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New IRS Regulations Target Retirement Age

Plans allowing full pensions for employees younger than 62 must justify their decision, but so far no guidance has been offered to help employers comply. One mystery: How to determine ‘typical retirement age.’

June 18, 2007
Related Topics: Retirement/Pensions, Benefit Design and Communication, Latest News

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 regulations, which were published in late May and imposed immediately, 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.

While the regulations say the retirement age can’t be earlier than what is typical for the employer’s industry, plans with a retirement age of 62 or older would automatically pass muster.

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,” says Nancy Gerrie, a partner with law firm McDermott Will & Emery in Chicago.

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.”

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,” says Bob Leonen, a Hewitt Associates Inc. consultant in Minneapolis.

Such a determination could be especially challenging if an employer’s pension plan covered employees working in a variety of industries. In such situations, it isn’t clear which industry statistics would be relevant, says Richard Shea, a partner at Covington & Burling 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. 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 eliminate an innovative retirement age selected by a very small percentage of cash-balance plan sponsors. Those sponsors defined typical 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 the agency 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 retirement age as five years of plan participation, the impact of whipsaw would be blunted, as 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,” says Gerrie of McDermott Will & Emery.

“It is a way of avoiding whipsaw,” says Kyle Brown, an attorney with Watson Wyatt Worldwide.

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.

Filed by Jerry Geisel of Business Insurance, a sister publication of Workforce Management. To comment, e-mail

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