When your company is buying another company, the future of the acquired company's 401(k) plan is often overlooked. But if I told you the wrong decision about an acquired 401(k) plan could result in plan disqualification or hundreds of thousands of dollars in penalties, wouldn't you revise your priorities quickly? Start revising.
How to handle a 401(k) is something plan sponsors should consider before the acquisition, not afterwards. Will the acquisition be made by buying stock or assets? That's the first question that must be answered.
In a stock acquisition, the buyer generally assumes all assets and liabilities of the seller. In effect, the buyer purchases the 401(k) plan, too. If both entities have 401(k) plans, the acquirer has three options: maintain two 401(k)s; terminate the acquired plan; or merge them. Each option has pros and cons. What's right for one company might be dead wrong for another - so choose carefully.
Maintain separate two plans
After a stock acquisition, buyer and seller are considered to be one employer, called a controlled group. Because of this rule, an employer can have two 401(k) plans only if each plan continues to satisfy minimum coverage requirements. That is, both plans must continue to cover a sufficient number of non-highly compensated employees.
The Internal Revenue Service gives you time to bring both plans into compliance. If your company buys another before the end of 1996, it has until Jan. 1, 1998, to meet minimum coverage. The transition period might not be as clear cut if the plans operate under different plan years.
The most significant benefit of maintaining an acquired 401(k) plan is employee satisfaction. But there are several drawbacks as well. Plan sponsors must file separate 5500 forms and perform separate discrimination tests. Hassle and cost factors are the big roadblocks here. If these issues seem minor, then perhaps Option 1 is the right choice.
Terminate the acquired plan
This alternative is attractive mainly because it's convenient - one plan, one set of costs. However, this is not an option if you want new employees to participate immediately in your 401(k) plan. Companies can be forced to pay hefty penalties if they terminate a plan and bring new employees into an old plan too quickly.
The IRS' "successor plan rule" says that an acquired company's 401(k) will be disqualified if more than 2% of its employees will participate in any other defined contribution plan (except an employee stock option plan) within one year. Participants in that plan may be taxed and, in order to avoid that, their employer will have to pay sanctions. Option 2 mandates that new employees wait a year to join your 401(k).
Merge the two plans
Merging the plans can boost morale while saving money and effort. But this option has one large downside for 401(k) plan sponsors: the preservation of "valuable benefits," including distribution options (receiving funds over five, 10 or 15 years). Those benefits must be maintained in the merged plan. Such multiple benefits can complicate plan administration and communication for the plan sponsor.
Loans and hardship withdrawals are not protected features and may be eliminated after a 401(k) merger.
Stock acquisitions are very different than asset acquisitions. When assets (i.e., a building or furnishings) are acquired, a 401(k) covering transferred employees is still the seller's responsibility. Because these employees no longer work for the seller, a question is whether they may receive a 401(k) distribution. The IRS notes if employees work at the same desks and do the same tasks, even for a new employer, then no "separation of service" has occurred and plan distributions aren't allowed.
There are two important exceptions to the so-called "same desk rule." If 85% or more of the company's assets in a given trade or business are purchased, the seller can make 401(k) distributions to its former employees. Let's say a company manufactures both batteries and flashlights and is selling off its battery business only. Since more than 83% of the assets in its battery trade will be sold and distributions made, plan assets can then be rolled over into the new employer's plan with no penalty. The successor plan rule does not apply in asset sales since buyer and seller are not considered an employer.
If a whole company or subsidiary is sold, 401(k) distributions are also allowed, provided the purchaser does not assume the seller's plan.
What is the best course of action when a 401(k) plan is part of a corporate acquisitions? There is no "best" way to proceed. Each case requires a different approach because the wrong decision could result in substantial penalties.
Mark Niziak is corporate counsel of New York Life Benefit Services Inc., Norwood, Mass.