IRS Removes Two Key Barriers to Help with Post-COVID Labor Shortages

by Prof. Robert Bloink and Prof. William H. Byrnes

Employers have been struggling across-the-board to rehire workers in the wake of the COVID-19 pandemic. Many employees chose to take early retirement because of health or workplace safety issues. Others simply reevaluated career goals in a post-pandemic world and have opted to change paths. In the meantime, business owners have struggled with labor shortages while working to get their companies back to business. The IRS has taken note and provided relief by removing key barriers that kept some employers from rehiring retired pension participants, while also clarifying the in-service distribution rules that could have kept some retirement plan participants from continuing to work past retirement age.

In-Service Pension Distributions: The Basics

Pension plans must be maintained primarily to pay “definitely determinable” benefits to participants during retirement or after attaining normal retirement age. In other words, a pension that does not permit in-service distributions can typically only pay benefits after the participant has experienced a “bona fide retirement”. Typically, whether a participant has experienced a bona fide retirement is based on a facts and circumstances analysis unless the plan document provides otherwise.

Violating this rule could jeopardize a pension plan’s tax-qualified status—causing many employers to hesitate when it comes to rehiring employees who began taking retirement distributions during a pandemic-induced early retirement.

The pension distribution rules are different from those governing defined contribution plans, such as 401(k)s. However, these rules may help provide guidance to plan administrators who have begun 401(k) distributions based on a past severance from employment and are looking to rehire (although the IRS has declined to specifically address the issue in the context of 401(k) plans).

New IRS Relief for Plan Sponsors

The latest IRS guidance addresses two key concerns about paying pension retirement benefits while employees continue to work—whether in a situation where the employee has (1) retired and returned to work or (2) continued to work past retirement age and wishes to begin taking retirement distributions. The IRS has updated its FAQs to provide relief in these areas for business owners looking to rehire in the wake of the COVID-19 pandemic.

The first question addresses a situation where a pension did not provide for in-service distributions and began paying benefits to a participant who experienced a bona fide retirement. According to the IRS, if the plan sponsor rehires the participant because of unforeseen hiring needs related to the COVID-19 pandemic, the individual's prior retirement will still be treated as a "bona fide retirement". In other words, the rehire would not jeopardize the plan’s tax-qualified status and payments could continue if permitted by the plan.

The IRS reasoned that a rehire due to unforeseen circumstances that do not reflect any prearrangement to rehire the individual will not cause the individual's prior retirement to no longer be considered a bona fide retirement under the plan.

The IRS was also careful to note that plan sponsors should carefully review their plan documents before rehiring. Some plans impose limitations on the employer’s ability to rehire plan participants within a certain amount of time after retirement and benefit commencement—and others prohibit the continued payment of benefits upon rehire.

The IRS has also clarified that a qualified pension can allow individuals to begin in-service distributions if the individual has either attained (1) age 59½ or (2) the plan's normal retirement age. However, distributions before age 59½ can lead to the imposition of a 10 percent penalty under IRC Section 72(t) unless an exception applies.

Conclusion

While it seems that the IRS relief was designed to help public schools rehire teachers, the guidance applies to all pension plan sponsors. Plan sponsors looking to rehire retired participants or provide incentives to retain employees who are approaching retirement age should pay close attention to the details and consider amending their pension documents if necessary to take advantage of this relief.