The 401(k) Partial Termination Rule: Have You Invoked It?



Navigating the pandemic continues to force companies to make tough choices, including temporarily or permanently reducing the workforce. Plan sponsors need to assess the ramifications for 401(k) plans.

 Understanding the IRS Partial Termination Rule

The Society for Human Resource Management (SHRM) is alerting plan sponsors that employee lay-offs can lead to unexpected costs. To avoid surprises—and the violation of regulations—It is critical to understand the partial termination rule. As SHRM explains:

In Revenue Ruling 2007-43, the IRS held that a 20 percent or greater employee turnover rate among retirement plan participants over a single year creates a presumption of a partial plan termination.

Because of the partial termination rules, at the end of the plan year, employers could find that funds are owed to employees who were let go. Here is IRS guidance on partial plan termination:

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.

 The law requires all affected employees” to be fully vested in their account balance as of the date of a full or partial plan termination. They must become 100% vested in all employer contributions (including matching contributions) regardless of the plans vesting schedule. Employee salary deferrals are always 100% vested.

Precautionary Advice for Plan Sponsors

As you navigate changing dynamics, remember, that at all times, you are still required to have an ERISA fidelity bond to protect the participants of your plan. However, the ERISA bond does not cover YOU as the fiduciary. That’s why Colonial Surety Company, a leading provider of ERISA bonds, strongly recommends you invest in fiduciary liability insurance—and makes it easy and affordable for you to do so. At Colonial, you can package fiduciary liability insurance with your ERISA bond. Fiduciary liability insurance provides you with personal protection, as well as a discount on ERISA coverage.

Protect yourself and your plan: Obtain your ERISA Bond Package Now.

Keep In Mind

SHRM reminds plan sponsors that the 20% turnover rate established by the IRS is a rebuttable presumption. Accordingly, if your company has previously had a pattern of high employee turnover, you may be able to demonstrate that your “over 20%” rate is routine.

Additionally, under the  Coronavirus Aid, Relief, and Economic Security (CARES )Act, employers who terminated employees because of COVID-19, but rehire them prior to the end of 2020, may not be subject to the partial termination rule. However, employers who have furloughed rather than terminated employees, may be subject to penalties related to the Affordable Care Act (ACA). (Read the full SHRM article here.)

If You Had a Partial Termination…

As a plan sponsor, if you determine that you did in fact have a partial plan termination, you must accelerate the vesting of the impacted participants. If you believe you have incurred a vesting failure, the IRS advices using the Voluntary Correction Program. As the IRS explains:

An employer who partially terminates a plan must determine which participants require an acceleration of vesting due to the partial termination. Participants who improperly incurred forfeitures are owed more benefits. To the extent those forfeitures have been distributed to other participants and cannot be recovered, the employer will be responsible for making the affected participants whole. This vesting failure can be corrected using the Voluntary Correction Program.

Don’t Forget These Fundamentals

With so many new challenges to attend to, don’t neglect the ERISA requirements for your plan. Let Colonial Surety Company help you.

Colonial is a leading provider of ERISA fidelity bonds, which ensure your retirement or benefit plan is U.S. Department of Labor compliant with ERISA bonding requirements. We’re licensed in all 50 states and U.S. territories and make it easy to obtain your I-Bond® (instant, online surety bond). We also include retroactive ERISA fidelity bond coverage for past years when the plan was not covered.

Now, with an ERISA bond package from Colonial, plan sponsors can affordably add fiduciary liability insurance for themselves. Quote and Purchase Your ERISA Bond Package Today!