The COVID-19 pandemic has brought so many different concerns to the forefront for employers, whether it be business owners or executive directors, such as PPP Loans, SBA EIDL loans, CARES Act tax credits, unemployment insurance reimbursements and frankly, just keeping the lights on. Another concern that employers who have retirement plans (such as 401(k) or 403(b)), also known as plan sponsors, need to be aware of is a Partial Plan Termination.
A partial plan termination can occur when a qualified retirement plan reaches a certain level of employee “turnover” in any given year. For most employers, this concern would only happen when there is a massive change in operations, such as a closure of a division or major restructuring. However, as part of the response to the COVID-19 pandemic, many employers have found themselves resorting to furloughs, immediate layoffs or furloughs that extend long enough to become layoffs. These involuntary separations could lead to “partial plan termination” which would then require any unvested retirement benefits to become immediately vested for the affected employees.
What is a Partial Plan Termination?
A partial plan termination is when, under the facts and circumstances, the Plan has changed to such a degree that adversely affects the rights of employees to vest in benefits of the plan. The plan is considered partially terminated for these employees (but otherwise continues to exist, generally).
When might a Partial Plan Termination Occur?
The IRS has ruled, first in court cases and then more formally in Revenue Ruling 2007-43 that there is a “rebuttable presumption” that if a plan experiences more than a 20% turnover rate in a period that a partial plan termination may have occurred. The underlying law and analysis does clarify that a termination is facts and circumstances driven and does not rely solely on the above bright-line calculation, but the presence of such turnover percentage indicates that a partial plan termination may have occurred. It is important to note that above a 20% turnover does not automatically mean there is a partial plan termination and that a below 20% termination means there is not a partial plan termination; the final determination is on the facts and circumstances.
Key Terms of a Partial Plan Termination Turnover
Turnover is calculated based the number of employees with “employer initiated severance” compared to the ratio of total vested and nonvested participants in the plan.
Employer Initiated Severance
Employer Initiated Severance refers to any separation other than those on account of death, disability or retirement. Revenue Ruling 2007-43 states explicitly that this can include “an event outside of the employer’s control, such as a severance due to depressed economic conditions” (i.e. COVID-19). The Revenue Ruling also indicates that in certain situations an employer can demonstrate that the severance was not employer initiated (voluntary).
A period is, in most cases, going to be any given plan year. However, for a short plan year (less than 12 months in the year) it may include the preceding year. A period can also be one year if there are a series of related services – for example if an employer furloughed staff in March 2020 which lead to a complete layoff in October 2020 and then also laid off employees in February 2021 as a result of COVID, the period could be 2020 and 2021.
An affected employee is actually not defined in the IRS Code or regulations, but under IRS guidance is designated as an employee who has separated from services and was one who stood to be affected by the termination of the plan. In most cases this would mean any potential layoffs that caused the termination.
What are the consequences of a Partial Plan Termination?
If an employer determines that, under the facts and circumstances, there has been a partial plan termination, any affected employee will immediately vest in any unvested retirement match contributions. Employee deferrals are always considered 100% vested. All qualified plans should have a provision in their plan document which states this as it is required.
The vesting will be for “all participating employees” who had a severance from employment during the period. The IRS guidance on their website (which is not legally binding but can provide insight) indicates that only affected employees need to be fully vested.
The immediate vesting could present interesting challenges for employers with separations that have already processed forfeitures and/or have had distributions or rollovers of plan balances.
What should employers do next?
If employers are concerned about partial plan terminations they should reach out to their TPA (third-party administrator) and potentially ERISA knowledgeable legal professionals to understand if they may have a partial termination and how to proceed. These experts will provide valuable knowledge and insight in the process.
Edward McWilliams, CPA
Ed is a Partner in the firm’s tax and business advisory practice focusing on providing services to middle market private companies across different industries as well as to early stage startups. Ed has over a decade of experience providing tax and business consulting services to these companies of different sizes and across different industries, bringing a broad and diverse knowledge base and strategic solutions to the many complex issues that businesses face.