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  • BC Network
    Tuesday, December 20, 2016

    claimIt might be tempting to conclude that the recent Department of Labor regulations on disability claims procedures is limited to disability plans.  However, as those familiar with the claims procedures know, it applies to all plans that provide benefits based on a disability determination, which can include vesting or payment under pension, 401(k), and other retirement plans as well. Beyond that, however, the DOL also went a little beyond a discussion of just disability-related claims.

    The New Rules

    The new rules are effective for claims submitted on or after January 1, 2018. Under the new rules, the disability claims process will look a lot like the group health plan claims process.  In short:

    • Disability claims procedures must be designed to ensure independence and impartiality of reviewers.
    • Claim denials for disability benefits have to include additional information, including a discussion of any disagreements with the views of medical and vocational experts and well as additional internal information relied upon in denying the claim. In particular, the DOL made it clear in the preamble that a plan cannot decline to provide internal rules, guidelines, protocols, etc. by claiming they are proprietary.
    • Notices have to be provided in a “culturally and linguistically appropriate manner.” The upshot of this is that, if the claimant lives in a county where the U.S. Census Bureau says at least 10% of the population is literate only in a particular language (other than English), the denial has to include a statement in that language saying language assistance is available. Then the plan must provide a customer assistance service (such as a phone hotline) and must provide notices in that language upon request.
    • New or additional rationales or evidence considered on appeal must be provided as soon as possible and so that the claimant has an opportunity to respond before the claims process ends.
    • If the claims rules are not followed strictly, then the claimant can bypass them and go straight to court. This does not apply to small violations that don’t prejudice the claimant.
    • As with health plan claims, recessions of coverage are treated like claim denials.
    • If a plan has a built-in time limit for filing a lawsuit, a denial on appeal has to describe that limit and include the date on which it will expire. Basically, claimants have to know that they need to sue by a certain date. The DOL noted in the preamble that, while this only applies to disability-related claims, they believe any plan with such a time limit is required to include a description or discussion of it under the existing claims procedure regulations.

    More information about the changes is available in this DOL Fact Sheet.

    What to Do

    While January 1, 2018 might seem like a long way off at this point, employers and plans need to consider taking the following steps early next year:

    1. For insured disability plans, plan sponsors need to engage their insurance carriers in a discussion about how these procedures will apply to them and what changes are needed to the insurance contracts. Some insurers may be slow to adopt these new procedures, which could put plan sponsors in a difficult position.
    2. For self-funded disability plans, plan documents will need to be updated, and procedures put in place.
    3. For retirement plans, there are some decisions to make. Recall that the procedures only apply if a disability determination is required. One way to avoid this is to amend the definition of disability so that it relies on a determination by the Social Security Administration or the employer’s long-term disability carrier. For defined contribution plans, this is likely to be the most expedient approach.

    For defined benefit pension plans, this may not necessarily work. To the extent the disability benefit results in additional accruals, such a change may require a notice under 204(h) of ERISA.  If a disability pension allows participants to elect a different from of benefit, then any change in the definition it may have to apply to future accruals under the plan, which means a disability determination may still be required for many years to come.  Additionally, tying a disability determination to something other than the SSA raises similar issues if the plan sponsor changes disability carriers or plans that change the definition of disability.

    Further, before going down the road of changing disability definitions, plan sponsors may want to consider whether a more restrictive definition, like the SSA definition, is consistent with their benefits philosophies. For plan sponsors who that cannot (or choose not to) amend their retirement plan disability definitions, plan documents must be amended before January 1, 2018 to incorporate these rules  and procedures must be developed to address them.

    1. All plans that have lawsuit filing deadlines, even if they don’t provide disability benefits, should revise their notices to include a discussion of that deadline.

     

    Thursday, November 17, 2016

    secThe Securities Act of 1933 prohibits the offer or sale of securities unless either a registration statement has been filed with the SEC or an exemption from registration is applicable. Although most qualified plan interests qualify for an exemption from the registration requirement, offers or sales of employer securities as part of a 401(k) plan generally will not qualify for such an exemption.  Accordingly, 401(k) plans with a company stock investment option typically register the shares offered as an investment option under the plan using Form S-8.

