Furloughs, Layoffs, and Terminations – What’s the Difference?

April 21, 2020

As the coronavirus continues to heavily burden businesses throughout the country, many employers are looking for ways to reduce their costs. Furloughs, layoffs, and terminations are becoming increasingly more common under the recent economic circumstances. But what, exactly, is the difference, and what does this mean for your 401(k) plan?

 

Furlough vs. Layoff vs. Termination

A furlough is placing an employee on a mandatory unpaid leave of absence for a period of time determined by the employer. This is typically a monodisciplinary action due to a lack of work or funds, and the employee has an expectation of returning back to work. The employer will usually (but not always) set a date for the employee to return to work.

 

An employer will often choose to furlough an employee when it needs to temporarily reduce payroll costs but foresees the employee returning to work in the near future. It allows the employer to retain trained staff and helps smooth the transition back to re-employment.

 

A layoff is considered a temporary separation from payroll for monodisciplinary reasons, with the potential – not expectation – to return to work. The employee is not employed by the company and is often encouraged to seek employment elsewhere.

 

A termination is dependent on the facts and circumstances, but it is generally considered a permanent severance from employment with no expectation that the employee return to work. The facts and circumstances test has three parts:

  • The severance was in good faith,
  • The individual is not treated as an employee for other purposes, and
  • There’s a reasonable expectation that the person will no longer be performing duties for the Employer.

 

If the three parts of the test are met, then the employee is considered terminated from employment.

 

There are several considerations for employers to think about when deciding whether to furlough, layoff, or terminate employees such as how 401(k) plan distributions, participant loans, and matching contributions will be impacted.

 

How Furloughs, Layoffs, and Terminations Affect 401(k) Plan Distributions

Since a furloughed employee is not terminated from employment, he or she may still be considered an active participant in the retirement plan. The types of distributions available to active participants are outlined in the Plan’s Adoption Agreement, and may include COVID-19 withdrawals or loans, hardship withdrawals, participant loans, or other in-service distributions.

 

Terminated employees may also take distributions from their 401(k) plan upon their severance from employment. Elective deferrals and any vested contributions are available for withdrawal. However, any funds withdrawn from the 401(k) account will likely be classified as taxable income, and participants under age 55 may be subject to a 10% early distribution penalty. Terminated employees also have the option to rollover their account balance to either a new employer’s plan or an IRA within 60 days of the distribution.

 

To help participants access the funds in their 401(k) account more easily, the CARES Act permits both terminated and active participants to take a distribution from their 401(k) account under the COVID-19 provisions as long as one of the following requirements are met:

  • The individual is diagnosed with COVID-19, or
  • A spouse or dependent is diagnosed with COVID-19, or
  • An individual who experiences adverse financial consequences as a result of being quarantined, furloughed, laid off, having work hours reduced, being unable to work due to lack of child care due to COVID-19, closing or reducing hours of a business owned or operated by the individual due to COVID-19; or
  • Any other factor as determined by the Treasury Secretary

 

Employers that currently do not offer coronavirus related distributions to employees but would like to, can do so immediately under the CARES Act. To learn more about the CARES Act, check out this article.

 

What Happens to 401(k) Participant Loans After Furloughs, Layoffs, and Terminations

Furloughed employees may want to consider taking a loan from their 401(k) account, rather than a distribution. The Plan Document should specify if loans are permitted from your employer’s plan. Unfortunately, employees who have been laid-off or terminated are unable to take a loan from their 401(k) account.

 

One consideration when taking a loan is scheduled loan repayments. Typically, participant loans are repaid through regular payroll deductions. So when an employee is furloughed and no longer on payroll, the employee may have a higher chance of defaulting on participant loans if they’re unable to make their regularly scheduled loan payments.

 

A laid-off employee may also be at risk for a participant loan default, especially if the 401(k) plan document does not permit other methods of repayment besides payroll deduction. Additionally, the plan document may require an accelerated loan repayment for outstanding loan balances upon termination of employment. If a furloughed or laid -off employee is struggling to repay their participant loan they may be eligible for relief under the CARES Act, which permits the employee to delay specific loan payments.

 

Impact on Employer Matching Contributions and Nonelective Contributions

Some 401(k) plans have allocation requirements in order to receive any sort of matching contribution from the employer. Common allocation requirements are:

  • requiring 1000 hours or service in a 12 month period, or
  • the employee must be employed on the last day of the plan year

 

A furloughed employee may have difficulty reaching the 1000 hours of service requirement, depending on the duration of the furlough. In this case, they may not be eligible to receive the matching employer contribution.

 

A laid off employee would most likely not receive the matching contributions where the plan document requires employment on the last day of the plan year. So they, too, would not receive the matching employer contribution.

 

With more employees becoming ineligible for the matching contribution due to reduced work hours or being terminated, the employer will not be making as large of a matching contribution to the 401(k) plan as they would otherwise.

 

Employers are still required to make contributions to the 401(k) plan that do not have allocation requirements. These contributions are usually a percentage of a participant’s compensation and are not contingent on salary deferrals. Since furloughed employees are not compensated during the furlough, their annual compensation is reduced, which in turn reduces the employer’s contribution.

 

Partial Plan Terminations Resulting from Terminations and Layoffs

If more than 20% of the company’s employees are terminated, a partial plan termination could be triggered. When this occurs, all of the participants immediately become 100% fully vested. This is impactful for plans that use a vesting schedule since this means that laid-off employees who were only partially vested or not vested at all at the time they were laid-off, will become fully vested when they take their distribution from the plan.

 

No Remittance Relief for Participant Contributions

Changes to an employee’s employment status can often cause delays with payroll processing. This may impact employee deferrals or matching contributions to the plan. The DOL still requires timely remittance of contributions to the plan, so employers should ensure that any contributions by a furlough or laid-off employee are remitted timely to the 401(k) plan.

 

There are many important considerations for a company when it comes to keeping your retirement plan compliant. Working with an experienced Plan Administrator can help identify the best strategy for your company’s retirement plan. Contact us for more information.

 

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