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Partial Termination - 100% Vesting Question


MarZDoates
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A plan sponsor lost a "large contract" in September, 2016, which has caused the dismissal of a significant portion of their workforce.  Let's say that more than 20% of the workforce terminated October 1, 2016.  We know that a partial plan termination has occurred.  We know we have to fully vest those affected.

Question:  Who is considered "affected"?  This is what we found in one research resource: 

"...all employees who experienced severance from employment during the applicable period should be made fully vested, including those whose terminations were voluntary.  The applicable period is the plan year."

Does this mean that if a participant terminated voluntarily in March, 2016 that was NOT fully vested needs to be made 100% vested? 

This participant took a distribution prior to knowing of the partial termination. The non-vested portion was forfeited (and subsequently used to reduce 2017 contribution).  Do we need to restore the forfeitures?

Thanks in advance for any input!

 


 

QPA, QKA

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16 minutes ago, MarZDoates said:

Does this mean that if a participant terminated voluntarily in March, 2016 that was NOT fully vested needs to be made 100% vested? 

Yes, that's exactly what that means. And no, that doesn't make any sense. And yes, you need to restore the forfeitures (plus earnings).

The IRS believes that employees who terminate during the applicable period must be 100% vested, even if that termination was voluntary. They state the following in their online FAQ (linked below): "An affected employee in a partial termination is generally anyone who left employment for any reason during the plan year in which the partial termination occurred and who still has an account balance under the plan."

https://www.irs.gov/retirement-plans/retirement-plan-faqs-regarding-partial-plan-termination

It doesn't make sense that voluntarily terminated employees would have to be fully vested due to a partial plan termination.  That seems at odds with the intent of the partial plan termination rules, especially since you don't count such employees to determine whether there has been a partial plan termination in the first place (see the following, excerpted from the exact same IRS FAQ linked above):

"Do employees who voluntarily quit count for purposes of determining a partial termination?

Generally, voluntary terminations do not count in determining whether a partial termination has occurred as they do for determining who must vest after partial termination. However, in some cases employees who appear to terminate employment voluntarily have been found to have terminated involuntarily under a constructive discharge theory. The employer's intent, working conditions and the reasonably foreseeable impact of the employer's conduct on the employees are factors in evaluating a constructive discharge."

IRS Revenue Ruling 2007-43 states, "If a partial termination occurs on account of turnover during an applicable period, all participating employees who had a severance from employment during the period must be fully vested in their accrued benefits, to the extent funded on that date, or in the amounts credited to their accounts."

The IRS is actively enforcing this position. See the 2016-11 issue of Employee Plans News (linked below) describing the EPCU project that contacted over 2,000 Form 5500 filers asking questions about potential partial plan terminations:

"In almost 10% of the cases, it was determined during the compliance check that a partial termination had occurred and affected participants had not been fully vested. In most of these cases forfeitures were reinstated. In a few of these cases, it was not necessary to reinstate the forfeitures for some or all of the affected employees because no distributions had as yet been made. In these cases the vesting percentages were corrected. The amount of forfeitures plus interest that was reinstated for cases with forfeitures totaled $2,208,678."

https://www.irs.gov/retirement-plans/employee-plans-compliance-unit-epcu-completed-projects-with-summary-reports-partial-termination-partial-vesting

 

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Let's acknowledge some possible variation.  Start with the presumption that all those terminated during the time period (which may cross into a subsequent plan year, depending on facts and circumstances) are those "affected".  Then the sponsor has the right to review and determine if some of them are not affected due to those F&C (for example, an employee death).

Next comes the documentation: as mentioned other times, it is advisable to amend the plan to document the 100% vesting, so it's in writing.

Finally, I strongly suggest you review prior discussions by searching the Defined Benefit message board; go to the top and click on "Forums (Message Boards)".  Your search term will be "partial termination" or "affected".

I'm a retirement actuary. Nothing about my comments is intended or should be construed as investment, tax, legal or accounting advice. Occasionally, but not all the time, it might be reasonable to interpret my comments as actuarial or consulting advice.

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2 hours ago, david rigby said:

Let's acknowledge some possible variation.  Start with the presumption that all those terminated during the time period (which may cross into a subsequent plan year, depending on facts and circumstances) are those "affected".  Then the sponsor has the right to review and determine if some of them are not affected due to those F&C (for example, an employee death).

David, can you please clarify your comment to the effect that a plan sponsor has the right to determine that some participants would not be affected due to F&C? IRS Revenue Ruling 2007-43 states:

"All participating employees are taken into account in calculating the turnover rate, including vested as well as nonvested participating employees. Employer-initiated severance from employment generally includes any severance from employment other than a severance that is on account of death, disability, or retirement on or after normal retirement age. An employee’s severance from employment is employer-initiated even if caused by an event outside of the employer’s control, such as severance due to depressed economic conditions. In certain situations, the employer may be able to verify that an employee’s severance was not employer-initiated. A claim that a severance from employment was purely voluntary can be supported through items such as information from personnel files, employee statements, and other corporate records.

