so. This could be accomplished by placing a higher percentage of the portfolio into equity investments. However, it is possible that a more aggressive portfolio might conflict with one’s risk tolerance. It is prudent for most investors to consider enlisting the advice of a professional to explain the risks and make recommendations regarding portfolio strategy. Others may simply have a planner perform a retirement adequacy assessment to ensure that the retirement plan is on target.

A second approach to determining adequacy uses advances in simulation methods and is known as a Monte Carlo approach. Often, individuals perceive risk as the likelihood of goal achievement or failure. The Monte Carlo simulation determines the odds of success of a specific financial plan. Most simulations will use several inputs, including asset allocation, bequest motives, pension plans, and desired annual spending. One advantage of this program is an estimation of odds of success, which has direct meaning to an individual. Further, if the odds of success are too low for an individual to accept, changing different inputs can show how the odds can be improved. One such change may include changes in asset allocation. However, while the programs will generate asset allocations, it is still up to an investor to select appropriate assets that conform to the recommendations. Many individuals may choose to use a professional for this.

Both of these approaches to determining asset adequacy require information about expected retirement benefits. Fortunately, this information tends to be readily available. Individuals age twenty-five and older who participate in Social Security will periodically receive a Personal Earnings and Benefit Estimate Statement (PEBES). This statement provides the taxpayer with information about his or her retirement benefits based on retiring at the age of full benefit eligibility, about the maximum delayed benefit, and about the reduced benefit obtainable at age sixty-two. The Social Security website (www.ssa.gov) provides online estimators for retirement benefits. Similar types of statements or calculators are available for most defined benefit pensions. This allows an individual or household to consider expected benefits when making planning decisions.

Asset allocation

While several factors need to be considered for asset allocation, including risk tolerance, the investment horizon is a key factor. This is because of the law of large numbers. As it relates to investing, the law of large numbers states that the longer an asset is held, the more the average annualized return can be expected to behave like the historical average for that asset type. This means that, while in any given year the return may be positive or negative, on average it should earn a return close to the historical average. This is important since, in the long run, stocks outperform all other asset types and small stocks tend to have the highest average return. One caveat is that this concept assumes that one holds a portfolio that is representative of the data. That is to say that owning one stock is not necessarily sufficient to assume that it should perform the same as the overall market. The idea is that one has a well-diversified portfolio that mitigates or eliminates any company-specific risks. This can be easily accomplished through the use of mutual funds, especially funds that are broadly based. One example of such a portfolio might be an index mutual fund that is based on the Standard and Poor 500.

The risk tolerance of an individual is the amount of risk that one is willing to assume in investment choices. This may be thought of as being related to the proportion of wealth that one would be willing to place in riskier assets such as stocks. Many financial planners will use some subjective measure of risk tolerance based on hypothetical scenarios. Using results from these measures, the planner formulates investment recommendations. However, a good planner will not only consider the client’s risk tolerance, but also more objective measures such as investment horizon (time until retirement).

A person’s asset allocation choice will determine the composition of the investment portfolio, that is the allocation of portfolio shares to stocks, corporate and government bonds, and money market instruments. Since stocks outperform all other investments in the long run, younger investors saving for retirement can take advantage of the time that they have before retirement and invest more aggressively. Some would say that individuals with at least twelve years or more to retirement should consider a portfolio heavily weighted with equities. However, as retirement looms closer and the horizon grows shorter, an all-stock portfolio is no longer an optimal choice because the confidence that stocks will have a higher return in the shorter-term decreases. At that time, it becomes prudent to shift some of the equity to fixed-income securities such as bonds or bond mutual funds. This uses the fixed return on the bonds to offset the increased volatility of the equity holdings. Therefore, in early working years, investors should be more aggressive when saving for retirement, and as investors approach retirement (within ten years or so) they should become more conservative.

At retirement, investors can spend accumulated asset to purchase a life annuity. This insurance contract promises an annual or monthly payment for the rest of one’s life in exchange for a lump sum payment. This eliminates the risk of outliving one’s assets, since the payments would be assured for one’s remaining life expectancy. There may be survivorship provisions as well in these contracts that provide income for surviving spouses or others. However, there is minimal control over the investment management of the annuity. Another potential disadvantage is that the annuity would not allow for advance payments which might be needed should any large one-time costs arise.

Other methods provide more control over assets. An alternative, the perpetuity approach, involves holding accumulated investments and using their proceeds for spending purposes. This gives the individual more control over distributions and investment management. However, without proper guidance, this approach increases the risk of outliving one’s assets. Some combination of both approaches may be more ideal, but is not necessarily feasible for households without significant wealth. A choice between the two approaches must therefore often be made. This choice can be made by comparing the perceived risk of asset shortfalls with the perceived risk of having any need for large distributions. One other consideration is the perceived opportunity cost of reduced management control. While annuities greatly reduce the shortfall risk, and the perpetuity approach allows the distribution amount to be determined by the investor. Another factor influencing this choice may be the desire to leave a bequest to heirs. While annuities may provide for survivorship, the ability to leave assets to heirs is much simpler when assets remain in the estate.

During retirement, assuming one does not annuitize all wealth, asset allocation becomes essential. Assets must maintain a level of return that will be sufficient to avoid shortfall and, potentially, provide for a desired bequest. The retirement asset allocation needs to include some highly liquid investments, as well as ones that will provide a reasonable rate of return. The use of money market transaction accounts might be advantageous, rather than a checking account, since money market accounts usually provide a real rate of return slightly higher than a regular savings account. Use of laddered Certificates of Deposit (CDs) can be useful as well. The laddered approach is to purchase CDs of varying maturities so that they mature as they are needed. Since there are other assets available in an emergency, these CDs should typically be able to be held until maturity. The remaining portfolio should be well diversified to minimize risk. Again, mutual funds may be ideal for this situation, as they bring inherent diversification.

Using a professional

Having access to some level of retirement advice has become easier than it once was. The Certified Financial Planner (CFP) designation has become the symbol for a financial advisor; a CFP practitioner has passed a comprehensive exam covering all major financial planning topics and is bound by a code of ethics that is strongly enforced by the CFP Board of Standards. Some of the known benefits of using a professional include improved asset allocation and asset choice. Planners can more efficiently evaluate adequacy of current financial plans than can most individuals, and they can provide advice on how to improve the likelihood of success by finding ways to improve the current plan. CFP practitioners can be found at most large financial institutions, including brokerage houses and investment companies.

Not every individual is comfortable with, or needs, formalized planning when other alternatives might be useful. Individuals with Internet access can find a wide variety of information and strategies online, for example. However, the majority of these strategies will come down to asset allocation based on investment risk tolerance and horizon. Common themes will include stocks for the long run and some level of liquidity in retirement. Some websites even have information for contacting representatives who are qualified to answer questions. Benefit counselors can typically answer basic questions and provide simple interpretations of information. Employer-provided counselors can also clarify issues related to any employer-provided benefits that exist, including pension plans and health benefits.

Special considerations

One important issue in retirement planning is the gender and marital status of an individual. Women tend to have a higher life expectancy than men, and married couples should consider the increased likelihood of shortfall for women— due not only to increased life expectancy but also because one or more of a couple’s retirement resources will be lost with the passing of a spouse, which may place an even greater importance on investments after this point.

Another source of concern is that women may have lower risk tolerance than men. While this difference is still under dispute, it has important implications for women preparing for retirement. Women may tend to be too conservative in their investing, and they therefore are less likely to be invested in stocks. Financial planners should be certain to spend time explaining the ideas behind the strategy of investing in stocks for the long run.

Historically married women have been able to rely on a husband’s savings, even when their own employers have offered defined contribution plans. However, given the increased likelihood of divorce today, women should be certain that they are contributing to assets in their own name and are part of the decision-making process. Then, should they find themselves on their own, they will not only have begun accumulation of their own resources, but will know why those decisions were made and will be able to participate in future investment choices.

Another important issue is the consideration of health concerns. While one may accumulate a significant amount of wealth prior to retirement, this wealth could easily be diminished because of illness. Medicare is generally not available until one is sixty-five years of age, and anyone retiring prior to this age should therefore make arrangements for some protection. However, Medicare is not all-inclusive and currently does not provide for nonhospital prescriptions or long-term care needs beyond 120 days. Therefore any long-term illness could quickly use up any personal savings. The financial effect of such an illness can be mitigated through the use of private insurance plans. This may include continued participation in private health insurance plans through a previous employer. However, a more common trend has been for households to acquire long-term care insurance. These plans can typically be purchased for five different levels of coverage, including skilled nursing care, intermediate nursing care, custodial care, home care, and adult day care. These policies can be quite costly, but lower rates may be attainable for those who elect to enroll at younger ages, such as in their mid-fifties. Despite their cost, these plans may prevent the diminishing of an otherwise sufficient investment portfolio.

Overall the key elements to a retirement plan include choosing a retirement age and level of living, making investment choices, and assuring proper health care coverage. Taking advantage of time and investing principles can lead to higher levels of accumulated savings by retirement, and thus a higher level of living in retirement.

Michael S. Gutter

See also Retirement, Decision-Making; Retirement, Early Retirement Incentives; Retirement Patterns; Retirement Planning Programs; Retirement, Transition

BIBLIOGRAPHY

Garner, R. J.; Young, E.; Arnone, W. J.; and Baker, N. A. Ernst and Young’s Retirement Planning Guide: Take Care of Your Finances Now . . . And They’ll Take Care of You Later. New York: John Wiley and Sons, 1997.

MSN Money. Available on the World Wide Web at http://moneycentral.msn.com

American Association of Retired Persons (AARP). AARP Webplace. Available on the World Wide Web at www.aarp.org

mPowerCafe. Available on the World Wide Web at www.mpowercafe.com

Kiyosaki, R. T., and Lechter, S. L. Retire Young, Retire Rich. New York: Warner Books Inc., 2001.

