How much of your 401(k) retirement account balance is yours to keep? It turns out that’s a tricky question if you’ve been laid off this year.
With mass layoffs commonplace during the Covid-19 pandemic, employers asked the Internal Revenue Service for advice on how to deal with the partial termination rule relating to employer contributions to their employees’ 401(k) workplace retirement accounts.
It’s an obscure issue, but it’s a big deal for the employees that it affects: It could mean thousands of dollars more credited to an employee’s 401(k) account. It’s also important that employers get it right. IRS auditors can catch this issue looking back at prior years, warns Jeff Holdvogt, an employee benefits lawyer with McDermott Will & Emery in Chicago.
“This is a complicated rule, and it’s not top of mind, so we could absolutely see employers realizing, ‘Hey, it turns out we incurred a partial termination. We have to go back and provide additional vesting,’” Holdvogt says.
How can you check what’s rightfully yours? Employees should ask: Was there a partial plan termination? Should I be fully vested? Here’s help understanding what’s at stake.
What does “vesting” mean? Any money you contribute to your 401(k) at work is yours to keep—it’s vested—from the day you put it in. But money your employer contributes to your account (employer matching contributions or profit-sharing contributions) may be subject to a vesting schedule. That could mean you have to work at the employer for three years, for example, until the employer contributions are vested and actually yours. Or it could be a graduated vesting schedule. That could mean that 20% of the employer money is yours after year one, 40% after year two, and so on, until you’re 100% vested in year five.
When an employer with a vesting program makes a contribution to an employee 401(k) account, the employer contributes it to a trust. Generally, if an employee quits or is laid off, any unvested money is forfeited. The money stays with the employer, who can reuse it to fund contributions for other employees.
If an employer ends its 401(k) plan, the employer has to fully vest everyone. That means any employer money in limbo waiting to be vested is credited to employees’ accounts. If there’s a mass layoff, that can trigger what’s known as a partial termination of the 401(k) plan—and full vesting for those employees.
What’s a partial termination? Generally, if an employer has a turnover rate of 20% or more, that counts as a partial termination, and employers have to fully vest employees they’ve laid off, just as they would have to fully vest employees if the 401(k) plan was ended altogether.
The issue during the pandemic that employers were struggling with is how to calculate the 20% turnover rate, given that many of them immediately let go a large number of employees, but then started bringing workers back. Is the turnover rate based on the percentage of employees let go, or if they bring workers back, does it count toward the turnover goal? The IRS weighed in on this in Question 15, an update to its “Coronavirus-related relief for retirement plans and IRAs questions and answers” page. If employers bring employees back, they don’t count as part of the turnover. That means that employers that hire back enough workers before year-end might be off the hook for paying out unvested employer contributions to terminated workers.
Employers finalize these turnover rate calculations at year-end. So if you’re laid off—and not hired back—you might not know if the layoff counts as a partial termination until your employer runs the calculations.
Bottom line: If you’re laid off as part of a mass layoff and have unvested 401(k) money, your employer might owe you that unvested money. If your employer hires back enough workers before the end of the year, then you’ll be out of luck.
Last Chance For Covid-19-Related 401(k) Loans: September 22