With the economic impacts of recent events, partial terminations are a frequent issue facing qualified plans. The Internal Revenue Code (the “Code”) requires all unvested benefits to immediately vest when a tax-qualified plan is either terminated or the plan experiences a “partial termination.” Whether or not a partial termination occurs, and the exact point in time the partial termination occurs, is determined by the IRS based on all the facts and circumstances involved.
While partial terminations frequently occur when there is a reduction in force, whether in a single event or a related series of layoffs, the IRS has indicated that a partial termination is triggered by: (1) any action taken by the employer, through a plan amendment or severance of employment, that serves to purposefully exclude a group of previously covered participants from participating; and (2) plan amendments that adversely affect participants’ rights to unvested benefits.
If there is a significant turnover in active participants, then there will be a presumed partial termination. How a turnover rate is determined involves looking at (i) how many active participants were involuntarily terminated (or affected by the employer action discussed above) during the “applicable period” (typically the plan year, although facts and circumstances may require looking at other periods), (ii) divided by the total of the number of active participants in the plan at the end of the prior plan year, plus any active participants added during the applicable period. The resulting percentage is the turnover rate.
Rev. Rul. 2007-43, provides that if the number of active participants in a plan is reduced by 20% or more in an applicable period there is a rebuttable presumption that the plan has been partially terminated. If there are no facts or circumstances which rebuts this presumption, the unvested account balances of affected participants must become vested. The IRS has taken the position that “affected participants” includes all participants who terminated employment during the applicable period, including those who voluntarily terminated.
terminations generally cannot be determined until after the end of the plan year/applicable period, and they can sneak up on you, so plan administrators should keep detailed records on all terminations and surrounding business circumstances on an ongoing basis.
For a discussion of current issues in partial terminations, see the article by Sherrie Boutwell and Ruel Pile at When Does a COVID-19 Furlough or Layoff Trigger a Partial Termination for Your Qualified Plan? (Part II), and their webinar on the topic from February 2021 Boutwell Fay LLP Webinar- Potential Impact of COVID-19 on Retirement Plans: Partial Plan Termination