Skip to content

Insights

The Basics of Partial Plan Terminations

There is no doubt that the past few years have been challenging for the U.S. economy, particularly the labor market. Many layoffs resulted from the pandemic; however, various other corporate events (e.g., plant closings, bankruptcy, insolvency, going out of business, changes in ownership, mergers, and/or acquisitions) can also cause significant workforce reductions. Plan sponsors of 401(k) plans must be aware that some “normal” employer actions, whether intentional or unintentional, may result in what is known as a partial plan termination.

What is a Partial Plan Termination?

According to the IRS, a partial plan termination occurs when more than 20% of the total plan participants were laid off in a particular year. Normally, when a participant terminates employment, he/she is entitled only to the vested amount(s) in their employer contribution account(s). However, in a partial plan termination, all contributions become vested at 100% immediately. All employees that terminated service during the year for any reason and had an account balance with the plan become fully vested in all employer contributions regardless of the plan’s vesting schedule(s). Note that if a plan does not offer employer contributions or does not impose a vesting schedule on employer contributions, incurring a partial plan termination will not have any effect on the plan.

How is a Partial Plan Termination Determined?

The 20% turnover rate associated with a partial plan termination is generally calculated by dividing the number of involuntary terminations (due to, say, one of the corporate events discussed previously) by the total of all participating/newly participating employees during the applicable period. The size of a company does not impact the determination of a partial plan termination.

What are the Exceptions to the Normal Partial Plan Termination Rules?

There are a few situations where the partial plan termination rules would not apply. The most common is when employees transfer from one entity of a legally related group to another, provided they are covered under a plan at the new employer. Partial plan terminations also do not typically apply to businesses that experience employee turnover on a routine basis, such as those that hire seasonal employees. However, those companies must be able to provide adequate supporting documentation of the routine turnover (e.g., human resources records and employee statements).

What if a Partial Plan Termination Has Occurred?

If it is determined that a plan incurred a partial plan termination, all participants who terminated employment in the applicable year will be 100% immediately vested. If any of those participants already took a full distribution of their account, the funds previously forfeited will be restored to make their account balance whole. For participants who have not yet taken a distribution, no further action is necessary. Their employer contributions will remain in their account as 100% vested. If they decide to take a distribution at any point after the partial plan termination, they will be able to withdraw the full amount, including the 100% vested funds. If it is concluded that a plan has not experienced a partial plan termination, no action is needed.

Which Participants Must Be 100% Vested?

If a plan has experienced a partial plan termination, the participants affected by the partial plan termination must get accelerated vesting. This includes participants who left employment for any reason during the period in which the partial termination occurred, and/or still have account balances under the plan on the date the partial plan termination occurred.

What are the Next Steps if a Partial Plan Termination is Thought to Have Occurred?

Because there are many factors that can impact whether a partial plan termination occurred, and all the facts and circumstances must be considered, plan sponsors should consult with legal or tax advisors who can make a legal determination.

Plan sponsors should also ​communicate with their plan administrators after major personnel changes. Plan administrators are generally not actively asking about layoffs, terminations, furloughs, etc., so they may not be aware that a “triggering” event has occurred.

Please contact us if you have questions about the information outlined above; our seasoned and experienced employee benefit plan professionals are here to help. You can also learn more on our Employee Benefit Plan services page.

About the Author

Steph Kramer

Steph joined McKonly & Asbury in 2016 and is currently a Manager in the firm’s Audit & Assurance Segment. Steph audits a broad spectrum of employee benefit plans, including 401(k), 403(b), retirement, profit sharing, health and… Read more

Related Services

Subscribe to Our Newsletter

Contact Us