[Federal Register Volume 69, Number 217 (Wednesday, November 10, 2004)]
[Proposed Rules]
[Pages 65108-65117]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-24874]


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DEPARTMENT OF TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-114726-04]
RIN 1545-BD23


Distributions From a Pension Plan Under a Phased Retirement 
Program

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This notice of proposed rulemaking contains proposed 
amendments to the Income Tax Regulations under section 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 public 
with guidance regarding distributions from qualified pension plans and 
will affect 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.

[[Page 65109]]


ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-114726-04), room 
5203, Internal Revenue Service, PO Box 7604, Ben Franklin Station, 
Washington, 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 (REG-
114726-04), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue, NW., Washington, DC, or sent electronically, via the IRS 
Internet site at www.irs.gov/regs or via the Federal eRulemaking Portal 
at www.regulations.gov (indicate IRS and REG-114726-04).

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Cathy A. 
Vohs, (202) 622-6090; concerning submissions and requests for a public 
hearing, contact Sonya Cruse, (202) 622-7180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

    As people are living longer, healthier lives, there is a greater 
risk that individuals may outlive their retirement savings. In 
addition, employers have expressed interest in encouraging older, more 
experienced workers to stay in the workforce. One approach that some 
employers have implemented is to offer employees the opportunity for 
``phased retirement.''
    While there is no single approach to phased retirement, these 
arrangements generally provide employees who are at or 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 retirement 
savings. However, phased retirement can also increase the risk of 
outliving retirement savings for employees who begin drawing upon their 
retirement savings before normal retirement age. Even though the 
annuity distribution options offered by defined benefit plans preclude 
outliving benefits, early distribution of a portion of the employee's 
benefit will reduce the benefits available after full retirement. On 
the other hand, phased retirement also can provide employees additional 
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 
2002-43 in the Cumulative Bulletin (2002-27 C.B. 38 (July 8, 2002)), in 
which comments were requested regarding phased retirement. Notice 2002-
43 specifically requested comments on a wide variety of issues, 
including the following:
    <bullet> Under what circumstances, if any, would permitting 
distributions from a defined benefit plan before an employee 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 
employee has actually reduced his or her workload?
    <bullet> If there are such circumstances, how should any early 
retirement subsidy be treated?

Comments Received

    Sixteen written comments were formally submitted in response to 
Notice 2002-43. These comments are in addition to the substantial 
number of articles and other published materials addressing phased 
retirement.\1\
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    \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 Don't 
Go! Why Phased Retirement May Make Sense For Your Government,'' 18 
Gov't 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.
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    While some of the comments expressed concerns over the potential 
for both dissipation of retirement funds and violation of age 
discrimination laws, commentators generally responded favorably to the 
proposal to provide guidance on facilitating phased retirement 
arrangements. These commentators noted that permitting pension 
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 
arrangements 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 retirement program be limited to employees who are eligible 
for immediately commencing retirement benefits under the plan 
(including those eligible for early retirement benefits). Other 
comments recommended that retirement benefits be permitted 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 income 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 funding obligations 
for employers. Others recommended that any early retirement subsidy 
available to an employee upon full retirement continue to be available 
if the employee participates in phased retirement. For example, one 
such commentator recommended not only that any early retirement subsidy 
be available upon phased retirement, 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 benefits be limited to cases 
in which there is a reduction in hours worked. Others recommended that 
a reduction in hours not be required and that a transition to a less 
stressful job also be considered phased retirement or that the full 
retirement benefit 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. Under this 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 retired and thus entitled to 20 percent of 
his or her retirement benefit. The employee would continue to accrue 
additional benefits based on the actual hours he or she continues to 
work.
    Several of the commentators discussed the implications of phased 
retirement benefits for purposes of the nondiscrimination rules of 
section 401(a)(4) and the anti-cutback rules of section 411(d)(6). Many 
of the comments said that phased retirement arrangements must be 
flexible and that

[[Page 65110]]

it would be important for employers to be able to adopt a phased 
retirement arrangement on a temporary (even experimental) basis.
    Many commentators expressed concern over the effect that a 
reduction in hours and the corresponding reduction in compensation 
would have on the final average pay of an individual for purposes of 
the benefit calculation when the employee fully retires. These comments 
generally requested guidance on this issue, including clarification as 
to whether an employee's final average pay is permitted to decline as a 
result of the employee's reduction in hours pursuant to participation 
in a phased retirement arrangement.

