Distributions After Normal Retirement Age in Defined Benefit Plans — Are You Getting It Right?
APRIL 25, 2018
With many retirement nest eggs still recovering from the 2008 economic downturn and its effect on 401(k) and other retirement savings, those who thought they were close to retirement have found themselves working longer and later in life than they had originally planned. Employers with a defined benefit plan may have more employees working beyond their plan’s normal retirement age. Where these calculations were previously done infrequently, more and more calculations with termination and commencement dates beyond normal retirement date are now needed.
Distributions beyond a plan participant’s normal retirement age can be a complex topic to discuss as well as correctly calculate. There are varying scenarios and plan provisions. Coordination between IRS regulations (that apply even if the plan document is silent) and the plan document are necessary in all cases.
It is most important to fully understand the specific facts. Did the participant terminate on or before the plan’s normal retirement age versus after? Further complexity arises if the termination is after the date that required minimum distributions should commence (i.e., April 1 following a participant reaching age 70½) or if there is a delay between termination and commencement of the pension benefit.
It is not always clear when an actuarial increase is necessary. The plan may stipulate benefits are to commence at the normal retirement date or when the participant makes a benefit election. Whether an actuarial increase under a plan is necessary for delaying the commencement of benefits beyond a participant’s normal retirement age depends on the terms of the plan. A plan may provide for “suspending” benefits until actual retirement, but that requires the plan to send a suspension of benefits notice to participants who actively work beyond normal retirement age at the participant’s normal retirement age. If the suspension of benefits notice is sent in a timely fashion, no actuarial increase is needed prior to April 1 following a participant turning 70½. If a suspension of benefits notice was required but not sent until a later date, an actuarial increase is required from what would have been the participant’s normal retirement date through the date the correction was made and the notice was finally sent to the participant.
If the plan does not provide for suspending benefits for those working beyond normal retirement age, the plan can stipulate that it will pay the greater of the all service benefit at termination and the accrued benefit at normal retirement date actuarially increased to the commencement date. Alternatively, the plan may provide that the participant’s accrued benefit is determined at the end of each plan year to be the greater of:
- the accrued benefit determined at the end of the last plan year plus the current year benefit earned and
- the accrued benefit at the end of the last plan year actuarially increased to the end of the current plan year.
If a plan allows for the commencement of retirement benefits at the normal retirement age despite the participant continuing to work and earning additional retirement benefits, the plan may provide for accruals after the normal retirement date to be offset by the actuarial value of the benefits paid. This offset limits the value of the continuing accruals and may offset the value entirely.
If a participant could have commenced distributions at the participant’s normal retirement date but delayed that commencement, there are two possible outcomes:
- The plan may specifically provide for a “retroactive annuity starting date”. That allows the participant to elect to commence benefits at a delayed commencement date and to receive a lump sum payment that is equal to all the “missed” payments retroactive to the normal retirement date.
- If the plan is silent on what happens if the participant makes their benefit election after the normal retirement age or specifies an actuarial increase is necessary, then the plan needs to actuarially increase the benefits from the normal retirement age to the commencement date.
So, the answer is—as is often the case in the defined benefit arena—it depends. Each scenario should be reviewed closely as different termination dates and different dates for electing the commencement of benefits in relation to normal retirement age can result in different plan provisions or regulations applying. Remember it is necessary to consider both the plan document provisions along with IRS regulations as a correct answer is based on a combination of both. Just because a plan document doesn’t specifically say an actuarial increase is required on April 1 following the participant turning age 70½ doesn’t mean a plan sponsor can ignore this regulation and not grant it. This also means the plan document should be reviewed and amended to clearly incorporate the IRS regulations.
Plan sponsors may not be aware of all the possible alternatives for post-NRA accruals, actuarial adjustments, suspension of benefit notices, and benefit payments. A plan sponsor is typically well served by reviewing its plan document in this regard and evaluating whether the plan is being operated in accordance with its terms in order to manage its liability exposure. Further, such a review presents an opportunity to design a plan and related administration actions that limits the plan’s liability, which is ultimately the plan sponsor’s liability and hence expense.