Employee turnover can trigger partial termination of plan, IRS official notes

Employee turnover caused by adverse economic conditions or employer-initiated actions can trigger a partial termination of a retirement plan, Employee Plans (EP) Specialist Lori Rider said at a May, 2014 at an IRS EP phone forum. As a consequence, the employer must fully vest affected employees in their plan benefits, Rider said. This includes returning improper forfeitures and making affected participants whole, she noted.

A partial termination can be caused by a significant corporate event, such as the closing of a plant or division, or can result from an amendment to the plan that excludes employees or adversely affects the vesting of benefits, Rider said. This includes a decrease in future accruals that could result in a potential reversion of plan assets to the employer. However, a partial termination does not result from a plan merger or conversion to another type of plan, she indicated, because all employees remain covered under the plan, the plan assets and liabilities retain the attributes of the initial plan, and the vesting requirements do not change.

In Rev. Rul. 2007-43, the IRS indicated that a turnover rate of participants of at least 20% will trigger a partial termination, Rider said. In Halliburton Co. v. Commissioner, 100 TC 216, she noted that the Tax Court concluded that a rate of less than 20% could be a partial termination if “accompanied by egregious abuse on the part of the employer.”

Under the 2007 ruling, a plan’s turnover rate is determined by dividing the number of participants who had an “employer-initiated severance” from employment during the “applicable period” by the sum of all plan participants at the start of the period, plus employees who joined the plan during the period. An employer-initiated severance includes any severance from employment other than death, disability or retirement after normal retirement age. It can include an event outside of the employer’s control, such as a fire that destroys a plant, if the employer decides not to rebuild the plant.

Voluntary terminations do not count toward the determination, unless there is a constructive discharge where the employer makes it difficult for the employee to continue working, Rider said. Transfers within a controlled group are not severance from employment. The applicable period depends on the facts and circumstances, she noted. Normally, it is the twelve-month plan year, but if a plan year is shorter than 12 months, it includes the immediately preceding plan year.

When a plan is terminated, plan assets must be distributed as soon as administratively feasible, Rider stated. As a rule of thumb, this must occur within 12 months following the date of termination. If the plan does not have an annuity option, the employer may distribute the account balance in a lump sum without the participant’s consent.

Acting Director for EP Examinations Thomas Petit explained that, when a plan terminates, the date of termination must be set; the participants’ benefits must be determined up to the date of termination; and all plan assets must be distributed according to the plan and as soon as administratively feasible, generally within one year. The IRS has certain concerns upon a plan termination:

• Was there accelerated vesting of benefits?
• Were accrual requirements and funding obligations met?
• Will any assets revert to the employer (subjecting them to a 20% excise tax as well as income tax)?
• Did the plan continue to satisfy the requirements under Code Sec. 401(a)(1)?

Plan terms must permit a reversion, or else surplus assets cannot revert to the employer, Rider said. An overfunded defined contribution plan can only have a reversion if the amount in a suspense account cannot be allocated because of limits on plan benefits under Code Sec. 415(c). In the event of a reversion, the employer must file Form 5330 and pay the excise tax by the last day of the month following the month of the reversion, she said.

Source: IRS EP phone forum, May, 2014.

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