Employees who have had a severance from employment with the employer maintaining the plan on account of a transfer to a different controlled group are not considered as having a severance from employment for purposes of calculating the turnover rate if those employees continue to be covered by a plan that is a continuation of the plan under which they were previously covered (i.e., if a portion of the plan covering those employees was spun off from the plan in accordance with the rules of § 414(l) and will continue to be maintained by the new employer).

Whether or not a partial termination of a qualified plan occurs on account of participant turnover (and the time of such event) depends on all the facts and circumstances in a particular case. Facts and circumstances indicating that the turnover rate for an applicable period is routine for the employer favor a finding that there is no partial termination for that applicable period. For this purpose, information as to the turnover rate in other periods and the extent to which terminated employees were actually replaced, whether the new employees performed the same functions, had the same job classification or title, and received comparable compensation are relevant to determining whether the turnover is routine for the employer. Thus, there are a number of factors that are relevant to determining whether a partial termination has occurred as a result of turnover, both in the case where a partial termination is presumed to have occurred due to the turnover rate being at least 20 percent and in the case where the turnover rate is less than 20 percent."

These paragraphs are discussing how the turnover rate is calculated, and the turnover rate is relevant to the analysis of whether a partial plan termination has occurred.  However, while an employer can argue F&C to reduce the turnover rate in an attempt to avoid a determination that there has been a partial plan termination, once it has been determined that there has in fact been a partial plan termination, the Revenue Ruling clearly states that all participants who terminated during the applicable period must be 100% vested:

"If a partial termination occurs on account of turnover during an applicable period, all participating employees who had a severance from employment during the period must be fully vested in their accrued benefits, to the extent funded on that date, or in the amounts credited to their accounts."

https://www.irs.gov/irb/2007-28_IRB/ar08.html

In other words, F&C only allow you to avoid a partial plan termination determination; F&C don't allow you to avoid fully vesting all participants with account balances/accrued benefits under the plan who terminated during the applicable period of the partial plan termination.

For the record, I do not agree with the IRS' interpretation of the partial plan termination rules and who constitutes an "affected" employee for purposes of the full vesting requirement imposed under Treas. Reg. Sec. 1.411(d)-2(b)(1). Nonetheless, this is the official IRS position on full vesting for affected employees, and it is on the lookout for plans that don't fully vest all plan participants who terminated during the applicable period of a partial plan termination. FWIW, there's a comment in the ERISA Outline Book mentioning that employers have found that the cost of fighting the IRS on this issue is not worth it.

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In the above cited IRS FAQ:  "An affected employee in a partial termination is generally anyone who left employment for any reason during the plan year in which the partial termination occurred and who still has an account balance under the plan."

If the remainder of the account was properly forfeited (When do forfeitures occur according to the Plan?), I think it would be reasonable to call the paid-out terminee as un-affected.

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Chip Brown, I agree with your comment, this will typically be the case in a well drafted Plan that participants whose accounts were forfeited (including 0% vested deemed cash-outs) would not have to be vested in a subsequent partial plan termination.  The original question dealt with this scenario where the terminated participant had already taken a distribution so I think Chip's comment answers the question.

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  • 4 weeks later...
On ‎5‎/‎25‎/‎2017 at 3:13 PM, imchipbrown said:

In the above cited IRS FAQ:  "An affected employee in a partial termination is generally anyone who left employment for any reason during the plan year in which the partial termination occurred and who still has an account balance under the plan."

If the remainder of the account was properly forfeited (When do forfeitures occur according to the Plan?), I think it would be reasonable to call the paid-out terminee as un-affected.

Chip: The account balance reference in the guidance is important, but applying that guidance to the original question here does not result in the paid-out terminee being unaffected - it's exactly the opposite.

Linda: Chip's comment does not answer the original question, because the terminated participant still had an account balance at the beginning of the "applicable period."

The problem here is not paid-out terminees who received their partially vested distributions from the plan prior to the applicable period of the partial termination (and therefore did not have an account balance under the plan during the applicable period), the problem is paid-out terminees who received their partially vested distributions from the plan during the applicable period.

Because the original question dealt with a scenario where the actual event that gave rise to the partial termination occurred September 2016, and the "applicable period" for the partial termination was the plan year (presumably calendar year 2016), the participant who terminated in March 2016 and took a partially vested distribution prior to the September 2016 event is an affected employee (according to the IRS guidance), and therefore (according to the IRS guidance) must be fully vested and receive a corrective distribution for the previously forfeited amount of his or her account balance.

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