Rehiring Employees by End of 2020 Could Prevent Partial Plan Terminations

In our May 2020 client alert, we addressed the possibility that COVID-19 layoffs could inadvertently cause a partial termination of a company’s qualified retirement plan. Recently issued IRS guidance provides that if participating employees whose employment was terminated due to COVID-19 are rehired by the end of 2020, the IRS generally will not deem a partial plan termination to have occurred. However, rehiring employees by the end of 2020 will not guarantee that employers will avoid a partial plan termination.

As described in more detail in our May alert, a partial plan termination would trigger 100 percent vesting for affected participants.

  • “Affected participants” are participants who had a severance from employment during the “applicable period.”
  • The “applicable period” is typically the plan year, but it can be a longer period if the employer has a series of related severances from employment.
  • Although the IRS determines whether a partial termination has occurred based on all the facts and circumstances, the IRS has established that if the employee turnover rate is at least 20 percent, 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.
  • An “employer-initiated severance” generally includes any severance from employment other than those 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).

In IRS FAQs on “Coronavirus-related relief for retirement plans and IRAs,” the IRS addressed the question “Are employees who participated in a business’s qualified retirement plan, then laid off because of COVID-19 and rehired by the end of 2020, treated as having an employer-initiated severance from employment for purposes of determining whether a partial termination of the plan occurred?” The IRS answered: “…participating employees terminated due to the COVID-19 pandemic and rehired by the end of 2020 generally would not be treated as having an employer-initiated severance from employment for purposes of determining whether a partial termination of the retirement plan occurred during the 2020 plan year.”

The IRS’s response provides some reassurance for employers who rehire employees by the end of 2020 that they will decrease their risk of incurring a partial termination. However, employers should be aware that rehiring employees in 2020 will not preclude a future IRS determination of a partial termination. The IRS does not address the possibility that the applicable period may extend past 2020, particularly if the employer has a series of COVID-19 terminations of employment, which would affect the calculation of the turnover rate. An employer might rehire employees by year-end 2020, but then subsequently terminate the employment of more employees in 2021, due to the enduring economic impact of the COVID-19 pandemic. Additionally, this guidance may be inapplicable to employers not in a financial position to rehire a significant number of employees by year-end 2020.

Therefore, employers should continue to monitor their employee turnover rate, even if they do rehire employees in 2020. Additionally, employers should keep detailed records of the circumstances of employees’ departures from employment; if an employer can demonstrate that an employee’s departure was clearly a voluntary resignation, employers may be able to disregard those former employees’ severances from employment in calculating the turnover rate.