Pension Protection Act Blog

When a plan terminates, the IRS says that affected participants become 100% vested in their account balances. More specifically, this requirement is from Internal Revenue Code section 411(d)(3), which states:

(3) Termination or partial termination; discontinuance of contributions. Notwithstanding the provisions of subsection (a), a trust shall not constitute a qualified trust under section 401(a) unless the plan of which such trust is a part provides that –

(A) upon its termination or partial termination, or
(B) in the case of a plan to which section 412 does not apply, upon complete discontinuance of contributions under the plan,

the rights of all affected employees to benefits accrued to the date of such termination, partial termination, or discontinuance, to the extent funded as of such date, or the amounts credited to the employees’ account, are nonforfeitable.

So how does an employer determine who is an affected participant so that particular participant’s vesting can be increased to 100%?

In a FAQ on plan termination, the IRS states that:

an “affected participant” in a plan termination, generally, is 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.

In the Treasury Regulations which provide guidance on IRC section 411(d)(3), the IRS does not define “affected participant”. This has left the court system to interpret who an affected participant is.

For example, the 6th Circuit Court of Appeals, in Borda v. Hardy, Lewis, Pollard, et al., 1998 Fed. App. 0075P, found that participants were not affected participants entitled to having their vesting increased to 100%. The participants terminated their employment and left their account balances in the plan. Subsequently, the employer went out of business which terminated the plan before the participants had incurred five consecutive breaks in service. The participants then sought 100% of their account balances, arguing that their vesting should be increased to 100% due to the termination of the plan.

The 6th Circuit, discussing IRS General Counsel Memorandum, GCM 39310 (April 1, 1994), found that:

the General Counsel Memorandum concluded that “an employee who separates from service but will not suffer a forfeiture until he incurs a break-in- service will become vested in his accrued benefit, to the extent funded, if the plan terminates prior to his incurring a break- in-service.”

Implicit in this conclusion, we believe, is an understanding that the employee who had separated from service was one who still stood to be “affected” by the termination of the plan. Nothing in the General Counsel Memorandum suggests that a former employee who would clearly be unable to avoid a forfeiture by returning to work, the employer having gone out of existence, could somehow be “affected” by a termination of the plan at the time of the employer’s dissolution.

The 6th Circuit then discussed a case decided by the 9th Circuit Court of Appeals, Flanagan v. Inland Empire Electrical Workers Pension Plan & Trust, 3 F.3d 1246 (9th Cir. 1993), which determined that a terminated participant is an affected participant entitled to 100% vesting due to the plan termination:

because it extinguished their opportunity . . . to return to covered employment and to revive their prior service credits.” Id . at1250.

The 6th Circuit states that the difference between their case and Flanagan is that, in Flanagan, the plan terminated but the employer did not go out of business, so the terminated participants could have been re-employed by the employer.

In both Borda and Flanagan, the 6th Circuit noted that the plan document did not define “affected participant”.

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