Partial Plan Termination Relief Explained

There is a lot to unpack in the recently passed COVID relief legislation, but the most significant element for plan sponsors impacted by the COVID-19 pandemic may well be the “temporary rule preventing partial plan termination.” Here’s what it means for you—and your plan sponsor clients.

What is a partial plan termination?

The determination of whether a partial plan termination has occurred is based on facts and circumstances, but as a general rule the IRS has said that a more than 20% reduction in the number of covered participants during a plan year is considered a partial plan termination.

Why does that matter?

In the case of a partial plan termination, impacted participants (those who lose their jobs) are immediately 100% vested in their accounts.

Can you give me an example?

Employer ABC, a restaurant, has a calendar year 401(k) plan with 20 participants as of Jan. 1, 2020. Due to the pandemic, the workforce as of Dec. 31, 2020, was reduced to just five participants who assist with to-go orders. ABC expects to rehire those individuals once the restaurant is allowed to open to full capacity. 

Under rules before the enactment of the new law, a partial plan termination has occurred because of the reduction in the workforce and therefore, those participants who were laid-off must be fully vested in the part of their accounts attributable to employer contributions (including earnings on those contributions). 

What’s changed?

With so many businesses suffering economic loss as a result of the COVID-19 pandemic, the Consolidated Appropriations Act, 2021, which was signed into law on Dec. 27, 2020, includes a temporary rule preventing certain partial plan terminations (Division EE – Taxpayer and Certainty Disaster Tax Relief Act of 2020, Title II, Section 209). Concerned that temporary economic disruptions might result in permanent displacement of retirement savings, and even actual plan terminations, the American Retirement Association has been a strong and leading advocate for the inclusion of this provision. Specifically, it says:

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.  

What does this mean?

The legislation was designed to acknowledge that an employer might need to layoff a significant percentage of its staff for a brief period, but plan to rehire/restore that staffing once the economic crisis passed. Because of the new legislation, there would be no partial plan termination if the active participant count as of March 31, 2021, is at least 80% of the active participant count on March 13, 2020 (the date the national emergency was declared). 

Is this relief available only for calendar year plans?

No. The relief applies for “any plan year which includes” the covered period. The intention of the provision is to provide relief for the 2020 plan year by allowing an employer to wait until March 31, 2021, to determine whether there has been a partial plan termination for 2020. 

An example: Assume the same facts as above (ABC had 20 participants as of January 1, 2020, and it was reduced to 5 as of December 31, 2020). ABC’s business picks back up and ABC rehires 12 of the previously laid-off employees before March 31, 2021. ABC now has 17 participants on March 31, 2021 (85% of the amount on March 13, 2020), and therefore there would be no partial plan termination for 2020 based on the relief in the Consolidated Appropriations Act, 2021.

Does the employer have to rehire the same individuals that were laid off?

No. The percentage is based on the total number of participants, thus the 80% does not have to be comprised of the same participants that were initially terminated. However, the terms of the plan matter.

The new relief is based on 80% of the “active participants.” If the 12 employees mentioned above are new hires, not rehires (e.g., the laid-off employees had already found other jobs), the answer would depend on the eligibility conditions of the plan. If there are no eligibility conditions and the new employees enter the plan on their date of hire, then there would be no partial termination in 2020 because the 80% threshold is satisfied, even though the participants are different. However, if the plan has eligibility conditions (such as a 30-day service requirement), then it depends on whether a sufficient percentage of the new hires have actually become participants (not just employees) on or before March 31, 2021. 

What about changes to employment status outside of the specified time period(s)?

It is not yet clear whether the new provision applies to employment changes that are outside of the covered period (March 13, 2020 – March 31, 2021). However, the relief was intended to be pandemic relief so it would be reasonable to assume the relief does not apply to events that occur outside of the timeframe.

What if a partial plan termination has been determined, but then is found not to apply under the terms of the relief?

In view of the continued economic uncertainty, it is possible that a determination of a partial plan termination could be made, benefits may or may not have already been distributed based on that initial determination, and subsequently it is determined that, under the relief, there is no partial termination. 

Here a couple of the potential issues/questions that we have already identified (and the questions that arise) on which the American Retirement Association will be seeking guidance from the Treasury and IRS.

Possible Scenario #1: Employer EFG laid-off more than 20% of its workforce during 2020. EFG’s plan permits distributions on termination of employment and many employees elected to receive a distribution. EFG determined there was a partial plan termination, and thus paid the laid-off workers their fully vested accounts. 

However, as of March 31, 2021, EFG rehires enough employees to avoid a partial plan termination for 2020. This means there was an overpayment to those who elected to receive a distribution, and likely communications to those who did not elect a distribution that they became fully vested. 

Question(s): Was there an overpayment to those who elected to receive a distribution? And for those participants who did not receive a distribution, is it permissible to subject their accounts to a vesting schedule? If distributions were previously made, we believe they were made in accordance with the law that existed at the times so there was no overpayment. For those that were not paid out, we believe based on the effective date of the provision that the plan sponsor could reasonably determine that there was no partial plan termination and therefore the vesting schedules could retroactively be reapplied. Or, alternatively, could the employer ignore the new provision and continue to fully vest the affected participants? We believe the intention of the statute is that this is permissible, and an employer could be more conservative by amending the plan, if necessary, to apply the partial plan termination rules without regard to the new statutory provision.

Possible Scenario #2: Employer LMN laid-off more than 20% of its workforce during 2020. LMN’s calendar year plan permits distributions within a reasonable period after the end of the plan year in which employment was terminated. Many employees who terminated employment earlier in the year are waiting to receive their distributions. 

Question(s): Once 2020 has ended, can LMN wait until after March 31, 2021, to pay benefits in order to determine if there has been a partial termination? What someone considers to be a “reasonable” period of time after the end of the plan would be a subjective determination. But if there is a concern, the plan might pay just the vested benefits until a determination is made on whether there has been a partial plan termination. If it is determined that there is a partial plan termination, then the plan would need to make another distribution to the affected individuals.

As these examples illustrate, implementation of the new partial plan termination rule may generate some challenges. The American Retirement Association has been a leading advocate for this provision on the Hill and our work will continue with the Treasury and IRS to address these concerns during implementation. Nevertheless, the temporary relief will likely be welcome news to many plan sponsors who might otherwise have a partial plan termination.    

If you have additional questions regarding this relief or its implementation, you can reach out to us at https://www.research.net/r/partialterm.