As things currently stand, in just over 10 months, governmental pension plans will be required to comply with regulations issued in final form by the Internal Revenue Service (IRS) in 2007 dealing with distributions from a pension plan upon attainment of normal retirement age. The IRS and Treasury have stated for the last several years that they would address serious public plan concerns with these regulations as they relate to the use of service as a component in determining the earliest age or date when a participant can retire with an unreduced benefit. However, despite very recent assurances that this long-awaited “fix” was imminent, there still has yet to be a formal release issued. Many state legislatures are already meeting, and if changes are required to be made, time is running out. While it is still hoped this issue can be resolved through the regulatory channel at Treasury and the IRS -- thus obviating the need for state changes -- Federal legislation has now been introduced in the House of Representatives to resolve the problem. But there is no guarantee that Congress will act on such legislation before the end of this year.
These so-called Normal Retirement Age (NRA) regulations were made applicable to private plans immediately upon their issuance in May of 2007, but public plans were given two years to make any necessary amendments to their laws and regulations. Thus, the NRA regulations were originally to have been effective for plan years beginning on or after January 1, 2009, for governmental pension systems. This effective date has been extended twice, and is now set to take effect for plan years beginning on or after January 1, 2013.
The IRS regulations reflect a change made by the Pension Protection Act (PPA) of 2006 that provides an exception to the general plan qualification rule that pension benefits can be paid only after retirement. This PPA exception permits a pension plan to commence payment of retirement benefits to an employee who is not separated from employment at the time of such distribution (known as an “in-service distribution”) as long as the employee has attained age 62.
However, the IRS also used this opportunity to (1) “clarify” that a pension plan is also permitted to make such in-service distributions after the participant has attained “normal retirement age;” and (2) provide rules on how low a plan’s normal retirement age is permitted to be.
Specifically, the new regulations require a pension plan’s normal retirement age to 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.” This is an effort by the IRS to prevent a normal retirement age from being set so low as to be a subterfuge to avoid the qualification requirements that, essentially, the benefit be truly related to retirement.
Several safe harbors are also provided in the regulations:
· a normal retirement age of 62 or later (or age 50 or later, in the case of a plan in which substantially all of the participants are qualified public safety employees) is deemed to pass muster;
· a normal retirement age lower than 55 (or 50 in the case of public employees) is presumed not to satisfy the requirement unless shown otherwise on the basis of facts and circumstances;
· a normal retirement age that is at least 55 but below 62 is presumed to be acceptable based on a “good faith determination of the typical retirement age for the industry in which the covered workforce is employed that is made by the employer.”
Significantly, the 2007 regulations do not provide a safe harbor (or other guidance) with respect to a normal retirement age that is conditioned (directly or indirectly) on the completion of a stated number of years of service, as is the case with many if not most public plans. In a notice (IRS Notice 2007-69) issued in August of 2007, the IRS and Treasury explained that the reason for this is because they expect that a private sector plan under which a participant’s normal retirement age changes to an earlier date upon completion of a stated number of years of service typically will not satisfy the ERISA vesting rules (found in Section 411 of the Internal Revenue Code).
But what about public plans? While the IRS noted at the time that sponsors of governmental plans were not subject to these Section 411 vesting rules, they nevertheless asked governmental plans to submit comments on whether normal retirement age under such a governmental plan may be based on years of service.
Specifically, they asked for comments on:
· whether and how a pension plan with a normal retirement age conditioned on the completion of a stated number of years of service satisfies the requirement , in order to be a qualified plan under IRC Section 401(a), that a pension plan be maintained primarily to provide for the payment of definitely determinable benefits after retirement or attainment of normal retirement age; and
· how such a plan satisfies the pre-ERISA vesting rules.
Public Plan Issues
Many governmental plans define normal retirement “age” as more a normal retirement “date.” That is, the plan formula provides the time or times when participants qualify for unreduced retirement benefits under the plan, often based wholly or partly on years of service.
If the IRS decides that the use of a normal retirement age conditioned (directly or indirectly) on the completion of a stated number of years of service does not meet the plan qualification standards described in IRC Section 401(a) and/or does not meet the pre-ERISA vesting rules, then all governmental pension plans will be required to specifically define a normal retirement age as a single “age.” This could prove to be very difficult to do, particularly when a participant can reach normal retirement age by satisfying one of several age and service combinations. Selecting an age that is higher than the lowest age would likely impair the constitutionally protected rights of the participants to any benefit conditioned on normal retirement. Selecting an age that is lower than the highest age could impact the actuarial cost of the plan.
Furthermore, even where there may be a true normal retirement “age,” if it is less than age 62, then the safe harbors that the IRS provides will be inadequate in many ways. For example, it is very unclear how “the typical retirement age for the industry in which the covered workforce is employed” would be applied in the diverse public sector setting.
NCTR and NASRA filed lengthy formal comments with the IRS in December of 2007 in response to these issues, underscoring that governmental pension plan sponsors have, for many decades, conditioned eligibility for normal retirement benefits on the completion of a stated number of years of service and many have defined normal retirement age as the time the participant becomes eligible for normal retirement. Indeed, prior to these new regulations, there was no reason to believe that such a practice was prohibited, at least for governmental plans, and in the past, the IRS has routinely approved service-based normal retirement ages through the determination letter process.
