401(k) Resource Guide - Plan Sponsors - Plan Termination

Although a 401(k) plan must be established with the intention of being continued indefinitely, an employer may (fully) terminate its 401(k) plan at its discretion. In certain cases, a partial plan termination is deemed to occur. Whether a partial termination occurs depends on individual facts and circumstances of a given case. In general, a partial termination is deemed to occur when an employer-initiated action results in a significant decrease in plan participation. As an example, a partial termination may be deemed to occur when an employer reduces its workforce (and plan participation) by 20%.

For purposes of the Internal Revenue Code, a 401(k) plan is not fully terminated unless:

• The date of termination is established,
• The benefits and liabilities under the plan are determined as of the date of plan termination, and
• All assets are distributed as soon as administratively feasible.

”Administratively feasible” is determined under all the facts and circumstances of a given case, but generally the IRS views this to mean within one year after the date of plan termination.

The law requires that all affected participants be fully vested in their account balance upon the date of plan termination or partial plan termination. Under a 401(k) plan, a participant’s elective deferrals are required to be fully vested at all times. Generally, matching contributions and any other employer contributions are not required to be fully vested but may be subject to a graduated vesting schedule. Upon full or partial plan termination, however, matching contributions and other employer contributions must be fully vested for all affected participants, regardless of the vesting schedule in the plan document.

An “affected participant” in a plan termination, generally, is any one who has an accrued benefit under the plan as of the date of the plan’s termination. Certain terminated employees are also treated as affected participants.

Unless the plan is qualified (i.e., meets the standards set forth in the Internal Revenue Code) upon plan termination, participants will not have tax-favored status of their benefits upon distribution. Plans must be amended for all qualification requirements in effect on the date of plan termination. An employer may wish to file Form 5310 with the IRS, requesting a determination letter as to whether the plan termination affects the qualified status of the plan. Prior to filing the application, the law requires that the employer provide notice to Interested Parties that it intends to file the application. The notice must be given not less than 10 days or more than 24 days prior to the day the application for a determination is made. Refer to Rev. Proc. 2006-6 for a complete explanation of the required notice.

Interested parties in a plan termination generally include:

• All present employees of the employer with accrued benefits under the plan,
• All former employees with vested benefits under the plan, and
• All beneficiaries of deceased former employees currently receiving benefits under the plan.

Interested party comments may be submitted to the IRS or to the Department of Labor. These comments will be considered by the IRS when reviewing the determination letter application.  Interested party comments are not entitled to confidentiality. The law specifically requires that all interested party comments will be made available to the employer.