    On September 22, 2016, the SEC released a Compliance and Disclosure Interpretation addressing the application of the registration requirements to offers and sales of employer securities under 401(k) plans that (i) do not include a company securities fund but (ii) do allow participants to select investments through a self-directed brokerage window.  Open brokerage windows typically allow plan participants to invest their 401(k) accounts in publicly traded securities, including, in the case of a public company employer, company stock.  The SEC determined that registration in this situation would not be required as long as the employer does no more than (i) communicate the existence of the open brokerage window, (ii) make payroll deductions, and (iii) pay administrative expenses associated with the brokerage window in a manner that is not tied to particular investments selected by participants.  This means that the employer may not draw participants’ attention to the possibility of investing in employer securities through the open brokerage window.

    The SEC apparently was concerned that some employers have been advising participants regarding their ability to invest 401(k) plan assets in company securities through open brokerage windows. This might occur, for example, when an employer has decided to remove the company stock fund as an investment option because of concern over potential stock drop litigation; in communicating such a change, the employer might point out to participants that they still have the ability to purchase company stock through the open brokerage window.

    The takeaway for public companies that do not offer a company securities fund in their 401(k) plan but do offer an open brokerage window is clear. They should either assure that communications to 401(k) participants include no reference to the option to purchase company securities through the open brokerage window or, if such communications are desirable, register an appropriate number of securities using Form S-8.

    Monday, October 31, 2016

    The IRS recently released updated limits for retirement plans.  Our summary of those limits (along with the limits from the last few years) is below.

    Type of Limitation 2017 2016 2015 2014
    Elective Deferrals (401(k), 403(b), 457(b)(2) and 457(c)(1)) $18,000 $18,000 $18,000 $17,500
    Section 414(v) Catch-Up Deferrals to 401(k), 403(b), 457(b), or SARSEP Plans (457(b)(3) and 402(g) provide separate catch-up rules to be considered as appropriate) $6,000 $6,000 $6,000 $5,500
    SIMPLE 401(k) or regular SIMPLE plans, Catch-Up Deferrals $3,000 $3,000 $3,000 $2,500
    415 limit for Defined Benefit Plans $215,000 $210,000 $210,000 $210,000
    415 limit for Defined Contribution Plans $54,000 $53,000 $53,000 $52,000
    Annual Compensation Limit $270,000 $265,000 $265,000 $260,000
    Annual Compensation Limit for Grandfathered Participants in Governmental Plans Which Followed 401(a)(17) Limits (With Indexing) on July 1, 1993 $400,000 $395,000 $395,000 $385,000
    Highly Compensated Employee 414(q)(1)(B) $120,000 $120,000 $120,000 $115,000
    Key employee in top heavy plan (officer) $175,000 $170,000 $170,000 $170,000
    SIMPLE Salary Deferral $12,500 $12,500 $12,500 $12,000
    Tax Credit ESOP Maximum balance $1,080,000 $1,070,000 $1,070,000 $1,050,000
    Amount for Lengthening of 5-Year ESOP Period $215,000 $210,000 $210,000 $210,000
    Taxable Wage Base $127,200 $118,500 $118,500 $117,000
    FICA Tax for employees and employers 7.65% 7.65% 7.65% 7.65%
    Social Security Tax for employees 6.2% 6.2% 6.2% 6.2%
    Social Security Tax for employers 6.2% 6.2% 6.2% 6.2%
    Medicare Tax for employers and employees 1.45% 1.45% 1.45% 1.45%
    Additional Medicare Tax* .9% of comp >$200,000 .9% of comp >$200,000 .9% of comp > $200,000 .9% of comp > $200,000

    *For taxable years beginning after 12/31/12, an employer must withhold Additional Medicare Tax on wages or compensation paid to an employee in excess of $200,000 in a calendar year for single/head of household filing status ($250,000 for married filing jointly).

