Remember Your Vest: Partial Plan Termination Rules Can Catch Employers by Surprise

HR & Safety

When manufacturers and other employers undergo a reduction in force, or closure or sale of a division, they may inadvertently overlook the effect of the transaction on their 401(k) plan.

One issue in particular to pay attention to in advance of the RIF or the division event is whether it will trigger a partial plan termination under Section 411(d)(3) of the Internal Revenue Code.

Section 411(d)(3) requires that all affected employees who had a severance from employment during the applicable period relating to the partial plan termination must be 100% vested in their accounts, even if they are not yet fully vested in the plan.

Because of this special vesting for partial plan terminations, errors can occur if affected participants receive distributions from the plan based on vesting percentages below 100%.

This article explains the applicable IRS test for determining whether a partial plan termination has occurred and what an employer should do if it has missed the occurrence of a partial plan termination and failed to treat its affected participants as immediately vested.

Did a Partial Plan Termination Occur?

The applicable IRS regulations establish a facts and circumstances test for determining when a partial plan termination has occurred.

Among the relevant factors is whether the employer has terminated a group of employees (whether vested or unvested in the plan) in connection with a company-initiated event such as a RIF, or the closing of a division or a company location.

The IRS has indicated that a 20% or greater turnover rate in the plan during the applicable period creates a rebuttable presumption that a partial termination has occurred.

The applicable period is generally one plan year (often the calendar year), although it can be longer than one plan year if there are a series of related corporate events.

In other words, the IRS considers there to be a partial plan termination when there is a 20% or more reduction in the number of employees participating in the plan during the plan year resulting from an employer-initiated company event other than routine employee turnover (voluntary departures unconnected to an employer-initiated event).

When the termination of the number of plan participants exceeds 20%, employers must point to other factors.

RIFs (whether due to business slowdowns or depressed economic conditions) and sales of divisions or subsidiaries are common types of employer-initiated events that can trigger partial plan terminations if they affect at least 20% of the plan participants.

When the termination of the number of plan participants during the applicable time period exceeds 20%, the employer must point to the existence of other factors, such as the terminations were due to voluntary resignations (aka normal non-employer initiated turnover), to explain the 20% or higher termination rate.

Unless those other factors exist, the IRS will conclude that a partial plan termination occurred.

What may seem like a straightforward determination can become complicated when an employer has multiple layoffs within a relatively short time period (such as over one to two years), where each RIF alone is below 20%, but when combined with the others, exceeds 20%.

In those types of situations, the IRS requires that the multiple RIFs be aggregated when running the 20% test.

Are There Different Considerations for RIFs vs. Division Events? 

When selling divisions, as part of the purchase and sale agreement, employers will often provide that their 401(k) plans will be amended to fully vest the affected employees of the division being sold.

By doing so, the partial plan termination requirements of immediate vesting are automatically met.

With RIFs, employers may overlook the partial plan termination issue

With RIFs, however, because no similar type of agreement may have been prepared in connection with the layoffs or RIFs, employers may overlook the partial plan termination issue.

When that happens, employers will need to correct the plan’s vesting error and make the affected employees whole.

Can a Plan Sponsor Correct a Missed Partial Plan Termination?

As long as the operational error is considered insignificant under the applicable IRS correction guidance, the employer can self-correct the error without involving the IRS.

Self-correction requires that affected employees be treated as 100% vested in their accounts and be made whole for any lost earnings that they suffered because of the forfeiture of their non-vested portion of their accounts.

An affected employee for this purpose is generally any employee who separated service for any reason (even voluntary terminations) during the plan year in question and who has an account in the plan.

Self-correction requires that affected employees be treated as 100% vested in their accounts.

Employers often obtain assistance from their 401k plan vendor/recordkeeper to do the lost earnings calculations for each affected employee.

If the plan’s forfeiture account still holds the affected employees’ forfeited amounts, then the employer would work with its plan recordkeeper to reallocate the forfeited amounts back into the accounts of the affected participants.

But if, for example, the employer has applied the forfeiture amounts to go toward the matching contributions for plan participants, then the employer will need to contribute additional amounts into the plan to restore the accounts that need to be 100% vested. (The plan cannot pull the matching amounts back from the other participants.)

In situations where an affected employee has already received a distribution of their plan account, then the plan will have to send a second set of distribution election forms to that participant, including the tax notice and rollover forms, for the restored amount that was added back to the account as a result of the partial plan termination.

Were There Any Special Rules Triggered by RIFs Due to COVID-19?

The Taxpayer Certainty and Disaster Tax Relief Act of 2020 changed how plan sponsors determine partial terminations during the height of the COVID pandemic.

During the 2020 and 2021 plan years, no partial plan termination occurred if the number of active participants covered by the plan on March 31, 2021, was at least 80% of the number of active participants covered by the plan on March 13, 2020 (the date then President Trump declared the COVID-19 pandemic a national emergency).

The IRS issued guidance on how to apply these special rules in the form of questions and answers on April 27, 2021, which employers may continue to find helpful in analyzing whether or not it may have suffered a partial plan termination during 2020 or 2021 due to layoffs relating to COVID-19.

Unfortunately, those special rules have now expired and will not apply for determining whether a partial plan termination has occurred in 2022 or in future years.

About the authors: Richard Cohen is a partner with Shipman & Goodwin LLP and chair of Shipman’s Employee Benefits Practice Group. His practice encompasses pensions and employee benefits, including tax-qualified retirement plans, 403(b) plans, non-qualified deferred compensation plans, SERPs, cafeteria plans, ERISA and COBRA compliance. Kelly Smith Hathorn is also a partner with  Shipman & Goodwin LLP and advises public and private sector employers on a variety of employee benefits issues. 

 For more information about Shipman’s manufacturing practice, please contact Alfredo Fernández (860.251.5353;


1 thought on “Remember Your Vest: Partial Plan Termination Rules Can Catch Employers by Surprise”

  1. C. Falls says:

    Having been affected by an involuntary RIF in 2022 (and having an unvested portion in a 401k plan), how and when can I confirm that the former employer has completed the determination of “partial determination”? In my case, the “nominal” workforce reduction was 20% in 2022 for the company (subject to precise accounting for the two layoff events).

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