Qualified plans: partial plan terminations.

• Author: Manary, Nancy J.

Employers that sponsor qualified plans must monitor those plans for compliance with the Code's requirements on partial plan terminations. Partial plan terminations occur when, by virtue of employer action, a plan realizes a significant decrease in the number of covered participants. In the case of a partial termination, a special 100% vesting rule applies.

Sec. 411(d)(3) provides in part that in order to be qualified, a plan must include a provision stating that in the case of a partial termination, all affected employees have a nonforfeitable right (100 % vesting) to their funded accrued benefit, in the case of a defined benefit plan, or their account balance, in the case of a defined contribution plan.

The Code does not define partial termination or affected employee. However, Regs. Sec. 1.411(d)-2 does provide guidance on what is and what is not a partial plan termination. Partial terminations occur as a result of employer action to:

* Terminate employees (a reduction in force, for example);

* Exclude, by plan amendment, a group of employees from future coverage under the plan; or

* In the case of a defined benefit plan, reduce significantly or cease future benefit accruals that result in a potential reversion to the employer.

Unlike most of the IRS's qualified plan regulations, this regulation does not provide any sort of bright-line test. Instead, it requires the IRS to consider all facts and circumstances surrounding a plan and the employer sponsoring the plan in determining whether a plan has incurred a partial termination.

When Does Partial Termination Occur?

Most partial terminations occur because of employer-initiated turnover. Courts have generally held that termination of a number of employees does not constitute a partial termination unless there is a significant reduction in plan participants (see Well v. Retirement Plan Admin. Comm. of the Terson Co., 933 F.2d 106 (2d Cir. 1991)). Historically, the IRS has used a 20% or greater turnover factor as a rebuttable presumption that a partial termination has occurred. When the turnover factor is greater than 20%, the IRS will require the employer to demonstrate why a partial termination has not occurred.

The IRS approach to determining the turnover rate is to divide the number of participating employees who had an employer-initiated severance from employment during the applicable period by the sum of all participating employees at the start of the applicable period plus the...