Siegel, Alan M.; Morris, V. B.; and Morris, K. M. The Wall Street Journal Guide to Planning Your Financial Future: The Easy-To-Read Guide to Planning for Retirement. New York: Fireside, 1998.

Stanley, T. J., and Danko, W. D. The Millionaire Next Door: The Surprising Secrets of America’s Wealthy. New York: Simon and Schuster, 1998.

Retirement Planning

Retirement planning describes the financial strategies individuals employ during their working years to ensure that they will be able to meet their goals for financial security upon retirement. Making sound decisions about retirement is particularly important for self-employed persons and small business owners. Unlike employees of some large companies, who can simply participate in the pension plans and investment programs offered by their employers, entrepreneurs must set up and administer plans for themselves and for their employees.

In recent years there has been a shift away from company-funded, defined-benefit pension plans. These plans were common within large firms during the 1950s through 1970s and into the 1980s. A defined-benefit pension plan is one in which the employer pays into and manages a plan based on calculations of how much the fund will need in order to provide an employee with a particular, defined post-retirement income. Such a plan guarantees all qualified employees with a predetermined retirement benefit. Many things have combined to cause a shift away from defined-benefit plans and towards defined-contribution plans. One of the more important of these, other than substantial demographic pressure that the retirement of the baby boom generation is having on all retirement issues, was the passage of an obscure provision in the Tax Revenue Act of 1978, the 401(k) provision. This provision went largely unnoticed for two years until Ted Benna, a Pennsylvania benefits consultant, devised a creative and rewarding application of the law, an application which became what is known today at the 401(k) plan.

A 401(k) plan is just one of various types of plans which fall under the umbrella of defined-contribution plans, as opposed to defined-benefit plans. A defined-contribution plan is one in which there is no guaranteed post-retirement benefit but rather a defined monthly or yearly contribution to a plan. How the plan's assets are invested and how much they are worth at retirement is not defined by the plans. Employees are responsible, in most cases, for investment decisions and the level of contribution made to the plan. With defined-contribution pension plans employees pay into the plan on a tax-deferred basis and in most cases, the employer agrees to a minimum contribution or agrees to match some percentage of the contribution made by the employee. Many business writers believe that this shift from defined-benefit plan to defined-contribution plan has helped to level the playing field for small businesses. Smaller companies are now able to offer the same type of retirement benefits as many larger employers.

Though establishing and funding retirement plans can be costly for small businesses, such programs also offer a number of advantages. In most cases, for example, employer contributions to retirement plans are tax-deductible expenses. In addition, offering employees a comprehensive retirement plan can help small businesses attract and retain qualified people who might otherwise seek the security of working for a larger company. The number of small firms establishing retirement plans grew during the 1990s, but small employers still lag far behind larger ones in providing this type of benefit for employees.

Retirement planning is a topic of interest to all Americans, not only to small business owners and entrepreneurs. The debate over whether Social Security will be available for the younger members of the current work force adds legitimacy to the need for early retirement planning. Longer life expectancies mean that more money must be set aside for retirement, while the uncertainty of investment returns and inflation rates makes careful planning essential. In fact, some experts recommend that individuals invest a minimum of 14 percent of their gross income from the time they enter the work force to guarantee a comfortable retirement.

Unfortunately, most of us are not doing this. In fact, most Americans approaching retirement in 2005 do not have enough to retire on according to Jack VanDerhei, Senior Research Fellow at the Employee Benefit Research Institute (EBRI). In response to an interviewer's question on the Public Broadcasting System's Frontline show, VanDerhei explained that most people approaching retirement now have about three times their annual salary saved for the post-retirement period. The EBRI recommends that a man have 6.3 times his annual salary available for post-retirement living and a woman 6.7 times her annual salary. (Women have a longer life expectancy than men and therefore need slightly more retirement savings.) Financial planners and insurance analysts recommend even higher retirement savings goals—10 to 15 times annual salary—as necessary for a reasonable retirement. What is clear in all studies on this subject is the fact that as Americans, we are not now saving adequately for retirement.

LAWS GOVERNING RETIREMENT PLANS

The Social Security Administration was created in the 1930s as part of President Franklin Roosevelt's New Deal. Private pension plans mushroomed shortly thereafter, offering coverage to millions of employees. In 1962 the Self-Employed Individuals Retirement Act established tax-deferred retirement plans from which account holders could withdrawals starting between the ages of 59 1/2 and 70 1/2. These plans—also known as Keogh plans after their originator, New York Congressman Eugene J. Keogh—were intended for the self-employed and for those who have income from self-employment on the side. Embezzlement from pension plans by trustees led to the passage of the Employee Retirement Income Security Act of 1974 (ERISA). One of the main provisions of ERISA was to set forth vesting requirements—time periods over which employees gain full rights to the money invested by employers on their behalf. ERISA governs most large-employer-sponsored pension plans, but does not apply to those sponsored by businesses with less than 25 employees.

TYPES OF RETIREMENT PLANS

The two main categories of retirement plans are defined-contribution and defined-benefit. Perhaps the most significant difference between defined-benefit and defined-contribution plans is the voluntary nature of defined-contribution plans. Such plans are usually fully voluntary, so that hourly or salaried employees elect to have a certain percentage of money deducted—before taxes—from their paychecks. Conversely, defined-benefit plans involve automatic contributions made by the employer, with no active participation on the part of the employee.

One significant advantage of defined-contribution plans is that the amount invested by employees can be rolled over into another account with another employer. Rollover activity into similar tax-deferred plans has continued to increase as tax laws require a 20 percent withholding tax to be paid on the lump sum if it is not rolled over. Nonetheless, defined-contribution plans continued to face scrutiny by many financial advisers for two reasons: 1) the investment decisions made by the company may be too restrictive for employees to meet individual goals; and 2) many times employees are not educated about the risk and returns associated with the investment vehicles available through the company plan. Similarly, the voluntary nature of defined-contribution plans makes detractors wonder if ill-informed employees will have less money in their defined-contribution accounts at retirement than they would have had under a defined-benefit plan.

OPTIONS FOR SMALL BUSINESSES

Small business owners can set up a wide variety of retirement plans by filling out the necessary forms at any financial institution (a bank, mutual fund, insurance company, brokerage firm, etc.). The fees vary depending on the plan's complexity and the number of participants. Some employer-sponsored plans are required to file Form 5500 annually to disclose plan activities to the IRS. The preparation and filing of this complicated document can increase the administrative costs associated with a plan, as the business owner may require help from a tax advisor or plan administration professional. In addition, all the information reported on Form 5500 is open to public inspection.

The most important thing to remember is that a small business owner who wants to establish a qualified plan for him or herself must also include all other company employees who meet minimum participation standards. As an employer, the small business owner can establish retirement plans like any other business. As an employee, the small business owner can then make contributions to the plan he or she has established in order to set aside tax-deferred funds for retirement, like any other employee. The difference is that a small business owner must include all nonowner employees in any company-sponsored retirement plans and make equivalent contributions to their accounts. Unfortunately, this requirement has the effect of reducing the allowable contributions that the owner of a proprietorship or partnership can make on his or her own behalf.

For self-employed individuals, contributions to a retirement plan are based upon the net earnings of their business. The net earnings consist of the company's gross income less deductions for business expenses, salaries paid to nonowner employees, the employer's 50 percent of the Social Security tax, and—significantly—the employer's contribution to retirement plans on behalf of employees. Therefore, rather than receiving pre-tax contributions to the retirement account as a percentage of gross salary, like nonowner employees, the small business owner receives contributions as a smaller percentage of net earnings. Employing other people thus detracts from the owner's ability to build up a sizeable before-tax retirement account of his or her own. For this reason, some experts recommend that the owners of proprietorships and partnerships who sponsor plans for their employees supplement their own retirement funds through a personal after-tax savings plan.

Nevertheless, many small businesses sponsor retirement plans in order to gain tax advantages and increase the loyalty of employees. A number of different types of plans are available. The most popular plans for small businesses all fall under the category of defined-contribution plans. In nearly every case, withdrawals made before the age of 59 1/2 are subject to an IRS penalty in addition to ordinary income tax. The plans differ in terms of administrative costs, eligibility requirements, employee participation, degree of discretion in making contributions, and amount of allowable contributions. Brief descriptions of some of the most common types of plans follow:

Simplified Employee Pension (SEP) Plans

SEP plans are employer-funded retirement accounts that allow small businesses to direct at least 3 percent and up to 15 percent of each employee's annual salary, to a maximum of $30,000, into tax-deferred individual retirement accounts (IRAs) on a discretionary basis. SEP plans are easy to set up and inexpensive to administer, as the employer simply makes contributions to IRAs that are established by employees. The employees then take responsibility for making investment decisions regarding their own IRAs. Employers thus avoid the risk and cost involved in accounting for employee retirement funds. In addition, employers have the flexibility to make large percentage contributions during good financial years, and to reduce contributions during hard times. SEP plans are available to all types of business entities, including proprietorships, partnerships, and corporations. In general, eligibility is limited to employees 21 or older with at least three years of service to the company and a minimum level of compensation. The maximum level of compensation for SEP eligibility is $170,000.

Savings Incentive Match Plan for Employees (SIMPLE)

SIMPLE plans take two forms: a SIMPLE IRA and a SIMPLE 401(k). Both plans became available in January 1997 to businesses with less than 100 employees, replacing the discontinued Salary Reduction Simplified Employee Pension (SARSEP) plans. They were intended to provide an easy, low-cost way for small businesses and their employees to contribute jointly to tax-deferred retirement accounts. An IRA or 401(k) set up as a SIMPLE account requires the employer to match up to 3 percent of an employee's annual salary, up to $6,000 per year. Employees are also allowed to contribute up to $6,000 annually to their own accounts. Companies that establish SIMPLEs are not allowed to offer any other type of retirement plan. As of early 1997, most small businesses chose the SIMPLE IRA option, as the SIMPLE 401(k) proved more expensive than a regular 401(k) due to the company matching requirements. The main problem with the plans, according to many financial planners, was that legislation is already being drafting that would make SIMPLE less simple and more expensive for the businesses that the plans were created to serve.

