Taming the Tariffs: Employee Benefit Issues for Employers During Times of Economic Uncertainty – Group Employee Terminations
This article provides reminders of some of the employee benefits issues to consider if your company is considering group terminations as a way to tackle the business impact of tariffs. In our experience, employers often provide enhanced benefits for employees losing their employment as part of a group termination. While the enhanced benefits may add to the employer’s costs on a temporary basis, it is still less expensive in the long run than the ongoing costs of maintaining a larger active workforce.
Another cost-saving option an employer may consider is to reduce or suspend employer contributions to retirement plans, which is further discussed here.
This article does not address the employment aspects of a group termination, such as whether the group termination triggers a federal or state WARN notice or other similar requirements and employers should consult their labor & employment counsel and advisors whenever considering a group termination of employees.
What Are the Impacts to Our 401(k) Plan for a Group Termination?
Vesting. When an employee terminates employment (whether in a single or group employee termination context), he or she will become eligible to receive a distribution of any vested benefit under the company’s 401(k) plan. While 401(k) plans rarely provide for full vesting when an employee experiences an employer-initiated termination of employment, if the group of terminated employees is large enough, then the 401(k) plan may experience a “partial plan termination,” which requires certain 401(k) plan accounts to become fully vested.
A 401(k) plan has a “partial plan termination” during a plan year if there is a significant change to the plan or a significant corporate event that affects the right of employees to vest in their plan benefits. While determining if a partial plan termination has occurred is a facts & circumstances test, current IRS guidance presumes that there is a partial plan termination when at least 20% of the 401(k) plan’s active participants experience an employer-initiated termination of employment (outside of a company’s “ordinary course” turnover) during a plan year or in connection with the same corporate event (e.g., a planned or coordinated reduction in force). When a partial plan termination occurs, the employer must fully vest any employee who left employment during the relevant plan year, including people who voluntarily left employment. There are several nuances to this analysis so we recommend that a company discuss any planned larger-scale reductions in force with its 401(k) plan recordkeeper and legal advisors to determine the application of the partial plan termination rules in that circumstance.
If a partial plan termination is not occurring, then you may also wish to consider whether to voluntarily vest 401(k) plan accounts for individuals affected by an employer-initiated group termination, provided the employee group is not disproportionately highly compensated (as defined under IRS rules). This will require a plan amendment and coordination with your 401(k) plan recordkeeper to administer the change.
Employer Annual Contributions. If your 401(k) plan provides employer contributions that require either a specific number of hours of service during the year and/or a last day of the year employment requirement as a condition for receipt of this contribution, you may wish to consider whether to waive those requirements for the employees affected by the group termination, provided the employee group is not disproportionately highly compensated. This will require a plan amendment; however, this plan provision need not be preserved in the plan going forward; for example, the amendment could be drafted to apply to employees who experience a group termination only during a limited window of time (e.g., 2025) or so it applies only to terminations at a specific plant or location.
Eligible Plan Compensation. One other item to remember is that if severance benefits are provided to employees, severance pay may never be subject to 401(k) plan deferrals or, generally, be considered to determine employer contributions under a 401(k) plan. That contrasts with certain regular post-termination payments related to final pay or benefits for services provided (e.g., final paycheck or vacation cashout) that may be subject to 401(k) deferrals and related employer contributions, depending on how your 401(k) plan defines compensation. Coordinate with your 401(k) plan recordkeeper and payroll processers to make sure 401(k) plan deferrals and employer contributions are only applied to eligible compensation.
What About Severance?
Employers that either rarely offer severance benefits or that do so on an ad hoc basis will often adopt a more formal severance program in connection with group terminations. This can be especially helpful if there is an expectation that employees work through a specific date to receive severance; the promise of severance benefits can serve as a retention tool. Typical severance benefits include severance pay and sometimes outplacement benefits and subsidized COBRA premiums (see the next question for more about COBRA). Whether a severance program is considered a plan subject to ERISA rules depends on whether there is an “administrative scheme.” The rule of thumb is that if the severance benefits will be paid overtime under normal payroll practices, rather than in a lump sum, we recommend that the severance program be set up to be ERISA compliant. An ERISA compliant severance program needs to be in writing, include specific claims and appeals procedures, and provide a summary plan description (which can often also serve as the written plan document) to eligible employees. If the program covers over 100 employees, a Form 5500 would also need to be filed.
