US Internal Revenue Service: irb04-47

8/14/2019 US Internal Revenue Service: irb04-47

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Bulletin No. 2004-4November 22, 200

HIGHLIGHTS

OF THIS ISSUEThese synopses are intended only as aids to the reader inidentifying the subject matter covered. They may not berelied upon as authoritative interpretations.

INCOME TAX

Rev. Rul. 2004107, page 852.Section 1274A inflation adjusted numbers for 2005.This ruling provides the dollar amounts, increased by the 2005inflation adjustment, for section 1274A of the Code. Rev. Rul.2003119 supplemented and superseded.

Rev. Rul. 2004108, page 853.CPI adjustment for below-market loans for 2005. Theamount that section 7872(g) of the Code permits a taxpayerto lend to a qualified continuing care facility without incurringimputed interest is published and adjusted for inflation for years19872005. Rev. Rul. 2003118 supplemented and super-seded.

EMPLOYEE PLANS

REG11472604, page 857.Proposed regulations under section 401(a) of the Code pro-vide rules permitting distributions to be made from a pensionplan under a phased retirement program and set forth require-ments for a bona fide phased retirement program. These regu-lations will provide the public with guidance regarding distribu-tions from qualified pension plans and will affect administratorsof, and participants in, these plans.

Notice 200477, page 855.Weighted average interest rate update; corporate bondindices; 30-year Treasury securities. The weighted aver-age interest rate for November 2004 and the resulting permis-sible range of interest rates used to calculate current liabilityand to determine the required contribution are set forth.

EMPLOYMENT TAX

Announcement 200496, page 872.This announcement advises employers about a new Code Y fuse on the 2005 Form W-2. This code will be used to identannual deferrals of income under a nonqualified deferred copensation plan.

Announcements of Disbarments and Suspensions begin on page 866.Finding Lists begin on page ii.


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The IRS MissionProvide Americas taxpayers top quality service by helpingthem understand and meet their tax responsibilities and by

applying the tax law with integrity and fairness to all.

IntroductionThe Internal Revenue Bulletin is the authoritative instrument ofthe Commissioner of Internal Revenue for announcing officialrulings and procedures of the Internal Revenue Service and forpublishing Treasury Decisions, Executive Orders, Tax Conven-tions, legislation, court decisions, and other items of generalinterest. It is published weekly and may be obtained from theSuperintendent of Documents on a subscription basis. Bulletincontents are compiled semiannually into Cumulative Bulletins,which are sold on a single-copy basis.

It is the policy of the Service to publish in the Bulletin all sub-

stantive rulings necessary to promote a uniform application ofthe tax laws, including all rulings that supersede, revoke, mod-ify, or amend any of those previously published in the Bulletin.All published rulings apply retroactively unless otherwise indi-cated. Procedures relating solely to matters of internal man-agement are not published; however, statements of internalpractices and procedures that affect the rights and duties oftaxpayers are published.

Revenue rulings represent the conclusions of the Service on theapplication of the law to the pivotal facts stated in the revenueruling. In those based on positions taken in rulings to taxpayersor technical advice to Service field offices, identifying detailsand information of a confidential nature are deleted to preventunwarranted invasions of privacy and to comply with statutoryrequirements.

Rulings and procedures reported in the Bulletin do not have theforce and effect of Treasury Department Regulations, but theymay be used as precedents. Unpublished rulings will not berelied on, used, or cited as precedents by Service personnel inthe disposition of other cases. In applying published rulings andprocedures, the effect of subsequent legislation, regulations,

court decisions, rulings, and procedures must be considered,and Service personnel and others concerned are cautionedagainst reaching the same conclusions in other cases unlessthe facts and circumstances are substantially the same.

The Bulletin is divided into four parts as follows:

Part I.1986 Code.This part includes rulings and decisions based on provisions ofthe Internal Revenue Code of 1986.

Part II.Treaties and Tax Legislation.This part is divided into two subparts as follows: Subpart A,Tax Conventions and Other Related Items, and Subpart B, Leg-islation and Related Committee Reports.

Part III.Administrative, Procedural, and Miscellaneous.To the extent practicable, pertinent cross references to thesesubjects are contained in the other Parts and Subparts. Alsoincluded in this part are Bank Secrecy Act Administrative Rul-ings. Bank Secrecy Act Administrative Rulings are issued bythe Department of the Treasurys Office of the Assistant Sec-

retary (Enforcement).

Part IV.Items of General Interest.This part includes notices of proposed rulemakings, disbar-ment and suspension lists, and announcements.

The last Bulletin for each month includes a cumulative indexfor the matters published during the preceding months. Thesemonthly indexes are cumulated on a semiannual basis, and arepublished in the last Bulletin of each semiannual period.

The contents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.

For sale by the Superintendent of Documents, U.S. Government Printing Office, Washington, DC 20402.

November 22, 2004 200447 I.R.B.


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Part I. Rulings and Decisions Under the Internal Revenue Codeof 1986Section 483.Interest onCertain Deferred Payments

26 CFR 1.4831: Computation of interest on certain

deferred payments.

As defined by section 1274A, the definitions for

both qualified debt instruments and cash method

debt instruments have dollar ceilings on the stated

principal amount. The limits to the stated princi-

pal amount are adjusted for inflation for sales or ex-

changes occurringin the 2005calendar year. See Rev.

Rul. 2004-107, page 852.

Section 1274.Determi-nation of Issue Price in theCase of Certain Debt Instru-ments Issued for Property

26 CFR 1.1274A1: Special rules for certain trans-actions where stated principal amount does not ex-

ceed $2,800,000.

As defined by section 1274A, the definitions for

both qualified debt instruments and cash method

debt instruments have dollar ceilings on the stated

principal amount. The limits to the stated princi-

pal amount are adjusted for inflation for sales or ex-

changes occurringin the 2005calendar year. See Rev.

Rul. 2004-107, page 852.

Section 1274A.SpecialRules for Certain

Transactions Where StatedPrincipal Amount Does NotExceed $2,800,000

(Also 1274, 483; 1.1274A1, 1.4831.)

Section 1274Ainflation adjusted

numbers for 2005. This ruling provides

the dollar amounts, increased by the 2005

inflation adjustment, for section 1274A of

the Code. Rev. Rul. 2003119 supple-

mented and superseded.

Rev. Rul. 2004107This revenue ruling provides the dollar

amounts, increased by the 2005 inflation

adjustment, for 1274A of the Internal

Revenue Code.

BACKGROUND

In general, 483 and 1274 determinethe principal amount of a debt instrument

given in consideration for the sale or ex-

change of nonpublicly traded property. In

addition, any interest on a debt instrument

subject to 1274 is taken into account un-

der the original issue discount provisions

of the Code. Section 1274A, however,

modifies the rules under 483 and 1274

for certain types of debt instruments.

In the case of a qualified debt instru-

ment, the discount rate used for purposes

of 483 and 1274 may not exceed 9 per-

cent, compounded semiannually. Section1274A(b) defines a qualified debt instru-

ment as any debt instrument given in con-

sideration for the sale or exchange of prop-

erty (other than new 38 property within

the meaning of 48(b), as in effect on the

day before the date of enactment of the

Revenue Reconciliation Act of 1990) if the

stated principal amount of the instrument

does not exceed the amount specified in

1274A(b). For debt instruments arising

out of sales or exchanges before January 1,

1990, this amount is $2,800,000.

In the case of a cash method debt in-

strument, as defined in 1274A(c), the

borrower and lender may elect to use the

cash receipts and disbursements method

of accounting. In particular, for any cash

method debt instrument, 1274 does not

apply, and interest on the instrument is ac-

counted for by both the borrower and the

lender under the cash method of account-

ing. A cash method debt instrument is

a qualified debt instrument that meets the

following additional requirements: (A) In

the case of instruments arising out of salesor exchanges before January 1, 1990, the

stated principal amount does not exceed

$2,000,000; (B) the lender does not use an

accrual method of accounting and is not

dealer with respect to the property sold o

exchanged; (C) 1274 would have applie

to the debt instrument but for an electio

under 1274A(c); and (D) an election un

der 1274A(c) is jointly made with respecto the debt instrument by the borrower an

lender. Section 1.1274A1(c)(1) of the In

come Tax Regulations provides rules con

cerning the time for, and manner of, mak

ing this election.

