Seyfarth Synopsis: The IRS recently sought to reassure employers that they will not jeopardize their retirement plan’s tax qualified status if they permit employees who have a bona fide separation from service to take a distribution from their retirement plan, even if they are rehired shortly thereafter by the same employer. The reassurance comes in the form of two FAQs that address COVID-related labor shortages and in-service distribution rules.
To maintain tax-qualification, retirement plans are required to limit a participant’s ability to take a distribution of their plan benefit while still working. However, and subject to controlled group rules that aggregate related employers, distributions are allowed once the participant leaves employment (separates from service) with the employer sponsoring the plan. In order to prevent “sham” separations (and commensurate benefit distributions), the IRS requires that the separation be “bona fide.”
Many employers have been and continue to be experiencing significant labor shortages as a consequence of the COVID-19 pandemic, and are looking to rehire employees who had previously separated from service and received or commenced to receive a distribution of their retirement benefits. The practice of rehiring former employees could be problematic based on existing IRS guidance if there were no bona fide retirement or separation at the time of initial employment termination. This could occur, for example, if an employer has agreed to rehire an employee at the time of the employee’s “retirement” or other separation from service.
In an effort to remind and reassure employers, the FAQs reiterate the IRS’s position that:
- The determination of whether an individual’s retirement or separation from service is bona fide for retirement plan purposes is based on a facts and circumstances analysis (in the absence of plan terms specifying the conditions under which a retirement or other separation from service will be considered bona fide); and
- A rehire due to unforeseen circumstances (such as COVID-related labor shortages) that do not reflect any prearrangement to rehire the individual will not cause the individual’s prior retirement or separation from service to no longer be considered “bona fide” under the plan.
The FAQs also remind employers that under the SECURE Act, defined benefit pension plans can be amended to allow in-service distributions to employees who have attained age 59 1/2. This change aligned the minimum age for in-service distributions under defined benefit pension plans with the existing age 59 1/2 in-service distribution rules for defined contribution plans (e.g., 401(k) and 403(b) plans).
While the new FAQs do not relax or otherwise modify existing IRS guidance relating to rehires and bona fide retirements/separations, they serve as a helpful reminder to sponsors of qualified retirement plans. Plan sponsors who wish to rehire a retired or previously separated employee to fill an unforeseen hiring need should first ascertain that the employee’s prior retirement/separation was bona fide and there was no previous agreement to rehire the employee.
This unforeseen need may arise as a result of the COVID-19 pandemic, or otherwise in the ordinary course of business. Also, plan sponsors should be mindful of plan terms that affect rehires and distributions. For example, plan sponsors should review any plan terms requiring that an individual who retires or otherwise separates from service and commences benefit distributions not be rehired within a specified period, any plan terms relating to the suspension of distributions upon rehire, and any other plan terms that may have an impact on the retirement benefit of a rehire.
If you have any questions or concerns about rehiring of a previously retired or separated employee, please contact your Seyfarth attorney.