    Thursday, October 20, 2016

    old-way-new-wayWith the looming end of the determination letter program as we know it, the IRS has issued an updated Revenue Procedure for the Employee Plans Compliance Resolutions System (EPCRS). Released on September 29, 2016, Rev. Proc. 2016-51 updates the EPCRS procedures, replaces Rev. Proc. 2013-12 and integrates the changes provided in Rev. Proc. 2015-27 and Rev. Proc. 2015-28. The updated revenue procedure is effective January 1, 2017 and its provisions cannot be used until that date. Rev. Proc. 2013-12, as modified by Rev. Proc. 2015-27 and Rev. Proc. 2015-28, should be used for any corrections under the EPCRS for the remainder of 2016. Highlights from the new revenue procedure are outlined below.

    Changes

    • Determination Letter Applications. Determination letter applications are no longer required to be submitted as part of corrections that include plan amendments. The new revenue procedure also clarifies that any compliance statement for a correction through plan amendment will not constitute a determination that the plan amendment satisfies the qualification requirements.
    • Favorable Letter Requirements. A qualified individually designed plan submitted under the Self Correction Program (SCP) will still satisfy the Favorable Letter requirement when correcting significant failures even if its determination letter is out of date.
    • Fees. The Voluntary Correction Program (VCP) fees are now user fees. Effective January 1, 2017 a plan sponsor must refer to the annual Employee Plans user fees revenue procedure to determine the applicable VCP user fees.
    • Model Forms. The model forms for a VCP submission (Forms 14568-A through 14568-I) can now be found on the IRS website.
    • Audit CAP Sanctions. The method used to determine Audit Closing Agreement Program (Audit CAP) sanctions has been revised. Sanctions will no longer be a negotiated percentage of the Maximum Payment Amount (MPA), but will be determined by the IRS on a “facts and circumstances” basis. The MPA will be one factor used to determine a sanction. Generally, sanctions will not be less than VCP fees.
    • Refunds. The IRS will no longer refund half of the user fee if there is disagreement over a proposed correction in an Anonymous Submission.

    Incorporations

    • The provisions of Rev. Proc. 2015-27, which clarify the methods that may be used to correct overpayment failures, modify the SCP for Code Section 415(c) failures to extend eligibility to certain plans with repeated corrections of excess annual additions so long as elective deferrals are returned to affected employees within 9½ months after the end of the plan’s limitation year, and lower the fees for certain VCP submissions, have been incorporated.
    • The provisions of Rev. Proc. 2015-28, which modify EPCRS by adding safe harbor correction methods for employee elective deferral failures in both 401(k) and 403(b) plans, have also been incorporated into Rev. Proc. 2016-51.
    Friday, October 7, 2016

    where-are-youFor many years, the PBGC has been helping reunite missing participants with their benefits under single-employer defined benefit plans. Now, a new PBGC proposed rule may open up the program to missing participants under other terminated plans.

    Under this proposed rule, terminated defined contributions plans may choose to transfer benefits of missing participants to the PBGC or to establish an IRA to receive the transfer and send information to the PBGC about the IRA provider.   The PBGC will attempt to locate the missing participants and add them to a searchable database. The PBGC notes that once the program is established, it may issue guidance making the reporting requirement mandatory for defined contribution plans as authorized under section 4050 of ERISA.

    The PBGC will accept the transfer of accounts of any size. If a plan sponsor chooses to transfer accounts to the PBGC, it must transfer the accounts of all missing participants.  There will be no fee for transfers of $250 or less. For transfers above that amount, a one-time flat fee will apply which the PBGC indicates will not exceed its costs associated with the program.  Initially, the fee has been set at $35.

    This newly-proposed voluntary program for defined contribution plans has certain limitations. For instance, it would only be available to locate missing participants upon plan termination.  It would not be available to locate missing participants for ongoing plans.  For example, the program would not be available to find missing participants in connection with a plan correction under EPCRS.  In addition, although the program would be available to many types of single-employer and multiemployer defined contribution plans, including abandoned plans, it would not be available to governmental plans and church plans.