NCTR, NASRA and other public sector organizations have also held numerous meetings with the Treasury Department and the IRS over the last several years to discuss the issues with the regulations as currently drafted, the most recent of which was on January 26, 2012.
Treasury and the IRS continue to say that a resolution of the issues involving the NRA regulations is “imminent.” Furthermore, in our last meeting with them, they suggested that they thought the public sector would be generally pleased with the outcome, although no details were shared as to what that outcome might look like.
Here is a somewhat educated guess. First, in response to increased pressure to complete the processing of determination letters from Cycles C and E, some of which are apparently being held up over this matter, a statement could be forthcoming that will allow the issuance of such letters with the understanding that, based on a final resolution of the regulations, results could be different going forward. For example, the log-jam might be broken for all but plans with NRAs based wholly on service, (perhaps with an exception for public safety plans)?
Then, revised regulations applicable to governmental plans would be issued for comment, with an extension of the effective date of 1/1/2013 in order to accommodate this process. The reason for this prediction is that in answer to repeated inquiries, we have been told that whatever is proposed will not be in final form, as were the regulations for the public sector in 2007, and that comments would be sought.
In the meantime, there is now legislation introduced in Congress that would address this issue as well. The legislation is HR 3561, the Small Business Pension Promotion Act of 2011, introduced by Congressmen Ron Kind (D-WI), Jim Gerlach (R-PA), and Richard Neal (D-MA) on December 5, 2011. All three are members of the House Ways and Means Committee, to which the bill has been referred.
The legislation is primarily designed to adjust regulations for required distributions from employee pensions, allowing certain deductions for contributions to individual retirement accounts (IRAs), and permitting companies to contribute more to pension plans without penalties. Congressman Kind describes it as helping to “put our small businesses on a level playing field with larger corporations by providing small business employees access to retirement and pension accounts as well as tax deductions related to those accounts, in the same sense as those available to larger, corporate employees.”
In addition, the legislation contains a provision to address problems with the 2007 NRA regulations as applied to rural electric cooperatives. While NCTR and other public sector organizations continue to hope that our discussions with Treasury and the IRS will lead to a productive regulatory resolution to our concerns in this area, we felt that we could not permit a bipartisan piece of legislation sponsored by three members of the Ways and Means Committee to advance with provisions related to the workings of the normal retirement age regulations that did not also address our specific concerns.
We therefore worked with the three Congressmen’s offices to include language dealing with this problem in Section 7(a)(2), “SERVICE-BASED RETIREMENTS IN GOVERNMENTAL PLANS”. We also made sure that Treasury and the IRS were aware of our efforts and that we in no way were indicating that we believed that discussions with them should not proceed. In a letter from NCTR and 18 other national organizations to Congressman Kind offering support for his bill, this point was stressed: “Our representatives have been working with the IRS and other Treasury Department officials for the last several years in an effort to favorably resolve this matter, and understand they may soon be modifying the regulation. While we hope the full extent of our concerns will be addressed, nevertheless, with the pending application of the IRS regulations now less than one year away, we greatly appreciate your readying legislation to properly remedy the harmful effects of the pending regulation.”
The goal of the governmental plan provision in HR 3561 is to ensure the following:
1. State and local retirement plans may have service-based normal retirement ages, either implied or implicit. Service-based normal retirement ages include, but are not limited to, a specified length of service (i.e., 30 years), combinations of years of service and age (such as the rules of 80 or 90), and requirements that participants reach a specific age and meet a years of service requirement (i.e., reach age 60 with 10 years of service or 65 with five years of service).
2. The Treasury Department must amend its regulations on normal retirement age to:
a. Recognize that the definition of normal retirement age for state and local
retirement plans is found in state and local law;
retirement plans is found in state and local law;
b. Provide that a governmental plan with a normal retirement age conditioned on the completion of a stated number of years of service (i) satisfies the requirements of Internal Revenue Service Regulation §1.401(a)-1(b)(1)(i) that a pension plan be maintained primarily to provide for the payment of definitely determinable benefits after retirement or attainment of normal retirement age, and (ii) satisfies the pre-ERISA vesting rules; and
c. Provide that the safe harbor provisions found in the May 2007regulations solely relate to in-service distributions, so as to not supersede the state and local-based definitions of normal retirement age, and must additionally recognize the unique nature of state and local retirement plans and their workforces.
In summary, although time is running short, it does appear that the Treasury Department and the IRS are aware of the legislative pressures facing public plans, and will soon release for comment proposed new regulations dealing with the meaning of “normal retirement age” as applied to governmental plans. It may well be that this release will be accompanied by another extension of the application of the regulations in order to accommodate this process. While it is still unclear as to what the new regulations will contain, Treasury has been provided with the language of the Kind bill, and has also been provided with the above “plain English” description of what the public sector intends to accomplish with this language. While they did not state agreement with it, they did not react negatively.
Difficult tea leaves to read, but it does appear that there could soon be movement on this front, and if there is not, or if it falls far short of what has been discussed over the last several years, legislation is now in the hopper that would address the problem. While it will be difficult for such a bill to advance this year as a free-standing bill due to the impact of the fall elections on the legislative process, it should be reintroduced in the 113th Congress, when tax reform legislation is likely to advance, regardless of the outcome in November.
· HR 3651