Qualified Retirement Plan Considerations in Corporate Transactions

Notwithstanding the current economic uncertainty, corporate transaction activity has remained steady, meaning buyers continue to address issues relating to a target company’s qualified retirement plans, such as a 401(k) plan. Treatment of a target company’s 401(k) plan affects both employers and employees, so, ideally, parties in a transaction will consider preferred strategies well in advance of closing. This article discusses two approaches: terminating the plan, or maintaining it after the transaction.

Quick Hits

• Mergers and acquisitions raise numerous issues, including whether to terminate or maintain a target company’s qualified retirement plan.
• The decision to terminate or maintain a plan involves various considerations, which can affect both employers and employees. Terminating the target company’s plan is the most common approach in a stock deal or merger, but practical issues sometimes require maintaining the plan.

Terminating the Plan

Terminating the target company’s plan often is the preferred strategy in a stock purchase or merger because it allows participants to take a distribution from the plan and, more importantly, avoids any potential qualification issues with the target’s plan coming over and “infecting” the buyer’s plan. Any action to terminate the plan must occur pre-close; otherwise, the termination effectively is treated as a merger into the buyer’s plan. On the other hand, in an asset purchase, the target’s plan usually is left behind, which allows participants to take a distribution even if the plan is not terminated. Typically, the buyer does not require termination of the plan when left behind in an asset purchase because the continued existence of the plan does not affect the buyer (and often specifically is excluded as a transferred asset in the purchase agreement).

There are a number of issues for consideration when contemplating a plan termination.

Compliance With Legal Requirements

When terminating a plan, the plan must be amended to be brought up to date with legal changes that have occurred since it was last amended. Additionally, a Form 5500 must be filed until all assets of the plan are distributed. Typically, the target and the buyer agree to delegate authority to wind down the target’s plan to the buyer’s benefits committee or other fiduciary.

Employee Consequences

Upon termination of the plan (assuming termination action is taken prior to closing), employees are eligible to receive a distribution of their account, which they may roll over to a buyer’s plan or to an individual retirement account. Accepting the rollover contributions generally does not expose the buyer’s plan to the same level of risk as a merger of plan assets.

Vesting of Employer Contributions

Participants in a terminated plan must become fully vested in their accounts in connection with the termination. It is possible that employees who terminate prior to the close also must be vested.

Maintaining the Plan

In some limited cases, buyers prefer to continue the target’s plan to provide continuity to employees affected by the transaction and limiting the changes that impact them directly. In other cases, it is not practicable to terminate the target’s plan because the buyer cannot integrate the target’s payroll system immediately and does not want to have a period when the target’s employees are excluded from participation in a plan. Whether the buyer maintains the target’s plan by choice or by necessity, there are various considerations.

Transition Period

The testing rules allow the plans to conduct the applicable nondiscrimination and coverage tests separately (effectively, as if the transaction had not occurred) through the end of the plan year immediately following the plan year of the transaction (e.g., for a transaction that closes in 2023, the transition period expires at the end of 2024). After expiration of the transition period, the plans must be tested on a controlled group basis (i.e., as if the entire controlled group were a single employer), which frequently causes headaches for unsuspecting buyers, especially when multiple subsidiaries are involved.

Merger

Most buyers decide to merge a target’s plan after expiration of the transition period to reduce the administrative costs associated with maintaining two plans. In connection with the merger, the buyer must review and align the two plans’ provisions, including analyzing whether any features of the target’s plan must be “protected.” Additionally, the buyer may want to consider reviewing and mapping over investment options (or transferring all investments to a default fund), and ensuring that administrative items (e.g., deferral elections) are transferred.

Note that the merger process is an opportunity for plan failures to occur (for example, elections are not implemented correctly in the buyer’s plan), so buyers will want to pay careful attention to the details of the merger process.

Final Thoughts

Treatment of a retirement plan in a transaction involves a number of moving pieces. Buyers may want to consider these issues in advance of closing to streamline the process, regardless of whether the decision is to terminate or maintain the plan.

Ogletree Deakins’ Employee Benefits and Executive Compensation Practice Group regularly provides legal updates in response to developments in employee benefits law. Please see the Employee Benefits and Executive Compensation blog for more information.

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