Profit Sharing Plans

Profit sharing plans enable employers to make a discretionary, tax-deductible contribution on behalf of employees each year, based on the level of profits achieved by the business. The total annual contribution is generally allocated among employees as a percentage of their compensation. Plan costs are tax deductible for the employer, and plan earnings are tax deferred for employees. Profit sharing plans are easy to implement, offer design flexibility, and provide a wide range of investment choices. Eligibility is typically limited to employees who are at least 21 years of age and who have at least one year of service. The employer's maximum deduction is 15 percent of the total annual salaries paid to nonowner employees (adjusted to 13.04 percent for the small business owner).

A common variation is the age-based profit sharing plan, in which contributions are based on an allocation formula that factors in the age or number of years to retirement of participants. Age-based profit sharing allows employers to reward valued older employees for their length of service. Another variation is the new comparability profit sharing plan, which allows employers to define classes of employees and set up the retirement plan so that certain classes benefit the most in terms of allocation. These types of profit sharing plans are similar to defined-benefit plans, but the employer contributions are discretionary.

Money Purchase Pension Plans

Money purchase pension plans are similar to regular profit sharing plans, but the employer contributions are mandatory rather than discretionary. The main advantage of money purchase plans is that they allow larger employer contributions than regular profit sharing plans. The employer determines a fixed percentage of profits that will be allocated to employee retirement accounts according to a formula. The maximum employer contribution jumps to 25 percent of payroll for nonowner employees (adjusted to 20 percent for the small business owner) or a total of $30,000 per employee. There are also combination money purchase-profit sharing plans that allow employers to select a fixed percentage for mandatory contribution and also retain the option of contributing additional funds on a discretionary basis when cash flow permits.

401(k) Profit Sharing Plans

The popular 401(k) plans are profit sharing plans that include a provision for employees to defer part of their salaries for retirement. The employer can make annual profit sharing contributions on behalf of employees, the employees can contribute up to $10,000 of pre-tax income themselves, and the employer can choose to match some portion of employee contributions. 401(k) plans offer a number of advantages. First, they allow both employer and employee to make contributions and gain tax advantages. Second, they can be set up in such a way that employees can borrow money from the plan. Third, 401(k) plans enable employees to become active participants in saving and investing for their retirement, which raises the level of perceived benefits provided by the employer. The main disadvantages are relatively high set-up and administrative costs. Eligibility for 401(k) plans is typically limited to employees at least 21 years of age who have at least one year of service with the company.

Small businesses that establish 401(k)s must be careful to avoid liability for losses employees might suffer due to fluctuations in the value of plan investments. Under ERISA, plan sponsors can avoid liability by ensuring that their 401(k) meets three criteria: offering a broad range of investment options to employees; communicating sufficient financial information to employees; and allowing employees to exercise independent control over their accounts.

Nonqualified Deferred Compensation Plans

Finally, there is a type of plan often used by businesses to supplement existing qualified plans and provide an extra benefit to key personnel and highly compensated employees. In small businesses, this usually includes the owner and founder. Broadly defined, a nonqualified deferred compensation plan (NDCP) is a contractual agreement in which a participant agrees to be paid in a future year for services rendered this year.

There are two broad categories of nonqualified deferred compensation plans: elective and non-elective. In an elective NDCP an employee chooses to receive less current salary and bonus compensation than he or she would otherwise receive postponing the receipt of that compensation until a future tax year. Non-elective NDCPs are plans in which the employer funds the benefit and does not reduce current compensation in order to fund future payments. Such plans are, in essence, post-termination salary continuation plans. The argument behind such non-elective plans, funded by employers, is the retention of key employees.

One feature in particular of nonqualified deferred compensation plans that has made them a very popular tool for use by large corporations and some small businesses, is the fact that they are not limited by the same non-discrimination rules imposed on qualified plans. NDCPs may be offered to a select group of employees only, unlike qualified plans to which all employees are eligible by definition. Consequently, the cost of this benefit is lower since it accrues to fewer people. NDCPs are a type of plan that is particularly useful for small business owners in augmenting their own retirement savings plans.

WHICH PLAN TO CHOOSE

Small business owners must carefully examine their priorities when selecting a retirement plan for themselves and their employees. If the main priority is to minimize administrative costs, a SEP plan may be the best choice. If it is important to have the flexibility of discretionary contributions, a profit sharing plan might be the answer. A money purchase plan would enable a small business owner to maximize contributions, but it would require an assurance of stable income, since contributions are mandatory. If the small business counts upon key older employees, an age-based profit sharing plan or a defined-benefit plan would help reward and retain them. Conversely, an employer with a long time horizon until retirement would probably do best with a defined-contribution plan. Finally, a small business owner who wants employees to be able to fund part of their own retirement should select a SIMPLE or a 401(k) plan. There are also many possibilities for combination plans that might provide a closer fit with a small business's goals. Free information on retirement plans is available through the Department of Labor at 800-998-7542, or on the Internet at http://www.dol.gov/ebsa/savingmatters.html.

see also Estate Tax; 401(k) Plan; Individual Retirement Accounts; Keogh Plans; Nonqualified Deferred Compensation Plans; Pension Plans; Simplified Employee Pensions

BIBLIOGRAPHY

"The 401(k) Paper Chase." Business Week. 27 March 2000.

Altieri, Mark P. "Nonqualified Deferred Compensation Plans." The CPA Journal. February 2005.

Clifford, Lee. "Getting Over the Hump before You're Over the Hill." Fortune. 14 August 2000.

Infante, Victor D. "Retirement Plan Trends." Workforce. November 2000.

Korn, Donald Jay. "Developing a Plan to Make Your Golden Years Brighter." Black Enterprise. October 2000.

Olson, John. "A Powerful Weapon in the War for Talent." National Underwriter Life & Health-Financial Services Edition. 23 June 2003.

Postal, Arthur D. "New Tax Bill Changes Rules on Nonqualified Deferred Comp Plans." National Underwriter Life & Health. 18 October 2004.

Szabo, Joan. "Pension Tension." Entrepreneur. November 2000.

U.S. Department of the Treasury. Internal Revenue Service. "Nonqualified Deferred Compensation Audit Techniques Guide." Available from http://www.irs.gov/businesses/corporations/article/0,,id=134878,00.html. 10 January 2005.

"What You Need To Set Aside For Retirement." Public Broadcasting Service. Frontline Available from http://www.pbs.org/wgbh/pages/frontline/retirement/world/need.html. Retrieved on 30 May 2006.

Wyss, David. "The Gathering Pensions Storm: Boomers will soon find their retirement kitty has been underfunded. Making up the shortfall will buffet corporations—and the economy" Business Week Online. 5 June 2006.

                               Hillstrom, Northern Lights

                                updated by Magee, ECDI

RETIREMENT

Retirement is primarily a twentieth-century phenomenon that developed through a convergence of public and private employment policies, a restructuring of the life span relative to work activity, and a redefinition of the terms of monetary compensation for work performed. It may be tempting to view retirement as the "natural" development of a social institution matched to the needs of older people experiencing declines in capacity; but the invention of a distinctive nonemployment status called retirement was not simply a response to human aging. Rather, in reconciling a transformed economy to an aging population with an increasing amount of surplus labor, an explicit policy of job distribution was produced. Retirement policies incorporated age as a characteristic that served as both a qualifying and an exclusionary principle for work and income. The fact that these policies were age-based can be linked to the social production of age as a predictor of individual capacity and potential, a production that had ideological roots in the science and larger culture of the time.

HISTORICAL DEVELOPMENTS

Whereas retirement contracts existed in both Europe and colonial America, Plakans (1989) argues that preindustrial retirement was a gradual transition. The head of a household transferred legal title to an heir in exchange for some combination of monetary payments, material provisions, and services as stipulated by the aged person or couple. These contracts were typical of agrarian economies in which land was the main factor in production; they represented the final step in a long and sometimes elaborate process of property transfer. These "stepping-down" practices were therefore most immediately linked to inheritance patterns; they could be used to ensure that family control of the land was maintained (Sorensen 1989).

Between 1790 and 1820, American legislatures introduced policies of mandatory retirement for certain categories of pubic officials. By the late 1800s, the majority of businesses still had no formal policies of fixed-age retirement. Instead, informal policies eliminated older workers from the labor force (Fischer 1977). This decline in the demand for older workers can be linked to changes in the structure of American capitalism. During the late 1800s the structure of American capitalism began to change from small-producer, competitive capitalism to large-scale corporate capitalism (Sklar 1988). Part of this reconstruction involved attempts to rationalize age relations in the workplace, a process that was embedded in a more general disenchantment with older workers and a devaluation of their skills. Indeed, the employment rates for men aged 65 and older showed a steady decline during this period, from 80.6 percent in 1870 to 60.2 percent in 1920 (Graebner 1980). According to Graebner's analysis, retirement became the impersonal and egalitarian method adopted by both public and private employers for dealing with superannuated workers. It allowed employers to routinize the dismissal of older workers, thereby restructuring the age composition of their workforces in a way they believed would enhance efficiency, a belief supported by the principles of scientific management. Pension plans legitimized this process and, at the same time, served as an effective labor control device.

The first pension plan (1875) is credited to the American Express Company, but benefits were restricted to permanently incapacitated workers who were at least 65 years old with a minimum of 20 years of service (Schulz 1976). In 1920, the first general piece of retirement legislation, the Civil Service Retirement Act, provided pension coverage for federal civilian employees. One year later, the Revenue Act of 1921 encouraged businesses to implement private plans by exempting both the income of pension and profit-sharing trusts and the employer contributions to these trusts from income tax liability. Nevertheless, coverage remained concentrated in a few industries, and 85 percent of the workforce continued to be without pension coverage.

