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FAQs Regarding COVID-19 and Governmental Retirement Plans FAQs Regarding COVID-19 and Governmental Retirement Plans

FAQs Regarding COVID-19 and Governmental Retirement Plans

This alert provides an overview of the frequently asked questions (FAQs) we have received regarding governmental retirement plans and the coronavirus outbreak (now known as COVID-19).

Question: Given the critical nature of some jobs, can we rehire retirees?

Answer: The federal government has not yet released any specific guidance to ease restrictions on the Internal Revenue Code's ("Code") reemployment/in-service distribution rules. In general, unless a plan allows for an in-service distribution, to continue receiving a retirement benefit, a plan participant must incur a bona fide severance from employment prior to reemployment. Treas. Reg. § 1.401-1(a)(2)(i); Revenue Ruling 74-254. A bona fide severance from employment means more than a termination of "covered employment." Rather, a bona fide severance from employment means the employee is no longer working for the employer, whether as a regular employee, a part-time employee, a seasonal employee, a contractual employee, an independent contractor, or a leased employee, etc. The IRS has issued both binding and non-binding guidance on the qualification requirement that there must be a termination from employment prior to a distribution from a qualified plan. In Private Letter Ruling (PLR) 201147038, the IRS exhaustively addressed how paying retirement benefits without a severance from employment may affect the qualified status of a plan, concluding that:

Employees who "retire" on one day in order to qualify for a benefit under the Plan, with the explicit understanding between the employee and the employer that they are not separating from service with the employer, are not legitimately retired. Accordingly because these employees would not actually separate from service and cease performing services for the employer when they "retire" these "retirements" would not constitute a legitimate basis to allow participants to qualify for early retirement benefits (which are then immediately suspended). Such "retirements" will violate section 401(a) of the Code and result in disqualification of the Plan under section 401(a) of the Code.

The IRS also noted in PLR 201147038 that "because a qualified pension plan is generally not permitted to pay benefits before retirement, an employee who 'retires' with the explicit understanding between the employer and employee that upon retirement the employee will immediately return to service with the employer has not legitimately retired and may not qualify for an early retirement benefit under the Plan." The IRS has stated repeatedly that the determination of whether there is or is not a bona fide severance from employment is to be determined using a facts and circumstances test. In general, it is not practical to apply a facts and circumstances test to each individual retiree; thus, many governmental retirement systems implement a minimum period of time, which is required in order to establish separation. However, federal law does not mandate a specific period of time employees must be separated from service before rehire in order for the severance from employment to be considered bona fide. Depending on a retiree's individual circumstances, the retiree could have incurred a bona fide separation from service even if the separation period does not meet the plan's required separation period.

Accordingly, given the unprecedented nature of COVID-19, a plan could permit rehires of retirees prior to the end of the required separation period, if the severance from employment was otherwise bona fide. However, whether a rehired member may return to service due to a need related to COVID-19 is still governed by the terms of the plan. Federal law requires that a plan operationally comply with the terms of the plan document. If the plan has an operational failure, it has a fiduciary duty to correct the noncompliance. Thus, any governmental entity considering modifications to its existing "return to work" restrictions should consider whether amendments to the plan are necessary.

In recognition of these restrictions, some states are issuing orders that suspend the plan provisions governing reemployment. For example, California Governor Gavin Newsom issued Executive Order N-25-20 to "ensure adequate state staffing to expedite emergency response and recovery." This Order suspended certain work hour limitations for retired annuitants. Under this Order, California's minimum days for a break in service requirement is suspended for retired annuitants hired to ensure adequate staffing during the state of emergency. However, the Order does not remove the requirement that an employee must still experience a bona fide break in service before being eligible to be rehired.

Question: In the case of an emergency, can we allow for in-service distributions?

