Many business owners, employment law counsel and benefit advisors are grappling with reductions in force/layoffs due to the unprecedented business and economic impact of COVID-19. I wanted to flag for you, briefly, a retirement plan compliance issue that these staff reductions can trigger. The rule applies to all qualified retirement plans not just 401(k) plans; special issues exist if your client has a defined benefit/pension plan, or if it has collectively bargained benefits.
The issue is this: the IRS established in Revenue Ruling 2007-43 that when employer action – including as a result of an economic downturn – results in 20% or more of the plan population being terminated from employment, then a presumption arises that everyone affected must be fully vested in their employer contributions under the plan. This is called a “partial plan termination.”
This is relevant only if the retirement plan has employer contributions, such as matching or profit sharing contributions, that are subject to a vesting schedule. Safe harbor contributions are always 100% vested as are employee salary deferrals.
The way the employer determines the 20% threshold is as follows:
- Start with the number of participants on the first day of the plan year which will also be the number of participants on the last day of the prior plan year, on Form 5500. For 401(k) plans you look at who is “eligible” to make salary deferrals not just those who actually make salary deferrals or otherwise have a plan account. (IRS Q&A with ABA from May 2004, Q&A 40).
- Add new participants (eligibles) added during the plan year in progress.
- Take that total number, and divide by the number of participants (eligibles) experiencing employer-initiated termination of employment.
- In all cases, count both vested and nonvested participants (eligibles).
If you are at 20% or more you have a presumed partial termination. Certain facts can rebut this presumption such as very high normal turnover but this message is meant to address reductions in force related to COVID-19 which are employer-initiated due to outside forces and thus the presumption would likely not be rebuttable.
If you meet or exceed 20% then all persons directly terminated by the employer during the year must be fully vested in their employer contributions. The IRS also recommends you fully vest collaterally-affected employees such as those who leave voluntarily, as often those voluntary departures are triggered by concern over the company’s future in light of the involuntary terminations. Even if the reduction in plan population is under 20%, a potential partial plan termination may have occurred depending on all of the facts and circumstances.
The period of a partial termination may exceed a single plan/calendar year in some cases but in the instance of COVID-19, with any luck, we will only be looking at 2020.
Fully vesting folks does not cost the employer money because the money is already in the plan. However if this is not done correctly it is a complicated and expensive fix “after-the-fact.”
Generally there is not a requirement to notify participants of full vesting as a result of partial termination at the employer level but it might be mentioned in distribution paperwork according to the practices of the client’s plan recordkeeper.
Partial terminations raise a number of other ERISA compliance issues – as does the COVID-19 crisis as a whole – so let me know if questions arise.
Wishing all readers safe passage through the next weeks and months.
The above information is provided for general informational purposes only and does not create an attorney-client relationship between the author and the reader. Readers should not apply the information to any specific factual situation other than on the advice of an attorney engaged specifically for that or a related purpose. © 2020 Christine P. Roberts, all rights reserved.
Photo Credit: Markus Spiske, Unsplash.