COVID-19 has shaken up the benefits world in a big way – new laws, new issues.  One issue that has been around for a long time, but isn’t often on the front page, is the partial termination of a retirement plan. However, difficult financial times bring this issue to the forefront when companies are laying off employees, closing plants and downsizing.

When an employer sponsors a retirement plan for its eligible employees, the plan document often provides for a vesting schedule for employer contributions as an incentive to keep good employees.  The longer they work for the company, the more they move up the vesting schedule so that eventually (usually after no more than 6 years), they become fully vested in employer contributions.  Employer contributions may take the form of discretionary or nondiscretionary contributions.  Employers may also make matching contributions that are contingent on employees deferring part of their wages into the plan.  Employee contributions to an employer sponsored retirement plan are always 100% vested.  If an employee leaves after a few years of employment, he or she will be entitled to all of his/her salary deferral contributions plus earnings, rollover contributions and the vested portion of any employer contribution.  Seems simple enough.

However, when an employer experiences a reduction in force, the possibility of a partial termination must be considered.  What constitutes a partial termination is a facts and circumstances determination but generally, where there is a 20% reduction in force, it is likely that a partial termination has occurred. What this means is that all affected participants who are involuntarily terminated/laid off will become 100% vested in their employer contributions (rather than the portion vested under the terms of the plan).  This is important for plan sponsors to be aware of as layoffs occur for the failure to properly vest affected employees’ retirement benefits upon a partial termination could result in disqualification of the retirement plan (which comes with negative tax consequences for the employer as well as those employees who participate in the plan).

If your company is downsizing or terminating/laying off employees, now is the time to review the partial termination rules so that you are not caught with a disqualifying plan issue.