Partial Termination of an Employee Benefit Plan

If your company has an employee benefits plan, here’s how it may be impacted if you’ve had to reduce staff during the recent economic downturn.

Employee reduction during the coronavirus pandemic will affect an employee benefit plan (“Plan”) differently depending on whether employer chooses to layoff or furlough employees. While a furlough is a temporary leave of absence from work, a layoff is a permanent separation from employment.

Furloughs vs. layoffs

Furloughed workers do not receive a paycheck, but are still considered employees; therefore, the furlough does not affect your Plan. Laid off workers on the other hand are no longer considered part of the company and your Plan can be partially terminated.

Your Plan may have a partial termination if more than 20% of your total Plan participants were laid off in a particular year. Partial terminations can occur in connection with a significant corporate event such as a closing of a plant or a division, or as a result of general employee turnover due to adverse economic conditions or other reasons that are not within the employer’s control.

Employers should consult with their ERISA attorneys on whether their Plan has been subject to a partial termination under the law as soon as they expect layoffs of more than 20% of total Plan participants.

Affected employees and partial terminations

The law requires all “affected employees” to be fully vested in their account balance as of the date of a full or partial plan termination. They must become 100% vested in all employer contributions (including matching contributions) regardless of the plan’s vesting schedule. Employee salary deferrals are always 100% vested.

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. Some Plans wait until an employee has five consecutive 1-year breaks in service before he or she forfeits their nonvested account balance. For these Plans, employees who left during the Plan year of the partial termination and who have not had five consecutive 1-year breaks in service are affected employees.

The IRS can potentially disqualify the Plan if companies fail to fully vest terminated employees, which would result in underpayments to former participants.

Get help with your employee benefit plan

If you have further questions or concerns about employee benefit plans, contact Qiming Liu, CPA, at qliu@krscpas.com or 201-655-7411. You can also check our Coronavirus Resources Page for updates related to the pandemic’s impact on individuals and businesses.