A partial plan termination occurs when 20% or more of plan participants are terminated or otherwise no longer eligible during an applicable period. This article explains what a partial plan termination is, how to determine if one applies to your plan, and what steps to take. Expand the sections below to learn more.
A partial plan termination occurs when 20% or more of employees who were participating in your plan are terminated or otherwise no longer eligible to participate during an applicable period.
Partial plan terminations are typically caused by a reduction in force due to an intentional decision by the plan sponsor — like bankruptcy, insolvency, going out of business, a change in ownership, or substituting another type of retirement plan. They can also happen unintentionally due to corporate mergers, acquisitions, or other events.
If your plan does not impose a vesting schedule on employer contributions, a partial plan termination will not affect your plan.
Important: Many factors affect whether a partial plan termination occurred. We recommend consulting a legal or tax advisor who can make a determination based on your specific situation.
According to the IRS, if the turnover rate in a 12-month period is 20% or greater, a partial plan termination is deemed to occur. The turnover rate is calculated by dividing the number of terminated participants by the total number of participating employees during the applicable period.
In general, look at the total number of participants who were eligible but are no longer eligible due to involuntary termination or a plan amendment that adversely affects eligibility or vesting.
Per IRS guidance, anyone who terminated employment should generally be included. Voluntary terminations or routine turnovers can be excluded, but use caution when excluding any termination.
An employee may have voluntarily left but been influenced by the same factors driving the partial plan termination. For example, if a company shuts down a division and other employees leave during that same period, their departures may be related. To exclude them, you need to show evidence that their decision was completely unrelated to the triggering events.
The IRS generally considers a full plan year to be the applicable period. There are exceptions:
If a company has a series of related layoffs over more than one plan year, the period may be extended.
If the plan terminates before Dec. 31, the period includes the prior plan year plus the short, final plan year. For example, if a plan terminates Jun. 2, 2025, the period to measure is Jan. 1, 2024 – Jun. 2, 2025.
The size of your business does not affect whether a partial termination applies. As long as your plan meets the 20% reduction in eligible participants, a partial plan termination is deemed to have occurred.
For example, if your company had four participants and one was terminated during the plan year, that is a 25% reduction — a partial termination would have occurred. However, if you then hired a new employee during that plan year who became eligible (or you can show this was normal turnover), a partial plan termination would not apply.
If we believe a partial plan termination may apply to your plan, we will notify you by email and dashboard notification. We will also provide a Partial plan termination report in your 401(k) administrator dashboard under Resource Library. That report includes data from our records to help you complete the worksheet below.
Lines 2 – 4 are based on facts and circumstances. You need to complete them as the plan sponsor.
Line
Description
Value
1
Total number of participants who terminated in the applicable plan year (or potentially longer period¹). This number should equal lines 2 – 4.
2
Number of voluntary terminations unrelated to corporate events (like retirement, death, disability, or finding a new job) or involuntary termination for cause
3
Number of seasonal or short-term employee terminations where the position is expected to be filled again next year or season
4
Number of involuntary terminations due to company downsizing, layoff, or reduction in force — or voluntary termination due to a constructive discharge²
5
Total participating employees at the start of the applicable plan year and employees who became participants during the plan year (or potentially longer period¹)
6
Divide line 4 by line 5
If line 6 is 20% (0.20) or higher, there is a presumption of a partial plan termination. All participants who terminated during the applicable period should likely be 100% vested in all employer contributions, including matching contributions.
If line 6 is less than 20% (0.20), it is likely that the plan did not incur a partial plan termination.
No matter your result, consider consulting an Employee Retirement Income Security Act (ERISA) attorney who can review your specific circumstances and make a legal determination. As a fiduciary, your cooperation is vital to make sure your plan complies with plan rules and regulatory requirements. Failure to meet your fiduciary duties can result in penalties and adverse tax consequences for your plan.
