“Retire” Doesn’t Mean “Rehire”

January 23, 2012

Authored by: benefitsbclp

In Private Letter Ruling 201147038, the Internal Revenue Service addressed an issue that surfaces frequently when an employer offers a voluntary retirement program. An employee may want to take advantage of the incentives offered under the program, but he or she may also want to continue working for the employer, and the employer may want the employee to continue working.

In this ruling, a plan proposed a funding rehabilitation plan which included eliminating unreduced early retirement benefits for participants with 20 or more years of service. Once the rehabilitation plan was effective, a participant would no longer be able to retire after 20 years of service with an unreduced benefit. The taxpayer proposed giving participants advance notice of the elimination of this right, along with the ability of affected participants to elect to retire during the notice period and then immediately return to employment. Upon reemployment, their pension benefits would be suspended, but they would have secured their eligibility for the 20-year unreduced early retirement benefit.

A 401(k) plan may not distribute salary deferral amounts until certain defined events, including severance from employment. A defined benefit plan must be a “pension plan,” which the IRS has defined in regulations to be a plan that is established and maintained to provide benefits to an employer’s employees over a period of years after retirement. While the term “retirement” is not defined in those rules, in Revenue Ruling 56-693, the IRS held that a plan would not be a pension plan if it permitted the payment of benefits prior to severance from employment.

Where an employee “retires” but then immediately or after a short break returns to employment, a question arises as to whether the employee had a severance from employment entitling him or her to a distribution under a qualified plan. Very little guidance is available to assist with this analysis. This recent ruling provides good insight into how an employer can analyze the situation to make sure these qualified plan distribution rules are not violated. In a nod to the standards applied under the nonqualified deferred compensation plan rules under Internal Revenue Code Section 409A, the IRS stated the following:

“These regulations [Treas. Reg. 1.409A-1(h) and 1.410(a)-7(b)] and Revenue Ruling [79-336] serve to clarify that an employee legitimately retires when he stops performing service for the employer and there is not the explicit understanding between the employer and employee that upon retirement the employee will immediately return to service with the employer.”

An employee “retiring” under a voluntary retirement program or even outside a program would likely not have a severance from employment if he or she has an arrangement or understanding with the employer that he or she will be rehired. It seems the IRS may take this position even if the break between the “retirement” and rehire is relatively lengthy, such as 3 months.