By the 1930s, the problem of superannuated workers was coupled with the more general problem of managing surplus labor. The changing technology of the workplace helped transform the labor process. A subsequent increase in worker productivity and the growing recognition of the cyclical crises inherent in industrial capitalism broadened the concern beyond that of simple superannuation to that of job distribution and consumption capacity.

The Depression of the 1930s greatly exacerbated the growing problem of old-age poverty and unemployment. By 1935 unemployment rates among those 65 and older were well over 50 percent. Even those with pension benefits did not escape poverty; trade union plans were collapsing, and state and local governments were reducing or discontinuing pension payments (Olsen 1982). Legislative proposals for alleviating some of these problems included the Townsend Plan and the Lundeen Bill. The Townsend Plan proposed a flat $200 monthly pension for older Americans; recipients had to spend the pension within thirty days. The Lundeen Bill proposed benefits at the level of prevailing local wages for all unemployed workers aged 18 and older (including the elderly) until suitable employment was located. Neither of these plans was directly related to a retirement transition. The Townsend Plan granted equal benefits to all nonemployed persons over age 60. The Lundeen Bill focused more on job creation for workers of all ages than on limiting labor supply through age exclusions.

In 1934, President Franklin Roosevelt appointed the Committee on Economic Security (CES) to develop legislation to address the problems of oldage poverty and unemployment. The Social Security Act of 1935 offered a solution that based benefits on the level of workers' contributions to a general trust fund. Upon their retirement, covered workers (primarily those in manufacturing) could draw retirement benefits, assuming they met the age and work eligibility requirements.

For the CES, retirement referred to complete withdrawal from the labor force. As stated by Barbara Armstrong, an original member of the CES, "[r]etirement means that you've stopped working for pay." According to Armstrong, the option facing the Roosevelt administration pitted older workers against younger workers (Graebner 1980, p. 186). Retirement would reduce unemployment by moving older workers out of the labor force, allowing industries characterized by surplus labor to transfer jobs from older to younger workers. The federal government could facilitate this process by shifting the focus of older workers' financial dependency from the wage contract to a federal income maintenance program. In that sense, the Social Security Act of 1935 established what was primarily a program of old-age relief; its limited coverage and low benefit levels precluded its serving as an effective instrument of retirement. However, in establishing a measure of income support for retired older workers, the act reinforced the view that in the competition for jobs, age was a legitimate criterion, and youth had the "higher claim" (Graebner 1980). Ironically, the mobilization for World War II created job opportunities for older workers, as it did for women. Even though these opportunities proved temporary, they challenged the connection between retirement and superannuation, a connection that was asserted more emphatically when the supply of labor exceeded the demand.

During the next several decades, considerable growth in private pension plans occurred; coverage increased from 4 million workers in the late 1930s to 10 million workers in 1950 and 20 million workers in 1960. The expansion was spurred by a number of factors including the desire of firms to encourage loyalty and reduce turnover, favorable tax treatment, and the 1949 Supreme Court decision to uphold a National Labor Relations Board (NLRB) ruling that pensions were appropriate issues of negotiation through collective bargaining (Schulz 1976). During this same period, Social Security coverage was extended to more workers, and Congress continued to raise benefits in response to changes in the cost of living, although real benefit levels remained relatively low (Derthick 1979).

DECLINING RATES OF LABOR-FORCE PARTICIPATION

Early research on retirement was centrally concerned with the question of voluntarism in the retirement transition, as well as with the financial, social, and psychological consequences of leaving the labor force. Even though the expansion of both government and employer-based pensions had improved the economic situation of older people in retirement, poverty rates among the elderly were still high. By 1960, 35.2 percent of persons aged 65 and older were below the poverty line, compared with 22.4 percent of the general population. Poverty was the norm for older white women and older African Americans (U.S. Bureau of the Census 1987).

During the 1950s, the Social Security Administration began studying the characteristics of newly entitled beneficiaries. Initial reports stated that early retirement occurred primarily because of poor health and difficulties finding and keeping jobs; the availability of Social Security retirement benefits played a secondary role (Wentworth 1945; Stecker 1955). Although these studies relied on beneficiary-reported reasons for retirement, a measurement strategy that was criticized because of its susceptibility to social desirability bias, the findings cannot be totally discounted. Retirement in the 1950s was not a financially attractive status for many older workers. Given that retirement income programs offered "fixed" benefits (benefits that remained nominally the same but, with inflation, declined in real terms), the financial security of middle- and working-class retirees was in jeopardy.

During the 1950s, retirement became more common. Insurance companies led the way in developing "retirement preparation" programs, as researchers attempted to define strategies for "successful aging." In an era of postwar prosperity, retirement came to be viewed as a "period of potential enjoyment and creative experience which accrues as a social reward for a life-time of labor" (Donahue et al. 1960, p. 361). Researchers investigating the effect of retirement on life satisfaction found that "retirement does not cause a sudden deterioration in psychological health as [had] been asserted by other writers" (Streib and Schneider 1971, p. 161). Rather than rejecting retirement, advocacy groups for the elderly lobbied for improved conditions of retirement, including more generous pension benefits. Mandatory retirement had not yet become an issue. Instead, the trend was in the direction of earlier retirement, that is, before the age of 65. In 1956 women and in 1962 men were allowed to retire at age 62 by accepting actuarially reduced Social Security benefits.

During the mid-1960s, in the context of Lyndon Johnson's War on Poverty, the issue of old-age poverty was again addressed. In the Older Americans Act of 1965, Congress established a "new social contract for the aged" (Achenbaum 1983, p. 85) by specifying a series of objectives that, if met, would significantly improve the quality of life enjoyed by older people. Among these objectives was an "equal opportunity to the full and free enjoyment of . . . an adequate income in retirement in accordance with the American standard of living
. . . [and] retirement in health, honor, and dignity" (U.S. Department of Health, Education, and Welfare 1976, p. 2).

Richard Nixon's presidency inaugurated the era of modern retirement. Whereas previous amendments to the Social Security Act had brought more and more workers into the system, they had not significantly improved the level of retirement benefits (Munnell 1977). The presumption that Social Security benefits should serve as retirement income supplements rather than as the primary source of income had not been challenged. But the persistently high rates of old-age poverty lent credence to the charge that benefits were inadequate. During the decade following passage of the Older Americans Act, benefits were increased five times and indexed to changes in the consumer price index. Both the "real" level of benefits and the replacement rate of benefits to previous earnings were improved. Enhanced retirement benefits allowed workers to maintain their standard of living across the retirement transition and helped redefine retirement as a legitimate nonwork status that average-income workers could afford to enter voluntarily. During the 1970s, employer-sponsored pensions were also being reorganized. The 1974 passage of the Employee Retirement Income Security Act (ERISA) regularized vesting plans and provided workers with some protection against benefit loss. Private sector initiatives aimed at inducing early retirement were also increasingly common (Barfield and Morgan 1969). Until the 1970s, workers choosing early retirement virtually always accepted reduced benefits. During the 1970s, however, employers began to offer early retirement incentive plans. Not only did these plans pay benefits at younger ages, but the present value of the benefits often exceeded that of normal retirement benefits.

The parallel changes in labor-force participation rates and in poverty rates among the elderly are noteworthy. In the latter part of this century, labor-force participation rates at older ages declined significantly. During the 1970s, rates for men aged 55–64 dropped from 83 percent (1970) to 75.6 percent (1975) to 72.1 percent (1980) (U.S. Department of Labor 1983). In addition, at the beginning of the decade, 24.6 percent of those aged 65 and older were living below the poverty line, twice the 12.1 percent that characterized the general population. By the end of the decade, the poverty rate among the elderly had dropped to 15.2 percent, compared to an overall poverty rate of 11.7.

As Figure 1 illustrates, the changes in labor-force participation rates (derived from the Current Population Survey) differ by both age and gender. Rates for men and women aged 65 and older appear to have stabilized and perhaps marginally increased from their lowest point. Rates for men aged 55–59 and 60–64 show overall declines with recent hints of a slight upturn. In contrast, rates for women in these age ranges have steadily increased during the last quarter-century, with rates for women in their late fifties surpassing rates for men in their early sixties during the last decade.

DETERMINANTS OF RETIREMENT

Most current research examining retirement is of one of two types: national longitudinal studies that address the behavior of workers across a wide variety of occupations and industries (e.g., Quinn and Burkhauser, 1994; Hayward et al. 1989) and studies of specific firms that assess the retirement behavior of workers who share substantial commonality in workplace features (e.g, Hardy et al. 1996; Stock and Wise 1990). The former design maximizes variation in both work context and individual characteristics, using statistical controls to assess the relative impact of individual and job characteristics on retirement transitions. Because of the sampling strategy, results from these studies can be generalized to the national population of older workers. The second design—the case study—limits observations to workers who share a particular work context and attempts to explain variation in workers' responses to a common decisional matrix.

In both these designs, individualized models of retirement have been dominant, although the relative emphasis of "sociological" versus "economic" models may differ. Retirement models proposed by economists have emphasized the financial considerations involved in exchanging one income flow (e.g., wages and salary) for alternative sources of income (e.g., pensions and income from savings and investments). They have proposed measurement strategies based on the calculation of the present discounted values of the various income streams to attempt to disentangle relative effects. Sociological studies of retirement frequently focus either on the social psychological consequences of retirement or on the importance of occupational structure in shaping behavioral contingencies. Both opportunities and constraints are unequally distributed across workers. Whereas unionized manufacturing jobs may protect older workers through seniority systems, they also provide early retirement incentives through employer-based pension plans. Older workers are also vulnerable to plant closings and job dislocations that accompany mergers, downsizing, and cutbacks. This theoretical framework views retirement transitions as a career characteristic, with late-career behaviors being at least partially contingent on earlier career opportunities. In addition, retirement behavior is embedded in more general macroeconomic conditions. Rates of unemployment, changes in both government and employer pension programs, and the age structure of both the population and the labor force are implicated. Combining insights from both disciplines leads to models in which the financial trade-off is captured by the relative effects of current earnings and the present value of pension benefits; human capital (and, indirectly, the probability of alternative employment) through education, health status, skill level, and age; characteristics of career through years of seniority, history of recent layoffs, and overtime work; and family situation through marital status and the presence of children in the home.

