Business owners considering a merger or acquisition should make sure employee retirement plans are thoroughly evaluated during a transaction's due-diligence phase to mitigate compliance risk.
CPAs and benefit plan advisers can play a vital role in helping C-suite executives put in place a strategy to address any changes needed to a company's retirement plan design due to a merger or acquisition. By being attentive to the effect a transaction will have on plan design at both companies (the buyer and seller), managers can ensure the smooth transition to a new retirement plan in the newly combined company.
Below are several key factors that CPAs and benefit plan advisers should consider to ensure a successful integration of plans during a merger or acquisition.
How does the transaction structure affect plan design?
Transactions generally fall into three categories — stock sales, asset sales, and mergers — and each affects retirement plans in different ways. Due to the difficulty of passing IRS nondiscrimination rules if both plans were retained, the buyer generally keeps its existing plan and terminates the seller's plan. In the rare instances when employee and business demographics align, the buyer can keep the seller's plan and allow it to cover only the new subsidiary while continuing to cover its legacy employees with the old plan.
In an asset sale, employees with the acquired company will be considered terminated and eligible for distributions from the seller's plan under its terms. Any employees from the selling company that are hired by the acquiring company would then become participants in the buyer's retirement plan according to its eligibility rules. If the acquiring company desires, its plan can be amended to provide employees with credit for service at the seller's company, which would allow the new employees to participate immediately in the buyer's plan. Provisions can even be made to provide vesting credit for service with the prior employer if the acquiring company wants to.
In a merger the surviving company is responsible for all plans sponsored or adopted by either the buyer or seller before the transaction. Benefit plan considerations are very similar to those of a stock sale.
Once the transaction structure has been determined, managers should next analyze three important considerations that affect retirement plan design: coverage rules, termination rules, and partial plan termination rules.
Sec. 410(b) contains specific rules that qualified retirement plans must consider regarding the benefits offered and which employees are covered. If a company or related group of companies offer a plan or multiple plans, each company's plan must pass nondiscrimination testing. This comes into play in mergers and stock sales because there generally is an immediate change in employee demographics and in the design and structure of the plans due to the transaction.
Fortunately, Sec. 410(b)(6)(C) provides relief during the transaction period by giving each company enough time to meet nondiscrimination testing requirements. The relief period is the first day the transaction is effective through the last day of the following plan year. Both plans may continue to operate separately under their existing terms during this period. For example, consider a transaction that is effective on May 24, 2018, and that both companies have retirement plans that cover the calendar year. The plans would receive this relief through plan year 2019, or until Dec. 31, 2019. Once the 2020 plan year begins on Jan. 1, the companies will need to meet the required coverage testing of Sec. 410(b) if both plans still exist.
Managers also need to consider rules under Sec. 401(k) that prohibit the termination of a 401(k) plan after a merger if there is an "alternative defined contribution plan" sponsored by the acquiring or surviving company (Regs. Sec. 1.401(k)-1(d)). If both plans continue to exist after the merger, employee deferrals and any qualified nonelective contribution balances in the 401(k) plan that are targeted for termination must be merged with the "alternative defined contribution plan" of the surviving company.
Any other contribution sources, such as matching or profit sharing contributions, can be distributed. This treatment is triggered in a merger and stock sale where both parties have plans and one of them is a defined contribution plan such as a 401(k) plan.
Once the date of merger occurs, the seller's 401(k) plan cannot be terminated without being merged into the acquiring company's deferred compensation plan. When there are administrative issues regarding the acquiring company's plan or a general desire to terminate the 401(k) plan — or that portion of the 401(k) plan in the case of a spinoff — these concerns should be communicated to the seller so the plan is terminated before the transaction date.
Plan assets do not need to be distributed before the transaction. Cessation of benefit accruals, however, must be terminated by a board resolution. Participants must be provided with a notice of termination at least 60 days, but no more than 90 days, before the termination date.