Answer: For defined contribution plan administrators (e.g. grandfathered 401(k) plans), a review of existing hardship distribution rules may be helpful. Hardship withdrawals under the safe harbor rules are already permitted for medical expenses incurred by the member and family members related to COVID-19. The Bipartisan Budget Relief Act of 2018 also expanded the list of reasons for a hardship withdrawal under the safe harbor rules to include losses incurred by members who reside in an area declared to be a disaster area by the Federal Emergency Management Agency. FEMA declared New York a disaster area as a result of COVID-19 on March 20, 2020, which, among other things, enables plan members to take a hardship distribution for COVID-19 related losses. We would expect more states to be subject to such declarations going forward. In addition, plan sponsors could consider amending their plan to expand the allowable reasons for a hardship distribution outside of the safe harbor rules to cover additional expenses related to COVID-19. In addition, for governmental 457(b) plans, consideration should be given to the plan's unforeseeable emergency provisions.

Plans also should review the plan provisions addressing loans, particularly related to the availability of loans during leaves (including leaves without pay). Legislation being considered in Congress would raise the loan limits to the lesser of $100,000 or 100% of the vested account balance. The legislation would also extend the loan repayment period by one year for individuals on a leave of absence due to COVID-19.

Plan sponsors of defined benefit, money purchase pension plan, and 457(b) plans also could consider amending these plans to permit in-service distributions. The Bipartisan American Miners Act of 2019 amended the Code such that these types of plans are now permitted to allow members to commence their benefits as early as age 59 ½ while still working. A plan sponsor could consider amending their plans to allow active members who are at least age 59 ½ to commence benefits.

Additionally, for terminated vested members in defined benefit plans, plan sponsors could consider allowing benefits to commence at ages younger than the plan’s current early or normal retirement age rules. There is no age limit for the time at which pension distributions can start for terminated vested participants.

As noted above, Congress is considering legislation that would waive the Section 72(t) 10% penalty on early withdrawals from retirement plans for individuals who have been impacted by the COVID-19 pandemic. Such relief would also allow participants three years to repay the distribution and to include the distribution in income ratably for more than three years.

Finally, keep in mind that, even if under the terms of the retirement plan in-service distributions are permitted, if the member is under age 59 ½ and has not had a bona fide separation from service, the 10% early distribution penalty may apply to the benefits. This is because the exceptions to the 10% penalty for substantially equal periodic payments and for distributions after the attainment of age 55 (age 50 for public safety employees) also require a bona fide separation from service.

Question: How do we comply with open meeting and quorum requirements during this time?

Answer: Generally, a quorum, or minimum number of those present at a meeting, is needed for any action the public bodies take. Your state law will govern how quorums must be established and may prohibit (or expressly authorize) virtual meetings. Some states, such as Florida and Vermont, have taken steps to either suspend state statutes that establish the need for an in-person quorum or to provide public health exceptions to the open meetings laws, which allow public meetings to be conducted safely. For example, the Board may be required to provide an alternative and free method of accessing the meeting. Some provisions allow a quorum to be formed even if the individuals who make up the quorum are not physically in the same place.

Question: Is paid leave considered "compensation" for plan purposes?

Answer: If a plan generally provides benefits based on W-2 compensation, increases in taxable fringe benefits and paid leave would be considered compensation for retirement contributions purposes. However, the plan's definition of "compensation" should be considered. Question: Will leave (paid or unpaid) impact vesting? Answer: Each plan will need to consider how leave related to COVID-19 will be considered for vesting purposes based on plan terms. This may be dependent on whether the leave falls under the new sick leave provisions or FMLA rules under the Families First Coronavirus Response Act, or the employer's general leave rules, including whether the leave is paid or unpaid.

Question: How do we stay in contact with participants?

Answer: Plans will want to make sure that participant contact information, including addresses and beneficiary elections, are up to date. With the potential for many changes in the near future, contacting participants will be important.

To discuss these issues and any other issues further, please contact Audra Ferguson-Allen, Robert L. Gauss, Tara S. Sciscoe, Christopher Sears, Lisa Harrison, Lindsay Knowles, or the Ice Miller Employee Benefits attorney with whom you most closely work.

This publication is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader should consult with legal counsel to determine how laws or decisions discussed herein apply to the reader’s specific circumstances.
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