Section 1274A(d)(2) provides that, fo

any debt instrument arising out of a sal

or exchange during any calendar yea

after 1989, the dollar amounts stated i

1274A(b) and 1274A(c)(2)(A) ar

increased by the inflation adjustment fo

the calendar year. Any increase due t

the inflation adjustment is rounded to th

nearest multiple of $100 (or, if the increas

is a multiple of $50 and not of $100, th

increase is increased to the nearest mul

tiple of $100). The inflation adjustmen

for any calendar year is the percentage (i

any) by which the CPI for the precedin

calendar year exceeds the CPI for calenda

year 1988. Section 1274A(d)(2)(B) de

fines the CPI for any calendar year as th

average of the Consumer Price Index as o

the close of the 12-month period endin

on September 30 of that calendar year.

INFLATION-ADJUSTED AMOUNTS

For debt instruments arising out of sale

or exchanges after December 31, 1989, th

inflation-adjusted amounts under 1274A

are shown in Table 1.

200447 I.R.B. 852 November 22, 200


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Rev. Rul. 2004107 Table 1

Inflation-Adjusted Amounts Under 1274A

Calendar Year

of Sale

or Exchange

1274A(b) Amount

(qualified debt

instrument)

1274A(c)(2)(A) Amount

(cash method debt

instrument)

1990 $2,933,200 $2,095,100

1991 $3,079,600 $2,199,7001992 $3,234,900 $2,310,600

1993 $3,332,400 $2,380,300

1994 $3,433,500 $2,452,500

1995 $3,523,600 $2,516,900

1996 $3,622,500 $2,587,500

1997 $3,723,800 $2,659,900

1998 $3,823,100 $2,730,800

1999 $3,885,500 $2,775,400

2000 $3,960,100 $2,828,700

2001 $4,085,900 $2,918,500

2002 $4,217,500 $3,012,500

2003 $4,280,800 $3,057,700

2004 $4,381,300 $3,129,5002005 $4,483,000 $3,202,100

Note: These inflation adjustments were computed using the All-Urban, Consumer Price Index, 19821984 base, published by the

Bureau of Labor Statistics.

EFFECT ON OTHER DOCUMENTS

Rev. Rul. 2003119, 20032 C.B.

1094, is supplemented and superseded.

DRAFTING INFORMATION

The author of this revenue ruling is

Avital Grunhaus of the Office of the Asso-

ciate Chief Counsel (Financial Institutions

and Products). For further information re-

garding this revenue ruling, please contact

Mrs. Grunhaus at (202) 6223930 (not a

toll-free call).

Section 7872.Treatmentof Loans With Below-MarketInterest Rates

CPI adjustment for below-market

loans for 2005. The amount that section

7872(g) of the Code permits a taxpayer

to lend to a qualified continuing care fa-

cility without incurring imputed interest

is published and adjusted for inflation for

years 19872005. Rev. Rul. 2003118

supplemented and superseded.

Rev. Rul. 2004108

This r evenue ruling publishes the

amount that 7872(g) of the Internal

Revenue Code permits a taxpayer to lendto a qualifying continuing care facility

without incurring imputed interest. The

amount is adjusted for inflation for the

years after 1986.

Section 7872 generally treats loans

bearing a below-market interest rate as if

they bore interest at the market rate.

Section 7872(g)(1) provides that, in

general, 7872 does not apply for any

calendar year to any below-market loan

made by a lender to a qualified continu-

ing care facility pursuant to a continuing

care contract if the lender (or the lendersspouse) attains age 65 before the close of

the year.

Section 7872(g)(2) provides that, in

the case of loans made after October 11,

1985, and before 1987, 7872(g)(1) ap-

plies only to the extent that the aggregate

outstanding amount of any loan to which

7872(g) applies (determined without

regard to 7872(g)(2)), when added to the

aggregate outstanding amount of all other

previous loans between the lender (or the

lenders spouse) and any qualified contin-

uing care facility to which 7872(g)(1)

applies, does not exceed $90,000.Section 7872(g)(5) provides that, for

loans made during any calendar year af-

ter 1986 to which 7872(g)(1) applies, the

$90,000 limit specified in 7872(g)(2) is

increased by an inflation adjustment. The

inflation adjustment for any calendar year

is the percentage (if any) by which the

Consumer Price Index (CPI) for the pre-

ceding calendar year exceeds the CPI for

calendar year 1985. Section 7872(g)(5)

states that the CPI for any calendar year is

the average of the CPI as of the close of the

12-month period ending on September 30

of that calendar year.

Table 1 sets forth the amount specified

in 7872(g)(2) of the Code. The amount

is increased by the inflation adjustment for

the years 19872005.

November 22, 2004 853 200447 I.R.B.


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REV. RUL. 2004108

TABLE 1

Limit under 7872(g)(2)

Year Amount

Before 1987 $ 90,000

1987 $ 92,200

1988 $ 94,800

1989 $ 98,800

1990 $103,500

1991 $108,600

1992 $114,100

1993 $117,500

1994 $121,100

1995 $124,300

1996 $127,800

1997 $131,300

1998 $134,800

1999 $137,000

2000 $139,700

2001 $144,1002002 $148,800

2003 $151,000

2004 $154,500

2005 $158,100

Note: These inflation adjustments were computed using the All-Urban, Consumer Price Index 19821984 base, published by the

Bureau of Labor Statistics.

EFFECT ON OTHER DOCUMENTS

Rev. Rul. 2003118, 20032 C.B.

1095, is supplemented and superseded.

DRAFTING INFORMATION

The author of this revenue ruling is

Avital Grunhaus of the Office of the Asso-

ciate Chief Counsel (Financial Institutions

and Products). For further information re

garding this revenue ruling, please contac

Mrs. Grunhaus at (202) 6223930 (not

toll-free call).

200447 I.R.B. 854 November 22, 200


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Part III. Administrative, Procedural, and Miscellaneous

Weighted Average InterestRates Update

Notice 200477

This notice provides guidance as to the

corporate bond weighted average interest

rate and the permissible range of interest

rates specified under 412(b)(5)(B)(ii)(II)

of the Internal Revenue Code. In ad-

dition, it provides guidance as to the

interest rate on 30-year Treasury securi-

ties under 417(e)(3)(A)(ii)(II), and the

weighted average interest rate and permis-

sible ranges of interest rates based on the

30-year Treasury securities rate.

CORPORATE BOND WEIGHTED

AVERAGE INTEREST RATE

Sections 412(b)(5)(B)(ii) and 412(l)

(7)(C)(i), as amended by the Pension

Funding Equity Act of 2004, provide that

the interest rates used to calculate currentliability and to determine the required

contribution under 412(l) for plan years

beginning in 2004 or 2005 must be within

a permissible range based on the weighted

average of the rates of interest on amounts

invested conservatively in long term in-

vestment grade corporate bonds during the

4-year period ending on the last day before

the beginning of the plan year.

Notice 200434, 200418 I.R.B. 848,

provides guidelines for determining the

corporate bond weighted average interest

rate and the resulting permissible range

of interest rates used to calculate current

liability. That notice establishes that the

corporate bond weighted average is based

on the monthly composite corporate bond

rate derived from designated corporatebond indices.

The composite corporate bond rate for

October 2004 is 5.57 percent. Pursuant

to Notice 200434, the Service has de-

termined this rate as the average of the

monthly yields for the included corporate

bond indices for that month.

The following corporate bond weighted

average interest rate was determined for

plan years beginning in the month shown

below.

For Plan Years

Beginning in:

Corporate

Bond

Weighted

Average

90% to 100%

Permissible

Range

Month Year

November 2004 6.17 5.56 to 6.17

30-YEAR TREASURY SECURITIES

WEIGHTED AVERAGE INTEREST

RATE

Section 417(e)(3)(A)(ii)(II) definesthe applicable interest rate, which must

be used for purposes of determining the

minimum present value of a participants

benefit under 417(e)(1) and (2), as the

annual rate of interest on 30-year Treasury

securities for the month before the date

of distribution or such other time as the

Secretary may by regulations prescribe.

Section 1.417(e)1(d)(3) of the Income

Tax Regulations provides that the applica-

ble interest rate for a month is the annual

interest rate on 30-year Treasury securi-

ties as specified by the Commissioner for

that month in revenue rulings, notices orother guidance published in the Internal

Revenue Bulletin.

Section 404(a)(1) of the Code, as

amended by the Pension Funding Eq-

uity Act of 2004, permits an employer

to elect to disregard subclause (II) of

412(b)(5)(B)(ii) to determine the max-

imum amount of the deduction allowed

under 404(a)(1).

The rate of interest on 30-year Treasury

securities for October 2004 is 4.86 percent.

Pursuant to Notice 200226, 20021 C.B.743, the Service has determined this rate

as the monthly average of the daily deter-

mination of yield on the 30-year Treasury

bond maturing in February 2031.

