Traditionally, the IRS has not permitted in-service distributions from defined benefit pension plans.  As a result, in recent years employers and the IRS have struggled with ways to implement “phased retirement,” which ideally includes both reduced hours of work and in-service pension distributions.  The Pension Protection Act of 2006 helped in some respects by providing that in-service distributions may be made to a participant who is age 62.  Now, the IRS has finalized regulations that allow in-service pension plan distributions to participants after the attainment of “normal retirement age.” 

Under the final regulations, a pension plan may define “normal retirement age” as an age that is “reasonably representative of the retirement age in which the covered workforce is employed,” but not later than age 65 or the fifth anniversary of plan participation.  They also provide a safe harbor for all plans of age at 62, or the later of age 62 and another specified date, such as the fifth anniversary of plan participation.  However, if the normal retirement age is between ages 55 and 62, it is presumed to meet the “industry standard” if the employer makes a good faith determination of the age based upon all of the relevant facts and circumstances.  A normal retirement age earlier than age 55 generally is presumed to be earlier than the earliest age under the appropriate industry standard.  However, the regulations specifically state that benefits may not be distributed to a participant before normal retirement age just because of a reduction in the number of hours that the participant works, so the concept of phased retirement is still limited.

The regulations provide a transition rule for employers that may have set the normal retirement age under their pension plans lower than the industry standard.  An employer may increase the normal retirement age under an existing plan, thus eliminating certain in-service distributions, without violating the anti-cutback rules by adopting an amendment after May 22, 2007 and before the last day for filing its income tax return for the 2007 fiscal year (including any extensions). 

Pension plan sponsors interested in adjusting “normal retirement age” to permit in-service distributions to employees should determine the normal retirement age that is reasonably representative of the retirement age for their industry and take action to amend their plans accordingly.