Many employers have been forced to make the difficult decision to reduce their workforces due to the economic impact of the coronavirus pandemic. A significant reduction of employees can have a widespread impact on many aspects of a business, and can even impact an employer’s retirement plan if the reduction has led to a “partial termination.”
Retirement plans that have experienced a partial termination are required to make all of the accounts of employees affected by a partial termination nonforfeitable. In other words, partially terminated retirement plans with contributions that are not immediately 100% vested must fully vest all accounts of participants impacted by the partial termination. Failure to comply with this partial termination vesting requirement can result in a costly correction for the employer, and can even result in the loss of the plan’s tax preferential status.
But how do you know if your plan has had a partial termination? The short answer is that a partial termination is presumed to have occurred if there is a 20% or greater reduction of participating employees in a retirement plan caused by employer-initiated terminations. A plan’s turnover rate is calculated by dividing the number of employees terminated due to an employer-initiated severance from employment (i.e., does not include employees that end employment due to retirement, death, or disability) during the applicable period by the total number of participating employees in the plan during the applicable period. The applicable period is generally the plan year, but can be longer if a series of events that led to the severances are related.
The long answer is more nuanced because there is no clearly defined rule to determine when a partial termination has occurred. Instead, IRS guidance and case law state that a partial termination will be determined on a case by case basis examining all facts and circumstances. The 20% turnover rate used above comes from IRS guidance that states that there is a presumption of partial termination if the turnover rate is 20 percent or more, but the turnover rate is only one piece of evidence that can be either supported or rebutted by other factors (e.g., closing a branch, cyclical layoffs, etc.).
If your plan has experienced a significant reduction in plan participants due to layoffs, it is critical that you analyze whether your plan has experienced a partial termination. If you have any questions regarding partial termination, please contact one of Graydon’s employee benefits team members.
