Key Takeaways
When a business is sold (often referred to as a merger and acquisition activity), its 401(k) plan must be addressed.
In a stock sale, the buyer generally inherits the existing 401(k) plan, including its history; in an asset sale, the seller's plan typically remains with the seller to deal with.
Both buyers and sellers need to plan to avoid unexpected costs and ensure employee benefits are handled correctly, as there are strict rules for these transitions.
Selling or acquiring a small business (often referred to as merger and acquisition activity, or M&A) is exciting, but there’s a lot to do to get it right. The owners of the business being sold (seller) and of the business making the purchase (buyer) should take the time to evaluate retirement plan issues and make decisions for their respective plans before the sale closing date. If you don’t make an informed choice about what’s best for your business ahead of time, you could find yourself responsible for unexpected and ongoing costs.
What happens to the seller’s retirement plan?
There are essentially four options for dealing with the seller’s retirement plan (the plan sponsored by the company that’s being sold):
The seller’s plan can continue
The seller’s plan can be terminated.
The seller’s plan can be merged into the Buyer’s plan
The seller’s plan can be frozen or maintained without the option of further contributions
Determining the best option
The options available, however, are partly determined by the type of sale: stock or asset.
In an asset sale, the buyer is only purchasing certain assets of the seller, like client lists, physical and/or intellectual property, equipment, and so on. Ownership of the company remains with the seller. The seller may be selling all of its assets as part of winding down the business, or it may only be selling part of what it owns with the intention of the company continuing in operation. The seller’s retirement plan does not pass automatically to the buyer.
In a stock sale, the buyer is acquiring ownership of the company from the seller. Ownership of the seller’s company includes everything that belongs to the company, including any active retirement plans.
Plan options in an asset sale: the onus is on the seller
In an asset sale, the seller generally maintains responsibility for its retirement plan after the sale. The seller can continue to sponsor the plan or terminate it, depending on what it is trying to accomplish as a company after the sale. The seller should be aware that:
If it continues the plan but has terminated 20% of its workforce, all affected participants will be 100% vested under the IRS partial plan termination rules.
If it intends to terminate the plan, it cannot simply walk away. It is the seller's responsibility to take all required actions to terminate the plan, including formal termination, distribution of assets, and filing the final Form 5500.
Sometimes, the parties agree that the buyer will assume sponsorship for all, or a portion, of the seller’s retirement plan after the sale. This typically only happens when the buyer agrees to hire a substantial number of the seller’s former employees. The buyer should understand that, in this situation, it is accepting all liabilities associated with the portion of the seller’s plan it accepts, such as any operational errors or audit issues.
If the buyer is assuming the role of plan sponsor of the seller’s plan, the buyer may choose to maintain the seller's plan separately or merge it into another plan it already sponsors. If the buyer is only taking a portion of the seller’s plan, that portion will “spin out” to a new plan established by the buyer or to another plan the buyer already sponsors. If a portion of the plan remains with the seller, the seller will need to decide what to do with that part of the plan, as discussed earlier.
Both buyer and seller should be aware that, if the buyer agrees to take all or part of the seller’s plan, employees who are terminated by the seller and hired by the buyer cannot take a distribution from either plan. The buyer will be treated under IRS rules as maintaining a “successor plan” for those employees, and they will only be entitled to a distribution if they have a future distributable event, such as obtaining Full Retirement Age or termination of employment from the buyer.
Plan options in a stock sale: the onus is on the buyer
In a stock sale, the buyer effectively assumes responsibility for the seller’s active retirement plan, including future and past obligations, as of the sale closing date. If the buyer does not want to be responsible for the seller’s plan, the seller executes a resolution to terminate the plan with an effective date before the sale closing date.
