Partial Plan Terminations — What Every Employee Benefit Plan
Sponsor Should Know About the Potential Impact of Employee Terminations
A “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
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 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 Occurred
The 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
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 Identified
If 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
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
- Adversely affect vesting rights
- Exclude employees previously covered
- Reduce or cease future accruals, resulting in potential employer
reversions to timely identify a PPT
Help is Available
IRS Revenue Ruling 2007-43 can provide guidance on analyzing a
qualified benefit plan for a PPT. Given the extensive judgment that
is typically involved in applying the partial plan termination rules,
and the potential consequences on the qualified plan status, it
is often recommended that the plan sponsor consult a qualified plan
advisor before making a determination.