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Partial Plan Terminations — What Every Employee Benefit Plan Sponsor Should Know About the Potential Impact of Employee TerminationsA “partial plan termination” sounds like a serious matter. In fact, it can be serious, with consequences including the potential disqualification of an employee benefit plan by the IRS. But such dire consequences can be avoided if an employee benefit plan sponsor conducts a timely evaluation to determine if a partial plan termination (PPT) has occurred. These issues have become even greater in the current economic climate, where millions of workers have lost their jobs in recent years. Many of those workers were participants in their employer’s qualified benefit plan — a fact that is critical to the future financial obligations of the plan and its standing with the IRS. Employer-Initiated SeveranceEmployer-initiated severance typically includes any break in employment other than that which occurs on account of death, disability, voluntary separation from service, termination for cause and retirement on or after normal retirement age. If employer-initiated severances resulting in involuntary reductions in plan participants are significant enough, qualified plans may incur a PPT under the provisions of the Internal Revenue Code (IRC) and regulations of the Internal Revenue Service (IRS). Voluntary employee terminations can be excluded from consideration if an employer has adequate documentation to support that severance was not employer-initiated. Determining If a PPT Has OccurredThe determination of whether or not a PPT has occurred can be problematic for many plan sponsors since IRC and IRS regulations provide only general guidance. All facts and circumstances of the workforce reduction must be taken into consideration. Also, any plan amendments that exclude a group of previously covered employees, or adversely affect the rights of employees to vest in benefits under a qualified plan, must be taken into consideration in evaluating whether a PPT has occurred. The IRS generally presumes that a PPT has occurred if a plan has a reduction of plan participants due to employer-initiated severance or a turnover rate of at least 20 percent over an applicable period, generally a plan year. The period may be longer than a plan year if there is a series of related employer-initiated severances. The turnover rate is calculated by dividing the number of plan participants who had employer-initiated severance during the plan year, by the total of all plan participants at the beginning of the plan year, then adding employees who became participants during the same period. Both vested and nonvested participants are included in the calculation of the turnover rate. Facts and circumstances may support the determination that a turnover rate for an applicable period is routine for an employer and does not result in a PPT. A largely seasonable workforce would be one example. Generally, an employer would look at the turnover rate in other periods and the extent to which terminated employees were replaced, the functions performed by the new employees and whether or not they performed the same functions, have the same job class or title, and receive comparable compensation. When a PPT is IdentifiedIf a PPT is deemed to have occurred, all affected participants who involuntarily left the employer during the applicable period become fully vested in their accrued benefits to the extent that they are funded on that date, or in the amounts credited to their accounts. If a PPT is identified after the nonvested benefits of affected participants have been forfeited, the plan sponsor must restore the forfeited amounts through additional contributions. Plan disqualification can result if a plan sponsor fails to fully vest affected participants after the IRS deems that a PPT has occurred. It is important for plan sponsors to review the facts and circumstances surrounding all severances and any proposed plan amendments that will:
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