MEASURING RETIREMENT

As the nature of retirement transitions changed, the question of measurement became more difficult. Armstrong's definition of "no longer working for pay" was being replaced by a variety of definitions oriented toward transitions out of career employment or full-time work, changes in major income sources (the receipt of Social Security or employer pension benefits), or changes in identity structures (e.g., through self-identification as a retiree). As definitions of retirement shifted toward receipt of pensions and the inclusion of part-time workers, the concerns of government turned toward the escalating cost of retirement and the advisability of delaying it. It became important to distinguish among exiting the labor force through "early" retirement, "regular" retirement, or disability, since these distinctions have implications for income replacement as well as labor-force reentry. Professionals, managers, and salespeople tend to delay retirement, whereas skilled and semiskilled blue-collar workers move more rapidly into retirement; clerical workers move more quickly into both retirement and disability statuses; and service workers experience relatively high rates of disability and death out of employment (Hayward et al. 1989). In addition, reentry into the labor force has become more common, with estimates of as many as one-third of retirees becoming reemployed, often within one to two years of their retirements. In short, the heterogeneity of what it means to be retired has increased considerably: it encompasses a broader age range; it involves diversity of income sources; and it allows for some level of postretirement employment.

ISSUES OF GENDER AND RACE

The development of retirement policy has been primarily oriented around the work careers of men, predominantly white men. The original Social Security program excluded industries in which women and blacks were concentrated. Although later amendments eventually covered these categories of workers, the benefit structure continued to reward long and continuous attachment to the labor force and to penalize workers for extended or frequent work interruptions. The temporal organization of women's lives relative to work and family, paid and unpaid labor, put women "off schedule" in accumulating claims to retirement income.

Spousal and survivors' benefits were designed to support couples and (primarily) widows during their later years. Research on women's retirement often focused on unmarried women and found that the determinants of retirement for women were similar to the determinants that had been identified for men. Although unmarried women and men differed in occupational locations, wages, health, and access to employer-sponsored pensions, these determinants appeared to sort unmarried women into retirees and workers in much the same way as they sorted men.

The pattern of women's labor-force participation has changed in recent decades, and more women—particularly more married women—are in the labor market. In fact, the trends in rates of labor-force participation for older women reflect both the increasing employment rates for successive cohorts of women and the tendency for more recent cohorts of older working women to retire at younger ages. The increase in dual-earner couples suggests that retirement decisions may be interdependent, with age differences, relative earnings, and the relative health of spouses figuring into joint decisions about careers, retirement, and postretirement employment.

Work and income disadvantages that are experienced at earlier stages of the life course cast a shadow on retirement transitions among minority group members. Lower earnings, lower job status, and discontinuity in labor-force attachment all undermine the financial platform for retirement. Work histories characterized by frequent spells of unemployment, illness, or temporary disability are linked to lower average retirement benefits and lower rates of savings and asset accumulation. In addition, African Americans are less likely to be married than whites and therefore more likely to be limited to their individual earnings and retirement resources. African Americans are more likely to exit work through disability and also more likely to continue to work intermittently after retirement. Gibson (1987) argues that disability can be used as another pathway to retirement for older African Americans, one that offers financial advantages. Because work histories can appear sporadic in old age as well as youth, establishing the timing of retirement as an event also can be difficult (Gibson 1987).

INTERNATIONAL COMPARISONS

Industrialization, economic development, demographic shifts, and politics are implicated in international comparisons of both the prevalence and the financing of retirement. Pampel (1985) reports that, among advanced industrial nations, a pattern of low labor-force participation among aged males is related to the level of industrialization and population aging. Cross-national comparisons of employment-to-population ratios demonstrate a continued decline in labor-force participation between 1970 and 1990 for men aged 55 and older. This decline is not, however, consistent across all age groups. Employment rates for men aged 55–59 have not shown the same proportional decrease as rates for men aged 60–64, or for those aged 65 and older. Compared to other Organization for Economic Cooperation and Development (OECD) countries (see Figure 2), Canada, Finland, Japan, Sweden, and the United States have relatively high rates of labor-force participation for men and women aged 65 and older.

Despite an overall downward trend in average age of retirement, nations continue to differ in the patterns of labor-force exits. Early retirement in European countries such as France, the Netherlands, and Germany remains the norm, with one-half to three-quarters of 60–64-year-old men out of the labor market (Guillemard and Rein 1993). Whereas early retirement in the United States was primarily financed through early retirement incentive programs (ERIPs) offered by private firms, more severe problems of unemployment in Europe fueled early retirement through expanded eligibility for state programs. Among some countries of western Europe and North America, disability programs also can operate as pseudo-retirement programs that allow workers to exit prior to normal retirement age. In contrast to the pattern of western Europe, Canada, and the United States, labor-force participation rates in Japan for men in all three age groups have been more resilient. Rates in 1990 remained relatively high, with more than one-third of men aged 65 and older participating in the labor force (Quinn and Burkhauser 1994). Cross-national comparisons of women's retirement patterns are more complicated. Whereas some countries show little change since 1970 (e.g., Canada, Australia, Italy, Japan, and the United States), others show patterns of labor-force withdrawal that parallel the trends for older men (e.g., Finland, France, West Germany, Spain, and the United Kingdom).

When comparing rates of labor-force participation, it is important to take into account national differences in census procedures, the definition of the labor force, and the kinds of activities that constitute "work." Because countries differ in the pathways workers take to retirement, using pension receipt as an indicator is also flawed. In Germany, for example, disability benefits and intermediate unemployment benefits also provide access to early retirement. Comparisons based on rates of labor-force participation confound country differences in full-time versus part-time employment, complete versus partial retirement, and unemployment and employment. In addition, cross-sectional figures do not allow a comparison of rates of withdrawal or reentry that would allow us to distinguish relatively stable from volatile labor markets.

Within each nation, policy development and social dynamics exert an important influence on retirement behavior. Recent debate in the United States and other countries has centered on the financial burdens of supporting a growing population of retirees and the desirability of reversing the trend toward early retirement. In 1983 the United States amended the Social Security Act to legislate a gradual increase in the age of full entitlement from 65 to 66 by 2009 and to 67 by 2027. Germany (1992 Pension Reform Act) and Italy have made similar policy changes. Japan tried to raise the retirement age from 60 to 65 but failed in their initial attempt. In 1990 Sweden succeeded in blocking the early retirement pathway through the disability fund, but in 1992 failed to abolish the partial retirement pension system. Even in France, where "old age is seen as a time of life when work is illegitimate (Guillemard 1983, p. 88) and where the legal retirement age was lowered to 60 in 1982, it is likely that the retirement age will be raised. This type of political reaction to demographic aging is one way of trying to shift the cost of early retirement from government programs to firms and individuals.

Other workplace policies linked to demographic aging, such as flexible retirement systems, are also being considered in countries like Germany, France, and Great Britain. Countries with lower rates of early exit, such as Japan and Sweden, provide an alternative approach to labor-market withdrawal which may alleviate the pressures of demographic aging. These countries structure retirement as a gradual process involving lowering wages, reducing hours, and reassigning workers. To some extent this model is already in place in the United States through "bridge jobs," in Sweden through partial retirement pensions, and in Japan through wage reduction arrangements.

DIRECTIONS FOR RESEARCH

Sociologists are also interested in the social context in which retirement decisions are made and retirement policies are developed. Family contexts, work contexts, economic contexts, and historical contexts all provide important frames of reference in which these behaviors are negotiated. To date, retirement research has refined both the measurement of concepts and the complexity of the behavioral models. Many of these refinements have involved the economic dimensions of retirement. The financial trade-off between pensions and wages, the changes in accumulated pension wealth, and the age-earnings profiles of different occupations have been captured in current models. What models of retirement continue to lack, however, is sensitivity to the social frames of reference (e.g., the shop floor, the office, the firm, the family, and the community). Studies that have addressed some of these issues (e.g., Hardy and Hazelrigg 1999) suggest, for example, that firm level features may be implicated in both the rate and the determinants of early retirement.

Retirement behavior may be primarily motivated by financial considerations. But given a threshold of financial security, perhaps the unfolding of the retirement process also involves the culture of the workplace, family dynamics, and societal values. Our first task is to theorize the social aspects of these decisions so that we can develop hypotheses. To test these hypotheses, a different data collection strategy is required—one that samples a sufficient number of observations of individual workers within sufficient numbers of organizational or, more generally, cultural contexts that can themselves be measured in terms of their salient characteristics. What has become clear is that retirement decisions are shaped by individual preferences, but that these preferences are shaped by the opportunities and constraints that workers encounter.

references

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Atchley, Robert 1982 "Retirement: Leaving the World of Work." Annals of the Academy of Political and SocialScience 464:120–131.

Barfield, Richard E., and James N. Morgan 1969 EarlyRetirement: The Decision and the Experience. Ann Arbor: University of Michigan Press.

Derthick, Martha 1979 Policymaking for Social Security. Washington, D.C.: Brookings Institution.

Donahue, Wilma, Harold Orbach, and Otto Pollak 1960 "Retirement: The Emerging Social Pattern." In Clark Tibbitts, ed., Handbook of Social Gerontology. Chicago: University of Chicago Press.

Fischer, David Hackett 1977 Growing Old in America. New York: Oxford University Press.

Gibson, Rose 1987 "Reconceptualizing Retirement for Black Americans." Gerontologist 27(6):691–698.

Graebner, William 1980 A History of Retirement: TheMeaning and Function of an American Institution 1885–1978. New Haven, Conn.: Yale University Press.

