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    Has Your Retirement Plan Experienced a Partial Plan Termination?

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    The economic uncertainty of the COVID-19 pandemic has forced many employers to furlough or layoff a significant percentage of their workforce.  These workforce reductions may inadvertently cause a “partial termination” of the employer’s qualified retirement plan triggering a requirement that all affected participants become 100% vested in their plan accounts.  Recent IRS guidance, however, may permit companies that rehire employees during 2020 to ‎avoid a “partial termination” for their qualified retirement plans.‎

    Background

    A partial plan termination may occur if a “significant” number of participants cease to be eligible to participate in the plan. IRS guidance creates a rebuttable presumption that a partial plan termination occurs if 20% or more of the total plan participants experience an employer-initiated severance from employment (turnover rate) during an “applicable period”.  Employer-initiated severances generally includes terminations for reasons other than on account of death, disability or retirement on or after normal retirement age and can be caused by events outside of the employer’s control, such as severances due to depressed economic conditions.  The applicable period is generally the plan year, but can be a longer if there are a series of related severances from employment.

    A partial termination of a qualified plan may also occur for reasons other than employer-initiated terminations. For example, a partial termination can occur if a plan is amended to adversely affect the rights of employees to vest in benefits under the plan, to exclude a group of employees who have previously been covered by the plan, or to reduce or cease future benefit accruals resulting in a potential reversion to the employer.

    Implications of a Partial Plan Termination

    If a partial termination has occurred, ‎ the IRS’ guidance provides that all participants who terminated employment during the “applicable period” must be 100% vested in the employer contributions (matching and profit-sharing/non-elective contributions) credited to their accounts as of the date of the partial termination, regardless of the plan’s vesting schedule.  This immediate vesting applies to all participants who terminated employment during the plan year when a partial termination occurs, even those employees who voluntarily terminated employment.

    Treatment of Furloughed Employees and Rehired Employees

    In light of the significant disruptions to many businesses due to the COVID-19 pandemic, many employers have experienced temporary workforce reductions which may result in a partial termination under the IRS’ ‎guidance.‎

    • Furloughed Employees – Employees on furlough or temporary lay-off, which is the equivalent of a short-term unpaid leave of absence, are still considered employees and not counted as terminated for the partial plan termination analysis. However, if these employees are not reinstated with a reasonable period of time, the employer should re-evaluate whether these employees should be considered as terminated for purposes of the partial termination rules.
    • Rehired Employees – Until recently, it was uncertain how employees who are rehired during a plan year would impact the partial termination analysis. The IRS recently updated its IRS Q&As on Coronavirus-related relief for retirement plans and IRAs to provide that plan participants who were laid off because of COVID-19 and rehired by the end of 2020 are not treated as having an employer-initiated severance from employment for purposes of determining whether a partial termination of the plan occurred during the 2020 plan year.

    While the IRS guidance provides some reassurance for employers who rehire employees by the end of 2020, it does not necessarily mean that a partial plan termination will not occur.  The IRS Q&As did not address whether the applicable period can extend past 2020.  As noted above, the “applicable period” can be longer than a 12-month plan year, particularly if the employer continues to have COVID-19 related terminations in 2021.  If the employer terminates additional employees in 2021 due to the COVID-19 pandemic, such terminations could affect the turnover rate calculation.

    Timing Issues

    Depending on an employer’s circumstances, it may not be known that a partial ‎plan termination has occurred until after the end of a plan year.  This creates a timing problem for ‎employers since a plan’s third-party administrator will typically apply the plan’s vesting schedule ‎to distributions throughout the year.  At the time when a partial plan termination has occurred, the ‎employer is required to restore the forfeited amounts to the affected employees to make them ‎whole, generally resulting in an additional distribution to the impacted former employees.  ‎Employers should review the plan’s forfeiture provisions to determine whether forfeited amounts ‎can be used to restore account balances, and may wish to keep this issue in mind when using the ‎forfeited funds to pay administrative expenses or to offset employer contributions for 2020 and ‎‎2021.‎

    Employer Actions

    The determination of whether a partial plan termination has occurred is a facts and circumstances determination.  Employers should continue to monitor their turnover rate, even if they rehire employees in 2020.

    The post Has Your Retirement Plan Experienced a Partial Plan Termination? appeared first on Employee Benefits.

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