Explanation of Provisions

Overview

    The proposed regulations would amend Sec.  1.401(a)-1(b) and add 
Sec.  1.401(a)-3 in order to permit a pro rata share of an employee's 
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 under the program. Under this pro rata approach, an 
employee maintains a dual status (i.e., partially retired and partially 
in service) during the phased retirement period. This pro rata or dual 
status approach to phased retirement was one of the approaches 
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 maintained primarily for retirement. Other approaches, such 
as permitting benefits to be fully available if an employee works 
reduced hours as part of phased retirement 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 Sec.  
1.401(a)-1(b) principle that benefits be paid only after retirement. In 
addition, although a number of commentators suggested that guidance 
address the practice of terminating an employee with a prearranged 
rehiring of the employee (or similar sham transactions), the proposed 
regulations do not address this topic because it involves additional 
issues outside the scope of this project.

Rules Relating to Phased Retirement

    Under the proposed regulations, a plan would be permitted to pay a 
pro rata portion of the employee's benefits under a bona fide phased 
retirement program before attainment of normal retirement age. The 
proposed regulations define a bona fide phased retirement program as a 
written, employer-adopted program pursuant to which employees may 
reduce the number of hours they customarily work beginning on or after 
a retirement date specified under the program and receive phased 
retirement benefits. Payment of phased retirement benefits is permitted 
only if the program meets certain conditions, including that employee 
participation is voluntary and the employee and employer expect the 
employee to reduce, by 20 percent or more, the number of hours the 
employee works during the phased retirement period.
    Consistent with the pro rata approach discussed above, the maximum 
amount that is permitted to be paid is limited to the portion of the 
employee's accrued benefit equal to the product of the employee's total 
accrued benefit on the date the employee commences phased retirement 
(or any earlier date selected by the plan for administrative ease) and 
the employee's reduction in work. The reduction in work is based on the 
employee's work schedule fraction, which is the ratio of the hours that 
the employee is reasonably expected to work during the phased 
retirement period to the hours that would be worked if the employee 
were full-time. Based in part on commentators' concerns regarding early 
retirement subsidies, the proposed regulations generally require that 
all early retirement benefits, retirement-type subsidies, and optional 
forms of benefit that would be available upon full retirement be 
available with respect to the phased retirement accrued benefit. 
However, the proposed regulations would not permit payment to be made 
in the form of a single-sum distribution (or other eligible rollover 
distribution) in order to prevent 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 combination thereof) 
that is customary for retirement, e.g., where the employer has 
reasonably determined in good faith that participants who cease 
employment with the employer after that age or service combination are 
typically not expected to continue to perform further services of a 
generally comparable nature elsewhere in the workforce. Such a 
retirement age might be considerably lower than age 65 in certain 
occupations (such as police or firefighters). As discussed further 
below (under the heading Application to Plans Other Than Qualified 
Pension Plans), the Treasury 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 before the employee 
attains age 59\1/2\ 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 59\1/2\ or separation from service. Accordingly, in lieu of a 
customary retirement 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 59\1/2\.
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    \2\ Cf., Edwards v. Commissioner, T.C. Memo. 1989-409, aff'd, 
906 F.2d 114 (4th Cir. 1990).
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Additional Accruals During Phased Retirement

    The regulations provide that, during the phased retirement period, 
in addition to being entitled to the phased retirement benefit, the 
employee must be entitled to participate in the plan in the same manner 
as if the employee were still maintaining a full-time work schedule 
(including calculation of average earnings) and must be entitled to the 
same benefits (including early retirement benefits, retirement-type 
subsidies, and optional forms of benefits) upon full retirement as a 
similarly situated employee who has not elected phased retirement, 
except that the years of service credited under the plan for any plan 
year during the phased retirement period is multiplied by the ratio of 
the employee's actual hours of service during the year to the 
employee's full-time work schedule, or by the ratio of the employee's 
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 
requirement to accrue a benefit, an employee participating in a phased 
retirement program will accrue proportionate additional benefits, even 
if the employee works fewer than 1,000 hours of service.
    The requirement that full-time compensation be imputed, with a 
proportionate reduction based on an employee's actual service, is 
intended to ensure that a participant is not disadvantaged by reason of 
choosing phased retirement. This rule precludes the need for extensive 
disclosure requirements, e.g., disclosure to alert

[[Page 65111]]

participants to rights that may be lost as a result of participating in 
a phased retirement program. To be consistent with the requirement 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 employee during phased 
retirement. See also Sec.  1.414(q)-1T, A-4 & A-5.
    Under the proposed regulations, the employee's final retirement 
benefit is comprised of the phased retirement benefit and the balance 
of the employee's accrued benefit under the plan (i.e., the excess 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 permitted to 
offer a new election with respect to that benefit.
    This bifurcation is consistent with commentators' recommendation 
that an employee who is in a phased retirement program 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 
employee's continued work with the employer. This approach also ensures 
that a phased retirement program offers an early retirement subsidy to 
the extent the employee has reduced his or her hours, and that the 
remainder of the employee's benefit rights is not adversely affected by 
participation in the phased retirement program.

