COVID-19 And Its Impact On Employees Who Have Been Laid Off And Their Vested Benefits From Their 401(k) Plans

Lost in the tumult of the last few weeks is a rather significant piece of pension legislation that was buried in the Consolidated Appropriations Act, 2021 that was signed into law on December 27, 2020.  You know it more for its granting an extra $600 to Americans that were qualified to receive it.  It provides a temporary rule and some much needed guidance for companies that were forced to lay off a significant percentage of their employees.  Such layoffs could very easily trigger something known as a “partial plan termination.”

While the determination that a partial plan termination has occurred is governed by the specific facts and circumstances of each company, as a general rule, the IRS has said that if there has been a more than 20% reduction in the number of covered participants during a plan year then the plan has experienced a partial plan termination.  If a plan does undergo partial plan termination, the affected participants (the ones that lost their jobs) are immediately 100% vested in their accounts.

So if a restaurant had 20 participants in its 401(k) plan as of 01/01/2020 and on 12/31/2020 had trimmed its workforce to 5 participants to assist with to-go orders, this restaurant has experienced a partial plan termination and the 15 participants who were laid off must now be fully vested in the part of their accounts attributable to employer contributions and the earnings on thise contributions.

With so many businesses suffering economic loss as a result of the COVID-19 pandemic and the associated reduction in their work forces, the recent legislation includes a temporary rule which basically places a moratorium on certain partial plan terminations.  Concerned that temporary economic disruption might result in permanent displacement of retirement savings (in other words, the laid off employees would now have access to their retirement accounts), and even actual plan terminations.  Specifically, it says:

A plan shall not be treated as having a partial termination (within the meaning of 411(d)(3) of the Internal Revenue Code of 1986) during any plan year which includes the period beginning on March 13, 2020, and ending on March 31, 2021, if the number of active participants covered by the plan on March 31, 2021 is at least 80 percent of the number of active participants covered by the plan on March 13, 2020.

So the legislation places, in effect, a temporary “stay” on a retirement plan experiencing a partial plan termination until March 31, 2021.  Companies that did experience a greater than 20% reduction in their workforce could then hold off on fully vesting those employees until March 31, 2021.  Some questions do arise though:

What about companies that lay off more than 20% of their workforce, fully vested those employees and then proceeded to pay them out?  Do they now have to seek out those laid off employees and try and recover the non-vested portion of their account?  In my opinion, no.  If distributions were previously made, I believe they were made in accordance with the law that existed at that time so there was no overpayment.

What about participants who have been laid off but have not yet been paid out?   I believe based on the effective date of the provision that the plan sponsor could reasonably determine that there was no partial plan termination (at least until March 31, 2021) and therefore the vesting schedules could retroactively be reapplied.

Now there is the world of the IRS, Washington and the legislation that it passes and then there is the real world within which we all live.  A plan sponsor can now take a “wait and see” attitude to determine if a partial plan termination has occurred.  As we now know, a partial plan termination would trigger 100% vesting on employer contribution account balances.  The plan sponsor can wait until March 31 of 2021 to make that determination.  However, the employees who were laid off may not be in an economic position to wait.  Many have been unemployed for over 9 months.  While they may have received enhanced unemployment insurance and the extra stipends that the current legislation and the CARES Act provided, that does not mean that they and their families have not suffered significant economic losses as a result of the pandemic.  Retirement plans were never intended to be a short term solution for employees to pay their rent and put food on the table.  However, for many of them, as a result of the pandemic, that is the circumstance that they face.  I certainly would not want to be the one to tell these employees that their employer will “wait and see” if a partial plan termination has occurred, and if it has, then and only then will they receive a distribution of their vested benefit.

Based upon a January 4th, 2021 article from the National Association of Plan Advisors (NAPA)