When M&A activity occurs, it is important to understand the impact it will have on your retirement plan. It is recommended that the retirement plan’s intent is discussed as early as possible in the negotiation process with counsel and the entity being acquired. It’s also important to review the respective plan documents to determine how related employers are treated in them. With the help of a strong consultant and counsel, you can make sure to choose a solution that best fits the needs of your business and the participants to ensure a smooth transition.
There are two types of acquisitions, an asset sale and a stock sale. An asset sale is the acquisition of specific assets of a company such as the building, the equipment, or the employees. In an asset sale, there is no transfer of ownership. If it involves the employees, they are typically treated as new hires.
A stock sale, on the other hand, is when a company acquires the equity of another company. This typically involves a transfer of ownership and, depending on the details of the new ownership structure, often the acquired entity becomes part of the buyers control group. In a stock sale, employees are typically treated as if they always worked for the buyer.
The following are the general considerations and actions of a stock acquisition where Company A acquires Company B and both companies have a 401(k) (or other qualified retirement) plan:
Terminate Plan B
Often the buyer may want to terminate Plan B (the plan belonging to the company being acquired) as the best perceived option. Importantly, the termination date must be before the sale date typically via a board resolution. If the terminating plan is part of a pooled plan, such as a MEP or a PEP, it may need to spin out before terminating. Upon termination, all benefits will become fully vested and participants will have a distributable event, allowing them to roll over their assets into Company A’s plan or an IRA.
The entire process should be coordinated with the retirement plan recordkeeper including any required notices. Don’t forget to close out Plan B’s remaining compliance and administrative obligations including nondiscrimination testing and form 5500 filings.
Merge Plan B into Plan A
A plan merger is sometimes the only viable option depending on the timing of the transaction. You should be aware that if there are any operational failures in one plan, it could affect the qualified status of the other plan. Therefore, due diligence is crucial. This involves ensuring that Plan B has filed all necessary Form 5500s, completed required audits, performed nondiscrimination testing (NDT) with any applicable corrections, executed required regulatory amendments, and resolved any known IRS or DOL inquiries since the plan’s inception. Company A may be responsible for correcting any operational failures to prevent disqualification.
To proceed with the merger, the recordkeepers of both 401(k) plans should be notified of the intent to initiate a “trustee-to-trustee transfer,” also known as a plan merger. The specific timeline and process will be established by the recordkeepers. It is also necessary to review the protected benefits for Plan B and make sure they are appropriately transferred to Plan A. Similarly, as before, Plan B should be properly closed out after the merger by completing all remaining compliance and administrative actions including nondiscrimination testing and 5500 filings.
Continue to operate Plan A and Plan B separately
You may be able to operate Plan A and Plan B separately. From a participant experience, this approach ensures that participants experience no disruption, maintaining a smooth operation for all involved. Additionally, it mitigates the risk of exposing either plan to qualification defect of the other as we discussed when merging a plan.
Operating plans separately often necessitates additional compliance testing. However, if certain conditions are met, a transition rule (IRC §410(b)(6) Transition Rule) can be applied for the year of acquisition and the following year. After this transition period, both plans must pass the minimum coverage test on a control group basis to complete the Nondiscrimination Testing (NDT) separately. Should they fail this test on a control group basis, then NDT must then be conducted on a combined basis.
Practically speaking, during an acquisition, companies may choose to operate separately and then merge before the transition period concludes.
To continue to operate both plans separately, notify the recordkeepers of the new control group and make sure to confirm who will be responsible for completing the combined compliance testing which could be either the recordkeeper or a Third-Party Administrator (TPA).
Freeze Plan B
Perhaps the decision may be to freeze Plan B. This action eliminates the risk of exposing Plan A to qualification defects of plan B but benefits typically do become fully vested. One of the perceived drawbacks is participants may have two sperate 401(k) accounts to manage and cannot distribute funds unless they terminate from the entire control group.
To freeze a plan, you’ll want to notify the recordkeeper of the intent to freeze, completing any applicable amendments, and no new contributions are allowed into the plan. Make sure to continue to complete all appropriate compliance obligations of Plan B including 5500 filings.
With early and proper due diligence, M&A activity and the impact to your retirement plan can be minimal and even positive.
Disclaimer: This communication is intended for general information purposes only and should not be construed as legal or tax advice. The content provided is not intended to encompass all compliance and legal obligations that may be applicable to your situation. This information and any questions as to your specific circumstances should be reviewed with legal counsel and/or a tax professional. Facts and circumstances may dictate process and available options.
