If you have had a substantial reduction in your workforce and sponsor a retirement plan, you need to learn what a partial plan termination is right now. The IRS is actively pursuing employers whose retirement plans may have experienced a partial termination event. It is important to note that the partial termination rules apply to both defined contribution and defined benefit plans.
Employee Plans Compliance Unit:
Current Project – Partial Termination/Partial Vesting
The IRS Employee Plans Compliance Unit’s Partial Termination/Partial Vesting Project focuses on information from employers’ Form 5500 (Annual Return/Report of Employee Benefit Plan) filings that indicate a partial termination event might have occurred. The goal of this project is to determine if the employers are following the requirements of the plan document and related law/IRS guidance on partial terminations.
Partial Plan Termination Determination
A partial termination occurs when a group of employees who have previously been covered by a retirement plan are involuntarily removed from participation in the plan and the resulting reduction in the participant group is significant. The determination of whether a partial termination has occurred is a fiduciary decision that is generally made by the plan administrator or administrative committee. It is often difficult for the plan fiduciary to determine whether a partial determination has occurred, and if it has, when it occurred. The IRS has issued guidelines for fiduciaries to follow, but it is still an individualized determination that the plan fiduciary must make based on the employer’s unique facts and circumstances.
Any of the following events could result in a partial plan termination:
- Plant or facility shutdown;
- Layoffs, downsizing or restructuring; or
- Sale that results in the exclusion of a group of participants from the plan.
The IRS has indicated that if 20% or more of participants turn over during a short period of time, there is a rebuttable presumption that a partial termination has occurred. Depending on the facts and circumstances, a turnover rate of less than 20% could be a partial termination, while a turnover rate greater than 20% may not.
Calculating the Turnover Rate:
The turnover rate is determined by dividing the number of participants with an “employer-initiated severance from employment
” during the “applicable period
” by the sum of (1) all participants at the start of the applicable period and (2) new participants added during the applicable period. All participants, both vested and non-vested, must be taken into account in calculating the turnover rate. (Remember, for 401(k) plans, an employee is considered to be a participant if he is eligible to make elective deferrals, regardless of whether the employee actually makes them.)
Employer-Initiated Severance from Employment:
The IRS guidance states that an “employer-initiated severance from employment
” generally includes any severance from employment other than a severance due to death, disability or retirement on or after normal retirement age. The IRS presumes all other severances from employment are employer-initiated, unless the employer is able to verify otherwise. The IRS further presumes that a severance from employment is employer initiated even if caused by an event outside the employer’s control, such as depressed economic conditions. Purely voluntary quits and terminations for cause, however, may be excluded from the turnover calculation, according to the IRS, based on information from personnel files, employee statements and other corporate records (which means it is extremely important to retain this type of supporting information, particularly in the event of an IRS audit).
The IRS has also indicated that an employer’s normal turnover rate is another factor to be considered in determining whether a partial termination has occurred for an applicable period. For example, if an employer’s historical turnover rate is 10% and the current year’s turnover rate is 22%, the employer may be able to argue that no partial termination has occurred during the current year because the “true” turnover rate for purposes of the partial termination analysis is 12%. Information relevant to this determination includes the extent to which terminated employees were actually replaced and whether the new employees performed the same functions, had the same job classification or title and received comparable compensation.
The applicable period used in calculating the turnover rate is generally the plan year, but depending on the circumstances, may be less or more. If the plan year is less than 12 months, the current and immediately preceding plan year must be used. If there are a series of related employer-initiated severances from employment in different years, then the turnover rate must be calculated over the entire period.
Affected Participants Must Be Vested
When a plan experiences a partial termination, all “affected participants” must be 100% vested in their benefits. There is no other consequence to a partial termination (i.e., a partial termination generally is not a distributable event, although the participants may be eligible for a distribution due to their termination of employment). Participants not affected by the partial termination remain subject to the plan’s vesting schedule.
There is some debate about who is considered “affected” by a partial termination arising from a significant reduction in the participant group. The law says that upon a partial termination, the rights of all affected employees to benefits earned to the date of the partial termination must be fully vested. The IRS has interpreted this rule to mean that all participants who had a severance from employment during the applicable period, even those whose separation was voluntary, must be fully vested. While the IRS’ position about who vests seems contrary to the intent of the partial termination rules (as is stated in both the statute and regulations) as well as the understanding of most employee benefits practitioners, the IRS’ position has not yet been successfully challenged. And, the IRS is actively enforcing this position as part of the IRS Employee Plans Compliance Unit’s Partial Termination/Partial Vesting Project.
It is important to remember that a partial plan termination can be triggered by a single significant event, such as a plant shutdown, or by a series of reductions in force throughout the year or over several years. When there is a good possibility that a partial termination has occurred, the best course of action is to deem a partial termination to have occurred and vest the affected participants.