The following 30-year Treasury rates

were determined for the plan years begin-

ning in the month shown below.

For Plan Years

Beginning in:

30-Year

TreasuryWeighted

Average

90% to 105%Permissible

Range

90% to 110%Permissible

Range

Month Year

November 2004 5.12 4.61 to 5.38 4.61 to 5.63

November 22, 2004 855 200447 I.R.B.


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Drafting Information

The principal authors of this notice

are Paul Stern and Tony Montanaro of

the Employee Plans, Tax Exempt and

Government Entities Division. For fur-

ther information regarding this notice,

please contact the Employee Plans tax-

payer assistance telephone service at

18778295500 (a toll-free number),

between the hours of 8:00 a.m. and

6:30 p.m. Eastern time, Monday through

Friday. Mr. Stern may be reached a

12022839703. Mr. Montanaro ma

be reached at 12022839714. The tele

phone numbers in the preceding sentence

are not toll-free.

200447 I.R.B. 856 November 22, 200


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Part IV. Items of General Interest

Notice of ProposedRulemaking

Distributions From a PensionPlan Under a PhasedRetirement Program

REG11472604

AGENCY: Internal Revenue Service

(IRS), Treasury.

ACTION: Notice of proposed rulemaking.

SUMMARY: This notice of proposed rule-

making contains proposed amendments to

the Income Tax Regulations under sec-

tion 401(a) of the Internal Revenue Code.

These proposed regulations provide rules

permitting distributions to be made from

a pension plan under a phased retirement

program and set forth requirements for a

bona fide phased retirement program. The

proposed regulations will provide the pub-

lic with guidance regarding distributions

from qualified pension plans and will af-

fect administrators of, and participants in,

such plans.

DATES: Written or electronic comments

and requests for a public hearing must be

received by February 8, 2005.

ADDRESSES: Send submissions to:

CC:PA:LPD:PR (REG11472604), room

5203, Internal Revenue Service, PO Box

7604, Ben Franklin Station, Washing-

ton, DC 20044. Submissions may be

hand-delivered Monday through Friday

between the hours of 8 a.m. and 4 p.m.

to CC:PA:LPD:PR (REG11472604),

Couriers Desk, Internal Revenue Service,

1111 Constitution Avenue, NW, Wash-

ington, DC, or sent electronically, via the

IRS Internet site at www.irs.gov/regs orvia the Federal eRulemaking Portal at

www.regulations.gov (indicate IRS and

REG11472604).

FOR FURTHER INFORMATION

CONTACT: Concerning the regulations,

Cathy A. Vohs, 2026226090; con-

cerning submissions and requests for

a public hearing, contact Sonya Cruse,

2026227180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

As people are living longer, healthier

lives, there is a greater risk that individu-

als may outlive their retirement savings. In

addition, employers have expressed inter-

est in encouraging older, more experienced

workers to stay in the workforce. One ap-

proach that some employers have imple-

mented is to offer employees the opportu-

nity for phased retirement.

While there is no single approach to

phased retirement, these arrangements

generally provide employees who are ator near eligibility for retirement with the

opportunity for a reduced schedule or

workload, thereby providing a smoother

transition from full-time employment to

retirement. These arrangements permit

the employer to retain the services of an

experienced employee and provide the

employee with the opportunity to continue

active employment at a level that also

allows greater flexibility and time away

from work.

During such a transition arrangement,

employees may wish to supplement their

part-time income with a portion of their re-

tirement savings. However, phased retire-

ment can also increase the risk of outliv-

ing retirement savings for employees who

begin drawing upon their retirement sav-

ings before normal retirement age. Even

though the annuity distribution options of-

fered by defined benefit plans preclude

outliving benefits, early distribution of a

portion of the employees benefit will re-

duce the benefits available after full re-

tirement. On the other hand, phased re-tirement also can provide employees addi-

tional time to save for retirement because

employees continue working while they

are able to do so, and can accrue additional

benefits and reduce or forgo early spending

of their retirement savings.

In light of this background, Treasury

and the IRS issued Notice 200243 in

the Cumulative Bulletin (20022 C.B. 38

(July 8, 2002)), in which comments were

requested regarding phased retirement.

Notice 200243 specifically requested

comments on a wide variety of issues,including the following:

Under what circumstances, if any,would permitting distributions from

a defined benefit plan before an em-

ployee attains normal retirement age

be consistent with the requirement that

a defined benefit plan be established

and maintained primarily for purposes

of providing benefits after retirement,

such as the extent to which an em-

ployee has actually reduced his or her

workload?

If there are such circumstances, howshould any early retirement subsidy be

treated?

Comments Received

Sixteen written comments were for-

mally submitted in response to Notice

200243. These comments are in addi-

tion to the substantial number of articles

and other published materials addressing

phased retirement.1

While some of the comments expressed

concerns over the potential for both dis-

sipation of retirement funds and violation

of age discrimination laws, commentators

generally responded favorably to the pro-

posal to provide guidance on facilitating

phased retirement arrangements. These

commentators noted that permitting pen-

sion distributions during phased retirement

would be attractive to both employers and

employees. Commentators also indicated

that any guidance issued should provide

that establishment of phased retirement ar-rangements be optional on the part of the

employer and that participation in any such

arrangement be voluntary on the part of the

employee.

Most of the comments recommended

that eligibility to participate in a phased

1 See, for example, Pension & Welfare Benefits Administration, U.S. Department of Labor, Report on Working Group on Phased Retirement to the Advisory Council on Employee Welfare

& Pension Benefit Plans, 2000; Forman, Jonathan Barry, How Federal Pension Laws Influence Individual Work and Retirement Decisions, 54 Tax Law. 143 (2000); Littler Mendelson,

Employers Consider Phased Retirement to Retain Employees, Maryland Employment Law Letter, Vol 10, Issue 6 (April, 2000); Geisel, Jerry, Rethinking Phased Retirement; IRS Call

for Comment May Signal Pension Law Changes, Business Insurance (June 24, 2002); Flahaven, Brian, Please Dont Go! Why Phased Retirement May Make Sense For Your Government,

18 Govt Finance Review 24 (Oct. 1, 2002); NPR, Morning Edition, Older Workers Turn to Phased Retirement, (May 18, 2004) at www.npr.org/features/feature.php?wfId=1900465

November 22, 2004 857 200447 I.R.B.


9/28

retirement program be limited to employ-

ees who are eligible for immediately com-

mencing retirement benefits under the plan

(including those eligible for early retire-

ment benefits). Other comments recom-

mended that retirement benefits be permit-

ted to start at a specific age or combination

of age and service; however, they noted

that current legislative constraints, notably

the section 72(t) 10 percent additional in-

come tax on early distributions, may limit

the desirability of this option.

Some commentators advocated that any

phased retirement arrangement should be

cost neutral and not create additional fund-

ing obligations for employers. Others rec-

ommended that any early retirement sub-

sidy available to an employee upon full re-

tirement continue to be available if the em-

ployee participates in phased retirement.

For example, one such commentator rec-

ommended not only that any early retire-ment subsidy be available upon phased re-

tirement, but also that the subsidy so paid

not be permitted to be applied to reduce the

remainder of the benefit that is earned by

the employee, particularly if the employee

continues working past normal retirement

age.

The comments were divided over what

constituted phased retirement. Several

recommended that phased retirement ben-

efits be limited to cases in which there is

a reduction in hours worked. Others rec-

ommended that a reduction in hours notbe required and that a transition to a less

stressful job also be considered phased

retirement or that the full retirement ben-

efit be payable after the attainment of a

specified age or years of service without

regard to any change in work.

The commentators who recommended

that phased retirement benefits be limited

to cases in which there is a reduction in

hours worked generally recommended that

the phased retirement benefits payable be

proportionate to the reduction in work,

based on a dual status approach. Underthis dual status approach, an employee

who reduces his or her work schedule

to, for example, 80 percent of full-time

would be considered to be 20 percent re-

tired and thus entitled to 20 percent of his

or her retirement benefit. The employee

would continue to accrue additional ben-

efits based on the actual hours he or she

continues to work.

Several of the commentators discussed

the implications of phased retirement ben-

efits for purposes of the nondiscrimination

rules of section 401(a)(4) and the anti-cut-

back rules of section 411(d)(6). Many of

the comments said that phased retirement

arrangements must be flexible and that it

would be important for employers to be

able to adopt a phased retirement arrange-

ment on a temporary (even experimental)

basis.

