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Prearranged Rehire of Retirees Could Disqualify Your Pension Plan

  • March 15, 2012

As an employee reaches retirement age, he may want to retire or cease working full-time.  The employer, however, may need or want the employee to continue to work temporarily or on a part-time basis.  The employee wants to begin to receive his pension plan payments. A frequent question in this scenario is, “Can we employ the participant part-time or for a few more months, but begin the employee’s pension payments?” 

The answer is “no.” A pension plan participant cannot begin to receive benefits before the earliest of death, disability or termination of employment.  Benefits cannot begin unless there has been a termination of employment.  (While there are exceptions, they are not practical for most plans.)  The follow up question usually is, “Can the employee quit and we rehire him after he goes to Florida for a week, a month, six months?”  The answers are “no,” “no,” and “probably not.”

The Internal Revenue Service has issued a private letter ruling that a pension plan would cease to be qualified under Code Sec. 401(a) if it allows workers who are under age 62 to “retire” in order to lock in an unreduced early retirement pension benefit, and then be rehired.

The arrangement presented to the IRS and considered in the private letter ruling involved an employer that wanted to eliminate a subsidized, early-retirement benefit under its pension plan.  The employer proposed to give participants notice 60 days before the date that the benefit is eliminated.  Eligible participants who retire during this 60-day window would then return to employment and have their benefits suspended while working. 

Before eliminating the benefit (i.e., the right of participants with 20 or more years of service to retire early with an unreduced pension benefit), the employer wanted to allow employees to “retire” on one day in order to qualify for the existing subsidized service pension benefit and return to work the very next day or a week later.  Neither the employee nor the employer intended for these “retirees” to actually terminate employment when they “retire” and qualify for their early retirement pension benefit.  The taxpayer asked the IRS to rule on whether the plan would be disqualified under Code Sec. 401. 

The IRS privately ruled that the proposed arrangement would cause the plan to be disqualified.  It interprets the law to require that when an employee legitimately retires, he separates from service with the employer.  If both the employer and employee knew at the time of “retirement” that the employee, with reasonably certainty, will continue to perform services for the employer, a legitimate termination of employment has not occurred upon “retirement.”  The IRS also said that under the regulations dealing with severance of employment, an employee retires on a severance of service date when his period of service ends with the employer. 

The IRS concluded that because a qualified pension plan generally cannot pay benefits before retirement, an employee who “retires” with the explicit understanding between him and the employer that he will return to service immediately has not legitimately retired, and may not qualify for an early-retirement benefit under the plan.  Because such employees do not actually separate from service and stop working for the employer when they “retire,” their supposed “retirements” would not constitute a legitimate basis to allow participants to qualify for early-retirement benefits. 

The bottom line:  for an employee’s pension benefits to begin, the termination from employment must be a real severance from employment.  The result of the private letter ruling illustrates the IRS position on any retirement with a prearranged rehire. 

Employers have legitimate reasons to rehire an employee who actually retires.  However, a prearranged agreement to rehire the employee risks the qualification of your pension plan.

©2012 Jackson Lewis P.C. This material is provided for informational purposes only. It is not intended to constitute legal advice nor does it create a client-lawyer relationship between Jackson Lewis and any recipient. Recipients should consult with counsel before taking any actions based on the information contained within this material. This material may be considered attorney advertising in some jurisdictions. Prior results do not guarantee a similar outcome.

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