Since the coronavirus pandemic began, many businesses have been forced to lay off and furlough employees in an effort to bring their workforce in line with reduced demand for products and services. Such downsizing can result in an unintended consequence that affects a business’ qualified retirement plan known as a partial plan termination.
This occurs when there is a turnover rate of at least 20 percent of plan participants during the applicable period, which is usually defined as a single plan year. However, the applicable period can be longer than one plan year if the termination events are related—for example, if there is a series of related severances due to an event such as COVID-19 that occurs over more than one year (e.g., 2020 and 2021).
Plan Termination and Vesting
Upon a partial plan termination, affected plan participants must be 100 percent vested in their entire retirement account balance as of their termination date. This includes not only their own contributions and earnings, in which they are automatically 100 percent vested when contributed, but also employer matching contributions. These may have been subject to a vesting schedule that required employees to complete a certain number of years of service before they were fully vested in these funds.
Keep in mind that the 20 percent turnover rate threshold only creates a presumption that a partial plan termination has occurred. However, this presumption can be rebutted if the turnover is a routine part of business, such as with a seasonal business. Other factors that can rebut a presumption of termination include the following:
- Were the employees replaced?
- Did the employer have a bad motive, such as realizing a tax benefit for prefunding the plan?
- Were the terminations related to a major corporate event, such as a plant closing?
You can use Form 5300 to ask the IRS for a determination letter of whether a partial plan termination has occurred.
What About Furloughed Employees?
To avoid laying off employees during the pandemic, some businesses have furloughed employees instead. A furlough is essentially an unpaid leave of absence in which an individual remains an active employee.
Furloughed employees are generally not factored into the initial partial plan termination analysis. However, if they aren’t brought back to work within a reasonable period of time, they should be considered terminated and counted when determining whether a partial plan termination has occurred.
You may consider amending your plan to count a certain amount of furlough time as hours of service that count for vesting purposes. This could help foster goodwill with affected employees because it won’t result in lost vesting service for employees who eventually return to work from furlough.
What About Rehired Employees?
In a recent Q&A, the IRS answered a question about the impact of employees who are laid-off due to COVID-19 and rehired before the end of 2020 on the partial plan termination calculation. These employees should generally not be considered to have had an employer-initiated severance from employment for the purposes of determining whether a partial plan termination occurred, according to the IRS.
Keep in mind, however, that a partial plan termination could still occur even if some laid off employees are rehired before the end of 2020. This could be the case, for example, if the workforce reduction was part of a series of related severances over multiple years.
The details of partial plan terminations can be complex. Therefore, you should obtain professional guidance and counsel regarding questions you may have about partial termination of your qualified retirement plan.
Partial Plan Termination Court Ruling
The issue of partial plan terminations was addressed in a court case in 2004, Matz v. Household Int’l Tax Reduction Inv. Plan. This case established four turnover rate categories:
- If the turnover rate is less than 10 percent, there is conclusively no partial plan termination.
- If the turnover rate is between 10 and 20 percent, there is a rebuttable presumption of no partial plan termination.
- If the turnover rate is between 20 and 40 percent, there is a rebuttable presumption that a partial plan termination has occurred.
- If the turnover rate is more than 40 percent, there is conclusively a partial plan termination.