Many commentators expressed concern

over the effect that a reduction in hours and

the corresponding reduction in compensa-

tion would have on the final average pay

of an individual for purposes of the bene-

fit calculation when the employee fully re-

tires. These comments generally requested

guidance on this issue, including clarifica-

tion as to whether an employees final av-

erage pay is permitted to decline as a re-

sult of the employees reduction in hourspursuant to participation in a phased retire-

ment arrangement.

Explanation of Provisions

Overview

The proposed regulations would amend

1.401(a)1(b) and add 1.401(a)3 in or-

der to permit a pro rata share of an em-

ployees accrued benefit to be paid under a

bona fide phased retirement program. The

pro rata share is based on the extent to

which the employee has reduced hours un-

der the program. Under this pro rata ap-

proach, an employee maintains a dual sta-

tus (i.e., partially retired and partially in

service) during the phased retirement pe-

riod. This pro rata or dual status approach

to phased retirement was one of the ap-

proaches recommended by commentators.

While all approaches suggested by

commentators were considered, the pro

rata approach is the most consistent with

the requirement that benefits be main-

tained primarily for retirement. Otherapproaches, such as permitting benefits to

be fully available if an employee works

reduced hours as part of phased retire-

ment or permitting distributions of the

entire accrued benefit to be paid as of a

specified age prior to normal retirement

age, are fundamentally inconsistent with

the 1.401(a)1(b) principle that benefits

be paid only after retirement. In addi-

tion, although a number of commentators

suggested that guidance address the prac

tice of terminating an employee with

prearranged rehiring of the employee (o

similar sham transactions), the propose

regulations do not address this topic be

cause it involves additional issues outsid

the scope of this project.

Rules Relating to Phased Retirement

Under the proposed regulations, a pla

would be permitted to pay a pro rata por

tion of the employees benefits under

bona fide phased retirement program be

fore attainment of normal retirement age

The proposed regulations define a bon

fide phased retirement program as a writ

ten, employer-adopted program pursuan

to which employees may reduce the num

ber of hours they customarily work begin

ning on or after a retirement date specifie

under the program and receive phased re

tirement benefits. Payment of phased retirement benefits is permitted only if th

program meets certain conditions, includ

ing that employee participation is volun

tary and the employee and employer ex

pect the employee to reduce, by 20 percen

or more, the number of hours the employe

works during the phased retirement period

Consistent with the pro rata approac

discussed above, the maximum amoun

that is permitted to be paid is limited to th

portion of the employees accrued benefi

equal to the product of the employee

total accrued benefit on the date the em

ployee commences phased retirement (o

any earlier date selected by the plan fo

administrative ease) and the employee

reduction in work. The reduction in work

is based on the employees work schedul

fraction, which is the ratio of the hour

that the employee is reasonably expecte

to work during the phased retirement pe

riod to the hours that would be worked

if the employee were full-time. Based i

part on commentators concerns regardin

early retirement subsidies, the proposeregulations generally require that all early

retirement benefits, retirement-type sub

sidies, and optional forms of benefit tha

would be available upon full retiremen

be available with respect to the phase

retirement accrued benefit. However, th

proposed regulations would not perm

payment to be made in the form of

single-sum distribution (or other eligibl

rollover distribution) in order to preven

200447 I.R.B. 858 November 22, 200


10/28

the premature distribution of retirement

benefits. The phased retirement benefit

is an optional form of benefit protected

by section 411(d)(6) and the election of a

phased retirement benefit is subject to the

provisions of section 417, including the

required explanation of the qualified joint

and survivor annuity.

Some comments suggested that phased

retirement be limited to employees who

have attained an age or service (or com-

bination thereof) that is customary for re-

tirement, e.g., where the employer has rea-

sonably determined in good faith that par-

ticipants who cease employment with the

employer after that age or service combi-

nation are typically not expected to con-

tinue to perform further services of a gen-

erally comparable nature elsewhere in the

workforce. Such a retirement age might

be considerably lower than age 65 in cer-

tain occupations (such as police or fire-fighters). As discussed further below (un-

der the headingApplication to Plans Other

Than Qualified Pension Plans), the Trea-

sury and IRS have concluded that they do

not have the authority to permit payments

to begin from a section 401(k) plan under

a bona fide phased retirement program be-

fore the employee attains age 591/2 or has

a severance from employment.2 Further,

section 72(t)(3)(B) provides an additional

income tax on early distributions if annuity

distributions are made before the earlier of

age 591/2 or separation from service. Ac-cordingly, in lieu of a customaryretirement

age, the proposed regulations adopt a rule

that is consistent with section 401(k) and

section 72(t)(3)(B), under which phased

retirement benefits may not be paid before

an employee attains age 591/2.

Additional Accruals During Phased

Retirement

The regulations provide that, during the

phased retirement period, in addition to be-

ing entitled to the phased retirement bene-fit, the employee must be entitled to par-

ticipate in the plan in the same manner as

if the employee were still maintaining a

full-time work schedule (including calcu-

lation of average earnings) and must be en-

titled to the same benefits (including early

retirement benefits, retirement-type subsi-

dies, and optional forms of benefits) upon

full retirement as a similarly situated em-

ployee who has not elected phased retire-

ment, except that the years of service cred-

ited under the plan for any plan year dur-

ing the phased retirement period is mul-

tiplied by the ratio of the employees ac-

tual hours of service during the year to the

employees full-time work schedule, or by

the ratio of the employees compensation

to the compensation that would be paid for

full-time work. Thus, for example, under a

plan with a 1,000 hours of service require-

ment to accrue a benefit, an employee par-

ticipating in a phased retirement program

will accrue proportionate additional bene-

fits, even if the employee works fewer than

1,000 hours of service.

The requirement that full-time compen-

sation be imputed, with a proportionate re-

duction based on an employees actual ser-

vice, is intended to ensure that a participant

is not disadvantaged by reason of choos-ing phased retirement. This rule precludes

the need for extensive disclosure require-

ments, e.g., disclosure to alert participants

to rights that may be lost as a result of

participating in a phased retirement pro-

gram. To be consistent with the require-

ment to use full-time compensation, the

proposed regulations require an employee

who was a highly compensated employee

before commencing phased retirement to

be treated as a highly compensated em-

ployee during phased retirement. See also

1.414(q)1T, A4 & A5.Under the proposed regulations, the

employees final retirement benefit is

comprised of the phased retirement ben-

efit and the balance of the employees

accrued benefit under the plan (i.e., the ex-

cess of the total plan formula benefit over

the portion of the accrued benefit paid as

a phased retirement benefit). Upon full

retirement, the phased retirement benefit

can continue unchanged or the plan is per-

mitted to offer a new election with respect

to that benefit.

This bifurcation is consistent with com-mentators recommendation that an em-

ployee who is in a phased retirement pro-

gram has a dual status, under which the

employee is treated as retired to the extent

of the reduction in hours and is treated as

working to the extent of the employees

continued work with the employer. This

approach also ensures that a phased retire-

ment program offers an early retirement

subsidy to the extent the employee has re-

duced his or her hours, and that the remain-

der of the employees benefit rights is not

adversely affected by participation in the

phased retirement program.

Testing and Adjustment of Payments

Subject to certain exceptions, the pro-

posed regulations require periodic testing

to ensure that employees in phased retire-

ment are in fact working at the reduced

schedule, as expected. Thus, unless an

exception applies, a plan must provide

for an annual comparison between the

number of hours actually worked by an

employee during a testing period and the

number of hours the employee was rea-

sonably expected to work. If the actual

hours worked during the testing period

are materially greater than the expectednumber of hours, then the employees

phased retirement benefit must be re-

duced prospectively. For this purpose, the

employees hours worked are materially

greater than the employees work schedule

if they exceed either 1331/3 percent of the

work schedule or 90 percent of the hours

that the employee would work under a

full-time schedule.

This annual comparison is not required

after the employee is within 3 months of

attaining normal retirement age or if the

amount of compensation paid to the em-ployee by the employer during the phased

retirement testing period does not exceed

the compensation that would be paid to

the employee if he or she had worked full

time multiplied by the employees work

schedule fraction. Further, no comparison

is required during the first year of an em-

ployees phased retirement or if the em-

ployee has entered into an agreement with

the employer that the employee will retire

within 2 years.

In the event that the employer and em-

ployee agree to increase prospectively thehours that the employee will work, then

the employees phased retirement benefit

must be adjusted based on a new work

schedule. The date of the agreement to in-

crease the employees hours is treated as a

comparison date for testing purposes.

In calculating the employees benefit at

full retirement, if an employees phased re-

2 Cf., Edwards v. Commissioner, T.C. Memo. 1989409, affd, 906 F.2d 114 (4th Cir. 1990).

November 22, 2004 859 200447 I.R.B.


