A new law (the 2012 Highway Investment Act) allows a phased retirement program for federal employees. In contrast, an IRS private letter ruling severely restricts pension plans from paying benefits to retirees who return to work before age 62. This difference in laws governing federal pensions and other pension plans is illogical.
The new law allows federal employees to work part time at 20% to 80% of their full-time schedule, receive pay and pension credit for that working percentage, and also receive a pension for the other (nonworking) percentage of their full-time schedule. No termination of employment is required to start this combination of work and pension.
In contrast, tax laws prohibit all other “pension plans” (money purchase pension plans and defined benefit pension plans) from providing benefits to an employee who is under age 62 and has not retired or separated from employment (unless the employee has reached the plan’s “normal retirement age”). Internal Revenue Code section 401(a)(36), Treas. Reg. sections 1.401(a)-1(a)(2) and 1.401-1(b)(1)(i). Because the meaning of key terms such as “retired” and “separated from employment” is open to varying interpretations, the practical impact of these laws has been uncertain. Just how long must an employee be absent from work to make a pension payment permissible before age 62? Under what circumstances may the employee return to work without jeopardizing the tax qualified status of the pension plan?
The IRS letter ruling (201147038) states that an absence from employment for a week or less is not a bona fide separation or retirement. The ruling refers to Treasury Regulations interpreting Code section 409A to define “retirement” and “separation.” (The ruling notes that “although section 409A and its regulations address a nonqualified plan arrangement the definitions regarding termination and separation from service are consistent with” the definitions for purposes of pension plan qualification.) The 409A regulations apply very strict rules. For example, the 409A regulations generally require that the employer and employee reasonably anticipate that after the date of termination the employee will either perform no further services, or services at a level of no more than 20 percent of the average services performed over the immediately preceding 36 month period. The regulations also list other relevant factors, such as whether the employee continues to be eligible for other employee benefit programs, whether the employee is permitted and available to perform service for others in the same line of business and whether a change in business circumstances, such as termination of the employee’s replacement, causes the employee to return to employment.
The result is: Plans that pay pensions to retirees under age 62 who are rehired after a short absence face possible disqualification if the IRS determines that the retirement was a sham, because the retiree returns to work at more than 20% of his prior work schedule. In contrast, the new law allows federal employees (including IRS employees) to switch to 20% to 80% part-time work and receive federal pensions before age 62 without terminating their employment.
These differences in laws for federal employee pensions and other pensions make no sense.
marybrauerlaw 