Here’s some good news for firms that have had to reduce their workforce: The IRS’ 401(k) partial termination rule – and its unexpected costs – may not apply to workers laid off or furloughed due to the pandemic, according to a new IRS ruling.
Typically, under IRS rules, a partial termination of a 401(k) plan may occur when there’s a significant reduction (generally more than 20%) in plan participation due to layoffs or terminations during a plan year.
When this happens, employees become 100% vested in employer contributions – which includes matching contributions – even if they haven’t yet met the vesting schedule under the plan.
CARES Act update
However, the IRS has recently updated its CARES Act guidance, issuing that employees terminated due to the pandemic don’t have to be counted as terminated employees if they’re rehired before the end of 2020.
This Cares Act update is significant because many employers use the forfeitures of terminated employees to offset employer matching contributions.
But employers may have to consider extended furloughs or layoffs, even if employees are rehired by year’s end. This is because plans require an employee to work a set number of hours before being granted vesting credit for a given year.
For example, if a 401(k) plan requires 1,000 hours of service in a plan year and an employer’s furloughs or layoffs were extensive, the partial termination rule will be applied.
In this case, employers might consider amending their plans to “count a certain amount of furlough time due to COVID-19 as hours of service” for vesting purposes, says Frost Brown Todd Attorney Michael Bindner.
“This likely will not cost much to the employer,” he adds, “but can go a long way in fostering goodwill with employees and will not result in lost vesting service for employees who return from furlough.”
