Jul 5, 2009

RETIREMENT AGE| Plan Qualification Requirements

A plan's normal retirement age is the age at which a participant can retire and receive the full specified retirement benefit. A defined-benefit plan must specify a normal retirement age in order to fully define the benefit. Defined-contribution plans do not need a normal retirement age for this purpose, but they may have a normal retirement age in order to specify an age at which participants can retire and begin to receive benefits or, as discussed below, an age beyond which no further employer contributions will be made.

Under Code Section 411(a)(8), a plan's normal retirement age can be no greater than the latest of:

  • age 65 or

  • the fifth anniversary of plan entry if a participant entered within five years of normal retirement age.

Thus, for example, a plan having a normal retirement age of 65 could provide normal retirement at age 67 for a participant entering at age 62.

Although most plans use 65 as the normal retirement age, the plan may specify an earlier normal retirement age. The use of an earlier normal retirement age in a defined-benefit plan requires that funding be accelerated—larger amounts must be contributed to the plan each year to fund each employee's benefit because the benefit will become payable at an earlier date. For plans in which tax sheltering is a primary consideration, such as plans oriented toward key employees in a closely held business, the use of the earliest possible normal retirement age can provide significant additional tax benefits by increasing the deductible plan contributions each year. However, if the normal retirement age is less than the Social Security retirement age, the Section 415 limitations are reduced. This tends to provide some limit on the use of unrealistically low normal retirement ages.

The IRS considers a plan's retirement age to be an actuarial assumption. Therefore, the requirement of "reasonableness" for actuarial assumptions, also puts some limit on the use of unrealistically low normal retirement ages.

Early Retirement
A qualified plan may designate an early retirement age at which an employee may retire and receive an immediate benefit. The early retirement benefit is usually reduced below that payable at normal retirement. The plan may have some service requirement for early retirement, such as ten years of service, or it may permit early retirement simply upon attainment of the early retirement age.

Under most defined-benefit plans, the monthly early retirement benefit is reduced below the monthly normal retirement benefit payable at age 65 because of two factors. First, the early retirement benefit will usually be limited to the participant's accrued benefit, and the participant will often have not accrued the full benefit at early retirement. Second, most plans require an actuarial reduction. The actuarial reduction is a mathematical adjustment based on (1) longer life expectancy at early retirement, (2) loss of investment earnings to the plan fund due to payments beginning earlier, and (3) loss of the possibility that the participant might die before payments begin—mortality.

Most plans do not require employer consent for early retirement. If employer consent is required, the IRS limits the early retirement benefit to the vested accrued benefit that would be payable if the employee terminated employment unilaterally, in order to avoid the possibility that the employer will favor highly compensated employees in granting early retirement benefits.

For defined-contribution plans, early retirement is usually treated the same as a termination of employment, and the benefit payable at early retirement is simply the amount of the participant's account balance as of that date. Thus, many defined-contribution plans do not specify an early retirement age.

Some employers offer a "subsidized" early retirement benefit—one that is reduced by less than the full amount dictated by the three factors discussed above—as an incentive for retirement. The subsidized benefit is often offered during a limited "window" period, during which the employee must either choose the benefit or lose the opportunity to receive it forever (or at least until the employer decides to offer another window benefit). There are specific legal protections under the Age Discrimination Act for employees in this situation.

Late Retirement
A qualified plan design should also cover the possibility of late retirement—retirement after the normal retirement age. Under the age discrimination rules discussed below, the plan must continue benefit accruals for employees who continue working after the normal retirement age unless the plan's benefit formula stops benefit accruals after a specified number of years and the employee has enough years of service to cease accruals for that reason. Benefit formulas must be designed carefully to ensure appropriate treatment of older employees. In smaller businesses, older participants are often owners or key employees who will want the plan to provide substantial benefits. On the other hand, many larger employers want to encourage earlier retirement and will want to provide only the minimum late retirement benefit required under the law


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