11/28

tirement benefits have been reduced dur-

ing phased retirement, the employees ac-

crued benefit under the plan is offset by an

amount that is actuarially equivalent to the

additional payments made before the re-

duction. The potential for this offset, like

other material features of the phased re-

tirement optional form of benefit, must be

disclosed as part of the QJSA explanation

as required under 1.401(a)20, Q&A36,

and 1.417(a)(3)1(c)(1)(v) and (d)(1).

If the employees phased retirement

benefit is less than the maximum amount

permitted or the employees work sched-

ule is further reduced at a later date,

the proposed regulations allow a plan to

provide one or more additional phased

retirement benefits to the employee. The

additional phased retirement benefit, com-

mencing a later annuity starting date,

provides flexibility to reflect future reduc-

tions in the employees work hours.

Provisions Relating to Payment After

Normal Retirement Age

The proposed regulations clarify that a

pension plan (i.e., a defined benefit plan or

money purchase pension plan) is permit-

ted to pay benefits upon an employees at-

tainment of normal retirement age. How-

ever, normal retirement age cannot be set

so low as to be a subterfuge to avoid the re-

quirements of section 401(a), and, accord-

ingly, normal retirement age cannot be ear-

lier than the earliest age that is reasonably

representative of a typical retirement age

for the covered workforce.3

Application to Plans Other Than Qualified

Pension Plans

The regulations that limit distributions

that are modified by these proposed reg-

ulations only apply to pension plans (i.e.,

defined benefit or money purchase pension

plans). Other types of plans may be subject

to less restrictive rules regarding in-ser-

vice distributions, including amounts heldin or attributable to: (1) qualified profit

sharing and stock bonus plans to the ex-

tent not attributable to elective deferrals

under section 401(k); (2) insurance an-

nuities under section 403(b)(1), and re-

tirement income accounts under section

403(b)(9), to the extent not attributable to

elective deferrals; (3) custodial accounts

under section 403(b)(7) to the extent not

attributable to elective deferrals; and (4)

elective deferrals under section 401(k) or

403(b). In general, these types of plans

are permitted to provide for distributions

after attainment of age 591/2, without re-

gard to whether the employee has retired

or had a severance from employment. Ac-

cordingly, they may either provide for the

same phased retirement rules that are pro-

posed in these regulations or may provide

for other partial or full in-service distri-

butions to be available after attainment of

age 591/2. However, eligible governmen-

tal plans under section 457(b) are not gen-

erally permitted to provide for payments

to be made before the earlier of sever-

ance from employment or attainment of

age 701/2. See generally 1.4576.

Other Issues

The proposed regulations also autho-

rize the Commissioner to issue additional

rules in guidance of general applicability

regarding the coordination of partial retire-

ment under a phased retirement program

and the plan qualification rules under sec-

tion 401(a).

These proposed regulations do not

address all of the issues that commenta-

tors raised in response to Notice 200243.

Thus, as noted above, the proposed regula-

tions do not address when a full retirement

occurs and specifically do not endorse

a prearranged termination and rehire as

constituting a full retirement. Further, the

proposed regulations only address certain

tax issues. For example, although com-

mentators pointed out that the continued

availability of health coverage would be

an important feature for employees in de-

ciding whether to participate in phased

retirement, the proposed regulations do

not include any rules relating to health

coverage. Similarly, the proposed regu-

lations do not address any potential agediscrimination issues, other than through

the requirement that participation in a

bona fide phased retirement program be

voluntary.

Proposed Effective Date

The rules in these regulations are pro

posed to apply to plan years beginning o

or after the date of publication of the Trea

sury decision adopting these rules as fi

nal regulations in the Federal Register

These proposed regulations cannot be re

lied on before they are adopted as final reg

ulations.

Special Analyses

It has been determined that this notic

of proposed rulemaking is not a significan

regulatory action as defined in Executiv

Order 12866. Therefore, a regulatory as

sessment is not required. It also has bee

determined that section 553(b) of the Ad

ministrative Procedure Act (5 U.S.C. chap

ter 5) does not apply to these propose

regulations, and, because these regulation

do not impose a collection of informationon small entities, the Regulatory Flexibil

ity Act (5 U.S.C. chapter 6) does not ap

ply. Pursuant to section 7805(f) of the In

ternal Revenue Code, this notice of pro

posed rulemaking will be submitted to th

Chief Counsel for Advocacy of the Smal

Business Administration for comment o

its impact on small business.

Comments and Requests for a Public

Hearing

Before these proposed regulations aradopted as final regulations, consideratio

will be given to any written comment

(a signed original and eight (8) copies

or electronic comments that are submitte

timely to the IRS. All comments will b

available for public inspection and copy

ing.

Comments are specifically requested o

the following issues:

Should eligibility to participate in phased retirement program be ex

tended to employees that reduce thei

workload using a standard, other tha

counting hours, to identify the reduc

tion, and, if so, are there administrabl

methods for measuring the reduction?

The proposed regulations require periodic testing of the hours an employe

3 While a low normal retirement age may have a significant cost effect on a traditional defined benefit plan, this effect is not as significant for defined contribution plans or for hybrid define

benefit plans.

200447 I.R.B. 860 November 22, 200


12/28

actually works during phased retire-

ment, and if the hours are materially

greater than the employees phased

retirement work schedule, the phased

retirement benefit must be adjusted.

As discussed above (under the head-

ing Testing), there are a number of

exceptions to this requirement. Are

there other, less complex alternatives

that also would ensure that phased

retirement benefits correspond to the

employees reduction in hours?

The proposed regulations require anoffset for the actuarial value of ad-

ditional payments made before a re-

duction in phased retirement benefits.

Should the regulations permit this off-

set to be calculated without regard to

any early retirement subsidy and, if so,

how should a subsidy be quantified?

The proposed regulations clarify thatthe right to receive a phased retirement

benefit as a partial payment is a sepa-

rate optional form of benefit for pur-

poses of section 411(d)(6) and, thus,

is a benefit, right, or feature for pur-

poses of the special nondiscrimination

rules at 1.401(a)(4)4. Comments are

requested on whether there are facts

and circumstances under which the age

and service conditions for a particu-

lar employers phased retirement pro-

gram should be disregarded in apply-

ing 1.401(a)(4)4 (even if the pro-

gram may only be in place for a tempo-

rary period), or under which the rules

at 1.401(a)(4)4 should otherwise be

modified with respect to phased retire-

ment.

Should any special rules be adopted tocoordinate the rules regarding distri-

butions and continued accruals during

phased retirement with a plans provi-

sions regarding employment after nor-

mal retirement age, such as suspension

of benefits?

A public hearing may be scheduled if

requested in writing by a person that timely

submits written comments. If a public

hearing is scheduled, notice of the date,

time and place for the hearing will be pub-

lished in the Federal Register.

Drafting Information

The principal author of these proposed

regulations is Cathy A. Vohs of the Office

of the Division Counsel/Associate Chief

Counsel (Tax Exempt and Government

Entities). However, other personnel from

the IRS and Treasury participated in their

development.

* * * * *

Proposed Amendments to the

Regulations

Accordingly, 26 CFR part 1 is proposed

to be amended as follows:

PART 1INCOME TAXES

Paragraph 1. The authority citation for

part 1 is amended by adding entries in nu-

merical order to read in part as follows:

Authority: 26 U.S.C. 7805 * * *

Section 1.401(a)1 also issued under 26

U.S.C. 401.

Section 1.401(a)3 also issued under 26

U.S.C. 401.

Par. 2. In 1.401(a)1, paragraph

(b)(1)(i) is amended by adding text be-

fore the period at the end of the current

sentence and a new second sentence, and

paragraph (b)(1)(iv) to read as follows:

1.401(a)1 Post-ERISA qualified plans

and qualified trusts; in general.

* * * * *

(b) * * *

(1) * * *

(i) * * * or attainment of normal re-

tirement age. However, normal retirement

age cannot be set so low as to be a sub-

terfuge to avoid the requirements of sec-

tion 401(a), and, accordingly, normal re-

tirement age cannot be earlier than the ear-

liest age that is reasonably representative

of a typical retirement age for the covered

workforce.

* * * * *

(iv) Benefits may not be distributed

prior to normal retirement age solely due

to a reduction in hours. However, not-

withstanding anything provided elsewhere

in paragraph (b) of this section (including

the pre-ERISA rules under 1.4011), an

employee may be treated as partially re-

tired for purposes of paragraph (b)(1)(i) of

this section to the extent provided under

1.401(a)3 relating to a bona fide phased

retirement program.

