IRS Puts Out "Phased Retirement" Proposal

November 10, 2004 ( - Federal government officials have proposed allowing employers to launch "phased retirement" arrangements where workers would gradually reduce their workload as they transition to retirement.

>The proposed  rules by the US Treasury Department and the Internal Revenue Service, IRS REG-114726-04, indicate that phased retirement benefits could not be paid before an employee reaches age 59 ½, reported. Profit-sharing and 401(k) plans could either provide for the same phased retirement rules that are proposed in these regulations or provide for other partial or full in-service distributions to be available after attainment of age 59½, under the plan. However, eligible 457 governmental plans could not provide for payments to be made before the earlier of severance from employment or age 70 1/2.

>The proposed regulations generally require that all early retirement benefits, retirement-type subsidies and optional forms of benefit available upon full retirement also be available in a phased retirement scenario. However, the proposal would bar payments in the form of a single-sum distribution (or other eligible rollover distribution) to prevent a premature benefit distribution. Also, they do not allow key employees to participate in phased retirement.

>According to the report, here’s how the system would work:

>Employees who are at or near eligibility for retirement could elect a reduced schedule or workload. The employer would benefit by keeping an experienced employee and the employee could continue active employment with greater flexibility and time away from work.

>A phased retirement employee would have a dual status, under which the employee would be treated as retired to the extent of the reduction in hours and treated as working to the extent of the employee’s continued work with the employer. Employer and employee would have to enter into an agreement, in good faith, under which the employee would reduce by 20% or more the number of hours the employee works during the phased retirement period.

>There would be periodic testing to make sure that phased retirement employees are in fact working at the reduced schedule. So, unless an exception applies, a plan would have to annually compare the number of hours actually worked by an employee during a testing period and the number of hours the employee was reasonably expected to work. If the actual hours worked prove to be materially greater than the number expected, the employee’s phased retirement benefit would be reduced prospectively, according to the Thompson report.

>Such a cutback would also have to happen if the employee’s work hours exceed either 133-1/3% of the anticipated work schedule or 90% of a full-time schedule. This annual comparison would not be required after the employee is within three months of attaining normal retirement age or if the employee’s compensation does not exceed pay at an ordinary full-time rate for the employee’s expected work schedule. Further, no such testing would apply for the first year of an employee’s phased retirement or if the employee agreed to fully retire within two years.

>The new rules follow an  IRS request for public comment on the concept in 2002.