On January 27, 2016, the IRS issued proposed regulations governing the extent to which governmental pension plans must comply with the rules governing normal retirement ages. In general, the rules are a positive step from the perspective of governmental plan sponsors, but they contain a few potential pitfalls.
The qualification rules of the Internal Revenue Code (“Code”) provide for several rules that are based on a plan’s normal retirement age. For example, a pension plan cannot pay in-service benefits before the earlier of age 62 or normal retirement age. Benefits must be fully vested at normal retirement age. Benefits under the plan must be definitely determinable (i.e., subject to calculation, rather than at an employer’s discretion) as of normal retirement age.
Final regulations defining normal retirement age for the definitely determinable requirement were published in the Federal Register as TD 9325 on May 22, 2007 (72 FR 28604) (“2007 NRA regulations”). However, these regulations were based in part on the vesting requirements of Code section 411. Governmental plans are exempt from the current version of Code section 411, and are required to comply only with the pre-ERISA version of that section. Thus, it was unclear to what extent governmental plans would be required to comply with the 2007 NRA regulations.
If applied to governmental plans, the 2007 NRA regulations would have had a serious impact on their operation. First, they required plans to contain language that specifically defined “normal retirement age.” While this would not have been a substantive change, in the case of many governmental plans it would have required a change in plan language that could be made only by legislative amendment. Given that many legislatures meet only every other year, timely amendments could have been an issue.
More importantly, the 2007 NRA regulations require that if a plan has a normal retirement age earlier than age 62, the normal retirement age must 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 (“reasonably representative requirement”). Under the 2007 NRA regulations, whether a normal retirement age that is not earlier than age 55 but is below age 62 satisfies the reasonably representative requirement is based on a facts and circumstances analysis. Section 1.401(a)-1(b)(2)(iv) of the 2007 NRA regulations provides that a normal retirement age that is lower than age 55 is presumed not to satisfy the reasonably representative requirement unless the Commissioner determines otherwise on the basis of facts and circumstances.
It is common for governmental plans to have a variety of ways to calculate when a pension is payable, some of which are not based on age at all. For example, a plan might provide that full benefits are payable after 25 years of service, regardless of the person’s age. This would mean that an employee hired at age 18 could retire as young as 43. It was unclear whether such a retirement age would be tested against he reasonably representative requirement based on the average age an employee would attain after 25 years of service, the youngest age at which an employee could have that much service, or some other measure. Clearly, defending age 43 as 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 could be challenging, especially given the presumption in the 2007 NRA regulations that such an age would not satisfy the reasonably representative requirement.
The effective date of the 2007 NRA regulations was generally May 22, 2007. In the case of a governmental plan (as defined in section 414(d)), the regulations were to apply with respect to plan years beginning on or after January 1, 2009. This was a major issue for governmental plans. In the first place, governmental plans can often be amended only by legislative action, and many legislatures meet only every other year. Thus, there would have been considerable time pressure on adopting the necessary amendments. Second, many states have interpreted either federal or state Constitutional provisions to preclude modification of any governmental plan in a way that is disadvantageous to any current employee. To the extent that the regulations might have imposed requirements that would impair the benefit of any employee hired before the plan amendment, they could have required amendments that would be impermissible under those Constitutional provisions.
Application of 2007 NRA Regulations to Governmental Plans
Notice 2007-69, 2007-2 C.B. 468, 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 §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 how such a plan satisfies the pre-ERISA vesting rules.”
The 2007 NRA regulations provided that, in the case of governmental plans, the regulations would be effective for plan years beginning on or after January 1, 2009. Notices 2008-98, 2008-44 I.R.B 1080, and 2009-86, 2009-6 I.R.B. 629, provided that the Department of the Treasury and the IRS intended to amend the 2007 NRA regulations to change the effective date of the 2007 NRA regulations for governmental plans to January 1, 2013. Again, no provision was made for grandfathering employees hired before that date.
Notice 2012-29, 2012-18 I.R.B. 872, announced that the Department of the Treasury and the IRS intend to modify provisions of the 2007 NRA regulations as applied to governmental plans in two ways. First, Notice 2012-29 announced the intent to modify the regulations to clarify that a governmental plan that is not subject to section 411(a) through (d) and does not provide for the payment of in-service distributions before age 62 will not fail to satisfy the requirement that the plan provide definitely determinable benefits to employees after retirement or attainment of normal retirement age merely because the pension plan does not have a definition of normal retirement age or because its definition of normal retirement age does not satisfy the requirements of the 2007 NRA regulations.
Second, Notice 2012-29 announced the intent to modify the 2007 NRA regulations to provide that age 50 or later is a normal retirement age that satisfies the 2007 NRA regulations in the case of a group of employees substantially all of whom are qualified public safety employees, whether or not the group of qualified public safety employees are covered by a separate plan. For this purpose, the term “qualified public safety employee” means an employee of a State or of a political subdivision of a State (such as a county or city) whose principal duties include services requiring specialized training in the area of police protection, firefighting services, or emergency medical services for any area within the jurisdiction of the State or the political subdivision of the State. It was, however, unclear whether it was permissible to have different normal retirement ages in a plan for employees other than public safety employees, e.g., to have different normal retirement ages for teachers and judges.