Once a buyer has inherited the seller’s plan—intentionally or otherwise—there are three options for maintaining it:
Freeze the acquired plan
Merge the acquired plan into the buyer’s plan
Separately maintain the acquired plan
Generally, plans inherited via a stock sale cannot be terminated after the sale closes.. There is an exception; if the buyer does not maintain a successor plan, it can terminate the seller’s plan after the sale closes. A successor plan is a plan of the same type that exists during a period starting on the original plan’s termination date and ending 12 months following the full distribution of the plan’s assets.
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3 options for when a company inherits a 401(k) plan in a stock sale
1. Freezing the plan
Freezing the acquired plan requires the buyer to fully maintain the plan, including the accounts, documents, annual Form 5500 filing, and so on, while prohibiting any further contributions.
2. Merging the plans
This is the most common option. Merging an acquired plan with the buyer’s existing plan requires separate accounting of the merged plans. To comply with the anti-cutback rule, a close comparison of the provisions in each plan is also required to determine if changes are needed to accommodate protected benefits. Protected benefits include accrued benefits, early retirement benefits, retirement-type subsidies, and other forms of optional benefits in a qualified retirement plan.
In a stock sale, the buyer may decide to merge plans after the transaction. However, doing so will still require a written agreement to transfer or merge the assets of one plan into the other.
Although a plan merger may result in some changes in a plan’s administrative terms (for example, the plan administrator or investment choices), it usually does not have a significant impact on a participant’s benefits.
3. Maintaining separate plans
The buyer may decide to maintain each retirement plan separately. This requires aggregation for certain compliance tests each year, and depending on demographics, amending the plans to more closely mirror one another.
New hire or vested employee?
In a stock sale…
The seller’s business continues to exist after the sale closes, but it now has new owners. The buyer has to decide what to do with this business after the sale closes. It may choose to keep the business running as a separate entity, or it may merge it into another business it owns. The buyer then needs to decide what to do with the employees of the purchased business and what benefits they will be entitled to. The buyer should understand that these employees are not “new hires” for benefit purposes and all of their service with the seller must be counted for benefit purposes, including plan eligibility and vesting.
In an asset sale…
Employees of the seller can be hired by the acquiring entity but are not automatically hired. They are essentially new employees of the buyer, meaning service with the seller is generally not automatically recognized. If the buyer wishes to credit service with the seller for eligibility, vesting, and/or allocation purposes, their plan must be amended to include prior years of service with the seller..
Due diligence before the transaction
In an ideal world, the buyer and seller in a stock sale have discussed the seller’s retirement plan before the sale is complete.
A buyer can take the following steps to learn about the seller’s current retirement plan:
Hire a qualified professional to review the seller’s retirement plan/s.
Identify the seller plan’s fiduciaries, and confirm that the plan is not currently subject to an IRS or DOL audit or any threatened, pending, or filed fiduciary breach lawsuits.
Review the seller’s plan process and procedures, compliance testing outcomes, plan documents and amendments, and any audit reports.
Determine if the seller’s plan will be terminated, and if so, make sure the resolution to terminate the plan is signed and effective before the sale closing date.
Good to know
Often, there is a “grace” period available through the end of the year after the year in which the transaction takes place, during which buyers can maintain two separate plans and be deemed to pass certain compliance testing. This gives the buyer some time to conduct some of their due diligence before determining what to do with the plans. Keep in mind that the analysis takes time. Don’t put it off!
If you’re thinking about or in the process of merging with or acquiring a company, we support Human Interest customers (and incoming customers) to help you determine the best retirement plan option available to your business. We’ll also take care of all the plan amendment notices and filings. Learn more about the services we offer.
Start a 401(k) with Human Interest
A Human Interest 401(k) plan can connect directly with your favorite payroll provider and has zero transaction fees.*
Article By
Wendy Baker, J.D.Wendy Baker is Senior Legal Counsel at Human Interest, bringing over 25 years of experience exclusively in the ERISA space, spanning defined contribution plan recordkeeping and administration. She has a J.D. from Case Western Reserve University, is a member of the North Carolina and Ohio Bars, the American Bar Association, and industry groups.