Guillemard, Anne-Marie 1983 "The Making of Old Age Policy in France: Points of Debate, Issues at Stake, Underlying Social Relations." In Anne-Marie Guillemard, ed., Old Age and the Welfare State. Beverly Hills, Calif.: Sage.

——, and Martin Rein 1993 "Comparative Patterns of Retirement: Retirement Trends in Developed Societies." Annual Review of Sociology 19:469–503.

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Plakans, Andrejs 1989 "Stepping Down in Former Times: A Comparative Assessment of Retirement in Traditional Europe." In David Kertzer and K. Warner Schaie, eds., Age Structuring in Comparative Perspective. Hillsdale, N.J.: Erlbaum.

Quinn, Joseph F., and Richard V. Burkhauser 1994 "Retirement and Labor Force Behavior of the Elderly." In Linda Martin and Samuel H. Preston, eds., Demography of Aging. Washington, D.C.: National Academy Press.

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Melissa A. Hardy
Kim Shuey

Retirement

Family and work experiences are closely interwoven throughout adults' life course. Family relationships and obligations, both prior and current, shape the timing of retirement, retirement adjustment, and pensions; retirement can alter marital and kin interactions.

Definitions and Trends

The concepts family and retirement are understood by most people, yet scientific definitions of these concepts vary considerably. Definitions of family refer to household composition, common ancestry, childbearing and childrearing, and they can be restricted to nuclear family members (parents and their offspring) or can include other kin (Bundesministerium für Umwelt, Jugend und Familie 1999; Wingen 1997). Problems in defining retirement arise in regard to the exact timing of the retirement transition as well as the distinction between occupational retirement and withdrawal from the labor force (Ekerdt and DeViney 1990; Szinovacz and DeViney 1999). Some individuals retire gradually whereas others take up a second career in later life. Receipt of retirement benefits (Social Security, pensions) is not always tied to labor force withdrawal. Women may reject the retiree identity altogether due to their involvement in family work (Bernard et al. 1995; Onyx and Benton 1996).

The diversification of family experiences since the 1970s (especially increases in divorce and in women's labor force participation) has led to considerable variability in family structures (Teachman et al. 2000). These changes already shape retirement transition processes today and will become even more important as the post-World War II birth cohorts reach retirement age. For example, as more and more women participate in the labor force, more couples face the retirement of both spouses (Szinovacz and Ekerdt 1995).

Retirement as we know it today—the withdrawal of basically healthy individuals from the labor force at a certain age (typically between ages 55 and 65) and with the expectation of receiving Social Security and/or pension benefits—is a relatively new institution. In the United States, Social Security was created in 1935. Some European nations (for example, Germany) had already adopted old age pensions by the end of the nineteenth century, whereas many developing countries still lack public benefits for their elderly (Williamson and Pampel 1993). Prior to the creation of Social Security, old age economic security was often achieved through contributions from unmarried children, forcing some children to delay marriage and forego further education and, thus, the prospect of upward mobility. Those elderly who were unable to work and who could not rely on family funds sometimes found support from their communities and charities but were at considerable risk of poverty (Haber and Gratton 1994; Held 1982). In undeveloped countries that lack old age security programs, the elderly must still rely on their own wages and family support (Ngan et al. 1999; Social Security Administration 1999). Under these conditions, labor force participation often continues well into old age. For example, during the late 1990s,
75.7 percent of men aged sixty-five and over were still economically active in Zimbabwe as were 68.8 percent of men aged seventy to seventy-four in Bolivia and 52.7 percent of men aged sixty-five and over in Pakistan. This compares to 10.6 percent of men aged sixty-five and over in Canada, 1.9 percent in Belgium, and 14.7 percent in Poland (International Labour Office 1999). With the implementation of state- or employer-funded old age pensions, retirement has become an expected and accepted life transition. Social Security programs typically define windows for "normal retirement" based on individuals' age and employment history (Blöndal and Scarpetta 1998; Gruber and Wise 1999). However, generous provisions for "early" retirement and alternative pathways into retirement (e.g., through unemployment and disability benefits) resulted in a trend toward early retirement (Gruber and Wise 1999; Kohli et al. 1991).

Family Influences on the Retirement Transition

Old age security programs define age-based windows for retirement, but they usually allow some choice in the exact timing of the retirement transition (although sometimes at the cost of reduced benefits). Consequently, factors other than age and employment history can and often do affect retirement decisions. Studies addressing motives for retirement indicate that marital and family reasons play some role in retirement decisions, especially among women (Clemens 1997; Disney et al. 1997; Ruhm 1996).

The specific marital characteristics entering retirement decisions include marital status, spouse's employment/retirement status, spouse's health, spouse's economic situation, and the quality of the marital relationship. Marriage and marital history are pertinent for retirement benefits (spouses can rely at least partially on current or former partners' pensions), are linked to employment history, and influence individuals' attitude toward retirement. Most studies suggest that married persons are more prone to retire (Flippen and Tienda 2000; Miniaci 1998; Szydlik and Ernst 1996) although contrary evidence exists as well (Lindeboom 1998; Ruhm 1996) for married men.

Perhaps the most widely studied phenomenon is spouses' tendency toward joint retirement (Allmendinger 1990; Blau 1998; Disney et al. 1997; Henkens 1999; Miniaci 1998; Pepermans 1992; Zweimüller et al. 1996). Explanations for this trend refer to joint leisure preferences of spouses, shared economic restrictions, and similarity in spouses' background characteristics such as age and education, as well as traditional gender roles that preclude continued employment of typically younger wives after their husbands' retirement (Gustman and Steinmeier 1994; Henkens et al. 1993). Indeed, several studies show that already retired men pressure their employed wives to leave the labor force (Skirboll and Silverman 1992; Szinovacz 1989). However, there is also evidence for wives' influence on their husbands' retirement decisions (Henkens and Siegers 1994; Smith and Moen 1998). Whether spouses are in fact able to implement joint retirement depends on a variety of circumstances, including the age difference between spouses, their economic situation, their health, and family obligations (Allmendinger 1990; Arber and Ginn 1995; O'Rand et al. 1992).

Research further suggests cross-influences of spouses' economic situation (wages, Social Security and pensions, Medicare eligibility) on each other's retirement timing, although these effects are often weak (Allmendinger 1990; Burkhauser et al. 1996; Madrian and Beaulieu 1998; Zweimüller et al. 1996). In addition, the spouse's health plays a role in retirement timing. A spouse's illness can either delay or hasten the partner's retirement depending on the balance between caregiver burden and financial needs associated with the spouse's disability (Hayward et al. 1998; Honig 1996; Szinovacz and DeViney 2000).

The attractiveness of retiring is also influenced by the quality of the marital relationship. Spouses who enjoy a close relationship, have joint hobbies, or desire more time with their partner are more inclined to retire, whereas couples in conflict-laden relationships may dread spending more time together and hence delay retirement (Henkens 1999; Honig 1998; Naegele and Voges 1989, as cited in Kohli et al.1989; Szinovacz and DeViney 2000). Some husbands also fear that retirement could undermine their power position in the marriage and postpone retirement for that reason (Szinovacz and DeViney 2000).

Not only marital but also family circumstances can impinge on retirement decisions. Financial obligations, especially for dependent children, may preclude early retirement (Miniaci and Stancanelli 1998; Pienta et al. 1994; Szinovacz, DeViney, and Davey 2001; Talaga and Beehr 1995), whereas the burden of care for frail relatives sometimes entices married women to retire (Miniaci and Stancanelli 1998; Zimmerman et al. 2000). Whether closeness of ties to relatives including adult children affects retirement transitions remains virtually unexplored. Preliminary evidence suggests that individuals who lack extended family ties (for instance, the childless) may delay retirement (Szinovacz, DeViney, and Davey 2001).

Family Influences on Postretirement Well-Being

Marital and family circumstances not only influence retirement timing, but they also have an impact on postretirement well-being. Being married and having a high quality marriage contribute to wellbeing throughout the life span and may become especially important during the retirement years (Niederfranke 1989; Reitzes et al. 1996). Retirement satisfaction is also furthered when spouses concur in their evaluation of retirement (Buchmüller 1996), when the other spouse adjusts well to retirement (Haug et al. 1992), and when couples engage in joint leisure activities and decision-making (Dorfman and Hill 1986; Dorfman et al. 1988). In contrast, the number of contacts with relatives (including adult children) appears less important for well-being than contacts with peers (Lee and Ishii-Kuntz 1987). However, wives' involvement with friends may curtail their husbands' retirement satisfaction (Dorfman et al. 1988). Nevertheless, high-quality relations with relatives can enhance retirement satisfaction (Dorfman et al. 1988), and desired geographical proximity to relatives can motivate relocation after retirement (Cuba 1992).

The realization of retirement plans is often contingent on family circumstances (Freericks and Stehr 1990). Continued economic responsibilities for children in the household and retirement prompted by family caregiving needs lead to the perception of retiring too early (Hardy and Quadagno 1995; Szinovacz 1989). Furthermore, the illness of spouses and care for close relatives can spoil postretirement plans and reduce retirement satisfaction (Clemens 1993; Kolland 1988; Vinick and Ekerdt 1991a). However, some men seem to derive self-esteem from caring for their ill wives (Szinovacz 1992). Retirement adjustment is also hampered when negative family events, such as widowhood or illness or death of relatives, occur in close proximity to the retirement transition (Clemens 1993; Szinovacz and Washo 1992).

Retirement Influences on Marital and Family Relations

Despite the popular notion that retirement creates multiple marital problems (Harbert, Vinick, and Ekerdt 1992; Siegert 1994), there is considerable continuity in marital relations over the retirement transition (Atchley 1992; Ekerdt and Vinick 1991). Indeed, retirement tends to reinforce preretirement marital quality, and many marriages profit from retirement (Myers and Booth 1996; Rosenkoetter and Garris 1998). Improvements in postretirement marriages are linked to decreased stress, more time for companionship, and a more traditional division of household labor after wives' retirement (Szinovacz 1996; Vinick and Ekerdt 1991a, 1991b).