    The proposed rule also establishes a similar voluntary program for terminated professional service defined benefit plans with 25 or fewer participants and a mandatory program for terminated multiemployer plans covered by title IV of ERISA, similar to the existing program for single-employer defined benefit plans.

    Finally, the proposed rule contains numerous changes to the existing rules. Most notable for defined contribution plans, the proposed rule modifies the criteria for being “missing” to include distributees of defined contribution plans who fail to elect a form or manner of distribution although their whereabouts are known.  The PBGC notes that this change is consistent with existing DOL regulations which currently treat such individuals similarly to individuals who cannot be found for purposes of the safe harbor for terminated defined contribution plans.  For terminating defined benefit plans, it would include distributees subject to mandatory “cash-out” who do not return an election form.  According to the PBGC, it can be difficult to find the benefits of non-responsive distributees after they have been transferred to IRAs.  It hopes to address this problem by bringing non-responsive distributees “into the PBGC fold” with its centralized governmental repository and pension search capability.   Defined benefit plan distributees whose benefits are not subject to a mandatory cash-out provision would only be considered missing if the plan did not know their whereabouts.   In making this distinction, the PBGC indicates that individuals with benefits that are not subject to cashout enjoy rights and features not available to those whose benefits may be cashed out and, absent an election, their benefits will be annuitized, preserving those rights and features.  In addition, for title IV plans the identity of the insurer issuing the annuity must be provided to the PBGC if their whereabouts are unknown.

    Other changes include more detailed requirements for diligent searches for defined benefit plans similar to those already required of defined contribution plans by DOL guidance, simplification of the existing rules and assumptions used for valuing benefits to be transferred to the PBGC, and changes in the defined benefit plan rules for paying benefits to missing participants and their beneficiaries.

    The new rule is generally proposed to be effective for plan termination dates after calendar 2017. In addition to the proposed rule, the PBGC has issued a set of FAQs as well as draft forms with instructions for each of the proposed programs.  Additional information can be found on the PBGC website here.

    Friday, September 23, 2016

    griefWhen the IRS announced that it would virtually eliminate the determination letter program for individually designed retirement plans, many practitioners moved through the classic Kübler-Ross five stages of grief (see the picture at the right).  Some have yet to finish.  In Announcement 2016-32, the IRS requested comments on how these plans can maintain compliance going forward since determination letters are no longer available.

    As a general rule, the IRS used to deny plans the ability to incorporate tax code provisions by reference (rather than reciting them wholesale in the plan), except for a very short list available here.  The IRS is asking if there are additional provisions that would also be appropriate to incorporate by reference.  This would avoid the need to reproduce these provisions wholesale and run the risk of a minor foot fault if the language did not line up.  It would also help avoid the need to update plans for law changes, in some cases.

    Additionally, much to the anger of many practitioners, the IRS has historically sometimes required a plan to include provisions that were not applicable to the plan.  For example, there are special diversification requirements for plans that hold publicly-traded employer stock, yet the IRS has required them even for private companies.  One wonders if the IRS actually observed numerous situations where privately held corporations became public companies and then failed to amend those of their plans that held employer stock.  What a scourge on the individually designed plan world this must have been!  The IRS would like to know if there are other provisions that could possibly be avoided and the likelihood that the plan sponsor will actually amend the plan when the provision becomes applicable.  While there may be a few of these provisions out there, there likely aren’t enough to make a significant difference in the length of individual designed plans or to stem the tide of faulty individually designed plans.

    For those employers who still want the comfort of an IRS letter of some kind, they could bargain with a company that offers a pre-approved plan.  However, there are challenges to switching to a pre-approved prototype or volume submitter plan, and the IRS wants to know about them.  For example, employers with unique plan designs or multiple different benefit formulas may not be able to fit under a particular pre-approved form.  Under the rules applicable to those plans, too much variation from the pre-approved form destroys the ability to rely on the letter and turns the plan into an individually designed plan (which can’t then get a determination letter).

