IRS Takes Steps to Resolve Issues Related to Normal Retirement Age under a Governmental Plan
The IRS regulations on normal retirement age have raised many issues for governmental plans. Notice 2012-29 announced intended changes that represent a significant step toward resolving those issues.
On May 22, 2007, the Internal Revenue Service published final regulations with respect to distributions upon attainment of normal retirement age (NRA) in a pension plan (the 2007 NRA regulations). These regulations raised issues for governmental plans due to a number of issues including:
- NRA was often not defined by a governmental plan,
- The rules for retirement ages that were deemed reasonable assumed a single NRA for the entire plan, and
- The legal commencement of benefits without a bona fide termination of employment depended on the definition of NRA.
Consequently, the effective date of the 2007 NRA regulations had been postponed until January 1, 2013 for governmental plans.1 The IRS has now released Notice 2012-29, which announces intended changes in the 2007 NRA regulation for a governmental plan2 and that the effective date of the 2007 NRA regulations will be further extended to at least January 1, 2015. Notice 2012-29 also invites comments on the intended changes and additional changes with respect to the definition of normal retirement age for a governmental plan.
Action Needed: Entities should carefully review Notice 2012-29 and the intended changes for the possible impact on their plans, and then consider if they want to submit comments, which are due by July 30, 2012.
Cheiron Observation: If the IRS approves plans with normal retirement ages consistent with the announced changes, we expect that many determination letter requests that had been pending with the IRS would move forward.
Brief Overview of 2007 NRA Regulations
The 2007 NRA regulations required that a pension plan be established and maintained primarily to provide systematically for the payment of definitely determinable benefits over a period of years, usually for life, after retirement.3 The regulations permitted a pension plan to make in-service distributions to a participant after the participant attains normal retirement age, or after attainment of age 62, even if the participant continued working.
The regulations required 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 (the "reasonably representative" requirement). The regulation provides that a normal retirement age of age 62 or later is deemed to satisfy the reasonably representative requirement. A normal retirement age of age 50 or later is deemed to satisfy the reasonably representative requirement only if substantially all of the participants in the plan are qualified public safety employees (within the meaning of section 72(t)(10)(B) of the Code).4
The 2007 NRA regulations did not specifically define retirement. However, the preamble to the proposed regulations5 provided that the proposed regulations "specifically do not endorse a prearranged termination and rehire as constituting full retirement." Elsewhere, that preamble refers to such practice as a "sham transaction."6 Consequently, the payment of retirement benefits without a bona fide separation from service would only be permitted after a reasonably representative normal retirement age or age 62 under the in-service distribution provisions.
Section 411(a)(8) of the Code defines the normal retirement age for a plan subject to that section as the earlier of (a) the time a participant attains normal retirement age under the plan or (b) the later of the time a plan participant attains age 65 or the 5th anniversary of the time a plan participant commenced participation in the plan. Section 411(e) generally provides that sections 411(a) through (d) do not apply to a governmental plan. Therefore, the definition of normal retirement age in section 411(a)(8) does not apply to a governmental plan, but the 2007 NRA regulations do apply.
Notice 2012-29 sets forth two changes to the 2007 NRA regulations with respect to governmental plans. The first change would be to clarify that a governmental plan that is not subject to sections 411(a) through (d) and does not provide for in-service distributions before age 62 will not fail the requirement to provide definitely determinable benefits merely because the plan does not have a definition of normal retirement age.
Cheiron Observation: This change effectively means that a governmental plan that requires that an employee retire in order to receive benefits will not need to demonstrate compliance with the "reasonably representative" requirement. However, the governmental plan will still need to be mindful of the IRS concern that retirement means a bona fide separation from service. Therefore, legitimate retirements at any age will not be a problem. Otherwise the in-service distribution rules must be satisfied.
The second change would be to modify the requirement that age 50 be considered a "safe harbor" only for a plan covering predominantly qualified public safety employees. Under the intended modification, a governmental plan could have a normal retirement age as low as age 50 for qualified public safety employees and a later normal retirement age for other employees even if the qualified public safety employees were not the predominant group of employees covered by the plan.
Cheiron Observation: This change allows a governmental entity to define a lower normal retirement age for qualified public safety employees without the need for a separate plan.
Lastly, the IRS announced its intention to delay the effective date of the 2007 NRA regulations for governmental plans until the later of (1) January 1, 2015, or (2) the close of the first regular legislative session of the legislative body with the authority to amend the plan that begins on or after the date that is 3 months after the final regulations are published in the Federal Register. Governmental plans may rely on Notice 2012-29 with respect to the extension.
The IRS and Treasury also asked for comments on (1) whether retirement after 20 or 30 years of service may be a normal retirement age that is reasonably representative for qualified public safety employees, and (2) whether there is information indicating that there are other categories of governmental employees who have career spans similar to qualified public safety employees that would justify a similar rule. Additionally, the IRS and Treasury requested any information that governmental plans have on the overall retirement patterns of other employees in government service.
Cheiron Observation: Cheiron consultants can assist you in providing comments on these questions. Responses should be submitted by July 30, 2012.
1See Notice 2008-98 and Notice 2009-86.2On November 8, 2011, the Internal Revenue Service published two advanced notices of proposed rulemaking (ANPRMs) concerning the definition of a governmental plan under Internal Revenue Code section 414(d). One ANPRM sets forth general rules that would apply to any plan that wanted to be considered as a governmental plan and the other ANPRM sets forth special rules for plans maintained by Indian Tribal governments. 3See section 1.401(a)-1(b)(1) of the 2007 NRA regulations, which re-stated a rule in regulations that had been issued prior to the Employee Retirement Income Security Act of 1974 (ERISA). 4Employees who provide police protection, firefighting services, or emergency medical services for any area within the jurisdiction of the State or political subdivision. 5Issued on November 10, 2004, and including rules for a bona fide phased retirement program. 6Also, see PLR 201147038 in which the IRS ruled that employees who "retire" on one day in order to qualify for benefits with the explicit understanding between the employee and employer that they are not separating from service with the employer are not legitimately retired.
Cheiron is an actuarial consulting firm that provides actuarial and consulting advice. However, we are neither attorneys nor accountants. Therefore, we do not provide legal services or tax advice.