As the economy continues to decline, many companies will be considering or may have already implemented a reduction in force as a way to reduce expenses. An often overlooked consequence of a reduction in force is its affect on the company’s 401(k) plan. In Revenue Ruling 2007-43, the IRS indicated that when there is a 20% turnover rate in a 401(k) plan, due to an employer-initiated action, there is a presumption that a partial plan termination has occurred, requiring the plan sponsor to vest all affected participants 100%.
To determine a plan’s turnover rate, the plan sponsor divides the number of participating employees affected by the company’s action during the applicable period by the total number of participating employees during the same period. Both vested and non-vested participants should be counted. The applicable period is typically the plan year. However, based on facts and circumstances, the applicable period may be extended to cover multiple plan years.
Example: ABC Company sponsors a 401(k) plan for its 100 employees. All 100 employees are participants in the plan. Due to the poor economy, ABC Company decides to reduce its headcount by 20 employees. To determine whether the plan experienced a partial plan termination, the plan sponsor calculates the turnover rate. The formula is: 20/100 or 20%. Here, the 20% reduction has resulted in a presumptive partial plan termination, which will require ABC Company to vest these twenty employees 100% in their individual accounts.
Frank Del Barto states that all companies considering a reduction in force must review the effect of the reduction on the 401(k) plan. Companies that have already implemented a reduction in force without having considered the 401(k) plan should review the facts and circumstances surrounding the reductions and the number and participants affected. Frank notes that companies considering a reduction in force should also review all other company-sponsored employee benefit plans for any COBRA continuation rights, conversion or portability options. Often, terminated employees are permitted to convert or “port” their company-provided basic life insurance and disability coverage for a limited period of time after cessation of employment.