When a buyer acquires a company – whether through a stock or asset transaction – one of the more consequential employee benefits decisions it will face is what to do with the target’s 401(k) plan. The buyer has three broad paths: terminate the plan prior to closing, continue the plan on a standalone basis post-closing, or eventually merge it into the buyer’s own 401(k) plan. Each path carries distinct legal, administrative, and cost implications. Equally important: if no affirmative decision is made, the default path is continuation, and it is complicated to terminate the plan later. The only practical path to later “terminate” the plan is a merger into the buyer’s controlled group 401(k) plan. This article outlines the key factors buyers should evaluate early in the transaction process to arrive at the right decision with confidence.

Key Fact Patterns to Consider

1.      Does the buyer group already have a 401(k) plan or other savings arrangement in place? If they do not, there is likely a stronger desire to continue the target plan to minimize additional set up costs and employee disruption, rather than terminate it.

2.      Asset transactions have unique issues.  The buyer is not required to continue the target 401(k) plan and to cause the plan to be assumed by buyer would require some additional efforts (for example, board resolutions by both parties and consents of vendors as a start).  In an asset transaction it is often preferable for a buyer to leave the target 401(k) alone and the selling company will need to deal with the plan post-sale.

3.      What to do if the target 401(k) plan has some identified errors and unusual features.  Typically where there are issues, a buyer would not want to incorporate the target’s plan into its current plan. It would prefer to stop the issues and correct the errors separate from the buyer’s current plan arrangement or terminate the plan (at least one day) prior to the closing of a transaction.  So in this case, a plan merger would be an undesirable path.

Path 1: Terminate the Target 401(k) Plan Prior to Closing

This approach is typically chosen when the buyer wants a clean break from the target plan (including any operational issues identified in diligence) and to avoid the successor plan rules. Timing is critical: to avoid successor plan treatment under the 401(k) regulations, the termination must be effective at least one day before closing.

While every situation is unique and diligence of a 401(k) plan is important in each transaction, here are some of the basic fact patterns to consider in coming to this decision:

Path 2: Continue the Target 401(k) Plan Post-Closing (Standalone)

If no affirmative decision is made, the default is that the target plan continues after closing. Continuation can be attractive where the buyer does not currently maintain a 401(k) plan, where the transaction structure makes assumption cumbersome (often in asset deals), or where the parties want to minimize immediate employee disruption while longer-term integration is evaluated.

In a stock acquisition, the main decision relating to a target’s 401(k) plan is whether the plan should be terminated pre-closing or continue post-closing. If the plan continues, it may remain standalone for a period of time and/or later be merged into the buyer group 401(k) plan. Buyers often ask: What is the difference, and does it matter? Depending on the facts and circumstances, it can matter a lot—one choice can cost much more in time, effort, and dollars.

In a plan termination situation, the successor plan rules under the 401(k) regulations will not apply where a plan is terminated at least one day prior to a closing.  Once the plan is “terminated” by the board’s adoption of a resolution to terminate the plan, the annual compliance testing should be completed, participants should be fully vested in their accounts under the plan and then participants should be allowed to take a distribution from the plan.  Distributions are often in the form of lump sum payments in cash or a rollover to an individual retirement account or another 401(k) plan the individual is a participant in.  The assets should be fully distributed within 12 months of the board resolution terminating the plan.  The sponsor of the 401(k) plan will remain responsible for finalizing all distributions from the plan and filing the final form 5500. 

Path 3: Merge the Target Plan Into the Buyer’s 401(k) Plan

In the case of buyer having another 401(k) plan and the target’s plan not being terminated prior to closing, then a plan merger is the practical alternative option given the successor liability rules under the 401(k) regulations. The plans need to have separate compliance testing performed in the event of a mi- year merger (and often when one plan is a safe harbor plan, a year end merger is the common approach, which can be a challenge when payroll transitions occur prior to the planned merger date).  In addition, in a merger, all of the assets in the target 401(k) plan trust would be moved to the buyer 401(k) plan trust after a protected benefit analysis and investment mapping analysis is performed.    Blackout notices will likely be required in this situation.  These actions are fiduciary actions and require some careful analysis and attention.  But the advantages include that the assets will remain in the plans, and there will not be issues with loan repayments which is triggered in most plan terminations.

Choosing the Right Path in a Particular Transaction

Each transaction and company is different and the facts in the specific circumstances should be considered and may lead to a different choice in each transaction. Special additional factors to be considered in deciding which path is preferred under the relevant circumstances:

  1. Are there many outstanding loans in the target plan and, if so, will a material amount of money be payable in a short-term post-closing or risk participants being subject to penalties?  Are there accommodations the buyer is able to make to address outstanding loans?  Having loans outstanding at the time of a plan termination is not a block to termination, but requires some careful considerations before proceeding.

  2. Is the target’s plan a multiple employer plan, such as one sponsored by a professional employer organization (PEO) or a pooled employer plan?  Those types of plans often have limitations on the ability to terminate participation in the plan and leave the obligations with the entity other than the target.  It is important to review these plan documents for termination provisions and often discussions with the plan’s recordkeeper and sponsor will be necessary to assess possibilities for post-closing.

  3. Similar to 2, is the buyer’s plan a multiple employer plan?  Would that plan accept a merger of plan assets into the buyer’s current plan trust or will additional costs be incurred?

There are many steps to any of the paths above and deciding which approach is best for your organization should be undertaken with a trusted advisor who is familiar with the common hurdles applicable to either arrangement, only a handful of which are noted above.  For example, in addition to the considerations above, buyers will want to focus on complying with state law retirement plan requirements and to address other retirement plan options, such as SIMPLEs and SEPs may be applicable.  The 401(k) plan termination is not the only option and the facts and circumstances will guide whether it is the right approach for a specific buyer in a specific transaction. 

Our team at Cohen & Buckmann can provide sellers and buyers more information on how to manage your 401(k) plan integration concerns before, during or after a merger or acquisition.