Pension Plan Terminations
June 02, 2020
In episode two of our conversation with Denise Finney, a partner in EisnerAmper’s Pension Services Group, she tells us about the pension plan termination process, possible unintended consequences for plan providers, tax implications, and advice to help mitigate risk when performing a full or partial plan termination.
DP: Let's pick it up from our last conversation. We could start with plan terminations. This sounds kind of nuclear option last resort. Tell us about plan termination.
DF: I guess it does sound drastic. However, there are numerous reasons why plan terminations occur and it could be voluntarily or involuntarily. Retirement plans are established with the intention to continue indefinitely. There are instances, though, where a business would need to voluntarily terminate a plan. For example, a company acquired another business that had its own 401k plan and the company just didn't want to maintain two separate plans. So they went ahead and terminated the acquired company is 401k plan. That would be a full termination. But in the last couple of months, we've been seeing an increase in partial plan terminations. For instance, an employer who laid off a substantial amount of their workforce due to COVID-19, they may have a partial plan termination and some employers don't realize that they've triggered this partial plan termination.
DP: Okay. So let's say you have a company that does a plan termination thinking that it's a good strategic cost cutting move, but there might be some unintended consequences there. Aren't there?
DF:Yeah. So if there's a full or partial plan termination, the effected participants, they become a hundred percent vested in their employer contributions, regardless of the plans vesting schedule. For example, based on years of service, a participant may be 60% vested, meaning they were entitled to 60% of their employer contribution account balance. However, when the full or partial plan termination occurred, really those affected participants are entitled to a hundred percent. Now a plan sponsor may be blindsided if the effected participants are improperly incurred forfeitures. Those participants are owed substantially, could be substantially, more benefits and really it's in the best interest of the plan sponsor the employer to identify these partial plan terminations as soon as practicable.
DP: Yeah. That sounds like it could be a really big hit to the employer. Talk to us a little bit about the calculation components.
DF:The calculation, it's really based on facts and circumstances, which can make it difficult to calculate whether or not there is a partial plan termination. The IRS has taken the position that if there's a 20% or greater turnover rate, the presumption is that the partial plan termination has occurred. However, voluntary terminations by employees are excluded from the turnover calculation. They're not considered employer initiated, but it's really up to the employer to prove that the employee voluntarily terminated. That evidence can be personnel files that show that the employee voluntarily terminated. And that's why it's so important for employers to keep and maintain good record. The turnover rate it's generally determined by dividing the number of participating employees who had employer initiated severance from employment by the sum of all participating employees. And we have to keep in mind that participants include employees who are eligible to participate regardless if they elect to defer or not. So you can see how some employers could unintentionally make an error here.
DP: Sure. And you know, as they say, timing is everything. So tell us a little bit about the timeline involved.
DF: Yeah. Another item to consider is that period covered. So generally the period of analysis is the plan year, but it can be longer, especially if there's a series of layoffs that extend beyond the plan year. An example of a calendar plan year, let's say, an employer had layoffs in December of 2019, and then they had additional layoffs March 2020, that in total they're 20% or more, they may have triggered a partial plan termination starting with those that were terminated in December of 2019, so even though those layoffs crossed over multiple plan years.
DP: The bottom line, Denise, for you as a pension plan expert, what actionable advice would you give to a client when it comes to plan terminations?
DF:Keep in mind that the IRS knows that plan sponsors do and can make errors with determining whether or not there is a partial plan termination, not providing a hundred percent vesting for those participants. And keep in mind that employers can expose themselves to these substantial tax consequences if the IRS decides to disqualify the plan for failure to identify a partial plan termination, and those tax consequences are for both the employer and employee, and also a participant could be owed more benefits if they improperly incurred forfeitures, because let's say the record keeper calculated less than a hundred percent vesting. That's why we recommend plan sponsors to communicate with their service providers, record keepers, plan auditors, so that they're aware of these potential items that occur like partial plan terminations. And definitely consult a ERISA counsel so they can help assist in actually doing the calculations, determining if this partial plan termination has occurred based on the facts and circumstances.
DP: Yeah. It sounds like one misstep and it could lead to a significant dollar impact. Denise, thanks for this valuable information.
DF:Thanks, Dave. I appreciate it.
DP: And thank you for listening to the EisnerAmper podcast series. Join us next time when we continue our discussion with Denise on the distribution of funds from plans.