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Reduction in Workforce and Partial Plan Terminations

“My client had a 35 percent reduction in workforce in January 2020. Does that automatically mean the business suffered a partial plan termination?”

ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare.  We bring Case of the Week to you to highlight the most relevant topics affecting your business.

A recent call with an advisor in Massachusetts is representative of a common inquiry related to reductions in workforce.

Highlights of Discussion

Not necessarily; it all depends on the facts and circumstances, and whether those terminated employees are rehired by the end of 2020.

The IRS presumes there is a partial plan termination when an employer reduces its workforce (and plan participation) by at least 20 percent during the plan year. This presumption is rebuttable, however. The IRS makes it clear that an actual determination of a partial plan termination is based on all the facts and circumstances of a particular scenario [Treasury Regulation § 1.411(d)-2(b)]. The IRS’s Revenue Ruling 2007-43 provides further guidelines to help determine if a partial plan termination has occurred. For additional coverage, please see RLC’s related Case of the Week.

The most recent guidance on this issue comes from the IRS’s Coronavirus-related relief for retirement plans and IRAs questions and answers, Q&A 15 (added July 2020). As a result, for purposes of determining whether a partial termination of a retirement plan occurred during the 2020 plan year, the IRS will not treat plan participants who were furloughed as having an employer-initiated severance from employment during the year if the business rehires them by the end of 2020. If that is the case, then immediate vesting of employer contributions would not apply.

Determining whether a plan is partially terminated is important because the IRS requires that all participants covered under the portion of a plan that is deemed terminated become 100 percent vested in matching and other employer contributions if the contributions were subject to a vesting schedule [IRC §411(d)(3) and Treasury Regulation 1.411(d)-2]. That could be very expensive, and something to think about if rehiring is a viable option.

Conclusion

The determination of whether or not a partial plan termination has happened depends on the facts and circumstances that occur over (at least) a full plan year. Although not binding legal authority, the IRS’s FAQ on rehires during 2020 provides plan sponsors insight into how the IRS will view such activities this year.

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Layoffs and Partial Plan Terminations

“Because of the current economic uncertainty, my client, a small business owner, may have to lay off a sizable portion of her workforce, with the hope of rehiring the individuals sometime down the road. How could this affect the 401(k) plan for the business?”   

ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare.  We bring Case of the Week to you to highlight the most relevant topics affecting your business.

A recent call with a financial advisor from Pennsylvania is representative of a common inquiry related to plan terminations

Highlights of the Discussion

  • Many business owners are in the same unsteady boat as your client right now. It is important for them to consider that when a significant number or percentage of employees who are participating in a business’s qualified plan are terminated and/or are no longer eligible to participate in the plan, a “partial termination” may have occurred in the eyes of the IRS. More simply put, the IRS could view the portion of the plan that covered the terminated employees as closed, while the other portion remains active.
  • Similar to a situation involving a complete plan termination, the IRS requires that all participants covered under the portion of the plan deemed terminated become 100% vested in matching and other employer contributions if the contributions were subject to a vesting schedule [IRC §411(d)(3) and Treasury Regulation 1.411(d)-2]. (Of course, employee salary deferrals cannot be subject to a vesting schedule00so they are always fully vested.)
  • Failure to fully vest the affected participants in their employer contributions to which they are entitled as of the termination date could result in underpayments from the plan when distributions to these individuals occur. These underpayments could, potentially, cause the IRS to disqualify the plan if the error is not corrected. This vesting failure can be corrected using the Employee Plans Compliance Resolution System.
  • Whether a partial termination exists may not be an easy call. The IRS makes it clear that the determination of a partial plan termination is based on the facts and circumstances of the particular scenario [Treasury Regulation § 1.411(d)-2(b)]. However, within Revenue Ruling 2007-43, the IRS provides the following guidance in helping to determine if a partial plan termination has occurred.

 

  1. The IRS presumes there is a partial termination when an employer reduces its workforce (and plan participation) by at least 20%. This presumption is rebuttable, however. For example, if the situation is such that the turnover rate is routine for the employer, that favors a finding that there is no partial termination (See Rev. Ruling 2007-43).
  2. The turnover rate is calculated by dividing employees terminated from employment (vested or unvested) by all participating employees during the “applicable period.”
  3. The applicable period is generally the plan year, but can be deem longer based on facts and circumstances. An example would be if there are a series of related severances of employment the applicable period could be longer than the plan year.
  4. The only severance from employment that is not factored in determining the 20% are those that are out of the employer’s control such as death, disability or retirement.
  5. Partial plan termination can also occur when a plan is amended to exclude a group of employees that were previously covered by the plan or vesting is adversely affected.
  6. In a defined benefit plan, partial plan termination can occur when future benefits are reduced or ceased.

 

  • The IRS adopted the 20% guideline in Rev. Proc. 2007-43 from a 2004 court case Matz v. Household International Tax Reduction Investment Plan, 388 F. 3d 577 (7th Cir. 2004), which, ironically, was dismissed in 2014 after its fifth appeal [Matz v. Household Int’l Tax Reduction Inv. Plan, No. 14-2507 (7th Cir. 2014)]. The greater than 20% presumption threshold still stands under the IRS’s revenue ruling.
  • If a partial termination may be an issue, a plan sponsor may seek an opinion from the IRS as to whether the facts and circumstances amount to a partial termination. The plan sponsor can file, IRS Form 5300, Application for Determination for Employee Benefit Plan with the IRS to request a determination of partial plan termination. According to the Instructions to Form 5300, one should follow the instructions under line 4a for Partial Termination Request.
  • Regarding the question on terminated employees who are later rehired, any new employer contributions to the plan after rehire would be subject to the plan’s vesting schedule. The IRC and regulations merely require full vesting for the amount in the plan as of the date of the partial plan termination. Consequently, if a terminated employee leaves behind his or her plan balance and is later rehired, the plan would have to apply two vesting schedules.

Conclusion

Based on the given facts and circumstances, a company could be deemed to have a partial plan termination. The participants affected by the partial plan termination must become 100% vested upon termination. Plan sponsors should monitor their companies’ turnover rates to ensure they are not experiencing a partial plan termination and, if they are, ensure affected former participants receive proper distributions from the plan.

© Copyright 2020 Retirement Learning Center, all rights reserved