    What might depress practitioners most is that the above areas are the only ones the IRS came up with as possibilities.  For example, it would make sense to let plans apply for a determination letter when there is a plan merger.  The IRS has historically requested the documents of plans that were merged into a plan under determination letter review.  Without allowing this, the IRS will end up not reviewing a plan until it is terminated.  At that time, the Service may be asking for plans that were merged from 20 or more years ago.  That level of recordkeeping would be prohibitive for some plan sponsors.  Additionally, if the IRS found an error at that time, it could be extremely difficult to fix.  Therefore, allowing a complete review of the plan when it is a party to a plan merger would be highly valuable. Additionally, since plans will be permitted to obtain a determination letter on initial adoption, a limited determination approval process might be available to review amendments to the already approved plan rather than the entire plan again.

    The Service will accept comments in writing on or before December 15.  Service employees responsible to draft the rules may also read this post, so feel free to leave your comments below.

    Friday, September 9, 2016

    certified-with-ink-padAs retirement plan professionals know, certain distributions from plans and IRAs to taxpayers can be rolled over to another plan or IRA within 60 days. Of course, sometimes 60 days is just not enough and the IRS recognizes that, having permitted a seemingly innumerable number of private letter rulings granting extensions.  These often occur where a financial advisor gave bad advice or made some kind of mistake or where some tragedy worthy of a blues or country song (or worse) befell the taxpayer that made it impossible to complete the rollover in 60 days.

    The IRS has had a small cottage industry the last decade or so of granting private letter rulings extending the 60-day period for these rollovers.  But now, they’ve decided to let plans and IRAs just take the taxpayer’s word for it.

    Under a new revenue procedure, taxpayers can now self-certify as to the reason that they need more time.  Now, taxpayers can’t just certify for any reason.  They have to have missed the 60-day period because of one or more of the following reasons:

    • An error on the part of the financial institution receiving the rollover or making the distribution
    • The distribution was made in the form of a check and the check was misplaced and never cashed (“I put the check where I knew I’d remember it. It was right next to my keys.”)
    • The distribution was deposited into and remained in an account that the taxpayer mistakenly thought was a retirement plan or IRA (“but this email said that it was an eligible plan and the money would also help the deposed prince of Nigeria…”)
    • The taxpayer’s primary residence was severely damaged (but not a vacation home, it seems)
    • A member of the taxpayer’s family died
    • The taxpayer or a member of his or her family was seriously ill
    • The taxpayer was incarcerated
    • Restrictions were imposed by a foreign country (does not include mandates from the deposed prince of Nigeria)
    • A postal error occurred (“I told them to address it to Santa Claus at the North Pole…”)
    • The distribution was made on account of a tax levy, but the proceeds of the levy were returned
    • The financial institution making the distribution delayed providing information that the receiving plan or IRA needed to complete the rollover, despite the taxpayer’s reasonable efforts to obtain the information (e.g., phone calls, emails, bad reviews on Yelp maybe?)

    There are other conditions too. The taxpayer has to make the contribution as soon as practicable once the identified impediment is no longer holding up the process.  A contribution within 30 days after the issue is resolved is treated as meeting this requirement.

    The good news for plans and IRA custodians is that they can rely on the certification unless they have actual knowledge that the excuse is not real. So they don’t have to have the same lie detector skills as parents or teachers.

    Of course, the IRS also reserves the right to verify this on audit. We are left to wonder how some of these will be verified.  For example, how does the IRS plan to prove that the taxpayer didn’t misplace a check?  Nonetheless, if the IRS finds that the self-certification was inappropriate, taxpayers will be subject to additional taxes and penalties.

    It’s worth noting that some “explanations” still don’t fly, even under this broad relief. Ignorance of the law is still no excuse (“I didn’t know I only had 60 days.”).  Also, an inability to count to 60 properly is not going to be enough to get someone off the hook.

    The IRS plans to modify the Form 5498 (which reports IRA contributions) to report any contributions received after the 60-day deadline, which will help let the IRS know whom to audit.

