Beware of ERISA entanglements and higher costs
Is your company contemplating buying another company, or a division of one? If so, be sure to assess and plan for the impact on your 401(k) plan, and that of the company you’re acquiring, before pulling the trigger. The same applies if you’re on the receiving end of an acquisition (though you might not be able to do as much if you’re the acquisition target). In either case, allow yourself plenty of time to work through a series of important decisions.
Asset vs. Stock Sale
Two major challenges that often arise in merger and acquisition (M&A) transactions are ERISA compliance issues and unanticipated costs. But these challenges generally come into play only if the acquisition is through a stock purchase, vs. an asset sale.
In an asset sale, what’s being acquired isn’t the legal entity of the business itself — which continues to live on independently after the sale — but merely the company’s assets. That means that the company that has sold its assets remains a going concern and the sponsor of its 401(k) plan.
Under an asset sale, the company that sold its assets typically will terminate its 401(k), and its participants will be able to roll their account balances into IRAs. Or, if your company hires the acquired company’s employees, they might also be able to roll them into your plan.
Stock Purchase Options
Where things get more complicated is when your company buys another in a stock purchase. The result is that the acquired company’s 401(k) plan lives on under your watchful eye. When an M&A transaction occurs via a stock purchase, you have three options:
Terminate the 401(k) plan.
Keep it running separately from your existing plan.
Merge it with your existing plan.
Why might you choose the first option? If you determine during due diligence before the acquisition that the 401(k) plan you have acquired has compliance issues, you would inherit those problems and need to address them. Merging a 401(k) that’s violating ERISA in some way could taint your original plan. And you’d still have to fix the noncompliant plan — even if you just kept it operating independently of your existing plan.
There can be downsides to a termination, however. One is that, under the “successor plan rule,” the former participants of that plan generally will have to wait a year before joining a new plan (such as your existing plan). You must distribute assets the participants had in the terminated plan to them. Many may succumb to the temptation to spend some of that money immediately, instead of rolling it into an IRA. Note that the successor rules don’t apply if the seller’s plan is terminated before the actual acquisition.
Suppose instead that the to-be-acquired company’s 401(k) plan is fully ERISA-compliant. Why not just let it continue as-is after the acquisition? You could for a while, but you might eventually run into problems with ERISA discrimination tests if one plan is more generous than the other. Plus, you’d probably pay more to administer two plans than one combined plan. In addition, the controlled group rules may require you to merge the plans once the transition period is over.
(For more on the third option, merging an acquired plan with yours, see “2 common ways to merge plans.”)
Added Costs to Consider
Even if merging the acquired company’s 401(k) with yours is the best way to go, it won’t be a cakewalk. It will run more smoothly, though, if you’ve studied the acquired company’s operational process and plan design to ensure that both are aligned, and you’ve determined how you want to harmonize the two.
Before migrating the acquired plan to your existing recordkeeping platform, review your vendor agreements to see how much warning you need to give them before making a change. Another key consideration is the Internal Revenue Code’s “anti-cutback” and protected benefit rules. It prevents plan sponsors from reducing the value of “protected benefits.” That might require you to raise the generosity of one plan to balance it with the more generous one. Protected benefits include:
Accrued benefits, such as the vested status of benefits and the value of such benefits before and after the merger,
Optional forms of benefits such as payment schedules, timing and medium of distribution,
Early retirement benefits, and
In-service withdrawal options.
The most common plan provisions not subject to the anti-cutback rule include the right to make elective deferrals, loans, hardship withdrawals and after-tax contributions.
Also, certain plan investment options, such as guaranteed investment contracts (GICs) and stable value funds (SVFs), have liquidity restrictions that can keep funds tied up for as long as a year to avoid penalties. Although GICs and SVFs can be tricky to deal with when merging plans, it’s also a big job to consolidate other plan investment options into your plan or replace them. Acquiring companies generally choose not to sweep the specific investment options of the acquired company’s 401(k) into their own.
Doing the Homework
These are just a few highlights of what may be involved in managing retirement plans during an M&A transaction, but enough to get you started down the path of planning your strategy. Also remember that terminating or merging plans will require you to file a final Form 5500, along with a final audit, if required. M&A involves many complex questions; be sure not to ignore your 401(k) plan.
2 Common Ways to Merge Plans
So let’s say you’ve just acquired another company in a stock purchase transaction and now need to merge its 401(k) plan with yours. Generally, there are two ways of doing so:
Fund mapping. Under this approach, you move participants’ assets from their original plan into funds in your plan that most closely resemble what they had in terms of investment objective and risk profile. (This can get tricky for you and the participants if there aren’t any comparable funds.) You also need to give participants notice about your intentions so they have an opportunity to invest their funds differently if they so choose.
Re-enrollment. In contrast, this approach involves putting the burden on participants to liquidate their holdings in their old plan and re-invest that cash into the investment options in your plan. Participants who elect not to make those decisions can be defaulted into qualified default investment alternatives.