Retirement Age Guidance for Public Pension Plans
Many public institutions maintain defined benefit pension plans that qualify as “governmental” pension plans. Although governmental plans are not subject to the provisions of the Employee Retirement Income Security Act of 1974, as amended (ERISA), such plans must satisfy certain pre-ERISA tax-qualification requirements under the Internal Revenue Code of 1986, as amended (Code), including vesting rules.
One such tax-qualification requirement is satisfaction of a pre-ERISA vesting rule that governs the definition of normal retirement age (i.e., the age when participants can receive unreduced retirement benefits). Typically, governmental plans do not define a precise “normal retirement age.” Instead, most governmental plans use “years of service” (years the participant has worked for the institution) to determine when a participant can start collecting normal retirement benefits.
Using years of service alone, however, may no longer satisfy the Code’s vesting rules per recent IRS guidance. In 2007, the IRS issued final rules on how to define “normal retirement age” in a defined benefit plan and provided a safe harbor for plans that defined normal retirement age as age 62 or older. But how the 2007 IRS final rules (including the safe harbor) applied to governmental pension plans remained unclear. Given that uncertainty, the IRS delayed compliance for such plans pending comments from the public sector.
On January 27, 2016, taking into account comments from the public sector (as well as prior IRS guidance and pre-ERISA “normal retirement age” rules), the IRS, issued proposed regulations addressing normal retirement age for governmental pension plans. Although the proposed regulations do not require a governmental plan to include an explicit definition of normal retirement age, the plan must specify the earliest age when a participant has the right to retire and receive a normal (unreduced) retirement benefit under the plan. Plus, any definition of normal retirement age that a governmental plan does include must be reasonably representative of the typical retirement age in the industry in which the covered workforce is employed.
To satisfy the “reasonably representative” requirement, the IRS provides three general safe harbor provisions. First, there is a safe harbor if the plan’s normal retirement age is at least age 62.
Second, for those plans that do not use age 62 or older as the normal retirement age, a separate provision may apply if the normal retirement age falls into one of the following safe harbor categories:
- The later of age 60 or the age when the participant is credited with at least five years of service. (For example, the plan can provide that a participant will reach normal retirement age after completing five years of service, if the participant has attained the age of 60);
- The later of age 55 or the age when the participant is credited with at least 10 years of service. (For example, the plan can provide that a participant will reach normal retirement age after completing 10 years of service, if the participant has attained the age of 55);
- The participant’s age plus years of service equals at least 80. (For example, the plan can provide that a participant will reach normal retirement age after the completion of thirty (30) years of service, if the participant has attained the age of 50); or
- An age determined by using a combination of the other safe harbors if the participant has completed at least 25 years of service, if that age is earlier than what the participant’s normal retirement age would be under the other safe harbors. (For example, the plan can provide that a participant will reach normal retirement age as the earlier of: when the participant is credited with 25 years of service or the later of age 60 or the age the participant completes five years of service).
Third, the proposed regulations include separate safe harbors for qualified public safety employees (such as employees that provide police protection, firefighting services, or emergency medical services), recognizing that such employees generally commence participation at an earlier age and have careers that continue for a limited period of years. These safe harbors cannot be used for other employees that may participate in the same plan. The safe harbors for qualified public safety employees are: (i) the attainment of at least age 50, (ii) a combined age and service of at least 70; or (iii) the completion of at least 20 years of service (regardless of age). Notably, the regulations explicitly permit the use of different normal retirement ages for different classification of employees.
If a plan fails to satisfy any of the safe harbors, however, then any determination of whether the defined normal retirement age is “reasonably representative of the industry” will be based on all the facts and circumstances. In this circumstance, the plan sponsor will be given deference only if, based upon the facts and circumstances, there is evidence of good faith. But how “good faith” will be established and whether independent data will be required to justify the plan’s definition of normal retirement age remains unclear.
As drafted, it appears that the proposed regulations recognize (a) the potential need for legislative session to amend certain governmental plan terms, and (b) the potential detriment that the proposed regulations may have on current plan participants. As a result, the regulations are proposed to be effective only with respect to employees hired during plan years beginning on or after the later of (a) January 1, 2017, or (b) the close of legislative session with authority to amend the plan that begins after the date that is three months after the final regulations are published. In the interim, the IRS is permitting governmental plan sponsors to rely on the proposed regulations, for periods prior to the effective date. Although permitted, government plan sponsors are not required to rely on the proposed regulations, and if they choose, can wait for the final rules to be issued.
If you have any questions about the proposed regulations or the potential impact at your institution, Saul Ewing’s Higher Education Practice Group is available to assist.
This article appears in the Spring 2016 edition of Saul Ewing’s Higher Education Highlights newsletter. Click here to see the complete newsletter.