Unanimous Supreme Court Decision Determines That Post-Retirement Plan Amendment Violates ERISA's Anti-Cutback Rule

by Karen Phillips

For two decades IRS informal documents, including the Internal Revenue Manual, have allowed plans to make amendments that change the types of post-retirement employment that trigger the suspension of benefits, even when the amendments apply retroactively to accrued benefits. In addition, the IRS has endorsed this practice by issuing favorable determination letters to plans containing such provisions. The IRS' practice, however, was arguably in conflict with formal IRS regulations that state that employers cannot impose new conditions on the receipt of benefits after those benefits have already accrued.

On June 7, 2004, in a unanimous decision penned by Justice Souter, the U.S. Supreme Court held that where a plan participant has already retired, Section 204(g) of ERISA prohibits an amendment of a pension plan that expands the categories of post-retirement employment that trigger suspension of the payment of early retirement benefits already accrued. (Central Laborers' Pension Fund v. Heinz, et al., 124 S. Ct. 2230 (2004).)

Factual Background

Thomas E. Heinz and Richard J. Schmitt Jr. retired from the construction industry in 1996. At the time, both were 39 years old and were eligible for early retirement benefits under the terms of the Central Laborers' Pension Fund, a multiemployer defined benefit pension plan. When Heinz and Schmitt retired, the plan contained a provision calling for the suspension of benefits if a plan participant engaged in "disqualifying employment." The plan defined "disqualifying employment" as any work performed in a job classification covered in a collective bargaining agreement in any occupation or job classification where contributions were to be made to the fund.

After they retired, Heinz and Schmitt both became supervisors for construction firms, which was not then disqualifying employment under the plan's terms. In 1998, however, the plan was amended and the definition of disqualifying employment was expanded to include work performed "in any capacity in the construction industry." Following the amendment, the plan informed Heinz and Schmitt that their benefits would be suspended because they were engaged in disqualifying employment.

Heinz and Schmitt filed a lawsuit alleging the suspension of their benefits violated ERISA's anti-cutback rule. The U.S. District Court for the Central District of Illinois ruled for the fund and Heinz and Schmitt appealed.

Seventh Circuit's Decision

In September 2002, the Seventh Circuit in a 2-1 decision reversed the lower court after concluding that ERISA's anti-cutback rule was violated by the amendment. (See Heinz v. Central Laborers' Pension Fund, 303 F.3d 802, 28 EBC 2505 (7th Cir. 2002).) ERISA's anti-cutback rule provides that the "accrued benefit of a participant under a plan may not be decreased by an amendment of the plan." (29 U.S.C. §1054(g)(1).)

The Seventh Circuit's decision created a split among the circuits because, in Spacek v. Maritime Association, 134 F.3d 283, 21 EBC 2610 (5th Cir. 1998), the U.S. Court of Appeals for the Fifth Circuit had ruled that a suspension of benefits is not protected by ERISA's anti-cutback rule. The pension fund appealed the Seventh Circuit's ruling, asking the Supreme Court to resolve the conflict between the Seventh and Fifth Circuits.

The Supreme Court's Decision

The Supreme Court, agreeing with the Seventh Circuit, found that, by placing materially greater restrictions on the receipt of benefits, the fund's amendment had the effect of eliminating or reducing the early retirement benefit in violation of ERISA's anti-cutback rule.

In reaching its decision, the Court rejected the fund's arguments that the anti-cutback rule applies only to amendments that directly reduce the dollar amount of a retiree's monthly benefit and not to amendments that merely suspend the receipt of the benefit. The Court stated that, "as a matter of common sense, a participant's benefits cannot be understood without reference to the conditions imposed on receiving those benefits, and an amendment placing materially greater restrictions on the receipt of the benefit 'reduces' the benefit just as surely as a decrease in the size of the monthly benefit payment." The Court was not persuaded to the contrary by provisions in the Internal Revenue Manual authorizing, and countless routine IRS determination letters approving, amendments to plan definitions of disqualifying employment that applied to benefits already earned. In adopting this interpretation of the ERISA's anti-cutback rule, the Court rejected two decades of actual IRS practice in applying that rule, and focused instead on the IRS Regulation, 26 CFR §1.411(d)-4, A-7, which provides that ERISA's anti-cutback provision prohibits plans from attaching new conditions to benefits that an employee has already earned.

In response to concerns expressed in an amicus brief filed by the Solicitor General of the United States about the adverse impact such a ruling would have on the pension plan community, Justice Souter, in a footnote, observed that the Court's decision would not require the IRS to rescind any determination letters it had previously issued approving amendments to plans' suspension of benefits rules, noting that Section 7805(b) of the Internal Revenue Code gives the IRS "the discretion to decline to apply decisions of this Court retroactively."

Justice Breyer's Concurrence

In a one-paragraph concurring opinion, Justice Breyer, joined by three other Justices, noted that in his view, the Court's decision would not foreclose future Labor or Treasury regulations that would explicitly allow plan amendments to enlarge the scope of disqualifying employment with respect to benefits attributable to already-performed services.

We anticipate that the IRS will issue some form of guidance to plans in the near future outlining the extent, if any, to which the Supreme Court's decision in Central Laborers' v. Heinz will apply to benefit suspensions that occurred before the decision was rendered and to pre-amendment benefit accruals earned by participants who did not retire until after a plan's benefit suspension rules were modified. This guidance should also tell plans what they must do prospectively, in terms of plan amendments and operationally, to conform to the Court's ruling. Less certain is whether the IRS will go further and consider proposing amendments to its regulations to give plans greater flexibility in revising their suspension of benefits rules in the future.

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