Many plan participants may be surprised to learn that their employer can discontinue their 401k plan at their own discretion. The IRS considers a plan terminated once an official date of termination is established by the sponsor, the benefits and liabilities under the plan are determined, and all assets are distributed as soon as administratively feasible (usually within one year). All participants would become fully vested in their account balance regardless of the plan’s vesting schedule and can roll their funds into a different qualifying account such as an IRA without penalty. The full-termination of a plan is typically a well-planned, thought-out decision. A partial plan termination on the other hand can be triggered without the plan sponsor even knowing it has happened.
A partial plan termination occurs when an employer terminates a significant amount of plan participants (generally defined as 20%). This can be caused by events such as a plant closing, or a plan amendment being made that excludes certain categories of employees. The most common cause of a partial termination is a large layoff or business reorganization. A partial termination would still exist even if the company is forced into the triggering event by circumstances beyond their control, like an economic downturn. The consequence of a partial plan termination is focused on vesting. Any affected participants would have the same rights as if it were a full plan termination, and they’d become immediately vested in their accounts regardless of the plan’s vesting schedule.
While the rule of thumb is that a decrease in plan participation of 20% or more would result in a partial termination, there are circumstances where this is not necessarily the case. A partial termination cannot be triggered by “routine turnover”. A company that typically experiences turnover of 20% per year would not have a partial termination. Turnover is considered “routine” if it is consistent year-to-year, if new employees are hired in place of the terminated ones, and if the new employees have similar job functions, titles, and compensation as the terminated ones. Additionally, employees who voluntarily quit will generally not count for purposes of determining a partial termination.
It’s important for a plan sponsor to be aware of what triggers a partial plan termination. If one occurs, the additional costs should be factored into business decisions, and all affected participants need to be 100% vested in their account balances. Keeping the above guidelines in mind can help a plan stay in compliance and prevent further headaches down the road.