By Jeff Chang
As many California public agencies are forced to furlough employees during the COVID-19 pandemic, questions arise as to how furloughs are treated for retirement plan distribution rules’ purposes.
Let’s begin with a bit of terminology: What is a “furlough?” Although the term can mean different things, most people agree that a furlough amounts to an employer-initiated reduction in hours or a period of employer-initiated unpaid time off. Unlike a “termination of employment,” a furlough contemplates that the furloughed employee will be called back to work as soon as the event(s) giving rise to the furlough (e.g., a lack of work; a government order to stay home) resolves. In many, if not most cases, public agencies that furlough their employees continue to carry them on, and pay for, employer-provided health coverage. Despite the extension of certain benefits to furloughed employees, their reduction in hours and loss of income may entitle them to unemployment benefits.
Questions naturally arise: If a worker is on unemployment, isn’t he unemployed? Hasn’t his or her employment terminated? Perhaps, for purposes of the unemployment insurance rules. However, the analysis is different when it comes to the retirement plan distribution rules.
As mentioned in an earlier Focus on Public Benefits post, most governmental retirement plans require, at a minimum, an employee to have a severance of employment before the employee can receive a distribution of his or her benefits. There are few exceptions to this rule for: unforeseeable emergency hardship distributions, coronavirus-related distributions (or CRDs), and statutorily authorized in-service distributions. So, absent one of these conditions, can an employee request and obtain a regular “severance of employment” distribution if they are furloughed?
It depends on the facts and circumstances of the particular case. There is some guidance from the IRS from which we can glean a number of principles:
- Do the employer and the employee reasonably anticipate that no services will be performed after a certain date? If so, it looks more like a severance. If, on the other hand, the parties anticipate a future call-back to work, the situation doesn’t look like a severance.
- Does the employee continue to be treated as an employee for other benefits (i.e., health plan) purposes? If so, the situation looks like more like a limited continuation of employment and not a severance.
Why are these determinations or characterizations so important? Failure to follow the rules that restrict or limit retirement plan distributions can disqualify a retirement plan, causing the employer and its employees to lose valuable tax benefits. If your furloughed workers are requesting the distribution of their retirement plan benefits, it is important for you make sure that the plan has a valid basis for making the distribution.
Jeff Chang is a partner at Best Best & Krieger LLP. He has four decades of experience skillfully evaluating benefit and retirement plan compliance to achieve maximum outcomes for public agency clients throughout California. He can be reached at email@example.com or (916) 329-3685.