Increasing numbers of employers are being forced to shutter places of business and lay off workers as the coronavirus pandemic continues. When laid off workers are participants in their employer’s qualified retirement plan, one consequence of the aggregate layoffs may be a partial termination of the plan under ERISA and the Internal Revenue Code. If a partial termination occurs, the affected employees will automatically become 100 percent vested in their plan benefits.
What is a partial plan termination?
Most employers are more familiar with the concept of formally terminating all or part of a qualified retirement plan. Formal termination ends employer responsibility for a plan and is both a vesting and a distribution event for all participants. A partial termination is different. First, it is only a vesting event and only for the affected employees. Second, it is a consequence of other events that affect the ability of a meaningful percentage of participants to realize plan benefits. There is no formal definition of a “partial termination” under ERISA or the Code. However, Treasury regulations make it clear that the employer’s severance of a sufficiently large group of plan participants – regardless of the reason – may be a partial termination.
For evaluating a potential partial termination, a layoff – where an individual’s employment ends with no certainty of return – is an employer-initiated severance. A furlough – where an individual’s employment is suspended with the expectation of return to work fairly soon – should not be viewed as a severance in the first instance. However, if circumstances change, the employer should consider whether there has been a severance.
When does a partial termination result from layoffs?
In the absence of a formal definition, the existence of a partial termination depends on facts and circumstances under IRS regulations. The relevant facts and circumstances have been fleshed out in Revenue Ruling 2007-43 and further explored in court decisions, but there is no bright line test. These general guidelines are based on the IRS guidance:
- A partial termination is presumed to occur if the total number of plan participants is reduced by at least 20 percent as a result of employer-initiated severances.
- The period for measuring the reduction is the plan year (or a longer period covering a series of related severances).
- Employer-initiated severance generally means any severance from employment other than death, disability, or retirement on or after normal retirement age. Thus, the presumption is that every severance occurring during the measuring period is employer-initiated unless the employer establishes that the termination was voluntary.
- All participating employees are taken into account – vested and non-vested – in calculating the percentage reduction.
- Other relevant facts and circumstances may include the usual rate of employee turnover (e.g., regular, seasonal fluctuations in the workforce do not cause a partial termination); the extent to which terminated employees were replaced; and other factors that may establish the reduction in participants for the period being examined is routine for the employer.
Of particular note in the current environment is the possibility that laid-off employees may be rehired within several months. In this case, the reduction measured over the entire plan year (roughly, total participating employees on the first day of the plan year compared to total participating employees on the last day of the plan year) might be a smaller percentage than it appears to be now.
What steps should employers consider?
When there is a partial termination of a qualified retirement plan, the affected participants are automatically fully vested. For participant accounts to be correctly administered, the employer needs to recognize the possibility of a partial termination when layoffs occur. Consult a professional adviser to evaluate the facts and circumstances and promptly notify the plan recordkeeper of any determination of a partial termination and the affected participants so that the recordkeeper can timely update its recordkeeping system to reflect 100 percent vesting of the affected participant account balances.