By Jenny Kiffmeyer, J.D – The Retirement Learning Center
Partial Plan Termination and the Applicable Period
ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business.
A recent call with an advisor in Ohio involved a case related to a partial plan termination. The advisor asked: “My client suffered an accident and cannot keep employees on at his business. He was wondering if he could lay off employees over time to avoid triggering full vesting for a partial plan termination?”
Highlights of Discussion
- The IRS will determine whether a partial plan termination has occurred based on the facts and circumstances of a particular scenario [Treasury Regulation § 1.411(d)-2(b)]. According to Revenue Ruling 2007-43, one of the circumstances considered is the employee turnover rate during “the applicable period.”
- The applicable period is a plan year (or, in the case of a plan year that is less than 12 months, the plan year plus the immediately preceding plan year) or a longer period if there are a series of related severances from employment. Consequently, in your client’s situation, because the layoffs would all occur as a result of a single event—the IRS would consider them related severances.
- There are other guidelines in Revenue Ruling 2007-43 that are helpful in determining if a partial plan termination has occurred.
- A partial termination may be deemed to occur when an employer reduces its workforce (and plan participation) by 20 percent.
- The turnover rate is calculated by dividing employees terminated from employment (vested or unvested) by all participating employees during the applicable period.
- The applicable period is generally the plan year but can be deemed longer based on facts and circumstances. An example would be if there are a series of related severances of employment the applicable period could be longer than the plan year.
- The only severances from employment that plan sponsors DO NOT factor in when determining the 20 percent ratio are those that are out of the employer’s control (e.g., an employee death, disability, retirement or depressed economic conditions).
- Partial plan terminations can also occur when a plan is amended to exclude a group of employees that were previously covered by the plan or vesting is adversely affected.
- In a defined benefit plan partial plan termination can occur when future benefits are reduced or ceased.
- The IRS adopted the 20 percent guideline in Rev. Rul. 2007-43 from a 2004 court case Matz v. Household International Tax Reduction Investment Plan, 388 F. 3d 577 (7th Cir. 2004), which, ironically, was dismissed in 2014 after its fifth appeal [Matz v. Household Int’l Tax Reduction Inv. Plan, No. 14-2507 (7th Cir. 2014)]. The 20 percent threshold still stands under the IRS’s revenue ruling.
- Keep in mind that employee turnover is not the only reason for a partial termination. A partial termination can also happen if a sponsor adopts amendments that adversely affect the rights of employees to vest in benefits under the plan, excludes a group of employees that previously had been included, or reduces or ceases future benefit accruals that can result in a reversion to the employer (in the case of a defined benefit plan), the IRS may find that a partial termination occurred, even if the turnover rate is under 20 percent (Issue Snapshot-Partial Plan Termination).
- If a partial termination may be an issue, a plan sponsor may seek an opinion from the IRS as to whether the facts and circumstances amount to a partial termination. The plan sponsor can file, IRS Instructions for Form 5300, Application for Determination for Employee Benefit Plan with the IRS to request a determination of partial plan termination.
Based on facts and circumstances over the applicable period, a company could be deemed to have a partial plan termination. The participants affected by the partial plan termination must become 100 percent vested in their account balances upon termination. Plan sponsors should monitor their companies’ turnover rates and amendment activities to be aware of potential partial plan terminations.