Is Pilon Pensionable
Payment in lieu of notice (PILON) is generally not pensionable under most IRS-qualified defined-benefit pension plans. The lump sum you receive instead of working your notice period typically won’t count toward your final-average-salary calculation or your years of pensionable service. But the real answer depends on how your specific plan defines “compensation.”
The key decision criterion that changes the answer: whether your plan document defines pensionable earnings as “compensation paid while actively employed” (PILON excluded) or uses a broader definition like “all W-2 wages” (PILON may be included). If the payment is labeled as salary continuation rather than severance/in-lieu-of-notice, it may be treated differently.
How Most Defined-Benefit Plans Treat PILON
Most defined-benefit pension plans calculate your benefit using this formula:
Annual pension = Benefit percentage × Years of credited service × Average of highest 3–5 years of salary
If PILON is counted in that average, your benefit rises. If it’s excluded, your benefit stays based only on actual salary earned while working. The difference can be thousands of dollars per year for life.
The practical implication: for a mid-career employee with 20 years of service and a $25,000 PILON payment, the exclusion can reduce lifetime pension benefits by $30,000 or more.
What the IRS Says
Under Treas. Reg. §1.415(c)-2(b)(3), the IRS explicitly excludes “payments in lieu of notice” and “severance pay” from the safe-harbor definition of compensation for retirement plan limits. Any plan using the IRS safe-harbor definition automatically excludes PILON.
Typical pensionable earnings include:
- Base salary or hourly wages
- Overtime pay (if consistently earned and the plan includes it)
- Commissions and bonuses (only if the plan specifically says so)
- Shift differentials
Typical exclusions:
- Severance pay
- Payments in lieu of notice (PILON)
- Reimbursement for expenses
- Fringe benefits (company car, housing)
- Non-cash compensation
The trade-off: Plans that use the safe-harbor definition get certain IRS compliance advantages, but they also create this gap for employees receiving termination pay. Some employers choose a broader definition to attract talent, but this is less common.
When PILON May Still Be Pensionable
Three scenarios where the general rule flips:
Scenario 1: The plan uses “Section 414(s) compensation” with broad election. If your employer adopts the broader definition of “all taxable wages” and pays the PILON as regular wages during a payroll period that still falls within your employment, the payment may be treated as regular wages.
Scenario 2: Union or government plans with explicit inclusion. Some union-negotiated plans or governmental 457(b) plans define “earnings” to include termination pay or payments made within a certain period after separation. For example, CalPERS generally excludes severance pay unless it’s paid as “salary continuation” during a notice period.
Scenario 3: Non-qualified executive plans. Supplemental executive retirement plans (SERPs) are not bound by IRS safe-harbor rules and can include PILON by design. If you’re a highly compensated employee, your SERP may treat PILON differently from your main pension plan.
The one factor that confirms which scenario applies: the label used in your plan document. “Severance pay excluded” means PILON is out. “Compensation while actively employed” means PILON is out. “All W-2 wages” with no severance exclusion means PILON may be in.
How to Verify Your Situation in 5 Checkpoints
Use this practical flow. Each checkpoint gives you a clear stop-or-continue signal.
Step 1: Get Your Summary Plan Description (SPD)
Your employer must provide this plain-English document. Look for “Definition of Compensation” or “Pensionable Earnings.”
Checkpoint: Does the SPD explicitly list PILON, severance, or notice pay as excluded? If yes, stop here. You have your answer.
Step 2: Scan the Exclusions List
If the SPD is ambiguous, focus on key phrases:
| Plan language | Likely PILON treatment |
|---|---|
| “Severance pay excluded” | Excluded |
| “Payment in lieu of notice excluded” | Excluded |
| “Compensation while actively employed” | Excluded |
| “All W-2 wages” | May be included |
| “All taxable compensation” | May be included |
| “Payments for unused leave excluded” | Not necessarily excluded |
Step 3: Request the Official Plan Document
The SPD is a summary. The official plan document (Form 5500 or adoption agreement) has the actual legal language. Request it from HR or the plan administrator.
Checkpoint: Does the official document use a safe-harbor definition or a broader one? Safe-harbor excludes PILON automatically. Broader definitions need closer scrutiny.
Step 4: Ask in Writing
Send a short email: “Does the plan consider payment in lieu of notice as pensionable compensation for calculating my final average pay under [Plan Name]?” Get the answer in writing.
Escalation signal: If the administrator gives you a vague or oral-only answer, escalate to the plan’s third-party administrator or a qualified pension attorney. A $2,000–$5,000 annual difference over 20 years of retirement is worth verifying.
Step 5: Request Two Benefit Estimates
If you’re close to retirement, ask for two estimates: one with PILON in, one with PILON out. That shows you the dollar difference and helps you decide whether to pursue the matter further.