Testing and Adjustment of Payments

    Subject to certain exceptions, the proposed regulations require 
periodic testing to ensure that employees in phased retirement 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 reasonably expected to 
work. If the actual hours worked during the testing period are 
materially greater than the expected number of hours, then the 
employee's phased retirement benefit must be reduced prospectively. For 
this purpose, the employee's hours worked are materially greater than 
the employee's work schedule if they exceed either 133\1/3\ 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 employee 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 employee's work schedule fraction. Further, no comparison is 
required during the first year of an employee's phased retirement or if 
the employee has entered into an agreement with the employer that the 
employee will retire within 2 years.
    In the event that the employer and employee agree to increase 
prospectively the hours that the employee will work, then the 
employee's phased retirement benefit must be adjusted based on a new 
work schedule. The date of the agreement to increase the employee's 
hours is treated as a comparison date for testing purposes.
    In calculating the employee's benefit at full retirement, if an 
employee's phased retirement benefits have been reduced during phased 
retirement, the employee's accrued benefit under the plan is offset by 
an amount that is actuarially equivalent to the additional payments 
made before the reduction. The potential for this offset, like other 
material features of the phased retirement optional form of benefit, 
must be disclosed as part of the QJSA explanation as required under 
Sec.  1.401(a)-20, Q&A-36, and Sec.  1.417(a)(3)-1(c)(1)(v) and (d)(1).
    If the employee's phased retirement benefit is less than the 
maximum amount permitted or the employee's work schedule 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, commencing a later 
annuity starting date, provides flexibility to reflect future 
reductions in the employee's 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 permitted to 
pay benefits upon an employee's attainment of normal retirement age. 
However, normal retirement age cannot be set so low as to be a 
subterfuge to avoid the requirements of section 401(a), and, 
accordingly, normal retirement age cannot be earlier than the earliest 
age that is reasonably representative of a typical retirement age for 
the covered workforce.\3\
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    \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 
defined benefit plans.
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Application to Plans Other Than Qualified Pension Plans

    The regulations that limit distributions that are modified by these 
proposed regulations 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-service distributions, including 
amounts held in or attributable to: (1) Qualified profit sharing and 
stock bonus plans to the extent not attributable to elective deferrals 
under section 401(k); (2) insurance annuities under section 403(b)(1), 
and retirement 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 59\1/2\, without regard to whether the employee has 
retired or had a severance from employment. Accordingly, they may 
either provide for the same phased retirement rules that are proposed 
in these regulations or may provide for other partial or full in-
service distributions to be available after attainment of age 59\1/2\. 
However, eligible governmental plans under section 457(b) are not 
generally permitted to provide for payments to be made before the 
earlier of severance from employment or attainment of age 70\1/2\. See 
generally Sec.  1.457-6.

Other Issues

    The proposed regulations also authorize the Commissioner to issue 
additional rules in guidance of general applicability regarding the 
coordination of partial retirement under a phased retirement program 
and the plan qualification rules under section 401(a).
    These proposed regulations do not address all of the issues that 
commentators raised in response to Notice 2002-43. Thus, as noted 
above, the proposed regulations 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 
commentators pointed out that

[[Page 65112]]

the continued availability of heath coverage would be an important 
feature for employees in deciding whether to participate in phased 
retirement, the proposed regulations do not include any rules relating 
to heath coverage. Similarly, the proposed regulations do not address 
any potential age discrimination 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 proposed to apply to plan years 
beginning on or after the date of publication of the Treasury decision 
adopting these rules as final regulations in the Federal Register. 
These proposed regulations cannot be relied on before they are adopted 
as final regulations.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in Executive Order 
12866. Therefore, a regulatory assessment is not required. It also has 
been determined that section 553(b) of the Administrative Procedure Act 
(5 U.S.C. chapter 5) does not apply to these proposed regulations, and, 
because these regulations do not impose a collection of information on 
small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) 
does not apply. Pursuant to section 7805(f) of the Internal Revenue 
Code, this notice of proposed rulemaking will be submitted to the Chief 
Counsel for Advocacy of the Small Business Administration for comment 
on its impact on small business.

