New IRS rules pave the way for phased-in retirement benefits

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in Small Business Tax,Small Business Tax Deduction Strategies

The lines between “working” and “retirement” are blurring. Back in the day, an employee called it quits, collected a gold watch or a plaque and walked out the door for good. Nowadays, many employees—especially those who are business owners or company officers—are likely to stay on in some limited capacity.

Strategy: Amend your company retirement plan to accommodate a “phased-in” retirement. The IRS has issued new final regulations that provide the guidance you’ll need. (T.D. 9325) The final regulations clarify and modify previously issued proposed regulations.

Notably, the new final regs permit in-service distributions under the Pension Protection Act of 2006 (PPA) and include safe-harbor rules, recognizing the changing business landscape. Thus, it will become more common for employees to cash in on retirement benefits while they continue to draw a paycheck.

The new regulations also can help with the transition of valuable information and skills from older employees to younger employees.

Here’s the whole story: Generally, a pension plan pays benefits to an employee after he or she separates from employment. Specifically, the tax code provides that normal retirement age for this purpose is the earlier of:

  • Normal retirement age under the plan (e.g., at age 62 or 65).
  • When the employee attains age 65 or the fifth anniversary of when the employee commenced participation in the plan. (IRC Section 411[a][8])

Under the new regulations, after the participant attains normal retirement age, he or she may start to receive payments. In addition, the regs take into account the PPA provision addressing a phased-in retirement program. The PPA allows a company to make a distribution to an employee who reaches age 62 but does not separate from employment.

New safe-harbor rule: The proposed regs established that the normal retirement age could not be set so low as to avoid the usual tax-law requirements. The new final regs replace the standard with a safe-harbor age of 62. However, pertinent facts and circumstances may dictate a normal retirement age earlier than 62. Prime example: The IRS notes special circumstances for public-safety employees.

Finally, a plan amendment that changes the normal retirement age to a later age will not violate the tax law merely because it eliminates a right to an in-service distribution prior to the amended normal retirement age. But the IRS cautions that this treatment does not provide relief from any other applicable requirements.

Tip: The final regulations are generally effective after May 22, 2007. Special rules may apply to government plans and plans maintained under collective-bargaining agreements.


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