IRS FAQs Address Effect of Rehires on Pension Plan Qualification

The IRS has added two new FAQs to its questions and answers regarding COVID-19 pandemic relief for retirement plans (see our Checkpoint article). The first considers whether rehiring retired plan participants to fulfill needs related to the COVID-19 pandemic jeopardizes the tax qualification of a pension plan that does not permit in-service distributions. As the FAQ notes, pension plans (unlike 401(k) plans and other profit-sharing or stock bonus plans) must be maintained primarily to provide for the payment of definitely determinable benefits after retirement or the attainment of normal retirement age. The FAQ explains that—absent plan provisions imposing additional limitations—whether a participant has had a bona fide retirement is based on the facts and circumstances. If a retired employee is rehired “due to unforeseen circumstances that do not reflect any prearrangement to rehire,” that will not prevent the employee’s retirement from being a bona fide retirement and benefit distributions could continue if permitted by the plan. Plan sponsors are warned, however, to review their plans for relevant limitations and provisions that may need to be amended, such as rules prohibiting rehire during a prescribed period and rules suspending benefits upon rehire.

The second new FAQ considers whether a pension plan could allow in-service distributions. The FAQ affirms that pension plans may allow in-service distributions after a participant attains either age 59 1/2 or the plan’s normal retirement age, citing current regulations, proposed regulations applicable to governmental plans, and an IRS notice regarding the amendment to Code § 401(a)(36) that lowered the age for in-service pension distributions (see our Checkpoint article). In-service distributions may, however, be subject to the 10% additional tax under Code § 72(t).

EBIA Comment: These FAQs interpret a requirement that does not apply to 401(k) plans, which are not required to provide “definitely determinable benefits” and are subject to more liberal rules regarding in-service distributions. But the FAQs nevertheless may be useful for 401(k) plan administration because one of the events permitting distribution of elective deferrals is “severance from employment,” and questions occasionally arise regarding the effect of a participant’s rehire when the participant’s severance was relied upon as the basis for a 401(k) distribution. IRS guidance has not directly addressed when a participant’s rehire might indicate there was no actual severance for 401(k) plan purposes, and the IRS has in the past declined to bless any bright-line standard for determining when rehire obviates a severance. Lacking clear guidance, 401(k) plan administrators and advisors presented with rehire situations may find this guidance instructive on the question of what constitutes a bona fide severance from employment, even for rehires that were not necessitated by the COVID-19 pandemic, because the FAQs appear to be implementing a general principle rather than creating a special exception for COVID-related rehires. For more information, see EBIA’s 401(k) Plans manual at Sections XII.A.2 (“Distributions of Contributions Other Than Elective Deferrals”) and XII.B (“Permissible Distribution Event: Severance from Employment”).

Contributing Editors: EBIA Staff.