A recent IRS revenue ruling clarifies that when the sponsor of a retirement plan takes action that results in a turnover rate of 20% or more in the number of participants in a qualified retirement plan there is a presumption that there has been a “partial termination” of the plan. As a result, participants affected by the action must be 100% vested in their plan benefits. The turnover rate is determined by dividing the number of participating employees affected (generally, those terminated by the employer’s action, usually during the plan year of the action) by the sum of the number of participating employees as of the beginning of the period and employees who were added as participants during the period. The relevant period can extend beyond one plan year if a series of employment terminations are related.
This situation most often arises when an employer sells a portion of a business or closes one of its facilities. Various courts have expressed differing views on how to determine whether a partial termination has occurred. For example, some courts have opined that the determination is based on only non-vested participants while others based it on all participants, whether vested or non-vested. The IRS makes clear that the determination is based on all participating employees, both vested and non-vested. The IRS also makes clear that it does not matter whether the employer-initiated action is due to events outside the employer’s control, such as a downturn in the economy. However, the revenue ruling includes qualified exceptions when terminations are voluntary or turnover is “routine.”
Note that a partial termination also may occur when a plan amendment excludes a group of employees who previously were covered. One additional important note on defined benefit pension plans is that full vesting is required upon a partial termination only “to the extent funded.” Thus, in general, if an event occurs and otherwise appears to be a partial termination, but the plan is not fully funded (i.e., all benefits could not be immediately paid out if the plan terminated), full vesting is not required.
This revenue ruling clarifies the IRS position (notwithstanding differing court opinions) and highlights the importance of qualified plan sponsors carefully considering whether a partial termination has occurred whenever there is a notable reduction in the number of participants in the plan.