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A Better Partnership


Jun 2015
June 11, 2015

Employing Retirees? Take Steps to Avoid Problems with Corporate Retirement Plans

As the workforce ages and retires, employers often seek to fill in gaps by hiring their own retirees as independent contractors or temporary or part-time employees. This practice threatens the tax qualification of employers’ retirement plans, both 401(k) plans and traditional pension plans.

Distributions from 401(k) and 403(b) plans are permitted only under narrow circumstances: death, disability, hardship, attaining age 59-1/2 or severance from employment. Distributions from pension plans are even more constrained: all in-service distributions are banned until the participant reaches at least age 62. The plan document may restrict distributions even further, for example, by not allowing any in-service payouts. Distributions made before the law and the plan allow disqualify the plan.

For example, if a participant “retires” at 57, takes a 401(k) distribution and returns to work for the same employer part-time, the retiree may be seen as not separated. The plan has then made an impermissible in-service distribution – a plan-qualification violation.

The employee may have a true severance if re-hired as an independent contractor rather than as an employee; the question is whether the re-hire truly is an independent contractor. The ongoing skepticism the IRS and courts have of “independent contractor” status doubly applies to former employees. Since the standard for “independent contractor” is whether the employer has a right to direct or control the individual, if the retiree is doing the same type of work, in the same place, with the same tools, what is the difference that suddenly creates an independent contractor status?

We recommend the following steps before hiring a retiree:
  1. Check your plan document. If your 401(k) plan permits in-service distributions at age 59-1/2, or your pension plan permits in-service payouts to begin at 62 or later (rare), and the employee took the retirement payout after the applicable age, then the plan is safe.
  2. Prohibit any understandings with retirees before retirement that they will be re-hired in any capacity.
  3. Require a minimum period of time before a retiree can be re-hired. Although no set time is safe-harbor, six months may be sufficient. Some employers use 90 days. This is not a substitute for step #2.
  4. If you re-hire the retiree as an independent contractor, make the position sufficiently different to support independent contractor status. Contract with the retiree to set goals, but turn control over to the retiree as to how the goals are to be accomplished. Let the retiree hire others; have him provide his own equipment and supplies and set his own hours. Allow him to work for other employers doing the same work. The less the work looks like the retiree’s prior employment, the better.
  5. If the retiree is safely re-hired, review the future effect of re-employment under the retirement plans. The retiree may be eligible for additional contributions or accruals. A pension may have to suspend monthly payments during re-employment and give notice to the participant of the suspension.

The attorneys in the Warner Norcross & Judd Employee Benefits/Executive Compensation Practice Group can help you properly handle the hiring of retirees.

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