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Severance of Employment: When Has it Really Occurred?

This article originally ran on June 30, 2015.

By Ellie Lowder, TGPC, Consultant 

Members constantly pose questions about the definition of severance of employment, which can be an important issue to determine regarding whether pre-59½ 403(b) or pre-70½ 457(b) participants are eligible to make withdrawals from their accounts. And it is important to note there are a number of twists in arriving at an answer that dovetails with the IRS position on this issue. 

Interviews with several IRS staff members lead us to different conclusions. One senior staff member in employee plans contends that you have not severed employment unless you have severed all ties with the employer. Another says that it is a “facts and circumstances” situation in which the IRS will check to see if the previously severed, but returning, employee is receiving employee benefits. This article digs deep into the issues that many of our members will face in properly guiding 403(b) and 457(b) participants. 

  • Issue 1: The participant severs employment in June 2015; however, has agreed to return to work in a part-time position in September. Are the random withdrawals made in the interim between June and September permissible? The answer, in all likelihood, is no. Because there was an agreement between the participant and the employer that a return to work would occur within a few months of the severance, the IRS would likely consider that a severance of employment has not taken place.
  • Issue 2: The participant retires from the school district in June; however, in November he receives a contract to work on some specific projects for the district. The contract describes the projects that are to be completed, and the timing for completion; however, it does not provide specifics on how the projects are to be undertaken. The participant is not assigned an office, and must provide his own tools and equipment to undertake the specific projects. Has this individual severed employment? It is probable that he will be regarded as an independent contractor because he is under contract for activities that differ from the job he filled during employment. The independent contractor status is also strengthened because the school district is not providing a work site for him, and is not setting specific activities he must perform to achieve completion of the projects.
  • Issue 3: Public school district employee leave District A to begin employment with a neighboring District B. Has she severed employment with District A? Yes, based on the fact that the Listing of Requirement Modifications was amended to reflect that a public school district is the employer — not the state in which she is employed.
  • Issue 4: The employee retires from School District A, but almost immediately places her name on the district’s substitute teacher list. She is not called to substitute teach. Has she severed employment? It is highly likely that the IRS would consider this a severance of employment. But assume that she is called upon to substitute on a long-term basis for a fellow teacher who is on leave of absence. In that case, it is probable that the IRS would not consider her as severed from employment with the employer.
Members will see that there are a considerable number of nuances to the question of whether an employee has severed employment, all of which must be carefully considered in determining whether an employee, not otherwise eligible to make withdrawals, can do so.