Comments and Requests for a Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written comments (a signed original 
and eight (8) copies) or electronic comments that are submitted timely 
to the IRS. All comments will be available for public inspection and 
copying.
    Comments are specifically requested on the following issues:
    <bullet> Should eligibility to participate in a phased retirement 
program be extended to employees that reduce their workload using a 
standard, other than counting hours, to identify the reduction, and, if 
so, are there administrable methods for measuring the reduction?
    <bullet> The proposed regulations require periodic testing of the 
hours an employee actually works during phased retirement, and if the 
hours are materially greater than the employee's phased retirement work 
schedule, the phased retirement benefit must be adjusted. As discussed 
above (under the heading 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 
employee's reduction in hours?
    <bullet> The proposed regulations require an offset for the 
actuarial value of additional payments made before a reduction in 
phased retirement benefits. Should the regulations permit this offset 
to be calculated without regard to any early retirement subsidy and, if 
so, how should a subsidy be quantified?
    <bullet> The proposed regulations clarify that the right to receive 
a phased retirement benefit as a partial payment is a separate optional 
form of benefit for purposes of section 411(d)(6) and, thus, is a 
benefit, right, or feature for purposes of the special 
nondiscrimination rules at Sec.  1.401(a)(4)-4. Comments are requested 
on whether there are facts and circumstances under which the age and 
service conditions for a particular employer's phased retirement 
program should be disregarded in applying Sec.  1.401(a)(4)-4 (even if 
the program may only be in place for a temporary period), or under 
which the rules at Sec.  1.401(a)(4)-4 should otherwise be modified 
with respect to phased retirement.
    <bullet> Should any special rules be adopted to coordinate the 
rules regarding distributions and continued accruals during phased 
retirement with a plan's provisions regarding employment after normal 
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 
published 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.

List of Subjects 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 is amended by adding 
entries in numerical 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 Sec.  1.401(a)-1, paragraph (b)(1)(i) is amended by 
adding text before the period at the end of the current sentence and a 
new second sentence, and paragraph (b)(1)(iv) is added to read as 
follows:


Sec.  1.401(a)-1  Post-ERISA qualified plans and qualified trusts; in 
general.

* * * * *
    (b) * * *
    (1) * * *
    (i) * * * or attainment of normal retirement age. However, normal 
retirement age cannot be set so low as to be a subterfuge to avoid the 
requirements of section 401(a), and, accordingly, normal retirement age 
cannot be earlier than the earliest 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, notwithstanding anything 
provided elsewhere in paragraph (b) of this section (including the pre-
ERISA rules under Sec.  1.401-1), an employee may be treated as 
partially retired for purposes of paragraph (b)(1)(i) of this section 
to the extent provided under Sec.  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:


Sec.  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 retirement 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

[[Page 65113]]

during the phased retirement period cannot exceed the phased retirement 
accrued benefit payable in the optional form of benefit applicable at 
the annuity starting date for the employee's phased retirement benefit.
    (ii) Availability of early retirement subsidies, etc. Except as 
provided in paragraph (a)(2)(iii) of this section, all early retirement 
benefits, retirement-type subsidies, and optional forms of benefit 
available upon full retirement must be available with respect to the 
portion of an employee's phased retirement accrued benefit that is 
payable as a phased retirement benefit.
    (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 eligible rollover distribution under section 402(c)(4).
    (3) Limited to full-time employees who are otherwise eligible to 
commence benefits. Phased retirement benefits are only permitted to be 
made available to an employee who, prior to the phased retirement 
period, normally maintains a full-time work schedule and who would 
otherwise 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 revenue rulings, notices, or other guidance published 
in the Internal Revenue Bulletin (see Sec.  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 
qualification 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 pursuant to which employees 
may reduce the number of hours they customarily work beginning on or 
after a date specified under the program and commence phased retirement 
benefits during the phased retirement period, as provided under the 
plan.
    (3) Phased retirement period. The term phased retirement period 
means the period of time that the employee and employer reasonably 
expect the employee to work reduced hours under the phased retirement 
program.
    (4) Phased retirement accrued benefit. The term phased retirement 
accrued benefit means the portion of the employee's accrued benefit 
equal to the product of the employee's total accrued benefit on the 
annuity starting date for the employee's phased retirement benefit, and 
one minus the employee's work schedule fraction.
    (5) Phased retirement benefit. The term phased retirement benefit 
means the benefit paid to an employee upon the employee's partial 
retirement under a phased retirement program, based on some or all of 
the employee's phased retirement accrued 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 reasonably 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 respect 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 respect to an employee, the term 
work schedule fraction means a fraction, the numerator of which is the 
employee's work schedule and the denominator of which is the employee's 
full-time work schedule.
    (c) Bona fide phased retirement program--(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 59\1/2\. A bona 
fide phased retirement program must be limited to employees who have 
attained age 59\1/2\. A plan is permitted to impose additional 
requirements for eligibility to participate in a bona fide phased 
retirement program, such as limiting eligibility to either employees 
who have satisfied additional age or service 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 employee's participation in 
a bona fide phased retirement program must be voluntary.
    (4) Reduction in hours requirement. An employee who participates in 
a bona fide phased retirement program must reasonably 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 enter into an agreement, in good 
faith, under which they agree that the employee will reduce, 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 available 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 retirement period, in addition to being entitled to payment 
of the phased retirement benefit, the employee must be entitled to 
participate 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 compensation in accordance with Sec.  1.414(s)-
1(f), and imputation of service in accordance with the service-
crediting rules under Sec.  1.401(a)(4)-11(d)), and must be entitled to 
the same benefits (including early retirement benefits, retirement-type 
subsidies, and optional forms of benefits) upon full retirement as a 
similarly situated employee who has not elected phased retirement, 
except that the years of service credited under the plan for any plan 
year during the phased retirement period is determined under paragraph 
(d)(1)(ii) or (iii) of this section, whichever is applicable.
    (ii) Method for crediting years of service for full plan years. The 
years of service credited under the plan for any full plan year during 
the phased retirement period is multiplied by an adjustment ratio that 
is equal to the ratio of the employee's actual hours worked during that 
year to the number of hours that would be worked by the employee during 
that year under a full-time work schedule. Alternatively, on a 
reasonable and consistent basis, the adjustment ratio may be based on 
the ratio of an employee's actual compensation during the year to the 
compensation that would be paid to the employee during the year if he 
or she had maintained a full-time work schedule.
    (iii) Method for crediting years of service for partial plan years. 
In the case of a plan year only a portion of which is during a phased 
retirement period for an employee, the method described in paragraphs 
(d)(1)(i) and (ii) of this section is applied with respect to that 
portion of the plan year. Thus, for example, if an employee works full 
time until October 1 of a calendar plan year and works one-third time 
from October 1 through December 31 of the year, then the employee is 
credited with 10 months for that year (9 months plus \1/3\ of 3 
months).

