IRS regulations target retirement age

WASHINGTON—Internal Revenue Service regulations that define the normal retirement age for a pension plan will force hundreds of employers that use a younger age to prove it is reasonable.

The final IRS regulations, which were published last week and imposed immediately, also effectively end an innovative but controversial design used by some cash balance plan sponsors that paid participants smaller benefits than those to which IRS regulators said participants were entitled.

The regulations, though, will have little, if any, impact on employers with pension plans that define retirement age—at which an employee can collect a full pension benefit—as 62 or older.

While the regulations say the retirement age can't be earlier than what is typical for the industry that the employer is in, plans with a retirement age of 62 or older would automatically pass muster under a safe harbor included in the regulations.

Currently, the vast majority of U.S. employers specify age 65 as the normal retirement age in their defined benefit plans, consultants and others say.

Still, as many as 5% of private pension plans specify younger retirement ages, especially those in physically demanding industries where employees retire earlier.

"The nature of the work may be such that working over age 60 is very burdensome," said Bob Walter, a principal and benefits consultant at Buck Consultants L.L.C. in Secaucus, N.J.

The regulations allow those employers to hang on to the way they define retirement age, but now they must justify that age.

"This is going to require some analysis and extra work," said Nancy Gerrie, a partner with law firm McDermott, Will & Emery L.L.P. in Chicago.

For plans that allow full retirement at 55 or older, the regulations require that it not be earlier than "the earliest age that is reasonably representative of the typical retirement age for the industry in which the covered workforce is employed."

Employers are expected to make a "good-faith determination of the typical retirement age" of the industry. That determination, the IRS says, should be based on "all the relevant facts and circumstances."

Benefit experts, though, say the IRS has given employers no guidance on how to make such determinations.

"It is very unclear what information would be required," said Bob Leone, a Hewitt Associates Inc. consultant in Minneapolis.

Such a determination could be especially challenging if an employer's pension plan covers employees working in a variety of industries. In such situations, it isn't clear which industry statistics would be relevant, said Richard Shea, a partner at Covington & Burling L.L.P. in Washington.

Still, experts note, the IRS will show deference to employers that use a retirement age of 55 or older, according to the regulations, which were published in the May 22 issue of the Federal Register.

On the other hand, if the employer selects a retirement age younger than 55, it would be presumed to be earlier than the earliest age employees typically retire, unless the employer is able to prove to the contrary.

The regulations include a special exception for pension plans covering public safety employees, such as police officers, firefighters or medical emergency personnel. Employers sponsoring such plans could use a full retirement age as low as 50 and automatically be considered reasonable by the IRS.

The regulations, though, eliminate an innovative retirement age selected by some cash balance plan sponsors. Those sponsors defined normal retirement age as attainment of five years of participation in the plan.

Employers took such an approach to offset the impact of an IRS proposal—one that attorneys say it never formally adopted but still used in enforcement—that had the impact of inflating the value of account balances for younger employees when they terminate employment.

Rather than simply giving employees the account balance, IRS agents said a methodology known as "whipsaw" had to be used. Under this approach, the account balance, expressed as a lump sum, is projected to the plan's normal retirement age using the interest rate that the plan uses to credit employees' account balances. That amount then is discounted using the 30-year Treasury bond rate—an index set under a 1994 law—to a current value, reflecting the employee's current age.

In certain situations, such as when the 30-year Treasury bond rate is much lower than the interest rate that employers use in crediting account balances, an employee terminating employment would be entitled to a sum greater than his or her account balance.

By defining normal retirement age as five years of plan participation, the impact of whipsaw would be blunted since account balances would not have to be projected very far.

"If you drop your normal retirement age down really low, you have less spread in the projection to normal retirement age and discount back to present value," said Ms. Gerrie of McDermott, Will & Emery.

"It is a way of avoiding whipsaw," said Kyle Brown, an attorney with Watson Wyatt Worldwide in Arlington, Va.

The new IRS regulations notwithstanding, whipsaw does not appear to be an issue for cash balance plan sponsors. Last year's pension funding reform law eliminated its application for distributions after the law was enacted, with terminating participants entitled to only the amount credited to their account balance.

The IRS, though, has yet to issue guidance to help employers comply with the change.