Prior to the Pension Protection Act of 2006 (the "PPA"), a pension plan1 (i.e., a defined benefit plan or a money purchase plan), was generally not allowed to make distributions to participants before the participant either separated from service, died, became disabled or reached the normal retirement age as specified under the plan.
Section 401(a) of the Internal Revenue Code of 1986, as amended (the "Code"), sets forth the qualification requirements with respect to a pension plan. Several of those requirements are based on a plan's normal retirement age. Section 411(a)(8) of the Code defines normal retirement age as the earlier of (a) the time a participant attains normal retirement age under the plan or (b) the later of the time a participant attains age 65 or the fifth anniversary of the time a plan participant commenced participation in the plan. The normal retirement age, as defined in a pension plan, is important because it, for example;
- Provides that an employee's right to his normal retirement benefit is non-forfeitable upon the attainment of normal retirement age, pursuant to Sections 401(a)(7) and 411 of the Code
- Permits a plan to offset accruals after normal retirement age by either the actuarial value of distributions made after normal retirement age or the actuarial value of increases in the benefits due to delay in payment, in accordance with Code Section 411(b)(1)(H)(iii), detailing such permissible offsets Revenue Ruling 71-24 provides guidance for the treatment of benefits under a pension plan for employees who continue employment after normal retirement age and includes an example that indicates that benefits are permitted to commence during employment after normal retirement age.
Revenue Ruling 71-147 provides that the normal retirement age in a pension plan, as contrasted with a profit-sharing plan, is generally the lowest age specified in the plan at which an employee has the right to retire without the consent of the employer and receive retirement benefits based on service to date of retirement at the full rate set forth in the plan, without actuarial reductions. The revenue ruling specifies that normal retirement age is typically age 65, but a different age may be specified, provided that, if it is lower than age 65, it represents the age at which employees customarily retire in the particular company or industry and is not merely a device to accelerate funding.
Revenue Ruling 78-120 modified Revenue Ruling 71-147 for purposes of Code Sections 411 (relating to vesting) and 415 (relating to maximum annual benefit accruals) by permitting a pension plan to specify any age that is less than 65 as the normal retirement age. However, if the normal retirement age specified in a plan is less than 55 and the retirement benefit under the plan begins before age 55, then for purposes of determining whether the benefit exceeds the maximum amount payable under Code Section 415(b)(1)(A) (i.e., the statutory limitation on the annual benefit payable under a defined benefit plan, which is US$185,000 for 2008), then the limit under Code Section 415(b)(1)(A) would be adjusted to reflect cost-of-living increases in accordance with Code Section 415(b)(2)(C), which provides for such cost-of-living increases.
2004 Proposed Regulation
On November 10, 2004, the Treasury issued proposed regulations which, had they been finalized, would have provided that a plan would be permitted to pay a pro-rata portion of an employee's accrued benefit before the attainment of normal retirement age under what was called a phased retirement program.2
Payment of such benefit would only be permitted if the phased retirement program provides that an employee's participation was voluntary and that both the employee and employer expected the participant to reduce the number of hours worked during the phased retirement period by at least 20 percent. The proposed regulations clarified that a pension plan is permitted to pay benefits upon an employee's attainment of the plan's normal retirement age; however, such normal retirement age cannot be set so low as to be a subterfuge to avoid the requirements of Code Section 401(a) and, accordingly, a plan's normal retirement age cannot be earlier than the earliest age that is reasonably representative of a typical retirement age for the covered workforce.
Further, the proposed regulations stated that the maximum amount that would be permitted to be paid to an employee would be limited to the portion of the employee's accrued benefit equal to the product of the employee's total accrued benefit on the date the employee commenced the phased retirement and the employee's reduction in work. The reduction in work would be based on the employee's work schedule fraction, which is the ratio of the hours that the employee is reasonably expected to work during the phased retirement period to the hours that would be worked if the employee was working full time. In addition, the proposed regulations generally would have required that all early retirement benefits, or subsidies and optional forms of benefit that would have been available upon full retirement, also be available with respect to the phased retirement accrued benefit, except that payments could not be made in the form of a single sum distribution (or other eligible rollover distribution). Also, the benefit provided under a phased retirement would have been an optional form of benefit protected by Code Section 411(d)(6) and the election of a phased retirement benefit would be subject to the provisions of Code Section 417, including the required explanation of the qualified joint and survivor annuity form of benefit.
