Beware of Partial Plan Termination Due to COVID-19

This year’s COVID-19 pandemic has affected all of our lives in numerous ways, but did you know it could be affecting your retirement plan? And not just the potential for market volatility. With many organizations experiencing workforce reductions, a plan could experience a partial termination. Partial terminations have been a possibility prior to COVID and you may already know about them, but if not, now is the time to learn. Should a partial plan termination be determined to have occurred, all affected employees (those terminated during the period) become fully vested in any contributions previously subject to a vesting schedule.

A partial termination occurs when there is a substantial employer-initiated employee turnover either due to a significant event or as a result of adverse economic conditions.  The Internal Revenue Service (“IRS”) established that a turnover rate of a plan of 20% or more during the applicable period would trigger a partial plan termination. The applicable period is generally one plan year; however, it can be longer if there are a series of related severances or a short plan year. In those instances, the previous year must also be included in the applicable period.

In its simplest form, the turnover rate is calculated by taking the number of all employees participating (both vested and non-vested) in the plan who had an employer-initiated termination of employment and dividing by the sum of all participating employees at the start of the applicable period plus any employees who became participants during the applicable period. However, the calculation can be much more complicated, and for a full walkthrough of the calculation, it is best to reference the IRS website. It is worth noting that a partial termination can also occur if the plan is amended in a way that negatively impacts existing participants.

If a partial plan termination has occurred, it will impact the distribution process carried out by your third party administrator (TPA). Thus, if you think your company has experienced a partial termination, make sure to start a discussion with your TPA. First, it is important to review the facts and circumstances surrounding the turnover (ex. terminations vs. furloughs). If it is then determined that a partial termination occurred, the census should be updated to reflect all affected employees as 100% vested. If affected employees have already taken distributions, then your TPA can move forward with returning any forfeited funds.

IRS Partial Plan Termination Resources:

IRS Treasury Regulation 26 CFR 1.411(d)-2: Termination or partial termination; discontinuance of contributions addresses partial plan terminations.

IRS Retirement Plan FAQs includes information regarding partial plan terminations.

The IRS Issue Snapshot – Partial Termination of Plan focuses on the impact of Revenue Ruling 2007-43 in determining if a partial termination occurred and addresses vesting requirements and affected employees.

IRS Rev. Rul. 2002-42 provides information about determining when the merger or conversion of a money purchase pension plan into a profit-sharing plan results in a partial termination of the money purchase pension plan and what communications must be provided to affected individuals in a money purchase pension plan that is merged or converted into a profit-sharing plan.
Author: Isabelle Wissocki | iwissocki@withum.com