    For employers, this ruling may result in some questions from their third party administrators. Most rollovers to qualified plans are likely made in direct trustee-to-trustee transfers, which are not a part of this ruling.  Because of that, the questions are likely to be few, but there could be some.  For example, if an employee comes forward with a self-certification that does not clearly fit into the list, but is close, the TPA may request that the plan administrator (which may be the employer or someone there) make a decision about whether the certification is sufficient.  Practically, however, certifications outside this specific list should not be accepted.

    The IRS has provided other resources on this issue as well which are available at the links below:

    – IRS Webpage – Accepting Late Rollover Contributions

    IRS frequently asked questions

    Friday, August 12, 2016

    IRSAs we previously reported, the IRS had said last year that determination letter program for retirement plans would largely be going away. Rev. Proc. 2016-37 includes information with respect to the future of the determination letter program.  As highlighted in a recent IRS webcast, a noteworthy development is that “subject to IRS resources” that post-initial determination letters may be available after 2017 in specified circumstances:

    (1) significant law changes,

    (2) new plan designs, and

    (3) Plan types that can’t convert to a pre-approved format.

    Number 3 means complex plans that do not fit on a pre-approved document may, ‘subject to IRS resources’ as published annually, be able to be submitted for a ruling under the determination letter program.  Therefore, complex individually designed plans may still have hope that the IRS will continue to rule on their qualified status.

    There were two other key points in the webcast.  First, the IRS will publish a “required amendments” list and that employers will have until the end of the second calendar year after the date the list is published to amend their plans.  Second, there will also be an operational compliance list issued annually that will be accessible on the IRS website, not published. The purpose of the operational list is to focus on the operation of the plan prior to the date of adoption of the amendment.  These lists will include information that is prospective only and will not include information from prior annual lists.

    Monday, July 11, 2016

    PenaltyThe Department of Labor (DOL), along with several other federal agencies, recently released adjusted penalty amounts for various violations. The amounts had not been adjusted since 2003, so there was some catching up to do, as required by legislation passed late last year.

    These new penalty amounts apply to penalties assessed after August 1, 2016 for violations that occurred after November 2, 2015 (which was when the legislation was passed). Therefore, while the penalty amounts aren’t effective yet, they will be very soon and they will apply to violations that may have already occurred.  Additionally, per the legislation, these amounts will be subject to annual adjustment going forward, so they will keep going up.

    The DOL released a Fact Sheet with all the updated penalty amounts under ERISA.  A few of the highlights are:

    General Penalties

    • For a failure to file a 5500, the penalty will be $2,063 per day (up from $1,100).
    • If you don’t provide documents and information requested by the DOL, the penalty will be $147 per day (up from $110), up to a maximum penalty of $1,472 per request (up from $1,100).
    • A failure to provide reports to certain former participants or failure to maintain records to determine their benefits is now $28 per employee (up from $10).

    Pension and Retirement

    • A failure to provide a blackout notice will be subject to a $131 per day penalty (up from $100).
    • A failure to provide participants a notice of benefit restrictions under an underfunded pension plan under 436 of the tax code will cost $1,632 per day (up from $1,000).
    • A payment in violation of those restrictions will be $15,909 per distribution (up from $10,000).
    • A failure of a multiemployer plan to provide plan documents and other information or to provide an estimate of withdrawal liability will be $1,632 per day (up from $1,000).
    • A failure to provide notice of an automatic contribution arrangement required under Section 514(e)(3) of ERISA will also be $1,632 per day (also up from $1,000).

    Health and Welfare

    • Employers who fail to give employees their required CHIP notices will be subject to a $110 per day penalty ($100, currently).
    • Failing to give State Medicaid & CHIP agencies information on an employee’s health coverage will also cost $110 per day (again, up from $100).
    • Health plan violations of the Genetic Information Nondiscrimination Act will also go up to $110 per day from $100. Additionally, the following minimums and maximums for GINA violations also go up:
      • minimum penalty for de minimis failures not corrected prior to receiving a notice from DOL: $2,745 (formerly $2,500)
      • minimum penalty for GINA failures that are not de minimis and are not corrected prior to receiving a notice from the DOL: $16,473 (up from $15,000)
      • cap on unintentional GINA failures: $549,095 (up from $500,000)
    • Failure to provide the Affordable Care Act’s Summary of Benefits and Coverage is now $1,087 per failure (up from $1000).

