When Conducting Layoffs Consider Potential Impact on 401(k) Plan
When laying off employees, do not forget to consider how that lay off might affect your 401(k) plan. Employees are always fully vested in their elective deferrals and rollovers, but matching contributions and profit sharing contributions are usually subject to vesting requirements. Upon termination of employment, terminated employees are typically paid only the vested portion of their employer sourced accounts, with the non-vested portion being forfeited.
When a qualified retirement plan terminates, all participants in the plan must be fully vested in all of their accounts in the plan. Likewise, when a qualified retirement plan has a “partial termination” all affected participants must become fully vested in all of their accounts in the plan.
What constitutes a partial termination is not clearly defined, but there are some guidelines. Partial terminations typically come in two ways, horizontal and vertical terminations. Vertical partial terminations usually involve the cessation of participation in a plan by a significant number of employees due to a corporate event such as lay-offs, plant closings, acquisitions or mergers. Horizontal partial terminations involve a reduction in benefits for a significant number of employees. For example, where an employer terminates its matching contribution for all employees at location A while the employer continues to match elective deferrals for all employees at location B, a horizontal partial termination might have occurred.
Whether a partial termination occurs will depend upon the facts and circumstances of each individual case. There are four primary factors the courts have considered. First, the courts consider the relative percentage of employees involved. Second, the courts consider whether there is a likelihood that the employer will derive a significant benefit from the action (many 401(k) plans provide that forfeitures are used to reduce future employer contributions). Third many courts consider whether it was external events or action by the employer that led to the cessation of coverage. Finally, many courts consider the potential of the cessation to benefit highly compensated employees.
Remember that failure to fully vest may be correctable under programs currently available to employers. These programs often provide amnesty and permit the plan sponsor to remedy actions already taken.