Notice 2012-29 also provided that the Department of the Treasury and the IRS intended to amend the 2007 NRA regulations to modify the effective date of the 2007 NRA regulations for governmental plans to annuity starting dates that occur in plan years beginning on or after the later of (1) January 1, 2015 or (2) the close of the first regular legislative session of the legislative body with the
authority to amend the plan that began on or after the date that was 3 months after the final regulations were published in the Federal Register. The reference to annuity starting dates meant that there was again no provision to meet Constitutional requirements by exempting employees hired before the effective date, whose annuity starting date was after the effective date.
New Proposed Regulations
The proposed regulations issued today, “Applicability of Normal Retirement Age Regulations to Governmental Pension Plans,” flesh out and amend the rules of Notice 2007-69 and Notice 2012-29 in several ways:
- The plan document for a governmental plan is not required to provide a specific definition of normal retirement age. Instead, normal retirement age is the lowest age specified in the plan at which the employee has the right to retire without the consent of the employer and receive retirement benefits based on the amount of the employee’s service to the date of retirement at the full rate set forth in the plan (that is, without actuarial or similar reduction because of retirement before some later specified age). This went beyond the language in Notice 2012-29, which had allowed a plan not to include such a definition only if the plan did not provide for the payment of in-service distributions before age 62.
- The proposed regulations provide for safe harbors under which a normal retirement age below age 62 will be considered to satisfy the reasonably representative requirement for any employee. These apply if normal retirement age is:
- Attainment of age 62, with or without a service requirement;
- Attainment of age 60 with 5 years of service;
- Attainment of age 55 with 10 years of service;
- Combined age and years of service of 80 or more; or
- Attainment of 25 years of service, regardless of age. (This last would have to be combined with one of the other permissible normal retirement ages, so that an employee hired at age 60 could not be required to wait until age 85 to be entitled to a full benefit.)
The proposed regulations indicate that these safe harbors are intended to cover all state plans and most or all local government plans.
- The proposed regulations provide for safe harbors under which a normal retirement age below age 62 will be considered to satisfy the reasonably representative requirement for public safety employees. These apply if normal retirement age is:
- Attainment of age 50;
- Attainment of 20 years of service, regardless of age:
- Attainment of a combination of age and service that totals at least 70.
The proposed regulations eliminate the requirement that “substantially all” employees covered by the plan or in a particular group under the plan be public safety employees. Again, the proposed regulations indicate that all state plans will meet one of the safe harbors.
- The regulations state that it is permissible to have different normal retirement ages for different classes of employees, so long as each satisfies the requirements. For example, a plan could have one normal retirement age for teachers and a different one for judges.
- For a normal retirement age that is outside of the safe harbors, the reasonably representative requirement will apply. The proposed regulations state that,
Similar to the treatment of normal retirement ages between ages 55 and 62 under the 2007 NRA regulations, it is generally expected that 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 will be given deference, assuming that the determination is reasonable under the facts and circumstances and that the normal retirement age is otherwise consistent with the pre-ERISA vesting requirements.
It is unclear whether this means that deference will be given to any good faith determination that a retirement age meets the reasonably representative requirement, or whether that applies only to a retirement age between 55 and 62, with a lower retirement age being presumed not to meet such requirement.
As discussed above, this issue is unlikely to be a concern in most instances, since state plans will typically provide for a normal retirement age that meets the safe harbors. The one place it is likely to be a concern is if employees not meet the definition of a public safety employee are covered by a plan for public safety employees. One commonly cited situation is that of prison guards, who must often retire at ages similar to those of police officers, but who are not considered public safety employees. If a plan that covered prison guards provided for a normal retirement age of 50, for example, the employer would have to show that such age met the reasonably representative requirement. It is unclear whether deference would be given to a good faith determination that the normal retirement age met such requirement, or whether extra hurdles would be imposed.
It is also unclear what would be required in order to show that there had been a good faith determination that a normal retirement age met the reasonably representative requirement. Would the employer have to provide some sort of documentation of the factors it had considered? What kinds of surveys or other evidence would be required?
The regulations are proposed to be effective for employees hired during plan years beginning on or after the later of (1) January 1, 2017 or (2) the close of the first regular legislative session of the legislative body with the authority to amend the plan that begins on or after the date that is 3 months after the final regulations are published in the Federal Register. Thus, for the first time, the IRS has recognized the Constitutional requirement not to change plan benefits in a way that would disadvantage employees hired before the effective date, even if they did not retire until after such date.
Plans are entitled to rely on the proposed regulations even before their effective date. The IRS states that if later regulations are more restrictive, they will apply without retroactive effect. Presumably, although this is not mentioned, the same grandfathering of existing employees will apply to changes required by more restrictive final regulations.
In general, the proposed regulations are favorable to governmental plans. They answer many of the questions raised by earlier guidance, and provide safe harbors that will cover all statewide governmental plans. While local governmental plans should be examining the guidelines to make sure they are in compliance, it is anticipated that most of them will be.
The one big issue in the proposed regulations is in the case of governmental plans that cover employees such as prison guards under benefit structures for public safety employees. Such plans will be required at a minimum to make a good faith determination that the reasonably representative requirement is met. It is unclear what procedures would be required to make such a determination, and whether deference would be given to it if the retirement age chosen were less than age 55.