What Is Deferred Retirement and How Does It Work?

Understanding Deferred Retirement

Deferred retirement occurs when an individual leaves an employer but postpones the commencement of their vested retirement benefits until a later date. This is common for those who change jobs before reaching their full retirement age or the age they wish to begin receiving income. Instead of taking an immediate distribution, the accumulated funds or future benefit rights remain with the former employer’s plan or are transferred to another eligible retirement account.

A fundamental concept in deferred retirement is “vesting,” which refers to an employee’s ownership of contributions made to their retirement plan. An employee becomes fully vested when they have complete, non-forfeitable rights to all contributions, including those made by their employer.

Vesting schedules vary, including immediate vesting, cliff vesting, and graded vesting. Immediate vesting grants full ownership from the outset. Cliff vesting requires an employee to complete a specific period of service, up to three years, to become 100% vested in employer contributions. Graded vesting allows employees to gradually gain ownership over a period of up to six years, with a certain percentage vesting each year. Only vested benefits can be deferred; any non-vested portion may be forfeited upon separation from service.

Benefits become eligible for deferral once an employee meets specific service or age requirements outlined in the plan documentation. Deferred retirement differs from early retirement, where an individual actively chooses to start receiving benefits before their normal retirement age, often with actuarial reductions. Deferred retirement is about delaying the initiation of benefits that have already been earned and vested.

Types of Plans Supporting Deferred Retirement

Deferred retirement applies to various types of employer-sponsored retirement plans, each with distinct characteristics regarding how benefits are held and distributed. Defined benefit plans, commonly known as pension plans, promise a specific monthly income in retirement based on a formula that considers an employee’s salary and years of service. When an employee leaves before retirement, their right to this future pension payment is deferred until they reach the plan’s specified eligibility age.

Defined contribution plans, such as 401(k)s, 403(b)s, and 457(b)s, operate differently. They are individual accounts where contributions are made by the employee, and often matched by the employer. In these plans, deferred retirement means the accumulated account balance remains invested within the plan or is transferred to another qualified account. The value of these deferred funds fluctuates with market performance, directly impacting the eventual retirement benefit.

Other plans, like SIMPLE IRAs and SEP IRAs, are individual retirement accounts established by employers. Funds in these accounts are portable and can be maintained or rolled over. These plans focus on individual contributions and growth, with immediate vesting applying to all contributions.

Management of Deferred Funds

Once retirement benefits are deferred, their management and potential for growth depend on the type of plan. For defined benefit plans, the former employer or the plan sponsor retains responsibility for managing the underlying assets and ensuring future payments. The deferred benefit amount may continue to accrue interest or cost-of-living adjustments according to the plan’s specific rules. This means the promised pension amount can increase over time, even if the individual is no longer actively employed by the company.

For defined contribution plans, individuals have several options for managing their deferred funds. One choice is to leave the funds in the former employer’s plan, where they remain invested according to the plan’s available options and are subject to its administrative fees. Another option is to roll over the funds into an Individual Retirement Account (IRA). This provides the individual with greater control over investment choices and may offer lower fees compared to some employer plans.

A third possibility is to roll over the funds into a new employer’s retirement plan, if permitted by the new plan. Regardless of where the funds are held, for defined contribution plans, the value of the deferred funds will continue to grow or decline based on the performance of the chosen investments until they are distributed. Individuals should keep their contact information updated with the plan administrator to ensure they receive all necessary communications regarding their benefits.

Claiming and Receiving Deferred Benefits

The process of claiming and receiving deferred retirement benefits involves specific steps and considerations regarding timing and taxation. Benefits can be claimed once an individual reaches the plan’s normal retirement age or an earlier age specified for early retirement. Required Minimum Distributions (RMDs) begin at age 73 for most traditional retirement accounts, mandating withdrawals to prevent indefinite tax deferral.

For defined benefit plans, common distribution options include a single-life annuity, which provides payments for the retiree’s lifetime, or a joint and survivor annuity, which continues payments to a beneficiary after the retiree’s death. Some plans may also offer a lump-sum payment option. The payout methods are detailed in the plan’s summary plan description.

With defined contribution plans, individuals have more flexibility in accessing their funds, including lump-sum withdrawals, installment payments over a set period, or continued deferral by keeping funds in an IRA. To initiate the process, individuals should contact the plan administrator of their former employer’s plan or their IRA custodian. They will need to complete required forms and provide necessary identification.

Distributions from most traditional deferred retirement accounts are subject to income tax upon receipt. Withdrawals made before age 59½ may incur a 10% early withdrawal penalty, unless a specific exception applies, such as disability or certain medical expenses.