    The above penalty amounts are usually maximums (the penalties are “up to” those amounts), which means the DOL has the discretion to assess a smaller penalty. Employers and plans should be mindful of these and the other penalty increases described in the fact sheet.  These increased penalties give the DOL additional incentive to pursue violations and assess penalties.  They also give the DOL greater negotiating leverage in any investigation.  For these reasons, it pays to be aware of the various compliance obligations (and any associated timing requirements) and make sure your plans’ operations are consistent with those obligations.

    Tuesday, July 5, 2016

    Part-time and full-time job working businessman business man conceptTypically, when a participant receives annuity payments from a defined benefit pension plan where he or she has a basis in the benefit (what Code Section 72 calls an “investment in the contract”), a portion of the payment is treated as a recovery of that basis. Therefore, it is not taxable to the participant.  That portion is determined under the rules of Code Section 72.  The most common way in which an employee has basis in his or her benefit is by making after-tax contributions.  Currently, this is more common in governmental defined benefit plans than other plans.

    However, it was not clear how these basis recovery rules worked in the context of phased retirement distributions. The IRS recently issued Notice 2016-39 to address the treatment of payments made by a qualified defined benefit pension plan to an employee during phased retirement.  Phased retirement is the period during which an employee begins to take distributions of a portion of his or her retirement benefits from a plan while continuing to work on a part-time basis.  During these periods, it may be difficult for the plan to do the typical calculation under Code Section 72.  Additionally, the employee may be continuing to accrue additional benefits, which would further complicate the calculation.

    The Notice provides that if certain conditions are met, the payments will not be considered amounts received as an annuity for purposes of Code Section. This means that, if the employee made after-tax contributions to the plan or otherwise has a basis in his or her benefit, then a portion of the payment will be treated as basis recovery and will be excluded from income using the calculation rules under Code Section 72(e)(8) described in the Notice.

    The Fix

    According to the Notice, any payments received by an employee from an applicable plan will not be treated as received from an annuity if all the following conditions are met:

      1. The employee begins to receive a portion of his or her retirement benefits when he or she enters phased retirement and begins part-time employment;
      2. The employee will not begin receiving his or her full retirement benefits until ceasing employment and commencing full retirement at an indeterminate future date. For this purpose, a date is “indeterminate” as long as it can be changed. Since the employee and employer can always agree to a later date, nearly every date will be indeterminate for this purpose;
      3. The plan’s obligations to the employee are based in part on the employee’s continued part-time employment, which impacts both the duration of the phased retirement benefits and the amount of additional retirement benefits the employee accrues during the phased retirement period. In other words, the plan only pays phased retirement benefits as long as the employee is part-time and the employee’s part-time status affects the employee’s ability to accrue benefits under the plan (although the Notice does not appear to say how it affects the accrued benefit); and
      4. Under the terms of the plan, the employee cannot make an election as to the form of the phased retirement benefit to be paid during phased retirement. Instead, the employee must elect a distribution option at full retirement that applies to the employee’s entire retirement benefit, including the portion that commenced as phased retirement benefits. In other words, the employee’s benefit at full retirement must be reduced by the actuarial equivalent of the amount received during phased retirement.

    Any amounts that are not received as an annuity will be subject to the special basis recovery rules in the Notice. Specifically, the amount excludible from the employee’s gross income will be a portion of each payment, calculated by multiplying the amount of the payment by the ratio of the employee’s investment in the contract (i.e., the employee’s basis) to the present value of the employee’s accrued benefit. The Notice provides that the basis recovery fraction may be fixed at the time payments begin under a phased retirement program. This avoids the need to redo the calculation as the employee makes additional contributions to the plan.

    The IRS also issued Revenue Procedure 2016-36, which provides that this Notice will not apply to amounts received from a non-qualified contract.