IRS Says Employers Can Rehire Workers Drawing Retirement Benefits

As employers across the country are facing critical labor shortages, the Internal Revenue Service (IRS) has stepped in, attempting to help by removing barriers that may have previously stopped employers from rehiring retirees and dissuaded many workers from continuing to work after reaching retirement age.

The IRS recently provided guidance in the form of answers to two new frequently asked questions (FAQs) on its website to alleviate two common concerns relating to the payment of retirement benefits to employees who are still working, either after reaching retirement age or when rehired after a retirement.

1. What counts as a bona fide retirement?

The first issue arises when an employee retires and begins drawing retirement benefits from a qualified pension or other retirement plan. For plans that do not permit in-service withdrawals of retirement benefits, IRS rules for plan qualification generally require that there be a bona fide retirement in order for the individual to receive retirement benefits. Neither the Internal Revenue Code nor the IRS define what constitutes a "bona fide" retirement. Some plans define which events qualify as a bona fide retirement, but others do not, instead relying on the facts and the circumstances surrounding termination of the employment relationship.

For years, the IRS has cautioned (including in an information letter) that situations in which an employer prearranges, at the time of retirement, to later rehire the retiree would not qualify as a bona fide retirement. As a result, payment of retirement benefits in that context would be impermissible and would potentially jeopardize the qualified status of the retirement plan.

In order to attempt to avoid this concern, many plans include specific terms or adopt special administrative procedures stating that the employer will not rehire someone until he or she has been separated from the employer for a stated length of time. Some plans also adopt administrative procedures providing that the employer will only rehire someone through a third party staffing provider and only if the need to rehire the individual was unforeseen at the time of the retirement.

The new IRS guidance clarifies for employers that now find themselves needing to rehire retirees due to unforeseen circumstances imposed by the COVID-19–related labor shortage that they can do so without concern about plan disqualification. As long as the original retirement was bona fide and the rehire was not prearranged at the time of retirement, employers may rehire their retirees, and if the plan permits, may continue to pay them retirement benefits while they are working after being rehired.

The IRS cautioned that employers should carefully review and amend their plans, if necessary, to adjust any provisions that would restrict rehire, require suspension of benefits upon rehire, or otherwise affect a rehired employee's pension benefits.

2. Payment of Retirement Benefits to Employees Still Working

The second area the IRS clarified in an effort to help employers facing a labor shortage relates to payment of retirement benefits to employees who are still working and have not yet retired. Qualified pension plans may permit employees to receive in-service distributions if they have either reached age 59½ or the plan's normal retirement age. An in-service distribution provision may allow employers to retain experienced employees who might otherwise consider retiring in order to access retirement funds but who may be willing to continue working full- or part-time if they are able to receive retirement benefits while working.

In-service distributions are only permissible if authorized by the terms of the retirement plan, so employers that want to take advantage of this provision will want to carefully review their plan terms to confirm whether in-service distributions are permitted and amend their plan documents if necessary.

While the IRS news release reflected a specific concern for employers in the educational arena, the guidance provided applies broadly to all qualified pension plans.

Stephanie A. Smithey is a shareholder in the Indianapolis office of Ogletree Deakins, where she co-chairs the employee benefits and executive compensation practice group. © 2021, Ogletree, Deakins, Nash, Smoak & Stewart, P.C. All rights reserved. Republished with permission.