The financial impact of COVID-19 is hitting all industries, resulting in unprecedented unemployment numbers. Businesses experiencing difficult economic times are responding in different ways, some by temporarily paying employees to stay home, others reducing hours with a coincident reduction in payroll, and others are implementing layoffs and furloughs. In an earlier blog post, we reminded readers to be mindful of the partial plan termination rules when considering their options. These rules require immediate 100% vesting of terminated employee accounts in qualified retirement plans if a partial plan termination is deemed to have occurred.
We continue to receive questions about when a partial plan termination may take place. Although there is not a bright line rule for when a partial plan termination occurs, the rule of thumb is that there is a partial plan termination when 20% or more of participants are involuntarily terminated (meaning their termination was employer-initiated – referred to as the “turnover rate”) during the applicable period. The applicable period is more than just the current plan year; the IRS sometimes looks at multiple years because there might have been a series of related terminations that will be consolidated to reach the 20% threshold.
If 20% of total plan participants are involuntarily terminated in the applicable period, there is a rebuttable presumption that a partial plan termination has occurred. For employers conducting layoffs in waves, it is likely that all the layoffs would be considered in the 20% presumption test, even if the waves cross plan years, and/or are further apart in time. If employers rehire terminated participants before the end of the year, these rehired employees may not be included in the turnover rate. Further, because a furlough is not intended to be a permanent separation of employment, the IRS would not include furloughed workers in the turnover rate, unless subsequently laid off within the applicable period.
Sponsors of qualified retirement plans that are anticipating or experiencing layoffs, furloughs or other reductions in employment as a result of the economic crisis need to consider the partial plan termination rules. These requirements can trigger unexpected vesting consequences, because all employees who are terminated during the year, even those who voluntarily terminated employment during the applicable period, must be fully vested in their accounts. If a plan sponsor does not properly vest the terminated participants, this could result in unanticipated operational failures that can jeopardize the plan’s qualified status.
