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