[[Page 65114]]

    (2) Ancillary benefits during phased retirement period--(i) Death 
benefits. If an employee dies while receiving phased retirement 
benefits, death benefits are allocated between the phased retirement 
benefit and the benefit that would be payable upon subsequent full 
retirement. See also Sec.  1.401(a)-20, A-9. Thus, if an employee dies 
after the annuity starting date for the phased retirement benefit, 
death benefits are paid with respect to the phased retirement benefit 
in accordance with the optional form elected for that benefit, and 
death benefits are paid with respect to the remainder of the employee's 
benefit in accordance with the plan's provisions regarding death during 
employment.
    (ii) Other ancillary benefits. To the extent provided under the 
terms of the plan, ancillary benefits, other than death benefits 
described in paragraph (d)(2)(i) of this section, are permitted to be 
provided during the phased retirement period.
    (3) Calculation of benefit at full retirement--(i) In general. Upon 
full retirement following partial retirement under a phased retirement 
program, the employee's total accrued benefit under the plan (including 
the employee's accruals during the phased retirement period, determined 
in accordance with paragraph (d)(1) of this section) is offset by the 
portion of the employee's 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 
employee's phased retirement benefit has been reduced under paragraph 
(d)(4) of this section, then the employee's accrued benefit under the 
plan is also offset upon full retirement by an amount that is 
actuarially equivalent to the phased retirement benefit 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 full retirement.
    (iii) Election of optional form with respect to net benefit. Upon 
full retirement, an employee is entitled to elect, in accordance with 
section 417, an optional form of benefit with respect to the net 
accrued benefit 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 employee may 
elect, in accordance with section 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 retirement benefit. Any such new optional 
form of benefit is calculated at the time of full retirement as the 
actuarial 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 
materially 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 for purposes of 
calculating the work schedule 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 comparison 
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 exceeds 
the work schedule, then, except as provided in paragraph (d)(4)(ii) or 
(v) of this section, the employee's 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 retirement benefit unless the hours worked during the phased 
retirement testing period are materially greater than the hours that 
would be expected to be worked under the work schedule. For this 
purpose, the employee's hours worked (determined on annual basis) are 
materially greater than the employee's work schedule if either--
    (A) The employee's hours worked (determined on an annual basis) are 
more than 133\1/3\ percent of the employee's work schedule; or
    (B) The employee's hours worked (determined 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 
paragraph (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 actually worked during the phased retirement testing 
period. The adjusted work schedule is applied to the employee's accrued 
benefit that was used to calculate the prior phased retirement benefit. 
This results in a new phased retirement accrued benefit for purposes of 
paragraph (b)(4) of this section. Second, a new phased retirement 
benefit is determined, based on the new phased retirement accrued 
benefit 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 under 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 commencing phased retirement benefit 
(and then, if necessary, to the next most recent phased retirement 
benefit, etc.).
    (iv) Comparison date for phased retirement testing period. The 
comparison date is any date chosen by the employer on a reasonable and 
consistent basis and specified in the plan, such as the last day of the 
plan year, December 31, or the anniversary of the annuity starting date 
for the employee's phased retirement benefit. As an alternative to 
testing the hours worked during the 12 months preceding the comparison 
date, the plan may, on a reasonable and consistent basis, provide that 
the comparison of actual hours worked to the work schedule be based on 
a cumulative period that exceeds 12 months beginning with either the 
annuity starting date for the employee's phased retirement benefit or 
any later date specified in the plan.
    (v) Exceptions to comparison requirement--(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 required for an employee who commenced phased retirement benefits 
within the 12-month period preceding the comparison date.
    (C) Employees with short phased retirement periods. No comparison 
is required during the first 2 years of an employee's phased retirement 
period if--