* * * * *

Par. 3. Section 1.401(a)3 is added to

read as follows:

1.401(a)3 Benefits during phased

retirement.

(a) Introduction(1) General rule.Under section 401(a), a qualified pension

plan may provide for the distribution of

phased retirement benefits in accordance

with the limitations of this paragraph (a)

to the extent that an employee is partially

retired under a bona fide phased retire-

ment program, as defined in paragraph (c)

of this section, provided the requirements

set forth in paragraphs (d) and (e) of this

section are satisfied.

(2) Limitation on benefits paid during

phased retirement period(i) Benefits

limited to pro rata retirement benefit. The

phased retirement benefits paid during

the phased retirement period cannot ex-

ceed the phased retirement accrued benefit

payable in the optional form of benefit

applicable at the annuity starting date for

the employees phased retirement benefit.

(ii) Availability of early retirement sub-

sidies, etc. Except as provided in para-

graph (a)(2)(iii) of this section, all early

retirement benefits, retirement-type subsi-

dies, and optional forms of benefit avail-

able upon full retirement must be avail-able with respect to the portion of an em-

ployees phased retirement accrued benefit

that is payable as a phased retirement ben-

efit.

(iii) Limitation on optional forms of

payment. Phased retirement benefits may

not be paid in the form of a single sum

or other form that constitutes an eligi-

ble rollover distribution under section

402(c)(4).

(3) Limited to full-time employees who

are otherwise eligible to commence ben-

efits. Phased retirement benefits are onlypermitted to be made available to an em-

ployee who, prior to the phased retire-

ment period, normally maintains a full-

time work schedule and who would oth-

erwise be eligible to commence retirement

benefits immediately if he or she were to

fully retire.

(4) Authority of Commissioner to adopt

other rules. The Commissioner, in rev-

enue rulings, notices, or other guidance

November 22, 2004 861 200447 I.R.B.


13/28

published in the Internal Revenue Bulletin

(see 601.601(d)(2)(ii)(b) of this chapter),

may adopt additional rules regarding the

coordination of partial retirement under a

phased retirement program and the quali-

fication rules of section 401(a).

(b) Definitions(1) In general. The

definitions set forth in this paragraph (b)

apply for purposes of this section.

(2) Phased retirement program. The

term phased retirement program means a

written, employer-adopted program pur-

suant to which employees may reduce the

number of hours they customarily work

beginningon or after a date specified under

the program and commence phased retire-

ment benefits during the phased retirement

period, as provided under the plan.

(3) Phased retirement period. The term

phased retirement periodmeans the period

of time that the employee and employer

reasonably expect the employee to workreduced hours under the phased retirement

program.

(4) Phased retirement accrued benefit.

The term phased retirement accrued bene-

fitmeans the portion of the employees ac-

crued benefit equal to the product of the

employees total accrued benefit on the

annuity starting date for the employees

phased retirement benefit, and one minus

the employees work schedule fraction.

(5) Phased retirement benefit. The term

phased retirement benefitmeans the ben-

efit paid to an employee upon the em-ployees partial retirement under a phased

retirement program, based on some or all

of the employees phased retirement ac-

crued benefit, and payable in the optional

form of benefit applicable at the annuity

starting date.

(6) Work schedule. With respect to an

employee, the term work schedule means

the number of hours the employee is rea-

sonably expected to work annually during

the phased retirement period (determined

in accordance with paragraph (c)(4) of this

section).(7) Full-time work schedule. With re-

spect to an employee, the term full-time

work schedule means the number of hours

the employee would normally work during

a year if the employee were to work on a

full-time basis, determined in a reasonable

and consistent manner.

(8) Work schedule fraction. With re-

spect to an employee, the term work sched-

ule fraction means a fraction, the numera-

tor of which is the employees work sched-

ule and the denominator of which is the

employees full-time work schedule.

(c) Bona fide phased retirement pro-

gram(1) Definition generally. The term

bona fide phased retirement program

means a phased retirement program that

satisfies paragraphs (c)(2) through (5) of

this section.

(2) Limitation to individuals who have

attained age 591/2. A bona fide phased

retirement program must be limited to

employees who have attained age 591/2. A

plan is permitted to impose additional re-

quirements for eligibility to participate in a

bona fide phased retirement program, such

as limiting eligibility to either employees

who have satisfied additional age or ser-

vice conditions (or combination thereof)

specified in the program or employees

whose benefit may not be distributed

without consent under section 411(a)(11).(3) Participation must be voluntary. An

employees participation in a bona fide

phased retirement program must be volun-

tary.

(4) Reduction in hours requirement. An

employee who participates in a bona fide

phased retirement program must reason-

ably be expected (by both the employer

and employee) to reduce, by 20 percent or

more, the number of hours the employee

customarily works. This requirement is

satisfied if the employer and employee en-

ter into an agreement, in good faith, underwhich they agree that the employee will re-

duce, by 20 percent or more, the number

of hours the employee works during the

phased retirement period.

(5) Limited to employees who are not

key-employee owners. Phased retirement

benefits are not permitted to be made avail-

able to a key employee who is described in

section 416(i)(1)(A)(ii) or (iii).

(d) Conditions for commencement of

phased retirement benefit(1) Imputed

accruals based on full-time schedule(i)

General rule. During the phased retire-ment period, in addition to being entitled to

payment of the phased retirement benefit,

the employee must be entitled to partici-

pate in the plan in the same manner as if

the employee still maintained a full-time

work schedule (including calculation of

average earnings, imputation of compen-

sation in accordance with 1.414(s)1(f),

and imputation of service in accordance

with the service-crediting rules under

1.401(a)(4)11(d)), and must be enti

tled to the same benefits (including earl

retirement benefits, retirement-type sub

sidies, and optional forms of benefits

upon full retirement as a similarly situate

employee who has not elected phased re

tirement, except that the years of servic

credited under the plan for any plan yea

during the phased retirement period is de

termined under paragraph (d)(1)(ii) or (iii

of this section, whichever is applicable.

(ii) Method for crediting years of ser

vice for full plan years. The years of ser

vice credited under the plan for any ful

plan year during the phased retirement pe

riod is multiplied by an adjustment rati

that is equal to the ratio of the employee

actual hours worked during that year to

the number of hours that would be worke

by the employee during that year under

full-time work schedule. Alternatively, o

a reasonable and consistent basis, the adjustment ratio may be based on the ratio o

an employees actual compensation durin

the year to the compensation that woul

be paid to the employee during the year i

he or she had maintained a full-time wor

schedule.

(iii) Method for crediting years of ser

vice for partial plan years. In the cas

of a plan year only a portion of which i

during a phased retirement period for an

employee, the method described in para

graphs (d)(1)(i) and (ii) of this section i

applied with respect to that portion of thplan year. Thus, for example, if an em

ployee works full time until October 1 o

a calendar plan year and works one-thir

time from October 1 through December 3

of the year, then the employee is credite

with 10 months for that year (9 month

plus 1/3 of 3 months).

(2) Ancillary benefits during phased re

tirement period(i) Death benefits. If a

employee dies while receiving phased re

tirement benefits, death benefits are allo

cated between the phased retirement ben

efit and the benefit that would be payablupon subsequent full retirement. See als

1.401(a)20, A9. Thus, if an employe

dies after the annuity starting date for th

phased retirement benefit, death benefit

are paid with respect to the phased retire

ment benefit in accordance with the op

tional form elected for that benefit, an

death benefits are paid with respect to th

remainder of the employees benefit in ac

200447 I.R.B. 862 November 22, 200


14/28

cordance with the plans provisions re-

garding death during employment.

(ii) Other ancillary benefits. To the ex-

tent provided under the terms of the plan,

ancillary benefits, other than death bene-

fits described in paragraph (d)(2)(i) of this

section, are permitted to be provided dur-

ing the phased retirement period.

(3) Calculation of benefit at full retire-

ment(i) In general. Upon full retire-

ment following partial retirement under

a phased retirement program, the em-

ployees total accrued benefit under the

plan (including the employees accruals

during the phased retirement period, de-

termined in accordance with paragraph

(d)(1) of this section) is offset by the por-

tion of the employees phased retirement

accrued benefit that is being distributed as

a phased retirement benefit at the time of

full retirement.

(ii) Adjustment for prior payments.If, before full retirement, the employees

phased retirement benefit has been re-

duced under paragraph (d)(4) of this sec-

tion, then the employees accrued benefit

under the plan is also offset upon full re-

tirement by an amount that is actuarially

equivalent to the phased retirement bene-

fit payments that have been made during

the phased retirement period that were

not made with respect to the portion of

the phased retirement accrued benefit that

is applied as an offset under paragraph

(d)(3)(i) of this section at the time of fullretirement.

