Phased Retirement Programs

 

By: Patricia K. Keesler

Benefits Law Group, P.K.Keesler, P.C.

Atlanta, GA

January 14, 2005

 

The IRS has recently proposed regulations on “phased retirement programs”. These regulations will allow certain part time workers, who have not yet reached normal retirement age, to receive in-service distributions from defined benefit pension plans.  The IRS has believes that these rules will enable employers to encourage older, more experienced workers to remain in the workforce by supplementing their part time income with pension payments, while also allowing them to continue to accrue pension benefits. 

 

These phased retirement regulations represent a significant departure from the long-standing IRS position that  distributions may not be made from defined benefit pension plans until after “retirement”.  The rules are effective for plan years beginning after final regulations are published.  The rules do not apply to defined contribution plans. The IRS does not believe it has the authority to allow distributions from 401(k) plans before the participant has attained age 591/2.  Profit sharing plans already allow in-service distributions at a stated age or after a certain number of years. 

 

The proposed regulations permit in-service distributions to plan participants who have not yet reached retirement age only under a “bonafide phased retirement program”. 

To be a “bonafide phased retirement program” the program must be adopted by the employer and must be in writing.  The program must provide that as of a certain age, the employee may work fewer hours and receive a pro rata portion of his or her retirement benefit from the plan while still working. Distributions may not exceed the pro rata share of the participant’s accrued benefit based on the reduced work hours. That is, a participant  who cuts his hours by 25%, can receive up to 25% of his pension benefit under the plan while still working. Such participants are considered partially retired and partially in service during the phased retirement period.

 

Other requirements of the program include the following;

           

1. The program must be voluntary for participants

 

2. Employees must reduce their work hours by at least 20%.

 

3. Phased retirees must continue to accrue benefits under the plan as if they were working full time.  Fulltime compensation is imputed.  However, it does appear,  that less than full time service can be recognized proportionately for benefit accrual purposes.

 

4. All payment options must be offered except lump sums, which are prohibited

 

5. Key employees may not participate in phased retirement programs.

 

6. With certain exceptions, an annual review of actual hours worked must be performed and payments adjusted to the extent there is a change in hours worked for the year.

 

7. The participant’s final benefit is comprised of the phased retirement benefit and the balance of the accrued benefit under the plan. The plan can offer new elections with respect to this benefit.

 

Phased retirement programs will be subject to nondiscrimination testing as a benefit, right, or feature, under Internal Revenue Code section 401(a)(4). These programs are also considered separate optional forms of payment that are the subject to anti cutback rules.

 

 The IRS has also addressed the definition of normal retirement in these proposed regulations. The regulations provide that the normal retirement age may not be earlier that the earliest age this is representative of a typical retirement age of the covered workforce.