Defined Contribution

Guidance on Substantial Workforce Cuts and DC Plan Terminations

Guidance on Substantial Workforce Cuts and Partial DC Plan Terminations
clock
3 min 18 sec

Employers that reduce their workforce or discontinue defined contribution (DC) plan eligibility for certain employee groups may experience an inadvertent “partial plan termination.” If not properly managed, this event could result in a disqualification of the entire plan.

Background

A partial plan termination is typically triggered by a distinct event or series of events (e.g., reductions in force, sales of subsidiaries). The determination of a partial plan termination is based on the facts and circumstances of the situation.

When a partial termination occurs, all participants who left employment during the applicable period must be fully vested. This includes participants who terminated service prior to when the plan sponsor identified that the partial plan termination had taken place. In that case, plan sponsors may have to restore previously forfeited balances and locate those former participants to inform them of the restored balances. To the extent forfeited assets have been used for other purposes (e.g., reducing employer contributions or paying plan expenses), the employer will be responsible for making the affected participants whole.

Vesting does not need to be accelerated for participants not affected by the event.

Generally, if the employer’s turnover rate is at least 20% during the applicable time period, there is a presumption that a partial termination of the plan has occurred. The time period in question depends on the facts and circumstances of a situation, and legal counsel may help determine the appropriate period to be considered. According to IRS Rev. Rul. 2007-43, the turnover rate is determined by “dividing 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.” Routine turnover during the year does not generally generate a partial termination. To understand what constitutes routine turnover, plan sponsors should consider how the current turnover compares to the turnover rate in other periods and if the employees were replaced.

Example:

ABC Company typically experiences 6% annual turnover. In July 2019 the company closed a division resulting in a 10% reduction in staff. In April 2020, the company experienced financial hardship due to the coronavirus pandemic and had to let go another 10% of its workforce. Although this situation spans plan years, a partial termination may have occurred. Legal counsel should weigh in and a plan sponsor can request a determination from the Internal Revenue Service (IRS). If it is determined that a partial termination occurred, the plan would need to fully vest participants who were terminated beginning in July and any forfeited account balances would need to be restored.

Definitions:

  • Participating employees: active participants and eligible employees
  • Applicable period: usually the plan year, although it can be cumulative if the terminations occurred over several years. If a short plan year is involved, it would include the year prior to the current one.
  • Employer-initiated severance: generally includes any turnover, with the exception of death, disability, or retirement.

A partial termination of a qualified plan can also occur for reasons other than turnover. For example, it can occur if a group of employees who had been covered by the plan was later excluded.

Bottom Line

Identifying a partial plan termination is important since the failure to recognize and act on it can cause disqualification of the entire plan. Plan sponsors that are uncomfortable relying on their own calculations can request a determination letter from the IRS to see whether a partial plan termination occurred. Legal counsel should also be consulted in determining the status of a partial plan termination.

Because partial plan terminations are generally determined at or after the end of a year, plan sponsors should continue to apply the current vesting schedule to mid-year distributions, but be prepared for the possibility of a partial plan termination at year-end and continue to monitor the plan status as the economic implications of the coronavirus pandemic continue to unfold.

Posted by

Share
Share on facebook
Share on twitter
Share on linkedin
Related Posts
Operations

What DC Plan Sponsors Should Know About Recent Litigation Trends: Part 2

Jana Steele
Jana Steele reviews key themes to emerge from our analysis of DC plan litigation from 2019-2022.
Operations

What DC Plan Sponsors Should Know About Recent Litigation Trends: Part 1

Jana Steele
In the first of two blog posts, Jana Steele provides an overview of DC plan litigation from 2019-2022.
Operations

Financial Wellness: Is It the Right Prescription for Your DC Plan?

Jana Steele
Jana Steele provides a summary of her recent white paper on financial wellness options for DC plans.
Operations

The Supreme Court Weighs in on Northwestern DC Case

Jana Steele
Jana Steele explains the implications of the Supreme Court's Northwestern ruling for DC plan sponsors.
Operations

DOL Shifts Tone on Private Equity in DC Plans

Patrick Wisdom
Patrick Wisdom analyzes the new DOL guidance on the role of private equity in DC plans.
Macro Trends

Is 2% Growth Good or Bad?

Jay Kloepfer
Jay Kloepfer examines GDP growth in 3Q21 and its implications for the future course of the recovery.
Operations

DOL Updates the Fiduciary Rule (Again)

Jana Steele
Jana Steele explains what the latest update to the fiduciary rule means for DC plan sponsors.
Operations

Watch What You Say: Employee Benefit Claims

Jana Steele
Jana Steele explains how a new EBSA letter on informational calls with plan participants affects sponsors.
Macro Trends

... And We're Back! The Rebound of the U.S. Economy

Jay Kloepfer
Jay Kloepfer assesses the current state of the U.S. economy.
Macro Trends

A JOLT of Inflation from the Labor Market?

James W. Van Heuit
Jim Van Heuit discusses recent changes to the labor market and what impact they may have on inflation.

Callan Family Office

You are now leaving Callan LLC’s website and going to Callan Family Office’s website. Callan Family Office is not affiliated with Callan LLC.  Callan LLC has licensed the Callan® trademark to Callan Family Office for use in providing investment advisory services to ultra-high net worth clients, family foundations, and endowments. Callan Family Office and Callan LLC are independent, unaffiliated investment advisory firms separately registered with the Securities and Exchange Commission under the Investment Advisers Act of 1940.

Callan LLC is not responsible for the services and content on Callan Family Office’s website. Inclusion of this link does not constitute or imply an endorsement, sponsorship, or recommendation by Callan LLC of their website, or its contents, and Callan LLC is not responsible or liable for your use of it. When visiting their website, you are subject to Callan Family Office’s terms of use and privacy policies.