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Pensions & Retirement Benefits: Federal Employment Law Insider -- In-service distributions from qualified pension plans clarified
     


J. Robert Brame and David S. Fortney, Editors
McGuireWoods LLP and Fortney & Scott, LLC

Vol. 5, No. 4
December 2007

EMPLOYEE BENEFITS

In-service distributions from qualified pension plans clarified

Henry deVos Lawrie, Jr. McGuireWoods

There have been two important developments regarding in-service distributions from qualified pension plans to support "phased retirement":

  • Final regulations issued under the Pension Protection Act of 2006 (PPA) permit in-service distributions from qualified pension plans after a participant reaches age 62, regardless of whether the normal retirement age under the plan is a later age, e.g., age 65.
  • In-service distributions may also be permissible when a participant reaches the plan's normal retirement age, even when the normal retirement date is lower than age 62 and therefore beyond the scope of the PPA.
Background

The IRS made a trial run at permitting phased retirement distributions back in 2004 when it proposed regulations to allow qualified pension plans to make in- service distributions meeting specific criteria to participants who had reached age 591/2. The regulations weren't finalized, and the IRS recently requested comment on the need for the regulations given the changes made under the PPA.

Issues addressed by final regulations

The final PPA regulations address several issues, including the ability to begin in-service distributions upon the earlier of normal retirement age and age 62. They don't address the proposed phase-out regulations or phased retirement. Instead, they focus on the reasonable determination of an age lower than 62 to qualify as a normal retirement age for in-service distribution.

The regulations provide a rebuttable presumption that a normal retirement age between 55 and 62 is representative of the typical retirement age for the industry in which the covered workforce is employed and therefore acceptable. The plan sponser has the burden of demonstrating that any earlier age is a typical retirement age for the industry in which the workforce is employed.

Changes made to final regulations

The proposed phase-out regulations would have required full-time employees to voluntarily reduce their hours by at least 20 percent as a precondition to in- service pension distributions and would have required that the percentage of pension payable be no greater than the percentage reduction in the participant's work schedule. The proposed regulations also would have prohibited "key employees" (defined as five percent owners or one percent owners who earn over $150,000) from participating in a phased retirement program. Those limitations have been deleted from the final regulations, and it now appears unlikely that the IRS will impose distribution limitations linked to the reduction in scheduled workload or key employee status.

As a result, employers have substantially greater latitude in the design of the phase-out arrangements than would be available if the proposed regulations had been finalized.

Impact on other aspects of the phase-out program

The proposed phase-out regulations may serve as a guide to the IRS on how to design other aspects of a phase-out program, including the following:

  • The proposed phase-out regulations require that the phased retirement program meet the minimum coverage requirements of Internal Revenue Code Section 410(b)(1) and that participation by individual participants be voluntary. It's unclear whether actual participation levels must be taken into account under the minimum coverage rules or whether a class of employees who are eligible to participate in the phased retirement program but don't do so can be considered.
  • Benefits must continue to accrue under the plan during the phase-out period.
  • It's presumed that participants who provide services excluded under the plan, such as "part-time" services, wouldn't be entitled to continuing accruals.
  • Optional forms of distribution, early retirement benefits, and retirement- type subsidies otherwise permitted under the plan must be available to the phase- out participants upon full retirement.
Copyright 2007 M. Lee Smith Publishers LLC

FEDERAL EMPLOYMENT LAW INSIDER does not attempt to offer solutions to individual problems but rather to provide information about current developments in federal employment law. Questions about individual problems should be addressed to the federal employment law attorney of your choice.

M Lee Smith Publishers