Workforce Reductions and Partial Termination Rules for Qualified Retirement Plans

An employer that experiences a decline in its workforce should consider whether the reduction in the number of its employees obligates the employer to accelerate vesting under affected qualified retirement plans. A qualified plan generally must grant full vesting to employees who are “affected” by a workforce reduction large enough to qualify as a “partial termination.”

What is a Partial Termination?

There are a variety of circumstances which can cause a partial termination. This newsletter focuses on partial terminations triggered by a significant reduction in plan participation as a result of employer-initiated terminations, such as reductions in force due to a company’s closure of its plants or facilities. An employer seeking to determine whether a partial termination has occurred must consider all the facts and circumstances. The following, however, are key factors when deciding whether a workforce reduction has triggered a partial termination:

  • Significant Reduction in Participation. The IRS (in Revenue Ruling 2007-43) takes the position that a 20% “turnover rate” (i.e., a 20% or greater reduction in plan participation) generally is considered “significant” enough to cause a partial termination. The IRS also has ruled that the turnover rate must be determined by dividing (i) the number of participating employees who incurred an employer-initiated severance from employment during the partial termination measuring period (see below) by (ii) the sum of all participating employees at the beginning of that period and those individuals who became participating employees during that period.
    • Employers must remember that the IRS considers a person to be a “participating employee” for this purpose if he/she is eligible to participate, even if he/she has not enrolled, and regardless of whether he/she is already vested. For example, an employee who is eligible to make elective deferrals to a 401(k) plan must be counted, even if he/she has never deferred.
    • The 20% threshold is a guideline rather than an absolute rule.
      • The IRS presumes that a plan with a 20% turnover rate has experienced a partial termination, but the employer can rebut this presumption. For example, an employer may demonstrate that it routinely experiences high turnover. As the IRS has explained, “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.” 
      • Conversely, it is possible that the IRS or a participant might assert that a partial termination has occurred even if the turnover rate has not crossed the 20% threshold.
      • Courts have declined to adopt the IRS’ 20% threshold, or even its calculation methodology, as hard and fast rules. The Seventh Circuit ruled in Matz v. Household International Tax Reduction Investment Plan that a conclusive presumption that a partial termination did not occur applies to turnover rates below 10%, and a conclusive presumption that one did occur applies to turnover rates above 40%, but those rules have not been adopted by the IRS or other courts.
      • Nonetheless, the safest approach is to follow the IRS guidelines. Taking an alternate approach puts the employer at risk of an adverse court determination if a participant sues, and it risks financial penalties and even plan disqualification if the IRS audits the plan.
  • Employer-Initiated Terminations. Only involuntary terminations other than death, disability, or retirement (on or after normal retirement age) are used to determine the number of employer-initiated terminations counted in item (i) of the turnover rate calculation.
    • Terminations are employer-initiated even if caused by circumstances outside the employer’s control, such as depressed economic conditions. The IRS did not provide an exception for circumstances in which an employee is fired for cause, although it is possible that a need to terminate certain employees for cause could be a relevant “fact and circumstance” taken into account when assessing whether the employer can rebut the partial termination presumption triggered by a 20% turnover rate. 
    • A “constructive discharge” (i.e., a termination that may technically have been a resignation initiated by the employee, but that resulted from a situation created by the employer that gave rise to the employee’s decision to leave, such as the creation of a hostile work environment or circumstances that made it impossible for the employee to perform his or her responsibilities, or an announcement of an impending termination of the employee’s position that leads the employee to preemptively resign) is considered an involuntary termination. The IRS’ website explains that, “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.”
    • It is the employer’s responsibility to maintain documentation that a termination is not “employer-initiated.” In the absence of evidence to the contrary, the IRS will assume that an employee’s termination was involuntary.
    • Employees are not treated as having incurred an employer-initiated termination if their portion of the plan is spun off and continues to cover them. For example, if an employer sells a subsidiary and spins off the portion of the plan covering the subsidiary’s employees so that they will continue to participate after the subsidiary changes ownership, their terminations will not cause a partial termination.
  • Partial Termination Measuring Period. The partial termination measuring period is generally the plan year (or the plan year plus the prior plan year, in the case of a short plan year). The period can be longer if there is a series of related workforce reduction events.
    • For example, if an employer undergoes two waves of downsizing in two different years, but both are connected to the same business transaction, or to the same set of economic difficulties, the employer generally will need to conduct a partial termination analysis based on all of the affected plan years.
    • Courts have historically included only the employer-initiated terminations linked to the related downsizing events in these multi-year computations, but the IRS has not issued clear guidance on this specific issue.
    • An employer that needs to aggregate multiple years should remember to check each year separately as well.


Consequences of a Partial Termination

If a partial termination occurs, all “affected participants” must become 100% vested in their benefits. (Defined benefit plans are required to provide full vesting only to the extent that benefits are funded.) Non-affected participants continue to be subject to the plan’s normal vesting provisions. 

In Revenue Ruling 2007-43, the IRS said that “all participating employees who had a severance from employment during the [partial termination measuring period] must be fully vested in their accrued benefits, to the extent funded on that date, or in the amounts credited to their accounts.” In an FAQ posted on its website, the IRS provided additional clarification, saying that, “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. Some plans wait until an employee has 5 consecutive 1-year breaks in service before he forfeits their non-vested account balance. For these plans, employees who left during the plan year of the partial termination and who have not had 5 consecutive 1-year breaks in service are affected employees.” 

This is broad language and does not limit the vesting obligation to those employees who experience involuntary, employer-initiated terminations. For partial termination measuring periods extending over multiple years, it is particularly significant that the IRS did not limit the obligations to individuals terminated in connection with the related downsizing events.

What to Do:    

  • If you are in the process of downsizing, closing facilities, or both, you should carefully monitor your turnover rate. Remember to keep track from year to year if your downsizing will extend beyond the end of the first plan year. 
  • If it is not clear whether a partial termination has occurred, you can seek a ruling from the IRS.
  • Once a partial termination occurs, take prompt action to vest affected participants as required, and to restore previously forfeited benefits for affected participants whose benefits were forfeited prior to the point that a partial termination was identified as having occurred. This is important to protect you against liability to participants for improperly forfeited benefits and against the imposition of sanctions by the IRS, and to protect your plan against disqualification. If you have a defined benefit plan, talk with your actuary about the extent to which the plan is sufficiently funded to trigger your vesting obligation.


If you have any questions or concerns, or if your company is downsizing or considering downsizing and you would like assistance in determining if a partial termination has occurred or is likely, please contact a member of the Employee Benefits and Executive Compensation Practice Group.

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Paul W. Holloway

Health and Welfare
Thomas J. Hurley
John W. Brill

Leslie E. DesMarteau
Lisa G. Pelta
Joseph E. Simpson

Annisa G. Chaudari
Josh Gmerek

Benefits Litigation
Erika N. D. Stanat

Mark R. Wilson

Executive Compensation
Christopher M. Potash

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