Summer 2007

Final IRS Regulations - Normal Retirement Age and In-Service Distributions

By Mary Beth Braitman, Terry A. M. Mumford, and Lisa Erb Harrison of ICE MILLER, LLP

Generally. On May 22, 2007, the IRS issued final regulations regarding distributions from pension plans upon attainment of normal retirement age prior to a participant's severance from employment with the employer maintaining the plan. Treas. Reg. § 1.401(a)-1(b). These regulations finalized the portion of the proposed phased retirement regulations relating to normal retirement age and in-service distributions upon attainment of normal retirement age. (The portion of the proposed phased retirement regulations which would have permitted in-service distributions before normal retirement age under a bona fide phased retirement program have not been finalized.) A pension plan that is subject to these final regulations includes a defined benefit 401(a) plan or a defined contribution 401(a) plan that is not a 401(k) or profit sharing plan. For example, a number of public employers have established a defined contribution plan to accept employer matching contributions to employee deferrals to a 457(b) plan or 403(b) tax-sheltered annuity. Plans that would not be subject to the final regulations include 401(k) plans, profit sharing plans, 457(b) deferred compensation plans, and 403(b) tax-sheltered annuities.

In-Service Distributions. The final regulations clarify that a pension plan may be designed to permit payment of benefits upon an employee's attainment of normal retirement age, even if the employee has not yet had a severance from employment with the employer maintaining the plan. This is consistent with the language included in the proposed regulations, as well as the existing practice among some pension plans based on earlier IRS guidance (such as Revenue Ruling 71-24). In-service distributions are not required to be included in the plan design.

Normal Retirement Age. However, the final regulations differ from the proposed regulations in defining a permissible normal retirement age under a pension plan. The proposed regulations had provided that a normal retirement age could not be set so low as to be a "subterfuge to avoid the requirements of section 401(a)" and, thus, could not be "earlier than the earliest age that is reasonably representative of a typical retirement age for the covered workforce." In response to comments expressing some reservations about this standard, the final regulations replace the subterfuge standard with a requirement that "the normal retirement age under a plan must 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." Treas. Reg. § 1.401(a)-1(b)(2).

Normal Retirement Age Safe Harbor-Age 62 or Older. The final regulations provide a "safe harbor" for a plan with a normal retirement age of age 62 or older, which is deemed to be 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. This safe harbor is based on Internal Revenue Code ("Code") Section 401(a)(36), as added by the Pension Protection Act of 2006 ("PPA"). Code Section 401(a)(36) provides that, for plan years beginning after December 31, 2006, a pension plan does not fail to qualify under Code Section 401(a) solely because the plan provides that a distribution may be made to an employee who has attained age 62 and who has not separated from employment at the time of the distribution.

Normal Retirement Age-Under Age 62 But Not Earlier Than Age 55. Under the final regulations, if a pension plan's normal retirement age is earlier than age 62, but not earlier than age 55, the determination of whether the normal retirement age "works" (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) is based on all of the relevant facts and circumstances. In the preamble to the final regulations, the Treasury Department states that, if the normal retirement age is between the ages of 55 and 62, it is generally expected that an employer's good faith determination of the typical retirement age for the industry in which the covered workforce is employed will be given deference, assuming that the determination is reasonable under the facts and circumstances. However, this normal retirement age range is not a safe harbor under the final regulations.

Normal Retirement Age-Under Age 55. If a normal retirement age under a pension plan is lower than age 55, the age is presumed to be earlier than the earliest age that is reasonably representative of the typical retirement age for the industry in which the covered workforce is employed, unless the Commissioner determines otherwise based upon the facts and circumstances.

Normal Retirement Age Safe Harbor-Qualified Public Safety Employees. Given the typically earlier retirement ages for public safety employees, for a pension plan where substantially all of the participants are "qualified public safety employees" (within the meaning of Code Section 72(t)(10)(B), as added by the PPA), a normal retirement age of age 50 or later is deemed not to be earlier than the earliest age that is reasonably representative of the typical retirement age for the industry in which the covered workforce is employed. Under Code Section 72(t)(10)(B), a "qualified public safety employee" means "any employee of a State or political subdivision of a State who provides police protection, firefighting services, or emergency medical services for any area within the jurisdiction of such State or political subdivision."

Part-Time Employment. The final regulations state that a reduction in hours does not constitute a retirement. Therefore, in-service distributions are not permissible prior to normal retirement age in the case of a reduction in hours worked. Treas. Reg. § 1.401(a)-1(b)(3).

Effective Date. The final regulations are generally applicable May 22, 2007. However, for governmental plans, the regulations regarding normal retirement age and part-time employment apply with respect to plan years beginning on or after January 1, 2009. Collectively bargained plans may have a different effective date.

Impact. These final regulations may have a significant impact for sponsors and administrators of defined contribution plans (other than 401(k) and profit sharing plans) that permit in-service distributions or who are considering the addition of such distributions under their plans. Plan sponsors and administrators will need to consider whether the safe harbors under the final regulations provide sufficient flexibility for their membership, or whether their actual retirement patterns would better align with the use of a normal retirement age outside the safe harbors that would need to be supported under the stated IRS standards. It is important to realize that implementation of the final regulations may require a plan language amendment.