[[Page 65115]]

    (1) The employee has entered into an agreement with the employer 
under which the employee's 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 employee 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 retirement age. No comparison is 
required for any phased retirement testing period ending within 3 
months before the employee's normal retirement age or any time 
thereafter.
    (vi) Agreement to increase hours--(A) General rule. In the event 
that the employer and the employee agree to increase prospectively the 
hours under the employee's 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 employee's hours as a 
comparison date for purposes of paragraph (d)(4)(iv) of this section. 
For purposes of this paragraph (d)(4)(vi), with respect 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 employee's hours under the new 
work schedule are materially greater (within the meaning of paragraph 
(d)(4)(ii) of this section) than the hours the employee would be 
expected to work (based on the employee's prior work schedule), the 
employer is required to reduce the employee's phased retirement 
benefit, effective as of the date of the increase, based on the new 
work schedule. In this case, the employee's new work schedule is used 
for future comparisons under paragraph (d)(4) of this section.
    (C) Permitted adjustments. If the employee's hours under the new 
work schedule are not materially greater (within the meaning of 
paragraph (d)(4)(ii) of this section) than the hours the employee would 
be expected to work (based on the employee's prior work schedule), the 
employer is permitted, but not required, to reduce the employee's 
phased retirement benefit, effective as of the date of the increase, 
based on the new work schedule. If the benefit is so reduced, the 
employee's new work schedule is used for future comparisons under 
paragraph (d)(4) of this section. If the employee's phased retirement 
benefit is not so reduced, future comparisons are determined using the 
employee's prior work schedule.
    (e) Other rules--(1) Highly compensated employees. An employee who 
partially retires under a phased retirement program and who was a 
highly compensated employee, as defined in section 414(q), immediately 
before the partial retirement is considered to be a highly compensated 
employee during the phased retirement period, without regard to the 
compensation actually paid to the employee during the phased retirement 
period.
    (2) Multiple phased retirement benefits permitted--(i) In general. 
A plan is permitted to provide one or more additional phased retirement 
benefits prospectively to an employee who is receiving a phased 
retirement benefit if the conditions set forth in paragraph (e)(2)(ii) 
of this section are satisfied. At the later annuity starting date for 
the additional phased retirement benefit, the additional phased 
retirement benefits may not exceed the amount permitted to be paid 
based on the excess of--
    (A) The employee's phased retirement accrued benefit at the later 
annuity starting date, over
    (B) The portion of the employee's phased retirement accrued benefit 
at the earlier annuity starting date that is being distributed 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 
employee's entire phased retirement accrued benefit at the annuity 
starting date for the prior phased retirement benefit, or
    (B) The employee's work schedule at the later annuity starting date 
is less than the employee's work schedule that was used to calculate 
the prior phased retirement benefit.
    (3) Application of section 411(d)(6). In accordance with Sec.  
1.411(d)-4, A-1(b)(1), the right to receive a partial distribution of 
an employee's accrued benefit as a phased retirement benefit is treated 
as an optional form of payment that is separate from the right to 
receive a full distribution of the accrued benefit upon full 
retirement.
    (4) Application of nondiscrimination rules. The right to receive a 
phased retirement benefit is a benefit, right, or feature that is 
subject to Sec.  1.401(a)(4)-4.
    (f) Examples. The following examples illustrate the application of 
this section:

    Example 1. (i) Employer's Plans. Plan X (as in effect prior to 
amendment to reflect the phased retirement program described below) 
is a defined benefit plan maintained by Employer M. Plan X provides 
an accrued benefit of 1.5% of the average of an employee's highest 
three years of pay (based on the highest 36 consecutive months of 
pay), times years of service (with 1,000 hours of service required 
for a year of service), payable as a life annuity beginning at age 
65. Plan X permits employees to elect to commence actuarially 
reduced distributions at any time after the later of termination of 
employment or attainment of age 50, except that if an employee 
retires after age 55 and completion of 20 years of service, the 
applicable reduction is only 3% per year for the years between ages 
65 and 62 and 6% per year for the years between ages 62 to 55. Plan 
X permits employees to select, with spousal consent, a single life 
annuity, a joint and contingent annuity with the employee having the 
right to select any beneficiary and a continuation percentage of 
50%, 75%, or 100%, or a 10-year certain and life annuity.
    (ii) Phased Retirement Program. Employer M adopts a voluntary 
phased retirement program that will only be available for employees 
who retire during the two-year period from February 1, 2006 to 
January 31, 2008. The program will not be available to employees who 
are not entitled to an immediate pension or who are 1 percent 
owners. Employer M has determined that employees typically begin to 
retire after attainment of age 55 with at least 15 years of service. 
Accordingly, to increase retention of certain employees, the program 
will provide that employees in certain specified work positions who 
have reached age 59\1/2\ and completed 15 years of service may elect 
phased retirement. The program permits phased retirement to be 
implemented through a reduction of 25%, 50%, or 75% in the number of 
hours expected to be worked for up to 5 years following phased 
retirement (other reduced schedules may be elected with the approval 
of M), with the employee's compensation during the phased retirement 
period to be based on what a similar full-time employee would be 
paid, reduced by the applicable percentage reduction in hours 
expected to be worked. In order to participate in the program, the 
employee and the employer must enter into an agreement under which 
the employee will reduce his or her hours accordingly. The agreement 
also provides that the employee's 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 Retirement Benefit. (A) 
Plan X is amended, prior to February 1, 2006, to provide that an 
employee who elects phased retirement

[[Page 65116]]

under M's phased retirement program is permitted to commence 
benefits with respect to a portion of his or her accrued retirement 
benefit (the employee's phased retirement accrued benefit), based on 
the applicable percentage reduction in hours expected to be worked. 
For example, for a 25% reduction in hours, the employee is entitled 
to commence benefits with respect to 25% of his or her accrued 
benefit. Plan X permits an employee who commences phased retirement 
to elect, with spousal consent, from any of the optional forms 
provided under the plan.
    (B) During the phased retirement period, the employee will 
continue to accrue benefits (without regard to the plan's 1,000 hour 
requirement), with his or her pay for purposes of calculating 
benefits under Plan X increased by the ratio of 100 percent to the 
percentage of full-time pay that will be paid during phased 
retirement and with the employee's service credit to be equal to the 
product of the same percentage times the service credit that would 
apply if the employee were working full time. Upon the employee's 
subsequent full retirement, his or her total accrued benefit will be 
based on the resulting highest three years of pay and total years of 
service, offset by the phased retirement accrued benefit. The 
retirement 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 retirement 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 the retirement benefit that would be due upon full 
retirement.
    (D) Because the terms of the phased retirement program provide 
that the employee's compensation during phased retirement will be 
reduced by that 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 59\1/2\ with 20 years of credited 
service. Employee E's compensation is $90,000, and E's 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, E's annuity starting date for the phased retirement 
benefit is July 1, 2006. Employee E's 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 E's 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 
E's work schedule fraction of 50%). Accordingly, Employee E's 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 2\1/2\ years)). Employee E 
elects a joint and 50% survivor annuity, with E's spouse as the 
contingent annuitant. Under Plan X, the actuarial factor for this 
form of benefit is 90%, so E's 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 subsequent full retirement, E's 
spouse would be entitled to a 50% survivor annuity based on the 
joint and 50% survivor annuity being paid to E, plus a qualified 
preretirement survivor annuity that complies with section 417 with 
respect to the additional amount that would be paid to E if he or 
she had fully retired on the date of E's death.
    (C) Subsequent full retirement benefit. Three years later, 
Employee E fully retires from Employer M. Throughout this period, 
E's 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 E's phased retirement benefit is required. E's highest 
consecutive 36 months of compensation would be $95,000 if E had not 
elected phased retirement and E has been credited with 1\1/2\ years 
of service credit for the 3 years of phased retirement (.50 times 3 
years). Accordingly, prior to offset for E's phased retirement 
accrued benefit, E's total accrued benefit as of July 1, 2009 as a 
single life annuity commencing at normal 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 E's phased retirement accrued benefit, E's 
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 E's additional early retirement benefit payable 
as a straight life annuity at age 62\1/2\ is equal to $16,545.94 per 
year ($17,887.50 per year times 92.5% (100% minus 3% for 2\1/2\ 
years)). Employee E elects, with spousal consent, a 10-year certain 
and life annuity that applies to the remainder of E's accrued 
benefit. This annuity is in addition to the previously elected joint 
and 50% survivor annuity payable as E's phased retirement benefit.

