There are basically four possible outcomes for retirement plans in an M&A deal:
- The plans of both companies are merged.
- The plan at the acquired company is terminated.
- Both plans from both companies are maintained.
- The plan from the acquired company is frozen.
So, what do you need to know if these circumstances apply to a deal that you are involved in?
You can operate two separate 401(k) plans after an M&A transaction, as long as each plan can separately meet certain tax rules, and pass the IRS’s annual “coverage testing.” This testing ensures that an adequate percentage of non-highly compensated employees take part in each plan versus highly compensated employees. There is also a transition tax rule that allows a company to have the two plans through the end of the acquisition year without having to past the coverage test as long as certain criteria are met.
You may be wondering, if you can maintain both 401(k) plans after the deal, why you would want to merge the two. Some of the factors to consider include:
- Whether it is a stock or asset sale and which party is responsible moving forward.
- The plans may not pass the coverage test independently.
- You may want to take a more universal approach to your employee benefit programs to standardize the employer-matching contribution or eligibility requirements.
- Combining them may allow you to secure better investment options and fees.
- There may be certain administrative and cost efficiencies achieved by streamlining the recordkeeping and other associated services and fees.
You also may be wondering if you need to have two 401(k) plans merged by a certain date. There is no rule that dictates that a company must merge the plans by a certain time. However, the transition tax rule timing mentioned earlier will usually affect the decision. It can also be useful from an administrative standpoint to try to time for a January 1st effective date to avoid having to complete additional paperwork in the year.
In the past, you could submit your 401(k) plan document to the IRS every five years to obtain what is called an “IRS determination letter.” Under this process, the IRS reviews your documents to ensure that the plan meets all legally required provisions for a tax-qualified retirement plan. The determination letter was basically the IRS’ approval of the plan. But the IRS has since discontinued the determination letter program. Now, a company can only get a determination letter in very limited circumstances, which does include the merging of two 401(k) plans as part of a recent merger or acquisition.
You are not legally required to get an IRS determination letter, but it can be useful and important for a few reasons:
- The letter gives your plan a specific determination from the IRS on its tax-qualified status.
- It allows you to identify and correct any issues the IRS may find during its review.
- It will make an audit process easier, should the IRS choose to audit your plan.
- In the event of a later M&A transaction, having the letter can help in the due diligence process for both you and the buyer.
The IRS provides certain rules about how and when you can get an IRS determination letter for a 401(k) plan merger.
- The merging of the plans must:
- Combine two or more plans previously sponsored by unrelated entities.
- Be related to a corporate merger or acquisition among the unrelated entities.
- It must take place by the last day of the first plan year that begins after the date the business was acquired.
- You must submit the IRS determination letter application by the last day of the first plan year of the surviving 401(k) plan that begins after the date of the plan merger.
In any merger or acquisition, you should always remember the importance of the employees’ morale, so you will want to act with caution when it comes to disturbing any benefits. You will want to make sure that this is taken into consideration before making any changes to 401(k) plans.
Americas: Sam Smoot at +1 (813) 898 2350 / Smoot@BenchmarkIntl.com
Europe: Michael Lawrie at +44 (0) 161 359 4400 / Enquiries@BenchmarkIntl.com
Africa: Anthony McCardle at +27 21 300 2055 / McCardle@BenchmarkIntl.com
ABOUT BENCHMARK INTERNATIONAL
Benchmark International’s global offices provide business owners in the middle market and lower middle market with creative, value-maximizing solutions for growing and exiting their businesses. To date, Benchmark International has handled engagements in excess of $8.25B across various industries worldwide. With decades of global M&A experience, Benchmark International’s deal teams, working from 14 offices across the world, have assisted thousands of owners with achieving their personal objectives and ensuring the continued growth of their businesses.