Employers considering layoffs during this period of economic uncertainty should be aware that extensive layoffs could inadvertently cause a partial termination of their company’s qualified retirement plan. Employers should monitor their employee turnover rate and consult with benefits counsel to determine the potential impact on their retirement plans.
Partial plan terminations can occur where a significant change to the plan or a significant event affects the rights of employees to vest in their plan benefits, such as termination of a large group of employees.
Vesting: A partial plan termination triggers 100% vesting for affected participants. Affected participants (generally, participants who had a severance from employment for any reason during the “applicable period” as defined below) must become fully vested, regardless of the plan’s vesting schedule. Depending on the plan’s vesting schedule and the scale of affected participants, a partial termination could result in substantial liabilities.
Turnover Rate: Determining whether a partial termination has occurred may be a complex process. The IRS determines whether a partial plan termination has occurred based on all the facts and circumstances. However, the IRS established in Revenue Ruling 2007-43 that if the employee “turnover rate” is at least 20%, there is a rebuttable presumption of a partial plan termination.
The “turnover rate” is determined by dividing (1) the number of participating employees who had an employer-initiated severance from employment during the applicable period, by (2) the total number of participating employees during the applicable period.
Applicable Period: The “applicable period” is typically the plan year, but it can be a longer period if a series of related severances from employment has occurred.
Employer-Initiated Severance: An “employer-initiated severance” generally includes any severance from employment other than one due to death, disability or retirement on or after normal retirement age, and includes severance due to events outside of the employer’s control (e.g., adverse economic conditions).
Also, an employer may be able to disregard former employees whose departure the employer can demonstrate was clearly a voluntary resignation by the employee. Note that a furlough would not be considered an employer-initiated severance for purposes of a partial termination, provided it does not result in a severance from employment. Furthermore, even where there is an employer-initiated severance from employment, one factor that might help rebut the presumption of a partial termination is whether the affected employees are rehired before incurring a break in service, because in that case their vesting rights would not be adversely affected by the severance from employment.
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