¹ There are at least two scenarios that could lead to a longer period: (1) if the plan terminates before Dec. 31, include the prior plan year plus the short, final plan year (for example, if a plan terminates Jun. 2, 2024, the period to measure is Jan. 1, 2023 – Jun. 2, 2024); (2) if there were a series of related layoffs over more than one plan year.
² Constructive discharge: According to the IRS, employees who appear to terminate voluntarily may have actually terminated involuntarily due to a "constructive discharge." The employer's intent, working conditions, and the reasonably foreseeable impact of the employer's conduct are all factors. This includes employees who found other work in anticipation of an office closure or layoff.
There are situations where a partial plan termination would not occur:
Transfers within a legally related group — When employees transfer from one entity of a legally related group to another and are covered under a plan at the new employer.
Routine turnover — Businesses with routine turnover, like retail establishments or companies employing seasonal employees, may not trigger a partial plan termination.
In the event of an audit, your company needs to offer adequate proof of routine turnover. Acceptable forms of proof include HR records and employee statements showing the voluntary nature of terminations.
Factors to help determine the impact of routine turnover include:
Turnover rates in other periods.
Whether terminated employees were replaced by new employees.
Whether new employees performed the same functions, had the same job classification or title, or received comparable compensation.
If a partial plan termination is confirmed, the following will apply:
We will 100% immediately vest all participants who terminated employment in the applicable year.
If any of those participants have already taken a full distribution, we will restore previously forfeited funds from the plan's forfeiture account. Affected participants can then request a distribution at any time.
If the forfeiture account balance is not enough, we will withdraw funds from your company bank account to restore terminated participant accounts.
For participants who have not yet taken a distribution, no further action is needed. Their employer contributions will remain in their account as 100% vested. If they take a distribution after the partial plan termination, they can withdraw the full amount.
Participants affected by the partial plan termination need to get accelerated vesting. This includes participants who:
Left employment for any reason during the period in which the partial termination occurred.
Still have account balances under the plan on the date the partial plan termination occurred.
Note: Determining affected participants for vesting is different from determining who counts toward the 20% threshold. For vesting, it does not matter why a participant left — even termination for cause qualifies.
Affected participants who previously took a full distribution will be made whole once previously non-vested funds are reapplied to their accounts. They can see this balance on their next quarterly statement.
If you prefer to notify affected participants yourself, you're welcome to do so. Participants can then request a distribution or rollover of the restored vested funds at any time.
If you have determined that your plan incurred a partial plan termination, contact our 401(k) Sponsor Support team as soon as possible after the end of the applicable plan year. Once the date of the partial plan termination is determined, we will work with you to fully vest the necessary participants and restore balances for any participants who may have taken a distribution before they could be fully vested.
The amounts you need to restore will be funded from either your plan's forfeiture account or by an ACH debit from the bank account on file with Gusto Retirement.
If you do not want to wait until after the end of the plan year, you can amend your plan to have 100% vesting as of the first day of the partial plan termination. This will include all participants who were active employees in the plan as of that date. If any participants have already distributed funds, they will need to be processed and adjusted manually.
If your partial plan termination occurred over a period longer than the prior plan year, let us know. No action is needed if your plan did not experience a partial plan termination.
Gusto Retirement does not charge additional administrative fees to help determine or manage a partial plan termination. However, if the plan's forfeiture account does not have enough to cover vested funds for participants who took a distribution, we will pull the funds from the bank account on file.
Information on your Form 5500 showing a significant reduction in plan participants can alert the IRS to a potential partial plan termination, which may trigger an audit. If audited before you voluntarily vest affected participants, the IRS may impose penalties and sanctions.
In severe cases, your plan could be disqualified. This would result in the plan's trust being taxed on all earnings due to loss of tax exemption. Plan benefits would be included in participants' incomes, and your company would also lose employer tax deductions for all plan contributions.
If you discover that your plan previously had a partial plan termination, identify the affected participants and grant them 100% vesting retroactively. Determine if any affected participants took a distribution where assets were improperly forfeited, and refund those forfeitures along with any earnings.