As businesses continue to respond to recent shifts in the U.S. economy, some employers have had to make the challenging decision to implement cost-cutting measures and reductions to their workforce. While a reduction in force can result in many moving parts for business operations, employers should be careful not to overlook the less obvious impacts on their business, including the administration of their retirement plans.
Suppose you are an employer who has had to reduce your workforce. In that case, one issue to consider is whether the loss in employee numbers may trigger a partial plan termination in your 401(k) or other qualified retirement plan. IRS guidance provides that generally, a partial termination occurs when there is a 20% or greater turnover rate during an applicable period. The applicable period is typically the plan year, but can be longer if a series of events that led to the severances are related. For example, if you have two separate reductions in force over a period of two years that are connected to the same business transaction, you will need to consider all affected employees over the period of the two years in which the terminations occurred. In addition to turnover, a partial termination can occur if a plan sponsor adopts amendments that adversely affect the rights of employees to vest in benefits under the plan or excludes a group of employees that previously had been included.
To calculate your turnover rate, you divide the number of participating employees who had an employer-initiated severance from employment during the applicable period by the sum of all of the participating employees at the start of the applicable period and the employees who became participants during the applicable period. You must ensure that all participating employees are counted, which, under IRS guidance, includes any employee eligible to participate, even if this employee has not elected to make deferrals. When determining those that had an employer-initiated severance, you do not need to include those where their severance was purely voluntary or where the termination was out of the employer's control (e.g., death, disability, or retirement).
There are a few exceptions to the general rule that allow the employer to escape the initial presumption if their turnover rate is over 20%. A plan sponsor may be able to exclude some employees from the calculation if they were terminated for cause. This can be shown using evidence, such as information from personnel files, employee statements, or other corporate records. A plan sponsor may also provide evidence that the turnover rate is routine by providing proof of similar turnover in previous plan years and employee replacement rates.
If a partial termination has occurred, you must fully vest all affected employees in their account balance or their accrued benefit. An affected employee in a partial termination is generally anyone who left employment for any reason during the plan year in which the partial termination occurred and who still has an account balance under the plan. If your organization has had or is planning a reduction in force and your company sponsors a retirement plan, you should run the calculations to ensure you haven’t had a partial plan termination. If you operate your business on a seasonal basis or have seen an uptick in voluntary terminations that may be unrelated to a layoff, you should be diligent about documenting the reason for the termination in order to prove an exception applies if the organization needs to invoke that argument in the future. If you have any questions regarding partial termination, please contact one of Bricker Graydon’s employee benefits team members.
