What would happen to your company’s 401(k) plan if you merged with or acquired another company? It’s a question that’s coming up more and more as mergers and acquisitions (M&A) activity continues to increase. In 2021, we saw record-high M&A deals, and they have continued into 2022.
Before finalizing a merger or acquisition, both parties should work out how the surviving or emerging entity will handle existing 401(k) plans. Will the surviving entity elect to sponsor the 401(k) plan? Will one plan merge into another? Will all or some of the plans need to be terminated? And most importantly, how could these options affect you and your employees post-merger/acquisition?
Assess the risks before acquiring, merging with, or terminating a plan.
With all the due diligence and negotiations that occur ahead of an M&A transaction, employee benefit plan considerations are sometimes an afterthought. The results can be costly, time consuming, and limiting.
Due diligence should be completed ahead of the transaction to uncover any existing fiduciary issues, especially in a stock transaction. If compliance and qualification errors exist in a 401(k) plan your company is acquiring, the company could inherit those issues and jeopardize the tax-qualified status of the plan. It’s critical to understand the extent of possible issues, and their potential to lead to unexpected costs.
In a merger or stock sale:
Mergers are generally more restrictive for the buyer. The buyer owns the acquired company and all the good and bad that comes with it, generally this includes responsibility for the acquired plan. The options:
- Both plans can continue for a period of time – until the end of the year after the sponsors merge. After, plan compliance testing is looked at on a combined-plan level, making it difficult or impossible to be in compliance. At the least, the plans would likely need to be amended to closely resemble each other. Maintaining separate plans can also limit advantages of economies of scale – both for investment “buying power” and for administrative fees and burden.
- Freeze the plan – the plan must be maintained, but no further contributions. Employees can be enrolled in the acquiring company’s plan. This can also be done as a lead up to a plan merger…
- The plans can merge – with anti-cutback rules, prior service must be recognized for eligibility, vesting, and allocation calculations. Also, some protected benefits, such as vesting terms and distribution options, cannot be reduced if they were contained in either plan. Other benefits and features can be reduced after some time.
- Termination of the seller’s plan prior to the sale – the successor plan rules prohibit distributions from a terminating plan if termination occurs after the deal closes, so this should take effect before the sale. Employees of the selling company can join the new plan similar to how they would in an asset purchase (below).
In an asset purchase:
An asset purchase agreement may include terms that provide for what will happen to the plan of the company whose assets are being acquired. Such terms should be reviewed carefully for the implications upon the sale. The options:
- If the transaction is an asset purchase, and there are no provisions addressing the matter, a company’s existing plans will remain the seller’s responsibility – they will continue to be the plan’s Sponsor.
- If the plan stays with the seller, the employees of the selling company would be considered terminated. The buyer’s existing plan can be amended to provide for recognition of prior service of the buyer’s former employees for eligibility and/or vesting purposes.
- The buyer could adopt the seller’s plan after the deal has been closed. Generally, plans would be aggregated for coverage and nondiscrimination testing purposes similar to the merger scenario of a stock sale.
New (to you) employees.
Regardless of the choice, as with the buyer’s current employees, procedures should be developed to ensure timely enrollment for acquired employees as soon as they are eligible, especially if a plan features automatic enrollment and prior service for eligibility or vesting.
Keep an eye on the audit threshold
Most voluntarily-established, non-governmental, private-industry plans are subject to the Employee Retirement Income Security Act (ERISA), oversight of which is conducted by the Department of Labor’s (DOL) Employee Benefits Security Administration (EBSA). ERISA sets the participation threshold requirements for a 401(k) plan to have an audit performed by a third-party CPA firm. Under ERISA, a 401(k) plan is required to have a third-party audit if:
- the plan has 100 or more participants – including separated participants with balances and eligible active participants, even if not contributing – on the first day of the plan year, or
- the plan hasn’t been previously audited and there are more than 120 of those participants on the first day of the plan year
Staying below the plan audit threshold can help you save money. In terms of mergers and acquisitions, you will want to understand how merging or terminating plans could affect the count, and whether it may trigger an audit.
ARB’s Employee Benefits, M&A & Succession Planning Advisory Services Teams work cohesively with clients to ensure successful M&A transactions and seamless transitions for their employee benefit plans. We help business owners determine the best options for their circumstances, so they can keep their employees happy and minimize unexpected costs ahead of, through, and after an M&A transaction. If you’re ready to learn more, contact me today.
by Benjamin A. Lord, CPA, CCIFP
Ben Lord is a Director at ARB specializing in audit and consulting services for employee benefit plans. Ben manages employee benefit plan audits in an efficient, cost-effective way by customizing services to meet a plan’s specific needs. He also specializes in consulting and financial accounting services for construction, real estate development, manufacturing, and professional services firms.