    Example 2. (i) Same Plan and Phased Retirement Program, Except 
Annual Testing Required. The facts with respect to the Plan X and 
M's phased retirement program are the same as in Example 1, except 
that the program does not provide that the employee's compensation 
during phased retirement will be reduced by that same percentage as 
is applied to calculate phased retirement benefits, but instead the 
compensation depends on the number of hours worked by the employee. 
Plan X provides for annual testing on a calendar year basis and for 
an employee's phased retirement benefit to be reduced 
proportionately if the hours worked exceed a threshold, under 
provisions which reflect the variance permitted paragraph (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 E's 
full time work schedule would result in 2,000 hours worked annually, 
E's work schedule fraction is 50%, and E works 500 hours from July 
1, 2006 through December 31, 2006, 1,000 hours in 2007, 1,200 hours 
in 2008, and 600 hours from January 1, 2009 through E's full 
retirement on June 30, 2009.
    (iii) Application of Testing Rules. No comparison of hours is 
required for the partial testing period that occurs in 2006. For 
2007, no reduction is required in E's phased retirement benefit as a 
result of the hours worked by E during 2007 because the hours did 
not exceed E's work schedule (50% of 2,000). For 2008, although the 
hours worked by E exceeded E's work schedule, no reduction is 
required because the hours worked in 2008 were not materially 
greater than E's work schedule (1,200 is not more than the variance 
permitted under paragraph (d)(4)(ii) of this section, which is 
133\1/3\% of 1,000). E's total accrued benefit upon E's retirement 
on July 1, 2009 would be based on 21.65 years of service to reflect 
the actual hours worked from July 1, 2006 through June 30, 2009.

    Example 3. (i) Same Plan and Phased Retirement Program, Except 
Material Increase in Hours. The facts with respect to the Plan X and 
M's phased retirement program are the same as in Example 2, except E 
works 1,400 hours in 2008 and 700 hours in the first half of 2009.
    (ii) Application of Testing Rules. No comparison of hours is 
required for the partial testing period that occurs in 2006. For 
2007, no reduction is required in E's phased retirement benefit as a 
result of the hours worked by E during 2007 because the hours did 
not exceed 50% of 2,000. However, the hours worked by E during 2008 
exceed 133\1/3\% of E's work schedule (50% of 2,000), so that the 
phased retirement benefit paid to E during 2009 must be reduced. The 
reduction is effective March 1, 2009. The new phased retirement 
benefit of $5,232.60 is based on 30% of the participant's accrued 
benefit as of July 1, 2006, payable as a joint and 50% survivor 
annuity commencing on that date (30% times $25,500 times the early 
retirement factor of 76% times the joint and 50% factor of 90%). 
This is equivalent to reducing the previously elected joint and 50% 
survivor annuity payable with respect to E by 40% (400 ``excess'' 
hours divided by the 1,000 hour expected reduction). When E retires 
fully on July 1, 2009, E's total accrued benefit as of July 1, 2009 
as a single life annuity commencing at normal retirement age is 
$31,065 per year ($95,000 times 1.5% times 21.8 years of service). 
This accrued benefit is offset by (A) E's phased retirement accrued 
benefit (which is $7,650 (600 divided by 2,000 times $25,500)) plus 
(B) the actuarial equivalent of 40% of the payments that were made 
to E from January 1, 2008 through February 28, 2009.

    Example 4. (i) Same Plan and Phased Retirement Program, Except 
Employer and Employee Agree to Decrease Hours. The facts with 
respect to the Plan X and M's phased retirement program are the same 
as in Example 2, except before 2008, E enters into an agreement with 
M to decrease E's number of hours worked from 50% of full time to 
25% of full time. E works 500 hours in 2008 and 250 hours in 2009.
    (ii) Application of Multiple Benefit Rule. Under paragraph 
(e)(2) of this section, Plan

[[Page 65117]]

M may provide for an additional phased retirement benefit to be 
offered to E for 2008. The maximum increase would be for the phased 
retirement benefit paid to E during 2009 to be increased based on a 
phased retirement accrued benefit equal to 75% of E's accrued 
benefit (1,500 divided by 2,000). Thus, the amount being paid to E 
would be increased, effective January 1, 2008, based on the excess 
of 75% of E's total accrued benefit on December 31, 2007, over E's 
original phased retirement accrued benefit of $12,750. Employee E 
would have the right to elect, with spousal consent, any annuity 
form offered under Plan X (with the actuarial adjustment for time of 
commencement and form of payment to be based on the age of E and any 
contingent beneficiary (and E's service, if applicable) on June 1, 
2008), which would be in addition to the previously elected joint 
and 50% survivor annuity payable as E's original phased retirement 
benefit. When E retires fully on July 1, 2009, Employee E's total 
accrued benefit as of July 1, 2009 would be offset by (A) E's 
original phased retirement accrued benefit plus (B) the phased 
retirement accrued benefit for which additional phased retirement 
benefits were payable beginning in 2008.

    (g) Effective date. The rules of this section apply to plan years 
beginning on or after the date of publication of the Treasury decision 
adopting these rules as final regulations in the Federal Register.

Mark E. Matthews,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 04-24874 Filed 11-9-04; 8:45 am]
BILLING CODE 4830-01-P