Employers are allowed to terminate 401K benefit plans offered to employees for a variety of reasons. Employers are not required by law to provide retirement savings plans, and can terminate them as a part of a bankruptcy or merger, in order to switch to another type of plan, or voluntarily terminate the plan.
According to the IRS, employers must give their employees notice of the plan termination at least 30 days in advance, and employees in the plan must immediately be 100% vested in their accounts upon plan termination, regardless of what the vesting schedule is within the plan document. This means they will be 100% vested in employer matching contributions and profit sharing contributions in their accounts upon termination of the plan. Employers are required to distribute the assets of the plan to employees as soon as it is feasibly possible upon plan termination, usually within one year. Participants are also allowed to roll over the distributed funds into another qualifying IRA or 401(k) without penalty.
An employer can also incur a partial plan termination. This usually happens when an employer closes a plant or division that results in significant number of employees being terminated at one time (usually above 20%). Employees that are affected by the partial plan termination have the same rights as if the entire plan was terminated, therefore they are also become 100% vested in their accounts regardless of the normal vesting schedule of the plan. Normal turnover is not considered a partial plan termination, even if it is over the 20% threshold in a given year. Some factors that signal normal turnover are if the terminated employees are replaced, the new employees perform the same functions and have the same job titles, and the new employees receive similar compensation. Voluntary terminations or employees that quit generally will not qualify the plan for a partial termination.
Employers need to be aware of partial plan termination guidelines to make sure that terminated employees receive proper benefits. In a partial plan termination, terminated employees should not incur any forfeiture in their accounts, as they are 100% vested upon the partial termination of the plan. If forfeitures are incurred in this situation, the employer is responsible to pay employees the amount that was forfeited. However, if the termination event does not fall under a partial plan termination, employees may have to forfeit portions of their account that are made up of matching and profit sharing contributions, based on the terms of the plan document.
Plan terminations can happen for a lot of reasons; however, the IRS has rules in place to protect the assets of employees in the event of termination. Employers should also consider the repercussions of plan terminations or partial terminations, and be aware of the rules regarding these events.
By Tyler Henkel