Does a Reduction in Workforce Equal a Partial Plan Termination?

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By Stacey L. Spencer, QKA | Manager, Employee Benefit Services

Have you had to reduce your workforce during 2012? If so, there may be repercussions that affect the retirement plan you sponsor. Your plan may have experienced a partial termination.

The IRS considers a partial termination to have occurred when an employer-initiated action results in a significant decrease in plan participation. Generally, the IRS presumes a partial termination has occurred when an employer experiences a workforce reduction of 20%.

The reduction in workforce rate is determined by dividing the number of participating employees who had an employer-initiated severance during the plan year by the sum of the number of participating employees at the start of the plan year and the number of employees who became participants during the plan year. Note that the period used to determine the turnover rate can be longer than the plan year if there is a series of related severances from employment. Also, exceptions are made for employers with traditionally high turnover rate, where annual turnover exceeds 20 percent on a regular basis.

An employer-initiated severance from employment generally includes any severance from employment, other than that on account of death, disability or retirement on or after normal retirement age. Voluntary terminations can also be excluded if the employer can prove that the termination was entirely voluntary. Employees who have been terminated in connection with a transfer to a different controlled group can also be excluded from consideration if they continue to be covered by a plan that is a continuation of the plan under which they were previously covered (such as a plan spin-off). Therefore, it is important to maintain proper records as to the reasons behind terminations of employment.

A partial termination of a qualified plan can occur for reasons other than turnover. Other reasons for a partial termination could include the adoption of plan amendments that adversely affect the rights of employees to vest in benefits under the plan, plan amendments that exclude a group of employees previously covered under the plan or the reduction or cessation of future benefit accruals resulting in a potential reversion to the employer.

If a plan experiences a partial termination, all affected participants must be fully vested in their account balance as of the date of partial termination. ‘Affected’ participants are those employees actually terminated by the employer. Typically, employer contributions are subject to a graduated vesting schedule. Upon a partial termination, however, all employer contributions and other employer contributions must be fully vested for all affected participants, regardless of the vesting schedule in the plan document.

Workforce reduction issues are challenging even without the added burden of determining if a partial termination has occurred. If your business has experienced a significant reduction in workforce, please contact us to discuss the possible ramifications to your retirement plan.

Contact:

Stacey L. Spencer, QKA

317-260-4421 | sspencer@greenwaltcpas.com