Partial Plan Terminations – How Does This Affect My Business?
Because of the current economic uncertainty due to COVID-19, some businesses have had to lay off considerable portions of their workforce, many with the hope of rehiring the individuals sometime down the road. Whether these layoffs are temporary or permanent, businesses are wondering how this might affect their benefit plan.
Below, we’re breaking down Partial Terminations for businesses – what they are, what it means for their plan and considerations in these challenging times.
What is a Partial Plan Termination?
According to the Internal Revenue Service (IRS), a 401(k) plan is generally determined to have a partial termination if more than 20% of total plan participants are laid off in a year. Generally, partial terminations are driven by significant changes to a business, such as the closure of a plant or division, or by adverse economic conditions that result in employee turnover.
Changes to the plan can also result in partial terminations. For example, if a plan is amended and eligibility requirements change, it may result in a partial plan termination if more than 20% of the previous plan participants are now excluded.
There is a level of judgment in the determination of whether a partial plan termination has occurred, and we generally recommend seeking advice from plan legal counsel before concluding as to whether a partial termination has occurred. If a plan sponsor routinely experiences employee turnover at rates greater than 20%, there are various factors to consider in determining if such turnover constitutes a partial plan termination. Plan sponsors may obtain an opinion from the IRS regarding its specific facts and circumstances. The IRS’ FAQs regarding Partial Plan Termination provides additional general information.
Implications of Partial Plan Terminations
If the plan sponsor determines that a partial termination has occurred, the affected participants become 100% vested in employer match and profit-sharing contributions as of the date of the partial termination. The immediate vesting also applies to participants who left employment voluntarily during the plan year when a partial termination occurs.
Failure to identify a partial plan termination could result in underpayments to plan participants if they are not properly fully vested and, ultimately, disqualification of the plan by the IRS.
Many plan sponsors have experienced workforce reductions because of this global pandemic, which have resulted in mass shutdowns. Some additional considerations for plan sponsors continuing to navigate this environment include:
- Termination vs. Furlough – Generally, those individuals who are on short-term layoff or furlough (i.e., what amounts to an unpaid leave of absence) are not considered terminated for the purposes of the 20% calculation; however, if the economic impact to plan sponsors extends for a significant period of time and employees are not reinstated, re-evaluation of whether these employees have been terminated is required.
- Use of Forfeiture Balances – As the economic impacts of COVID-19 are still fluid, ascertainment of partial plan termination may not occur until late 2020 or perhaps even into 2021. In circumstances where plan sponsors are still applying the vesting schedule to mid-year distributions and it is later determined that a partial plan termination has occurred, affected employees who have taken distributions during the year would have to be made whole. Plan sponsors should keep this in mind when using the forfeitures balance to pay administrative expenses or offsetting employer contributions during 2020 or 2021.
With partial plan terminations, considerations and implications of defined benefit plans are significantly more complex than those of qualified defined contribution plans. If you have concerns regarding either your defined benefit or defined contribution plan in light of COVID-19, please contact your BMF Advisor.
Visit our COVID-19 Resource Center for information and resources for you and your business.
Dana E. Mountjoy?>
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