By Michael L. Cecere, CPA, MST
Gray, Gray & Gray, LLP
Businesses reducing headcount during the coronavirus pandemic should be aware that choosing between a layoff or a furlough will create different impacts on the company’s retirement plan or defined benefit plan.
A furlough is a short-term cessation of work for a defined period. Although not receiving a paycheck, furloughed workers remain “on the books” as current employees. Since a furlough is, by definition, not designed to be permanent it has no effect on a qualified retirement or defined benefits plan.
While a layoff may initially have the same intent – a temporary work stoppage – it does leave the door open to a permanent separation. While laid-off workers are sometimes rehired, they are officially separated from employment. A layoff is considered an indefinite break in the employment relationship which the IRS says can trigger a partial termination of a retirement or defined benefit plan.
When there is a true separation from employment (generally defined as 20 percent or more of the participants in a qualified retirement plan or defined benefits plan) the IRS views it as a partial plan termination. The 20 percent limit is calculated by taking the number of employees terminated from employment (vested or unvested) and dividing it by all participating employees during the period in question. (Not included in the 20 percent measurement are employees whose employment ends due to death, disability or retirement.)
Once a partial plan termination occurs the participants being terminated become fully vested. This includes any company match or profit-sharing contributions. If you fail to fully vest participants it could result in underpayments to former participants, which could potentially cause the IRS to disqualify the plan.
It is important to note that the IRS considers the circumstances surrounding each partial plan termination individually. One factor is how the plan measures an employee’s service – actual hours, elapsed time, or some other method.
Before deciding whether to furlough or lay off employees, it makes sense to consult with your benefits plan administrator or certified public accountant to anticipate the potential impact on your retirement plan or defined benefits plan and the costs that may be incurred.