By Linda J. Kramer, CPA, MBA
Director of Employee Benefit Services
Perhaps your company has lost a contract or big customer. Or it sold a division. If these actions have significantly reduced your workforce, you must determine if a partial retirement plan termination has occurred. Often, while management is busy making critical decisions, the effects on retirement plans are overlooked.
What is a partial plan termination?
A retirement plan is effectively partially terminated when a company’s workforce is downsized by a certain percentage due to decisions made by the company’s management. There are significant economic impacts of a partial plan termination, and plan sponsors are advised to understand what triggers such an event and head it off.
What happens in a partial plan termination?
When a retirement plan is partially terminated, all affected participants (those who have been laid off) become 100% vested in their employer contributions, regardless of the vesting schedule. This means these funds will not be available to offset expenses of the plan or for allocation to remaining participants. Those participants who remain employed by the company continue to follow the vesting schedule in the plan documents.
Failure to fully vest those affected may result in disqualification of the plan.
How do you know if a partial plan termination has occurred?
To determine if a partial plan termination has occurred, a company must have accurate participant census data. The percentage reduction in the number of plan participants must be calculated, but beware that the percentage reduction to trigger a partial termination is not a fixed number. Many years ago, the percentage was as high as 80%. However, various court cases and rulings over the years have brought it down to around 20%. The courts look at the percentage reduction, along with facts and circumstances, in each case.
Additionally, the period of time over which the workforce reduction occurs impacts whether a partial plan termination has taken place. The period used to calculate the reduction is not necessarily a plan year. For example, if management has a three-year plan to downsize, then the percentage would be calculated for the three-year period involved.
If the calculations show a reduction in plan participants near or above 20%, you should contact your plan’s TPA (third-party administrator) to determine if a partial plan termination has occurred. It may be best to take a conservative approach and fully vest all affected participants. If you find that you had a partial termination in a prior period and affected participants were not fully vested, the plan has an operational defect which may disqualify it. However, this may be corrected through the Voluntary Compliance Resolution Program of the IRS.
Can a partial plan termination be avoided?
Although not advisable for all plans, it is possible to eliminate the issue by changing the plan language to fully vest all participants who are involuntarily terminated. In any case, it is important to recognize when business operating decisions will affect your pension plan.
If you would like to discuss your company’s retirement plan and the impact business decisions may have on it, contact your G.T. Reilly advisor.
