With an increasing number of businesses currently being affected by the COVID-19 Pandemic, Plan Sponsors are facing new challenges. Many sponsors are taking unfortunate, but necessary steps to weather these events, such as suspending or reducing employer contributions, or laying off and furloughing employees. As a result, Partial Plan Terminations are becoming more common. If you are a Plan Sponsor who offers an employer contribution which is subject to a vesting schedule, there are important rules you should be aware of.
What is a Partial Plan Termination?
Though the Internal Revenue Code does not specifically define what constitutes a Partial Plan Termination, the Internal Revenue Service (IRS) will examine each case by the facts and circumstances looking for a significant reduction in the number of participants in the plan.
The two main factors that the IRS uses to make its determination are:
- Percentage of reduction in participants
- If the reduction is over 40%, it should be presumed that a partial plan termination has occurred.
- If the reduction is less than 40%, but at least 20%, there is a rebuttable presumption that a partial plan termination has occurred. This determination has come down on both sides of the line.
- If the reduction is less than 20%, there is a rebuttable presumption that a partial plan termination has not occurred.
- Facts and Circumstances
- Who is involved (vested and non-vested participants)?
- Who initiated the terminations and what was the reason?
- Even if an employee voluntarily terminated, they may still be counted toward the 20% benchmark if they did so with the belief they were going to be terminated.
- What is the period of time?
- Other significant facts or circumstances.
Consequences to a Partial Plan Termination
If your plan is deemed to have a Partial Plan Termination, all affected participants become immediately 100% vested in their funded benefits.
Why can this be an issue?
If an affected participant received a distribution from the plan prior to the determination, they may have been paid out with a portion of their employer contribution balance improperly forfeited.
These forfeited amounts, which may have been utilized to reduce employer contributions, or pay plan related expenses, are now due to the participant along with potential earnings assessed through the Employee Plans Compliance Resolution System (EPCRS). See Fixing Common Plan Mistakes – Vesting Errors in Defined Contribution Plans for more information.
What can be done to make sure this is handled the right way?
There are two widely accepted options:
- Immediately 100% vest all participants utilizing EPCRS for any participant affected with prior termination dates, and ensure that proper distributions are processed.
- Seek IRS determination. The IRS will review the relevant facts and circumstances to determine whether a partial plan termination has occurred. This involves filing the Form 5300, which also has a IRS filing fee, along with any preparation fees to your plan provider.
Are there any special changes or exemptions due to the COVID-19 Pandemic?
As of the date of this writing, there is no special relief due to COVID-19.
Many employers have asked whether rehiring all the participants who were laid off means a partial plan termination can be reversed. There are arguments for both sides of this issue. The conservative approach would be to fully vest participants, understanding the cost of doing so would be to forgo any forfeitures of non-vested employer contribution accounts, and follow EPCRS guidance if necessary.
Partial Plan Terminations can be very confusing, and the regulations surrounding them are vague. Luckily, you are not alone. By engaging with your Third Party Administrator, Legal Counsel, and Tax Advisor, you can determine whether or not you have had a partial plan termination. At Aegis Retirement Partners, we will work directly with our clients to ensure that whatever action is taken is appropriate in light of current legislation.
This document provides general information and shouldn’t be considered recommendations or legal advice.
For additional information, please visit the IRS website at https://www.irs.gov/retirement-plans/retirement-plan-faqs-regarding-partial-plan-termination.