Partial Plan Terminations – An Update

In our April 2020 post, we detailed how employee layoffs can cause a qualified retirement plan to undergo a “partial termination,” resulting in required 100% vesting of the affected employees’ benefits. As 2020 drew to a close, with the COVID-19 pandemic continuing to affect many businesses, Congress enacted a special rule on partial terminations as part of the Consolidated Appropriations Act. The special rule is protective of employers, partly because it makes it more difficult to trigger a partial termination during certain years, but primarily because it gives employers certainty that no partial termination has occurred if a special test is met.

The usual tests for a partial termination are based on facts and circumstances but include a rebuttable presumption of partial termination if the employer has turnover of 20% or more during a plan year. The special rule provides relief for employers that prevents the occurrence of a partial termination during certain plan years if the number of active plan participants decreases by no more than 20% during a period of roughly one year from the onset of the pandemic. It reads in full as follows:

A plan shall not be treated as having a partial termination (within the meaning of 411(d)(3) of the Internal Revenue Code of 1986) during any plan year which includes the period beginning on March 13, 2020, and ending on March 31, 2021, if the number of active participants covered by the plan on March 31, 2021 is at least 80 percent of the number of active participants covered by the plan on March 13, 2020.

Unlike the rebuttable presumption under the normal rules, the special rule establishes a conclusive presumption of no partial termination based on a 20% or less net decrease in active plan participants during the March 13, 2020 to March 31, 2021 period, regardless of the total turnover an employer may experience during any plan year that includes this period.

The special rule has several surprising features. If the rule is read literally, rather than by reference to the likely policy objectives, it can prevent a plan from having a partial termination in any plan year that begins or ends between March 13, 2020 and March 31, 2021, even if the employer has major layoffs outside that period but during the plan year. For example, a calendar year plan of an employer that laid off 50% of its workforce in January 2020 and then satisfied the 80% test with the remaining employees during the March 13, 2020 to March 31, 2021 period would not have a partial termination during 2020. Similarly, a calendar year plan of an employer that lays off 50% of its workforce in April 2021 but satisfied the 80% test during the March 13, 2020 to March 31, 2021 period would not have a partial termination during 2021.

The special rule also encourages an employer that has implemented significant layoffs during 2020 or early 2021 to wait until March 31, 2021 before it can determine whether its plan has had a partial termination. Accordingly, even if an employer lays off 50% of its workforce at some point during the March 13, 2020 to March 31, 2021 period, it will not know until March 31, 2021 whether the number of active participants covered by the plan on that date is less than 80% of the number of active participants covered by the plan on March 13, 2020. If the employer laid off 50% of its workforce in April 2020, for example, the employer will not be obligated to vest the affected participants until March 31, 2021, because the employer might still hire enough employees – who need not be the same employees who were terminated – to meet the 80% test. Terminated participants who may wish to take a distribution or roll over their benefits may not know for some time whether their benefits will be fully vested.

These possibly counterintuitive results, far from contrasting with the normal rules for partial terminations, underscore key features of those rules. Just as the special rule makes it impossible for an employer to tell at the time of a layoff whether the layoff will result in a partial termination, so under the normal rules an employer may not know until months after a layoff whether the layoff created sufficient turnover to trigger a partial termination. The key difference is that the special rule can provide certainty that no partial termination has occurred if the net decrease in active participants for the March 13, 2020 to March 31, 2021 period is sufficiently low, providing a hard and fast test in an area that is normally evaluated on a facts-and-circumstances basis.

Moreover, just as the special rule is indifferent to whether the active participants as of March 31, 2021 are the same people as the active participants as of March 13, 2020, so under the normal rules employee turnover is based on an impersonal numerical formula – participating employees who have employer-initiated severances in the applicable period (and who were not rehired during the period) divided by the sum of participating employees at the start of the applicable period and employees who become participants during the applicable period. Under the normal rules, new hires push down the turnover rate, even though hiring new employees does not cause participants affected by a layoff to be any less affected. The 80% test is simpler, being based solely on active participant numbers at the beginning and end of the March 13, 2020 to March 31, 2021 period. The key difference, again, is that the special rule provides a per se test that can prevent the occurrence of a partial termination even where a partial termination would otherwise be unavoidable based on facts and circumstances.

IRS guidance on the application of the special rule, including in situations where a plan sponsor fully vested the benefits of participants affected by a layoff based on the occurrence of a partial termination before the enactment of the Consolidated Appropriations Act, would be helpful. We will provide a further update on the issuance of any such guidance. In the meantime, plan sponsors that implement significant layoffs during any plan year that includes the period beginning on March 13, 2020 and ending on March 31, 2021 should consult a professional adviser to evaluate whether and when the benefits of affected participants may need to become fully vested.