Partial plan termination
Partial plan termination is not clearly defined in the law or regulations and is quite subjective. Some generally accepted definitions are the termination of 20% or more of the participants in a particular year, the closing or sale of a manufacturing plant, terminations or divestiture of an identifiable division, or employee turnover due to adverse economic conditions.
The law requires that all "affected employees" be fully vested in their account balances as of the date of the event, regardless of the plan's vesting schedule. An important note is that the identification of a partial termination or the employees identified within one can include terminations in more than one plan year.
While it is common for the buyer to want to terminate the acquired company's benefit plan, the opportunity is frequently missed. As noted above, the seller would need to terminate the plan before the transaction. Under notice requirement laws, plan participants must be notified no less than 60 days before the termination date of the plan (and no more than 90 days).
If the plan or portion of the plan is terminated, participants would be 100% vested in their benefits and eligible for plan distribution. (Hopefully, the participants would elect to roll these benefits into another tax qualified account or the acquiring company's plan.) Participants then would be enrolled in the acquiring company's plan(s) based upon the eligibility requirements of those plans.
Plan administrators or sponsors should review plan documents for terms that may grant immediate eligibility to employees of the acquired company; otherwise the newly hired employees of the seller could have a gap in retirement plan participation. (For employee communication purposes, this eligibility requirement should be examined and considered.)
If the seller's plan is not terminated before the transaction, the plan(s) sponsored or adopted by the target company would effectively become the acquiring company's plan. In this instance, the transition relief of Sec. 410(b)(6)(C) is generally used, and the seller's plan would not cover the acquiring company's employees and vice versa. This relief is available until the end of the plan year following the date of the transaction. At that time or prior, the plans of the entities would need to be amended to exclude each company's employees, and the plans would need to pass Sec. 410(b) testing for the entire organization's employee base. Another option is to merge the plans in a way that would cover all employees.
Another (rare) option — if the seller's plan is not terminated and the acquiring company does not want to merge plans — would be to continue the seller's plan as a "frozen plan," where the plan continues to exist but financial contributions cease. The seller's plan would be amended so that no future contributions can be made and employees would be covered by the acquiring company's plan based on that plan's eligibility requirements. The "frozen plan" would continue to exist and operate separately and would be subject to all administrative and reporting requirements.
In a merger, which is very similar to a stock sale, plan sponsors in general have two choices for retirement plans. One method is for the seller's plan to be frozen immediately and to enroll those employees in the acquiring company's plan. In the other method, the seller's employees would continue participating in their plan until the two plans can be merged. This is generally done before the end of transition relief under Sec. 410(b)(6)(C), unless the plan demographics allow both plans to exist. In that case, the plans may be able to coexist within the same employer.
On the effective date of the transaction, employees with the selling company are considered terminated and then hired by the buyer. The seller must also determine if a partial plan termination has occurred and if vesting should be adjusted. (As with a stock sale, it is anticipated that participants would roll their benefits to another tax qualified account or the buyer's plan depending on eligibility requirements.)
If the asset sale covers an identifiable division or significant numbers of employees, partial plan termination is likely triggered for those affected participants. If the entire organization is involved, partial plan termination is implicated.
Participants in the seller's plan would be eligible to participate in the buyer's plan based upon the eligibility requirements of the buyer's plan. As noted previously, the buyer's plan documents may have terms that grant immediate eligibility to the seller's employees that would prevent any gap in participation for the impacted employees.
During merger or acquisition transactions, CPAs and benefit plan advisers must evaluate the many moving parts involved with integrating retirement plans and adhere to several important deadlines. The considerations outlined in this article, while not comprehensive, can serve as a useful tool to help professionals become aware of the issues in managing these transitions and ensure retirement plan compliance.
Chris Shankle, CPA, CGMA, is a senior vice president with Argent Trust and specializes in employee benefit plans where he assists plan sponsors with fiduciary responsibilities and plan governance. He has more than 25 years of experience of providing tax and retirement solutions. He is a member of the AICPA Tax Executive Committee. To comment on this article or to suggest an idea for another article, please contact Sally Schreiber, senior editor, at Sally.Schreiber@aicpa-cima.com.