With the current health and economic challenges presented by the coronavirus (COVID-19), organizations may be forced to downsize by laying off a portion of the workforce. While this is a sad state of business globally that is largely out of the control of employers, these layoffs can have an impact on ERISA qualified plans. When enough employees are terminated, a “partial” plan termination can occur which requires that the affected workers become fully vested in their retirement plan benefits; a potential cost the employer must consider[1]. The Internal Revenue Service (IRS) considers this a partial plan termination, which is referred to in our industry as a Reduction-in-Force (RIF).
To avoid compliance problems with a RIF, it is important to identify whether a partial termination will occur or not. Depending on the facts and circumstances, your plan may have a partial plan termination. As outlined in the IRS “Issue Snapshot - Partial Termination of Plan:”
IRC section 411(d)(3) specifies that a plan will not be qualified unless it provides that, upon its partial termination, the rights of all “affected employees” to benefits accrued to the date of such partial termination, to the extent funded on that date, or the amounts credited to their accounts, are nonforfeitable.
The facts and circumstances determine whether or not a partial termination occurred under IRC section 411(d)(3). If a partial termination occurs, all participating employees who had a severance from employment during the applicable period must be fully vested in their account balance or their accrued benefit, to the extent funded.
Under Rev. Rul. 2007-43, the IRS established that a 20% or greater turnover rate in the applicable period creates a rebuttable presumption that a partial termination occurred.[2]
A partial plan termination happens if an action by the employer causes a significant decrease in plan participation. Layoffs, plan amendments, or business reorganizations that cause a decrease in plan participation are counted even if they are caused by events beyond the employer’s control. The law requires all “affected employees” to be fully vested in their account balance as of the date of a full or partial plan termination. This means they must become 100% vested in all employer contributions regardless of the plan’s vesting schedule. An affected employee in a partial termination is generally anyone whose employment was terminated by the employer for any reason during the plan year in which the partial termination occurred and who still has an account balance under the plan.
However, there is an exception for employers in high turnover industries. According to the IRS website, “Retirement Plan FAQs regarding Partial Plan Termination”[3]:
We typically experience employee turnover in excess of 20 percent per year. Is this a partial termination?
Probably not. Routine turnover during the year is generally not considered a partial termination.
Factors relevant to determining whether the turnover rate is routine include:
Information on the turnover rate in other periods and the extent to which terminated employees were actually replaced,
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- whether the new employees performed the same functions,
- whether the new employees had the same job classification or title, and
- whether the new employees received comparable compensation.
The regulations point out that a partial termination can arise in a number of situations including:
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- The termination of a group of employees formerly covered under the plan;
- A plan amendment excluding a group of employees who have previously been covered;
- A plan amendment that adversely affects the rights of employees to vest in benefits under the plan; or
- In a defined benefit plan, the reduction or cessation of future benefit accruals resulting in a potential reversion to the employer.
Generally, voluntary terminations by the employed participant do not count in determining whether a partial termination has occurred. For examples of the IRS thinking on relevant facts and circumstances, see Rev. Rul. 2007-43.
Tips for planning a partial plan termination:
- Determine goals and document business necessity
- Decide how changes will affect the plan
- Determine applicable deadlines
- Explore possible union issues
- Consider P.R. problems
- Prepare plan amendment(s)
- Provide necessary notices
- Plan and train staff for exit meetings
RIFs are never easy or pleasant. However, developing a comprehensive, thoughtful plan and obtaining appropriate professional advice will allow employers to minimize compliance challenges and maximize good will. The economy may change, and, with luck, an employer may, in a few months, wish to rehire the terminated employees, which will create a different set of issues regarding the rehiring of previously eligible participants.
[1] "It does not appear that a Section 403(b) plan is subject to the rules for vesting on plan termination and partial plan termination applicable to tax-qualified plans under Code Section 411(d)(3) because that code section does not apply to Section 403(b) plans and ERISA's vesting rules do not contain a counterpart to Code Section 411(d)(3)." 403(b) Answer Book, 10th edition.
[2] https://www.irs.gov/retirement-plans/partial-termination-of-plan
[3] https://www.irs.gov/retirement-plans/retirement-plan-faqs-regarding-partial-plan-termination
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