Nevertheless, some changes in marital relations do occur after retirement. Many wives expect retired husbands to contribute more to household work (Brubaker and Hennon 1982 ), and some studies suggest that husbands attempt to live up to this expectation, although they may focus their efforts on traditional male tasks such as home repairs (Niederfranke 1991; Schäuble 1989; Szinovacz 2000). Although many wives appreciate their husbands' efforts (Dorfman 1992; Vinick and Ekerdt 1991b), others perceive husbands' help as an interference in their domain and complain that their retired husbands are "underfoot" (Ekerdt and Vinick 1991; Kohli et al. 1989). Such perceptions prevail when husbands' housework is motivated by lack of other meaningful activities or when husbands criticize their wives' performance (Hill and Dorfman 1982; Vinick and Ekerdt 1991a).

Another concern in retirement marriages is the planning and coordination of spouses' time and leisure activities. Wives often adapt to their retired husbands' needs and negotiate the couple's leisure endeavors (Gilford 1986; Niederfranke 1991) but may resent increased demands by their retired husbands (Clemens 1993). Problems can also arise when spouses approach retirement with unrealistic or discordant expectations about joint endeavors (Caradec 1994; Ekerdt and Vinick 1991; Kohli et al. 1989; Vinick and Ekerdt 1992).

Lowered marital satisfaction often results if the husband retires prior to his wife and the couple abides by traditional gender role attitudes (Moen, Kim, and Hofmeister 2001; Myers and Booth 1996). In contrast, wives' retirement tends to reduce marital disagreements and arguments (Szinovacz and Schaffer 2000).

Retirement may further impinge on spouses' relative power in the relationship. Because a man's power is grounded in his status as provider, retirement can undermine his position in the marriage and render him more dependent on his wife (Kulik and Bareli 1997; Szinovacz and Harpster 1993).

Much speculation but little evidence exists concerning the effects of retirement on relationships to extended kin. Retirees seem to attach more importance to kin relationships (Niederfranke 1991) although this does not always result in more frequent contacts (Kremer 1985; Niederfranke 1991). Increased involvement seems to occur, especially in relations with grandchildren (Östberg 1992; Schäuble 1989), and men may catch up on previously neglected contacts with their children (Niederfranke 1991; Szinovacz and Davey 2001). On the other hand, retirees may be less able to provide financial support to children (Kremer 1985).

Retirement Programs and Social Change

Family and demographic change during the past decades (especially women's rising labor force participation, increases in divorces, and decreases in fertility after the baby-boom during the 1950s and 1960s) have unleashed debates about Social Security programs in many countries. Central to these debates are the call for adequate independent old age security for women and generational equity in social programs.

Social Security regulations in the United States and many other industrialized countries reflect a male provider-role ideology that is at odds with today's family values and behaviors (Arber and Ginn 1991; Rolf 1991; Sainsbury 1996). In most countries, old age security and private pension benefits are tied to continuous work histories (exceptions are countries with flat old age benefits such as Australia, but many of these countries have additional employment-based public or private pensions such as superannuation in Australia; see Social Security Administration 1999). Because it is primarily women who disrupt employment for child or elder care, their retirement benefits tend to be considerably lower than men's. Women's lower wages and employment in industries that are not covered by private pensions further aggravate this economic disadvantage (Gonnot et al. 1995; Kingson and O'Grady-LeShane 1993; Walker et al. 1993). Although a growing number of countries have begun to address this inequity by crediting some care years as "work" years in Social Security calculations (the United States does not have such credits), these credits rarely provide full compensation for lost work opportunities. Furthermore, most European Community countries have also implemented paid leave programs for mothers that encourage longer work disruptions (McMullen and Marshall 1999; Prinz and Marin 1999). Consequently, in countries both with and without childcare credits, many wives or widows must rely on their spouses' benefits (Hieden-Sommer 1994; Pampel 1998; Rosenman and Winocur 1990), an option that negates the value of women's own achievements in the labor force. Furthermore, reliance on spouses' benefits is limited for the growing number of retiring divorcees (for instance, in the United States, spouse benefits for divorcees are restricted to marriages lasting ten years or more, yet most divorces occur earlier), and some countries still disregard nonmarital unions.

Lower fertility, when combined with higher longevity, brings about increases in the old-age dependency ratio, that is, the number of persons sixty-five and over as a proportion of the "working" population. Some argue that taxes that finance programs and benefits for the increasing number of elderly deplete the economic resources of relatively smaller younger cohorts, often at the expense of programs for children (for a review of these arguments see Kingson et al. 1986; Quadagno 1991), and advocate reductions in government spending for the elderly, including Social Security, or a shift to individually funded pension schemes. Nevertheless, opinion surveys show consistently high support for tax-funded old age pensions (Dekker 1993), and history—as well as evidence from present-day countries without old age pensions—tells us that family-funded support for the elderly is insecure and not conducive to intergenerational ties (Kingson et al. 1986; Ngan et al. 1999; ). Indeed, as Alan Walker (1999, p. 10–11) notes, the generational contract inherent in taxfunded old age pension schemes implies "acceptance of the notion that generations are interdependent" and thus serves intergenerational solidarity and social cohesion. At a time when families are struggling to adapt to new societal and economic realities, retirement policies and programs are needed that further gender equality, incorporate alternative family life styles, and protect intergenerational ties.

See also:Adulthood; Elders; Family Development Theory; Family Policy; Grandparenthood; Housework; Intergenerational Relations; Later Life Families; Leisure; Marital Quality; Power: Marital Relationships; Stress; Time
Use; Widowhood; Work and Family

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Other Resource

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maximiliane e. szinovacz

CANADA, INCOME PROTECTION FOR RETIREES

Means-tested and social insurance programs have evolved to provide income support to people who cannot, or are not expected to, support themselves. Thanks to old-age income protection schemes, typically referred to as social security, growing numbers of men and women around the world face an economically secure old age, free of work. Between 1940 and 1999, the number of countries with programs that provide cash benefits to older persons, the disabled, and survivors rose from thirty-three to at least 167.

Social security programs take a variety of forms. They may be noncontributory and paid for out of general revenues, or they may require contributions from workers and employers. They may be defined benefit plans, which use a formula to calculate benefits based on some combination of earnings and years of employment, or defined contribution plans, whose benefits depend on plan contributions. Some provide a flat-rate benefit to all residents of a country, subject to certain conditions; others are based on work histories and years of earnings. Programs may be targeted to individuals or families with income and/or assets below a certain level; others pay benefits to anyone who has met the contribution requirements. Mandatory savings programs, such as provident funds, are found in a number of countries, and in a few countries, mandatory private pensions add another layer of income protection in old age.

In the more developed countries of the world, social security coverage is nearly universal. The continued aging of the population of the more developed countries is prompting many of them to reassess their social security systems in light of rising old-age dependency ratios and concern that the public sector might not be able to maintain current levels of support without substantially higher taxes. In many countries, efforts to reduce the rate of growth of social security expenditures while ensuring adequate retirement income have resulted in the reform of old-age social insurance schemes along with the promotion of occupational pensions and individual saving for old age. This has been the case in Canada, whose approach to old-age support shares a number of features with that of the United States, while it also differs in fundamental ways.

Canada, like the United States, has a public, mandatory, contributory, earnings-related pension program covering almost all workers, which provides a portion of the income workers will need in retirement. Disability benefits are available in both Canada and the United States. Both countries also offer tax incentives to encourage employers to offer private pensions and residents to save for their own retirement. Canada, however, provides what is referred to as a universal benefit, although it is subject to recovery from higher income persons. Supplemental payments may be available to those with inadequate income. The United States lacks a universal benefit, but it, too, offers protection to very low-income elderly through a separate, means-tested program of income support, the Supplemental Security Income Program.

Public income support programs for older nonworkers

Two national programs help protect older Canadians from destitution in old age: (1) the Old Age Security program, which includes the Old Age Security pension (OAS), the Guaranteed Income Supplement (GIS), and the Allowance (including the Allowance for the Survivor); and (2) the Canada Pension Plan (CPP). Canadian law allows the provinces to opt out of the CPP if they offer a similar pension plan. The province of Quebec has chosen this route and established the Quebec Pension Plan (QPP), which is very similar, but not identical, to the CPP.

The Old Age Security pension is a universal monthly benefit available to persons age sixty-five or older, regardless of employment history, who are either Canadian citizens or legal residents who have lived in Canada for at least ten years since turning eighteen. The full Old Age Security pension is paid to persons who have resided in Canada for at least forty years since turning eighteen; partial benefits are paid for shorter residency. Benefits, which are financed from general revenues, are paid monthly and, to protect purchasing power, adjusted quarterly based on increases in the Consumer Price Index. Pensioners with individual net income above a certain level must repay all or part of the OAS in what is known as a clawback.

The Guaranteed Income Supplement is an income-tested monthly benefit paid to recipients of the Old Age Security pension who have little other income—among whom, unmarried persons, especially women, predominate. The amount of the GIS depends on marital status as well as income; any money other than the Old Age Security pension is defined as income for the purpose of determining the GIS amount. GIS benefits decline as OAS benefits rise. The GIS is indexed quarterly to reflect increases in the Consumer Price Index. The government bears the whole cost of these benefits, which may be supplemented by income-tested benefits in the provinces. Over one-third of all Old Age Security pensioners receive full or partial GIS benefits, although this figure varies widely by province.

The Allowance may be paid to spouses, partners (including common-law and same-sex partners), and survivors. These benefits are based on need and limited to persons between the ages of sixty and sixty-four who have lived in Canada for at least ten years since turning eighteen. Benefits, which are indexed quarterly, are converted to an Old Age Security pension when a recipient turns sixty-five.

