COVID-19 has forced many employers to reduce their workforce through furloughs or layoffs. These reductions may cause employers to experience a partial plan termination of their qualified retirement plans, which requires 100% vesting of affected participants. While there has been uncertainty about whether a partial termination occurs if employers rehire furloughed or laid off employees by the end of 2020, the Internal Revenue Service recently updated its Q&As relating to the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) to provide clarity on this issue.

What Is A Partial Plan Termination?

The rights of participants in a qualified retirement plan fully vest when the plan is terminated. Meaning, upon termination, none of the money contributed by the employer to the participants’ retirement accounts is returned to the employer. A partial plan termination also triggers 100% vesting for all affected participants. The only guidance from the Internal Revenue Code or accompanying regulations states that it depends on the facts and circumstances of each case to determine whether a partial plan termination occurs.

While this requirement to consider the facts and circumstances provides little practical guidance, courts and the IRS have largely considered the “turnover rate” in a partial plan termination analysis. A turnover rate of at least 20% in an employer-initiated severance of plan participants during the applicable period creates a presumption that a partial plan termination has occurred. Employer-initiated severances typically involve severance for reasons other than death, disability, or retirement on or after normal retirement age. The applicable period is the plan year or longer if there is a series of related severances.

The 20% turnover rate only creates a presumption that a partial plan termination has occurred. This presumption may be rebutted if, considering the facts and circumstances, the turnover is a routine part of the employer’s business.

Updated IRS Guidance

In its recent guidance, the IRS considered the following question relating to partial plan terminations:

Are employees who participated in a business’s qualified retirement plan, then laid off because of COVID-19 and rehired by the end of 2020, treated as having an employer-initiated severance from employment for the purposes of determining whether a partial termination of the plan occurred?

The IRS answered, “Generally, no. Subject to the facts and circumstances of each case, participating employees generally are not treated as having an employer-initiated severance from employment for purposes of calculating the turnover rate used to help determine whether a partial termination has occurred during an applicable period, if they’re rehired by the end of that period.” Thus, employees who had been furloughed or laid off due to COVID-19 but are rehired by the end of 2020 would likely not be treated as having an employer-initiated severance for the purposes of determining a partial plan termination.

The COVID-19 crisis has forced many employers to make difficult decisions that impact their workforce. This IRS guidance provides good news for employers who may have reduced their workforce but are considering or planning to bring employees back to work by the end of 2020. In some situations, employers may avoid a costly vesting event if they bring back employees to reduce the turnover rate to below 20%.

However, it is still critical to consider the surrounding facts and circumstances to determine whether a partial plan termination has occurred. A partial plan termination may still occur even if some employees are rehired by the end of 2020, if the reduction is part of a series of related severances over multiple years.

Conclusion

As the uncertainty surrounding COVID-19 continues, this IRS guidance provides some reassurance about the economic impact to employers considering or planning to bring back workers by the end of 2020. However, whether a partial plan termination, and a costly vesting event, occurs is still dependent on the facts and circumstances of each case.