Unlike many ERISA benefits, there are no rules that require equal severance benefits, so highly compensated employees can receive richer severance benefits than lower-paid employees, or the benefits can vary by location or position. In addition, there is no legal requirement that the severance plan be continued indefinitely – it can remain in effect only for a finite period.
What Happens to Health Coverage for Employees Who Are Terminated?
In the normal course, terminated employees enrolled in an employer’s group health plan (whether that be medical, prescription drug, dental, vision, or health flexible spending accounts) can continue this coverage generally for up to 18 months under federal COBRA rules, or for smaller employers under state-specific “mini-COBRA” laws, by paying the full cost of such coverage.
Sometimes employers may choose (or be required under an employment contract or severance policy) to subsidize all or part of the terminated employee’s premium costs for COBRA continuation coverage. For example, you may let terminated employees continue to pay active employee rates for COBRA coverage. In that case, you need to be mindful of whether your health plan is a self-insured or fully-insured plan as there could be different tax reporting obligations on such subsidies based on how benefits are provided. If your health plan is fully insured, there are no tax consequences to the terminated employees because of the subsidized COBRA premiums. If your health plan is self-insured, however, and the subsidized COBRA premiums favor highly compensated employees, the amount of that subsidy may need to be treated and taxed as compensation. Note that if you choose to provide the subsidy as a cash payment regardless of whether the former employee spends it on COBRA coverage or otherwise, it is always considered taxable compensation even if they actually use it to buy COBRA coverage. Companies should take care to properly communicate, document, and tax report and withhold from any COBRA coverage subsidy benefits.
How Are Outstanding Stock Options or Other Equity Incentive Plan Awards Treated?
You will need to check the equity incentive plan documents and individual award agreements to properly determine any impact on outstanding awards in the event of an employee termination. In addition, you can’t stop there— you also need to make sure there are no other rules that may apply to an employee’s equity awards under an existing employment agreement, applicable severance policy, or any other individual contract. Unless the award provides for accelerated vesting on a termination of employment, any outstanding and unvested equity awards would typically be forfeited at termination of employment. In a group termination situation, employers often consider whether to provide for additional vesting if the plan or award agreement does not already require it. If additional vesting is desired, remember to check the equity plan or award agreement to determine the necessary process to approve the additional vesting, for example, whether approval of the board of directors or an officer is required to make that change.
Will the Company Need to Make Payments on Deferred Compensation Plans?
Possibly, depending on the terms of the deferred compensation plan. A termination from employment (called a “separation from service” under the Code Section 409A rules) is one of the permissible payment events under Code Section 409A for nonqualified deferred compensation plans. To the extent any terminated employees are participating in a deferred compensation plan, you will need to carefully review the plan and award agreements to determine any impact from the termination on vesting or payment obligations. If separation from service is a payment triggering event, the company will need to be ready to make those required payments, which will come from the company’s general assets unless the company has set up one of the limited ways that a company may set aside certain funds for deferred compensation obligations. The cash outlay for making these payments will need to be considered as part of the overall costs of a group termination.
Do the Same Considerations Apply for Employees Who Are Covered under a Collective Bargaining Agreement?
When considering employee terminations for any employees represented by a union, you should always first check the terms of the applicable collective bargaining agreements and consult with your labor advisors on the company’s obligations in connection with a group termination. While the summaries above do apply generally for employer-sponsored retirement and welfare benefits, there may be specific provisions in a collective bargaining agreement or under union-sponsored benefit plans that will require certain company actions or require the company to further bargain with the union in the event of a planned reduction in force.
Don’t Forget About Releases!
If you decide to provide enhanced benefits to employees in connection with a group termination, consider whether to condition those enhanced benefits on the impacted employees executing a general release of claims. It is difficult to condition enhanced 401(k) benefits on the provision of a release, but releases otherwise work well in connection with the other benefit enhancements discussed above. You should coordinate with your employment and benefits advisors for the appropriate form of any release of claims that employees will provide in connection with a group termination.