Pension Protection Act of 2006
The PPA added Section 401(a)(36) of the Code, providing that, for plan years beginning after December 31, 2006, pension plans may be amended to allow participants who attain the age of 62, and who have not separated from service, be allowed to take in-service distributions, regardless of whether the normal retirement age under the plan is a later age.
On December 26, 2006, the IRS issued Notice 2007-8, soliciting comments as to whether in light of the existence of the new Code Section 401(a)(36), the provisions relating to phased retirement contained in the 2004 proposed regulations should be finalized. The period for submitting comments ended on April 16, 2007.
Final PPA Regulations
On May 22, 2007, the Treasury issued final regulations (the "Final PPA Regulations") under Sections 401(a) and 411(d)(6) of the Code, that reflected new Code Section 401(a)(36). The Final PPA Regulations provide rules permitting distributions to be made from a pension plan upon attainment of normal retirement age, even if prior to a participant's severance from employment with the employer maintaining the plan. In addition, the Final PPA Regulations, included the ability under a plan to begin making in-service distributions upon the earlier of normal retirement age and age 62, but they do not make reference to or otherwise directly address phased retirement. Finally, the Final PPA Regulations provide limited relief under Code Section 411(d)(6), relating to impermissible cutbacks.
The Final PPA Regulations modified the 2004 proposed regulations by replacing the "subterfuge standard" with a requirement that the normal retirement age be an age that is not earlier than the "earliest age that is reasonably representative of the typical retirement age" for the industry in which the covered workforce is employed. It also established a normal retirement safe harbor age of 62, with or without a specified period of years of participation. If a plan's normal retirement age is earlier than age 62, the determination of whether the age is not earlier than the earliest age that is reasonably representative of the typical retirement age is based on all of the facts and circumstances. If the normal retirement age is between ages 55 and 62, then it is generally expected that a good-faith determination of the typical retirement age for the industry in which the covered workforce is employed that is made by the employer will be given deference, assuming that the determination is reasonable under the facts and circumstances. However, a normal retirement age that is lower than 55 is presumed to be earlier than the earliest age that is reasonably representative of the typical retirement age for an industry, absent facts and circumstances that demonstrate otherwise.
IRS Notice 2007-69
IRS Notice 2007-69, issued on August 27, 2007, provides temporary relief for certain pension plans under which the definition of normal retirement age may need to be changed to comply with the Final PPA Regulations. The temporary relief, which takes the form of allowing affected plan sponsors to adopt interim amendments, assuming they meet certain conditions set forth in the Notice and/or submit requests for letter rulings as to whether their definitions of normal retirement age satisfy the Final PPA Regulations, extends through the first day of the first plan year that begins after June 30, 2008. In addition, the notice generally identifies potential violations of the vesting and accrued benefit requirements for defined benefit plans under Section 411 that may arise from a definition of normal retirement age, based on a minimum period of service that does not meet the requirements of the Final PPA Regulations.
Further, the notice clarifies that plans that must be submitted to the IRS for a favorable determination letter during cycle "B" (i.e., between February 1, 2007 and January 31, 2008) must comply in form with the Final PPA Regulations.
In light of the Final PPA Regulations, plan sponsors should have substantially greater latitude in the design of in-service distributions than would have been available if the proposed 2004 regulations had been finalized. This is because many of the restrictions under the proposed 2004 regulations are no longer applicable in light of Code Section 401(a)(36).
Clients that maintain a defined benefit plan or a money purchase plan may want to think about adding an in-service distribution provision to their plans. However, being that the Final PPA Regulations for all practical purposes merely parrot the statute, in the absence of further guidance, they may want to either use age 65 as the in-service distribution age instead of age 62, or wait for further guidance to be issued by the Treasury.