(iii) Election of optional form with re-

spect to net benefit. Upon full retirement,

an employee is entitled to elect, in accor-

dance with section 417, an optional form of

benefit with respect to the net accrued ben-

efit determined under paragraph (d)(3)(i)

and (ii) of this section.

(iv) New election permitted for phased

retirement benefit. A plan is permitted to

provide that, upon full retirement, an em-

ployee may elect, in accordance with sec-

tion 417 and without regard to paragraph(a)(2)(iii) of this section, a new optional

form of benefit with respect to the portion

of the phased retirement accrued benefit

that is being distributed as a phased retire-

ment benefit. Any such new optional form

of benefit is calculated at the time of full

retirement as theactuarial equivalent of the

future phased retirement benefits (without

offset for the phased retirement benefits

previously paid).

(4) Prospective reduction in phased

retirement benefit if hours are materi-

ally greater than expected(i) General

rule. Except as otherwise provided in this

paragraph (d)(4), a plan must compare

annually the number of hours actually

worked by an employee during the phased

retirement testing period and the number

of hours the employee was reasonably

expected to work during the testing period

forpurposes of calculating the work sched-

ule fraction. For this purpose, the phased

retirement testing period is the 12 months

preceding the comparison date (or such

longer period permitted under paragraph

(d)(4)(iv) of this section, or any shorter

period that applies if there is a compari-

son date as a result of an agreed increase

under paragraph (d)(4)(vi) of this section).

In the event that the actual hours worked

(determined on an annual basis) during the

phased retirement testing period exceedsthe work schedule, then, except as pro-

vided in paragraph (d)(4)(ii) or (v) of this

section, the employees phased retirement

benefit must be reduced in accordance

with the method provided in paragraph

(d)(4)(iii) of this section, effective as of an

adjustment date specified in the plan that

is not more than 3 months later than the

comparison date.

(ii) Permitted variance in hours. A plan

is not required to reduce the phased re-

tirement benefit unless the hours worked

during the phased retirement testing periodare materially greater than the hours that

would be expected to be worked under the

work schedule. For this purpose, the em-

ployees hours worked (determined on an-

nual basis) are materially greater than the

employees work schedule if either

(A) The employees hours worked (de-

termined on an annual basis) are more

than 1331/3 percent of the employees

work schedule; or

(B) The employees hours worked (de-

termined on an annual basis) exceed 90

percent of the full-time work schedule.(iii) Adjustment method. If a phased

retirement benefit must be reduced under

paragraph (d)(4) of this section, a new

(i.e., reduced) phased retirement benefit

must be calculated as provided in this para-

graph (d)(4)(iii). First, an adjusted work

schedule is determined. The adjusted work

schedule is an annual schedule based on

the number of hours the employee actu-

ally worked during the phased retirement

testing period. The adjusted work sched-

ule is applied to the employees accrued

benefit that was used to calculate the prior

phased retirement benefit. This results

in a new phased retirement accrued ben-

efit for purposes of paragraph (b)(4) of

this section. Second, a new phased re-

tirement benefit is determined, based on

the new phased retirement accrued bene-

fit and payable in the same optional form

of benefit (i.e., using the same annuity

starting date and the same early retirement

factor and other actuarial adjustments) as

the prior phased retirement benefit. If

an employee is receiving more than one

phased retirement benefit (as permitted un-

der paragraph (e)(2) of this section) and

a reduction is required under paragraph

(d)(4) of this section, then the reduction

is applied first to the most recently com-

mencing phased retirement benefit (and

then, if necessary, to the next most recentphased retirement benefit, etc.).

(iv) Comparison date for phased retire-

ment testing period. The comparison date

is any date chosen by the employer on a

reasonable and consistent basis and spec-

ified in the plan, such as the last day of

the plan year, December 31, or the anniver-

sary of the annuity starting date for the em-

ployees phased retirement benefit. As an

alternative to testing the hours worked dur-

ing the 12 months preceding the compar-

ison date, the plan may, on a reasonable

and consistent basis, provide that the com-parison of actual hours worked to the work

schedule be based on a cumulative period

that exceeds 12 months beginning with ei-

ther the annuity starting date for the em-

ployees phased retirement benefit or any

later date specified in the plan.

(v) Exceptions to comparison require-

ment(A) In general. The comparison of

hours described in paragraph (d)(4) of this

section is not required in the situations set

forth in this paragraph (d)(4)(v).

(B) Employees recently commencing

phased retirement. No comparison is re-quired for an employee who commenced

phased retirement benefits within the

12-month period preceding the compari-

son date.

(C)Employees with short phased retire-

ment periods. No comparison is required

during the first 2 years of an employees

phased retirement period if

(1) The employee has entered into an

agreement with the employer under which

November 22, 2004 863 200447 I.R.B.


15/28

the employees phased retirement period

will not exceed 2 years and the employee

will fully retire at the end of such period;

and

(2) The employee fully retires after a

phased retirement period not in excess of

2 years.

(D) Employees with proportional pay

reduction. No comparison is required for

any phased retirement testing period if the

amount of compensation paid to the em-

ployee during that period does not exceed

the compensation that would be paid to the

employee if he or she had maintained a

full-time work schedule multiplied by the

work schedule fraction.

(E)Employees at or after normal retire-

ment age. No comparison is required for

any phased retirement testing period end-

ing within 3 months before the employees

normal retirement age or any time there-

after.(vi) Agreement to increase hours(A)

General rule. In the event that the em-

ployer and the employee agree to increase

prospectively the hours under the em-

ployees work schedule prior to normal

retirement age, then, notwithstanding

the exceptions provided in paragraphs

(d)(4)(v)(B) through (D) of this section,

the plan must treat the effective date of

the agreement to increase the employees

hours as a comparison date for purposes

of paragraph (d)(4)(iv) of this section. For

purposes of this paragraph (d)(4)(vi), withrespect to an employee, the term new work

schedule means the greater of the actual

number of hours the employee worked

(determined on an annual basis) during the

prior phased retirement testing period or

the annual number of hours the employee

reasonably expects to work under the new

agreement.

(B) Required adjustments. If the em-

ployees hours under the new work sched-

ule are materially greater (within the

meaning of paragraph (d)(4)(ii) of this

section) than the hours the employeewould be expected to work (based on

the employees prior work schedule),

the employer is required to reduce the

employees phased retirement benefit, ef-

fective as of the date of the increase, based

on the new work schedule. In this case,

the employees new work schedule is used

for future comparisons under paragraph

(d)(4) of this section.

(C) Permitted adjustments. If the em-

ployees hours under the new work sched-

ule are not materially greater (within the

meaning of paragraph (d)(4)(ii) of this sec-

tion) than the hours the employee would be

expected to work (based on the employees

prior work schedule), the employer is per-

mitted, but not required, to reduce the em-

ployees phased retirement benefit, effec-

tive as of the date of the increase, based on

the new work schedule. If the benefit is so

reduced, the employees new work sched-

ule is used for future comparisons under

paragraph (d)(4) of this section. If the em-

ployees phased retirement benefit is not

so reduced, future comparisons are deter-

mined using the employees prior work

schedule.

(e) Other rules(1) Highly compen-

sated employees. An employee who par-

tially retires under a phased retirement pro-

gram and who was a highly compensatedemployee, as defined in section 414(q),

immediately before the partial retirement

is considered to be a highly compensated

employee during the phased retirement pe-

riod, without regard to the compensation

actually paid to the employee during the

phased retirement period.

(2) Multiple phased retirement bene-

fits permitted(i) In general. A plan is

permitted to provide one or more addi-

tional phased retirement benefits prospec-

tively to an employee who is receiving a

phased retirement benefit if the conditionsset forth in paragraph (e)(2)(ii) of this sec-

tion are satisfied. At the later annuity start-

ing date for the additional phased retire-

ment benefit, the additional phased retire-

ment benefits may not exceed the amount

permitted to be paid based on the excess

of

(A) The employees phased retirement

accrued benefit at the later annuity starting

date, over

(B) The portion of the employees

phased retirement accrued benefit at the

earlier annuity starting date that is beingdistributed as a phased retirement benefit.

(ii) Conditions. The additional phased

retirement benefit described in paragraph

(e)(2)(i) of this section may be provided

only if

(A) The prior phased retirement benefit

was not based on the employees entire

phased retirement accrued benefit at the

annuity starting date for the prior phased

retirement benefit, or

(B) The employees work schedule a

the later annuity starting date is less than

the employees work schedule that wa

used to calculate the prior phased retire

ment benefit.

