Special Tax Rules for Rehiring Staff

If you find yourself short-staffed, there's no harm in calling a former employee who has retired. You won't jeopardize your pension plan's tax status if you rehire retirees. Nor is it a problem if you permit distributions of retirement benefits to employees who hit the age of 59 1/2 or your plan's normal retirement age, even if they don't intend to quit anytime soon.

The IRS wants to offer technical guidance for those that sponsor pension plans for their employees. After all, you want to meet your employment objectives and still comply with your plan's qualification rules. With today's dearth of qualified employees to fill open positions, the IRS feels your pain.

You may rehire former employees — even those who have already retired and are receiving pension benefit payments. If permitted under your pension plan's terms, these folks can continue to receive benefits and work for you. At the same time, if you have existing employees who are at the plan's normal retirement age, they can keep working with you. The IRS specifically notes, "This may assist in the retention of employees eligible for retirement."

How does this work?
For example, if a public school district that sponsors a qualified pension plan experiences a critical labor shortage due to the COVID-19 pandemic that was unforeseen at the time of an individual's prior bona fide retirement, the school district rehires the individual to help ease the labor shortage and the plan terms do not define a bona fide retirement in a way that prevents the rehire, the individual's reemployment would not keep the prior retirement from being a bona fide retirement. Consequently, if plan terms permit, benefit distributions could continue after the rehiring.

Furthermore, a rehiring that doesn't reflect any prearrangement with the individual at the time of retirement will not cause the prior retirement to fail. And if a qualified individual wants to borrow from the retirement plan you sponsor, you may provide an additional year to repay plan loans.

The benefit distributions continue to be taxable under your employee's income for the year of distribution, but there's a loophole: If a retired employee received a COVID-19-related distribution in 2020, that employee won't owe federal income tax on the distribution.
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The bottom line? If you're having staffing issues, retirees can be a good source for your immediate needs. Just make sure your arrangements harmonize with your pension plan. Remember, however, that few things are more complicated than pension regulations, so be sure to work closely with a qualified tax adviser.