With the COVID-19 wreaking havoc on the U.S. economy, many small businesses and organizations have no choice but to furlough or lay off employees to cut expenses. This article discusses the main difference between “furlough” and “layoff” – and more importantly, how they impact employer-sponsored retirement plans.

Layoffs
Generally speaking, a layoff involves downsizing or, more commonly, severance of employment without any performance-related cause. In most cases, this severance is anticipated to be perpetual.

Furloughs
Furlough, on the other hand, is a temporary postponement from work typically without pay for a limited period of time. This strategy is utilized to help save jobs and keep the organization competitive once the market begins to improve.

Impact on employer-sponsored retirement plans

Partial plan termination
With the distinction between furlough and layoff out of the way, let’s dig deeper into the Internal Revenue Service (IRS) rule in regards to the “partial plan termination” topic. There exists an IRS rule that states that a decrease in workforce that results in the severance of 20% or more of the total number of plan participants will be considered to be a partial plan termination of the plan. In a partial plan termination, the accounts of severed and affected employee become fully (100%) vested. Put simply, for those 401(k) and 403(b) plans currently utilizing vesting schedules (i.e., 6-year graded), this means that the laid-off employees who were either not vested or only partially vested when they were laid off must be treated as 100% vested. They will receive the entire amount of the employer contributions in their accounts when they take withdrawals from the plan.

So then are both furloughed and laid-off workers counted in determining if your plan has a partial plan termination? Generally, just laid-off employees. Furloughed employees generally are not counted. That said, the determination of partial plan termination is based on facts and circumstances and there is no “bright line test.”

Participant Withdrawals
Generally, in order for employees to withdraw their 401(k) or 403(b) funds, they must meet certain criteria – one of them being termination of employment.  Generally, laid off employees can take a withdrawal from the plan. On the flip side, furloughed employees are unlikely to qualify to withdraw their retirement account. Why? They typically are expected to return to work at some point in the future and do not fully meet the “termination of employment” definition. Once again, limited guidance exists as far as termination of employment goes and employers should seek guidance from an expert, such as an ERISA attorney, when possible.

What about participant loans?
A furloughed employee without pay can have his or her loan suspended up to one year. In such a situation, the loan has to be re-amortized when the employee returns to work, and the maximum 5-year term must be kept (meaning if he employee took a loan out for 5 year term and he suspends loan payment for one year, he now has 4 year to pay it off). In the case where the plan adopts the CARES Act loan relief, the same participant can extend the loan up to a year and the loan can be re-amortized over 5 years (as opposed to 4 years). What about terminated/severed employees with loan balances? Typically, they will have 60 days from termination of employment to repay the loan otherwise the loan balance will become taxable. However, they can repay the loan balance by the due date of their tax returns and avoid any taxes and penalties (the 2017 tax reform made this possible).

Final words
Employers thinking about reducing their workforce, particularly where the reduction is expected to be 20% or more, should consult with their retirement plan experts to determine whether or not a partial plan termination will occur.

Please do not hesitate to call our office if you have any questions. We are here to help.