(3) Application of section 411(d)(6). I

accordance with 1.411(d)4, A1(b)(1)

the right to receive a partial distribution o

an employees accrued benefit as a phase

retirement benefit is treated as an optiona

form of payment that is separate from th

right to receive a full distribution of th

accrued benefit upon full retirement.

(4) Application of nondiscriminatio

rules. The right to receive a phased retire

ment benefit is a benefit, right, or featur

that is subject to 1.401(a)(4)4.

(f) Examples. The following example

illustrate the application of this section:Example 1. (i) Employers Plans. Plan X (as i

effect prior to amendment to reflect the phased re

tirement program described below) is a defined ben

efit plan maintained by Employer M. Plan X provides an accrued benefit of 1.5% of the average of a

employees highest three years of pay (based on th

highest 36 consecutive months of pay), times year

of service (with 1,000 hours of service required fo

a year of service), payable as a life annuity begin

ning at age 65. Plan X permits employees to ele

to commence actuarially reduced distributions at an

time after the later of termination of employment o

attainment of age 50, except that if an employee re

tires after age 55 and completion of 20 years of ser

vice, the applicable reduction is only 3% per year fo

the years between ages 65 and 62 and 6% per year fo

the years between ages 62 to 55. Plan X permits em

ployees to select, with spousal consent, a single lif

annuity, a joint and contingent annuity with the employee having the right to select any beneficiary an

a continuation percentage of 50%, 75%, or 100%, o

a 10-year certain and life annuity.

(ii) Phased Retirement Program. Employer M

adopts a voluntary phased retirement program tha

will only be available for employees who retire dur

ing the two-year period from February 1, 2006, t

January 31, 2008. The program will not be avai

able to employees who are not entitled to an imme

diate pension or who are 1 percent owners. Em

ployerM hasdetermined that employeestypicallybe

gin to retire after attainment of age 55 with at least 1

years of service. Accordingly, to increase retentio

of certain employees, the program will provide tha

employees in certain specified work positions wh

have reached age 591/2 and completed 15 years o

service may elect phased retirement. The program

permits phased retirement to be implemented throug

a reduction of 25%, 50%, or 75% in the number o

hours expected to be worked for up to 5 years fol

lowing phased retirement (other reduced schedule

may be elected with the approval of M), with the em

ployees compensation during the phased retiremen

period to be based on what a similar full-time em

ployee would be paid, reduced by the applicable per

centage reduction in hours expected to be worked

In order to participate in the program, the employe

and the employer must enter into an agreement unde

200447 I.R.B. 864 November 22, 200


16/28

which the employee will reduce his or her hours ac-

cordingly. The agreement also provides that the em-

ployees compensation during phased retirement will

be reduced by that same percentage. The program is

announced to employees in the fall of 2005.

(iii) Plan Provisions Regarding Phased Retire-

ment Benefit. (A) Plan X is amended, prior to Febru-

ary 1, 2006, to provide that an employee who elects

phased retirement under Ms phased retirement pro-

gram is permitted to commence benefits with respect

to a portion of his or her accrued retirement bene-fit (the employees phased retirement accrued bene-

fit), based on the applicable percentage reduction in

hours expectedto be worked. For example, for a 25%

reduction in hours, the employee is entitled to com-

mence benefits with respect to 25% of his or her ac-

crued benefit. Plan X permits an employee who com-

mences phased retirement to elect, with spousal con-

sent, from any of the optional forms provided under

the plan.

(B) During the phased retirement period, the em-

ployee will continue to accrue benefits (without re-

gard to the plans 1,000 hour requirement), with his

or her pay for purposes of calculating benefits un-

der Plan X increased by the ratio of 100 percent to

the percentage of full-time pay that will be paid dur-

ing phased retirement and with the employees ser-

vice credit to be equal to the product of the same per-

centage times the service credit that would apply if

the employee were working full time. Upon the em-

ployees subsequent full retirement, his or her total

accrued benefit will be based on the resulting high-

est three years of pay and total years of service, offset

by the phased retirement accrued benefit. The retire-

ment benefit payable upon subsequent full retirement

is in addition to the phased retirement benefit. Plan

X does not provide for a new election with respect to

the phased retirement benefit.

(C) In the case of death during the phased retire-

ment period, the employee will be treated as a former

employee to the extent of his or her phased retirement

benefit and as an active employee to the extent of theretirement benefit that would be due upon full retire-

ment.

(D) Because the terms of the phased retirement

program provide that the employees compensation

duringphased retirementwill bereduced bythat same

percentage as applies to calculate phased retirement

benefits, Plan X does not have provisions requiring

annual testing of hours actually worked.

(iv) Application to a Specific Employee(A)

Phased retirement benefit. Employee E is age 591/2

with 20 years of credited service. Employee Es

compensation is $90,000, and Es highest three

years of pay is $85,000. Employee E elects phased

retirement on April 1, 2006, and elects to reduce

hours by 50% beginning on July 1, 2006. Thus,Es annuity starting date for the phased retirement

benefit is July 1, 2006. Employee Es total accrued

benefit as of July 1, 2006, as a single life annuity

payable at normal retirement age is equal to $25,500

per year (1.5% times $85,000 times 20 years of

service). Thus, Employee Es phased retirement

accrued benefit as of July 1, 2006, as a single life

annuity payable at normal retirement age is equal to

$12,750 per year ($25,500 times 1 minus Es work

schedule fraction of 50%). Accordingly, Employee

Es phased retirement benefit payable as a straight

life annuity commencing on July 1, 2006, is equal to

$9,690 per year ($12,750 per year times 76% (100%

minus the applicable reduction for early retirement

equal to 3% for 3 years and 6% for an additional 21/2

years)). Employee E elects a joint and 50% survivor

annuity, with Es spouse as the contingent annuitant.

Under Plan X, the actuarial factor for this form of

benefit is 90%, so Es benefit is $8,721 per year.

(B)Death during phased retirement. If Employee

E were to die on or after July 1, 2006, and before sub-

sequent full retirement, Es spouse would be entitled

to a 50% survivor annuity based on the joint and 50%survivor annuity being paid to E, plus a qualified pre-

retirement survivor annuity that complies with sec-

tion 417 with respect to the additional amount that

would be paid to E if he or she had fully retired on

the date of Es death.

(C) Subsequent full retirement benefit. Three

years later, Employee E fully retires from Employer

M. Throughout this period, Es compensation has

been 50% of the compensation that would have

been paid to E if he or she were working full time.

Consequently, no adjustment in Es phased retire-

ment benefit is required. Es highest consecutive

36 months of compensation would be $95,000 if E

had not elected phased retirement and E has been

credited with 11/2 years of service credit for the 3

years of phased retirement (.50 times 3 years). Ac-

cordingly, prior to offset for Es phased retirement

accrued benefit, Es total accrued benefit as of July

1, 2009, as a single life annuity commencing at nor-

mal retirement age is equal to $30,637.50 per year

($95,000 times 1.5% times 21.5 years of service)

and, after the offset for Es phased retirement accrued

benefit, Es retirement benefit as a single life annuity

commencing at normal retirement age is equal to

$17,887.50 ($30,637.50 minus $12,750). Thus, the

amount of Es additional early retirement benefit

payable as a straight life annuity at age 621/2 is equal

to $16,545.94 per year ($17,887.50 per year times

92.5% (100% minus 3% for 21/2 years)). Employee

E elects, with spousal consent, a 10-year certain

and life annuity that applies to the remainder of Esaccrued benefit. This annuity is in addition to the

previously elected joint and 50% survivor annuity

payable as Es phased retirement benefit.

Example 2. ( i) Same Plan and Phased Retire-

ment Program, Except Annual Testing Required. The

facts with respect to thePlan X andMs phasedretire-

ment program are the same as in Example 1, except

that theprogram does not provide that theemployees

compensation during phased retirement will be re-

duced by that same percentage as is applied to calcu-

late phased retirement benefits, but instead the com-

pensation depends on the number of hours worked

by the employee. Plan X provides for annual test-

ing on a calendar year basis and for an employees

phased retirement benefit to be reduced proportion-ately if the hours worked exceed a threshold, under

provisions which reflect the variance permitted para-

graph (d)(4)(ii) of this section.

(ii) Employee Has Small Increase in Hours. The

facts with respect to Employee E are the same as in

Example 1, except that Es full time work schedule

would result in 2,000 hours worked annually, Es