Older Canadians may also be eligible for provincial or territorial income supplements in addition to federal income security. Other benefits, such as tax relief, that assist low-income older persons are available as well.

The government-funded OAS, GIS, Allowances, and provincial and territorial supplements guarantee a minimum income for older Canadians that is not enough to lift all older persons above the poverty level. As is the case in the United States, poverty in old age is far more common among women and the unmarried, who are predominantly women. Nonetheless, as is also the case in the United States, without these programs the poverty rates would be substantially higher.

The Canada Pension Plan and the Quebec Pension Plan are earnings-related pension programs administered by the government, paying full retirement benefits at age sixty-five. Early reduced benefits may be paid starting at age sixty, and benefits are increased if receipt is delayed up to age seventy. Beneficiaries must have made at least one year of contributions to qualify for this pension. In the United States, eligibility for retired worker benefits under Social Security requires forty quarters, or ten years, of contributions. All workers in Canada, between the ages of eighteen and seventy, including the self-employed, must contribute to the Canada Pension Plan or the Quebec Pension Plan. As with the Old-Age and Survivors Insurance (OASI) program in the United States, contributions are paid only on earnings up to an annually adjusted maximum and not on investment or other sources of income. Unlike the United States, earnings below a minimum, set at C$3,500, are not subject to pension taxation in Canada. Benefits are indexed only at the beginning of the year.

In 2001, Canadian workers and their employers in both the CPP and QPP each paid 4.3 percent of the worker's earnings up to the maximum of C$38,300, which is indexed to average wage growth. The exempt first C$3,500 of earnings is not indexed. Self-employed workers contribute the employer's and the employee's share. The employer-employee contribution rate will rise to 4.95 percent of wages by 2003, where it is scheduled to remain.

Legislation enacted in 1998 introduced changes that move the Canada Pension Plan from pay-as-you-go financing, where contributions in any one year are largely paid out in benefits that year, to a system with greater funding. Designed to help pay future pension benefits in an aging Canada, the reserves are to be invested in a diversified portfolio of securities, rather than solely in provincial bonds, which was the practice until recently. In the United States, substantial reserves that will help pay for the baby boomers' retirement have been building in the Social Security Trust Funds, and proposals have been made to invest a portion of these reserves in equities.

The formula used to calculate benefits at the time of retirement in Canada adjusts previous earnings to make them comparable to average national earnings at the time a worker retires. The adjustment is based on the maximum pensionable earnings for the previous five years. Up to 15 percent of low-income years may be deducted from the pension calculation, as well as years when someone was caring for a child under the age of seven. In the United States, benefits are based on thirty-five years of earnings; only the five years of lowest earnings (out of forty) are deducted from the benefit calculation. For many women, these are years of zero earnings spent caring for young children. The resultant pensions in Canada, which are gender-neutral, are designed to replace about 25 percent of average earnings.

Spousal benefits are not paid under the Canada Pension Plan or the Quebec Pension Plan. However, survivors' benefits are payable to legally married and common-law survivors. These benefits amount to 60 percent of the spouse's retirement pension, up to a maximum, and are reduced for retirement below the age of sixty-five. In the United States, the spousal benefit, which amounts to a maximum of 50 percent of a Social Security beneficiary's retired worker benefit, remains an important feature of the Social Security program. Upon widowhood, survivors—99 percent of whom are women—become eligible for 100 percent of the decedent's Social Security benefit.

The Canada Pension Plan provides credit splitting upon divorce or separation. Based on the premise that marriage or a common-law relationship is an economic partnership, credit splitting acknowledges that both partners are entitled to share the pension credits earned by either partner during their marriage or cohabitation. Upon divorce or separation, pension credits earned during cohabitation are combined and divided equally between the partners, even if one spouse never contributed to the CPP. Such splitting generally works to the advantage of the lower earner in a partnership, typically the wife, and produces a higher retirement benefit than otherwise would have been received. Pension sharing, or assignment, enables spouses who are retired to split their combined CPP benefits equally if one of the spouses requests this.

Credit splitting and pension sharing remain rare in pension systems around the world. In the United States, a divorced spouse who has been married for at least ten years is also eligible for spousal benefit of up to 50 percent of the other spouse's retired worker benefit. A surviving spouse—whether a widow or divorcée who had been married ten or more years—will collect 100 percent of the former spouse's benefit if that is higher than her own benefit. Common law partners may also be eligible for spousal and survivor benefits in states that recognize these marriages. Earnings sharing, as it is called in the United States, has been proposed for Social Security; under these proposals, spouses would split equally the contributions, even zero contributions, made to Social Security during the years that they were married. Although extensively studied in the 1980s, earnings sharing has not advanced legislatively in the United States.

Canadian workers may be eligible for disability benefits if they have worked and contributed to the Canada Pension Plan or Quebec Pension Plan for a specified period. To qualify for disability benefits, a worker must have "severe and prolonged incapacity [physical or mental] for any gainful activity" (U.S. Social Security Administration, 1999, p. 65). Benefits consist of a basic flat-rate payment and a payment based on earnings. At age sixty-five, disability benefits are converted to a retirement pension. Access to health insurance is an important component of financial wellbeing in old age, and virtually all Canadians are eligible for publicly funded health care in Canada. In the United States, the Social Security Disability Insurance program helps workers who are unable to "engage in substantial gainful activity due to impairment expected to last at least one year or result in death" (U.S. Social Security Administration, 1999, p. 372). The programs of both countries require a recency of work test to qualify for disability benefits.

Private income support programs for older nonworkers

Canadians are encouraged to save for retirement through registered pension plans (RPPs) and registered retirement savings plans (RRSPs). Registered pension plans, which may be referred to as private or occupational pensions, are of two basic types: (1) a defined benefit plan and (2) a money purchase, or defined contribution plan. Most RPPs require employee contributions. Like their counterparts in the United States, defined benefit plans in Canada promise a specific benefit based on earnings and years of covered service; employers are required to fully fund these plans. A defined contribution plan merely defines the contribution level; payment at retirement depends on accumulated contributions and the return on the investment of those contributions.

While the CPP and QPP cover virtually all workers in the paid labor force, registered pension plans covered only about 40 percent of paid workers in 1997. Private pension plans in the United States cover approximately half of the workers in the paid labor force. In both countries, coverage is greater among employees in larger establishments than in small ones. Men and higher-wage workers are more likely to be covered than women and low-wage workers. In neither country are cost-of-living adjustments required.

A registered retirement savings plan is a tax-deductible savings plan that, up to certain limits, allows individuals to claim tax deductions for retirement contributions. Contributions accumulate tax free, as do individual retirement account (IRA) contributions in the United States. Funds are subject to taxation when they are received, unless used to purchase a retirement annuity or registered retirement income fund, in which case tax deferment continues until the funds are received as retirement income. As of 1999, Canadian tax filers who claimed retirement savings set aside over 11 percent of their income for retirement; 55 percent of that was in RRSPs, and 45 percent in RPPs.

Summary

There are three levels in Canada's retirement income system. The first level is the Old Age Security program, the second is the Canada Pension Plan, and the third is private savings, which includes individual savings and private or employer-sponsored pension plans. The U.S. retirement income system also has three components: Social Security, employer-provided pensions, and individual savings. Canada's Old Age Security program and the U.S.'s Social Security program are intended to provide a foundation of old-age support supplemented by income from the other levels of the system. In neither country is any one component of the system intended to serve as the sole source of retirement support, unlike a number of European countries, which have very generous replacement rates (retirement benefits as a percentage of pre-retirement earnings) in their public social security programs.

One of the most significant differences between the Canadian and the U.S. social security programs is that Canada offers a universal pension and the United States does not. A key similarity between the two systems is the mandatory, earnings-related component that covers workers in the two countries and that requires contributions from both workers and their employers. These earnings-related programs both provide relatively modest replacement rates that are adjusted to keep pace with inflation. There is a greater use of general revenues to support older persons in Canada than in the United States.

Neither the Canadian publicly financed retirement income system nor the one in the United States provides all of the financial support middle-income retirees are likely to need in old age. Both countries attempt to have these benefits supplemented by employer-provided pensions and individuals savings. Both countries make supplemental benefits available to the needy elderly, although the programs that do this are very different from one another.

Despite differences in the public retirement income systems of Canada and the United States, both contribute roughly the same amount to total retirement income, though less of the total comes from the earnings-related pension in Canada than in the United States. About 50 percent of the aggregate income of persons age sixty-five and older in Canada in 1997 came from the OAS (29 percent) or the CPP/QPP (21 percent), while about 46 percent of the aggregate income of the sixty-five-plus population in the United States in 1998 came from publicly funded pensions, mainly from Social Security. Canada's Guaranteed Income Supplement goes to a much higher proportion of older persons than does the U.S.'s SSI, although GIS is not, according to Turner (2001), a poverty program like the U.S.'s Supplemental Security Income program.

Another significant difference between the Canada Pension Plan and the U.S. Social Security program is the diversified investment of reserves currently permitted in the CPP but not in the U.S. Social Security program. Credit splitting also distinguishes the publicly financed income retirement system in Canada from that in the United States.

Improvements in both systems over the years have resulted in sharp declines in the proportion of poor or low-income elderly. Though economic security continues to elude many retirees, especially women, the availability of indexed benefits guaranteed for life has gone a long way toward enhancing the economic security of older nonworkers in Canada and the United States. As a result, retirement in comfort and dignity is a reality for growing numbers of retirees in both countries.

Detailed information on income support for older nonworkers in Canada can be found at the web site of Human Resources Development Canada (www.hrdc-drhc.gc.ca). Information for U.S. programs can be found at www.ssa.gov.

Sara E. Rix

See also Canada; Canada, Health Care Coverage for Older People; Income Support for Nonworkers, National Approaches; Social Security, History and Operations; Social Security, Long-Term Financing and Reform; Welfare State.

BIBLIOGRAPHY

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