Real-World Trade-Off: What Changes When the Plan Includes PILON
If your plan does include PILON, there is a practical catch: the IRS annual compensation limit under IRC §401(a)(17) still applies. For 2025, the limit is $350,000 (check current year). If your salary plus PILON pushes you over that limit in any single year, the excess is excluded from benefit calculations regardless of plan language.
Concrete example: You earn $340,000 in your final year and receive a $30,000 PILON. Total: $370,000. Only $350,000 counts. The PILON effectively adds only $10,000 to your pensionable earnings, not the full $30,000.
Expert Tips for Checking PILON Pensionability
Tip 1: Focus on the phrase “while actively employed.”
Many plan documents tie pensionable earnings only to “compensation paid while an active employee.” PILON is paid after your employment ends. If the plan says “while actively employed,” PILON is out regardless of how it’s taxed.
Common mistake: Assuming that because PILON is taxed as wages on your W-2, it counts for pension purposes. Taxability and pensionability are separate concepts.
Tip 2: Check each plan separately if you have multiple plans.
If you have both a qualified defined-benefit plan and a non-qualified SERP, one may exclude PILON while the other includes it. Always verify each plan document independently.
Common mistake: Applying the rule from your main pension plan to a SERP. Non-qualified plans have different rules and can be more flexible.
Tip 3: Request the plan amendment history.
Ask the plan administrator for the latest “Restated Plan Document” and any amendments from the last 10 years. Some older plans included “all compensation” and later amended to exclude severance. Your retirement date relative to the amendment matters.
Common mistake: Assuming the current policy always applied. A plan change could affect your benefit if you retired before the amendment.
Worked Example: The Dollar Difference
Consider a defined-benefit plan with 1.5% × years of service × average of highest 5 years of salary.
- Employee works 20 years and earns $80,000 per year in each of the last 5 years.
- At termination, employee receives a $25,000 PILON.
- Plan excludes PILON.
Calculation without PILON:
Average salary = $80,000
Annual pension = 1.5% × 20 × $80,000 = $24,000 per year
If PILON were included (plan uses “total W-2 wages”):
Average salary = ($80,000 × 5 + $25,000) ÷ 5 = $85,000
Annual pension = 1.5% × 20 × $85,000 = $25,500 per year
Bottom line: $1,500 per year difference ($125 per month). Over 20 years of retirement, that’s $30,000 in total benefits.
Common Misconceptions
“PILON is the same as severance, so it’s always excluded.”
Not always. Some plans distinguish between “severance in lieu of notice” (excluded) and “salary continuation during notice period” (included). If the employer structures the payment as “salary continuation” with FICA withholding and keeps you on the payroll for a few extra pay periods, it may count as regular wages.
“My plan administrator gave me a verbal yes, so I’m safe.”
Verbal answers are not binding. Get confirmation in writing, and request a written benefit calculation that shows the PILON included. Only the written plan document and written administrator interpretations hold up under audit.
“The IRS treats it as wages, so my plan must count it.”
Tax treatment and pension plan definition are independent. The IRS treats PILON as taxable wages (Box 1 of your W-2), but the pension plan’s definition of compensation is controlled by the plan document, not the tax code.
Where to Go for a Definitive Answer
Because plan language varies, you cannot rely on a general rule alone. Take these concrete actions:
- Request a copy of your plan’s Form 5500 and Summary Annual Report – they contain the formal plan name and help you request the full document.
- Contact your plan administrator in writing (email is fine) and ask: “Does the plan consider payment in lieu of notice as ‘compensation’ for calculating my pension benefit under [Plan Name]?”
- If you are a member of a union or public employee system, check the collective bargaining agreement or state statute that defines pensionable earnings. For California, review the Public Employees’ Retirement Law (PERL) for final compensation rules.
- If you have a non-qualified plan or SERP, the rules are different—these plans are not subject to IRS safe-harbor rules and may include PILON by design.
Disclaimer: This article provides general information and does not constitute legal or financial advice. Plan language varies, and IRS safe harbors are ceilings, not floors. If a significant benefit is at stake, consult a qualified pension attorney or enrolled actuary.
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Michael Reynolds is a retirement benefits researcher and the lead author at Pension FAQ. With over 12 years of experience analyzing employer pension plans, state retirement systems, and Social Security policy, he specializes in translating complex pension rules into clear, actionable guidance for American workers and retirees.
Michael holds a Bachelor’s in Economics from the University of Michigan and has completed the Certified Retirement Counselor (CRC) program. His work has been cited by financial planners and HR professionals helping employees navigate their pension options.
At Pension FAQ, Michael leads a team covering employer plan access, state pension taxation, teacher and public employee retirement systems, professional sports pensions, and pension calculation rules. All content is rigorously reviewed against official plan documents and IRS guidelines.
Disclaimer: Pension FAQ content is for educational purposes only and does not constitute financial, tax, legal, or retirement benefits advice. Always consult your plan administrator or a qualified professional for decisions about your specific situation.