January 12, 2019 12:09 am
If your business currently participates in a 401(k) plan for your employees, then you’ll want to know what the rules and regulations are in the event that you ever decide to terminate the plan. There are a number of reasons why you might be considering the termination of your company’s 401(k) plan: maybe you’re closing down the business or merging with another company. Whatever the reason may be, the following are 11 things to consider if you plan to terminate your company’s 401(k) plan.
If your company is purchasing or merging with another company, you’ll potentially have to worry about two sets of employees that have different 401(k) plans. Much will depend on whether the acquisition is an asset or stock sale. If it’s an asset sale, then you will be buying the assets and liabilities of the company, but the seller of that company will keep the possession of the legal entity. With a stock sale, you’re purchasing both the assets and liabilities as well as taking possession of the legal entity.
You have two options if the acquisition is a stock sale– you can either merge their 401(k) plan into your plan or you can keep it on a stand-alone basis, although this is rarely done as a result of IRS non-discrimination rules. If the acquisition is an asset sale, you can also have the seller terminate their 401(k) plan prior to the acquisition, which means any new employees you take on can simply sign onto your existing plan.
Generally speaking, most businesses choose to merge plans to help reduce disruption to new employees. However, you may want the seller to terminate their plan if it’s an option if they have protected benefits you don’t want to assume (such as liberal vesting terms), the seller’s plan has uncorrected defects that could corrupt your plan, or you want to treat the employees of the seller’s company as new employees for the purposes of your 401(k) plan.
It’s worth noting that you do have some time to merge 401(k) plans if you decide to do this–the IRS allows you to test two 401(k) plans separately for non-discrimination up until the last day of the plan year following the year of the sale.
All 401(k) plans require annual non-discrimination testing to be compliant. This is to ensure that your 401(k) plan doesn’t unfairly benefit the owners of your company, key employees, or highly-compensated employees over non-highly compensated employees. If you are going to terminate your 401(k) plan, make sure it’s compliant up until the termination date by performing compliance testing for the final year-to-date period, meaning from the beginning of the plan year to the date of termination.
Additionally, you may need to update your plan documents with all current laws and regulatory changes in order to terminate it to ensure that it remains compliant up to the date of the termination.
You will need to update your plan so that all employees participating are 100 percent vested upon the termination of the plan. This means that they own all of the balance in their account. If you have ex-employees who haven’t forfeited their unvested balance on the day the 401(k) plan is discontinued, they will become 100 percent vested. Doing this helps to ensure that the correct benefit calculations are made upon the termination of the plan.
If you have any ex-employees who were on your plan, you will need to track them down so that you can process distributions to them if they have money in the plan. Both employees and ex-employees have the right to choose their payment options.
Keep in mind that it often takes some time to track down ex-employees, which means you’ll want to get started on this right away. In some cases, it can take upwards of six months to find everyone. If you are unable to track down certain ex-employees, you can establish an IRA for them as a last resort.
You are legally responsible for following the guidelines of your 401(k) plan up to the date of the termination. This means that you will need to continue matching or making contributions (including deferrals, employer contributions, and loan payments) as outlined in your plan to your employee 401(k) accounts.
The owners or board of the company will first need to adopt a formal corporate resolution terminating your 401(k) plan. Once you process distributions and all assets have been paid from the plan, you will have to file a Form 5500 with the IRS/DOL. You will need to continue annual administration until all of your plan’s assets are distributed. Only then can you submit the final filing, which will be due within seven months of the date on which all of your assets were distributed.
You may also want to submit your termination plan to the IRS for approval. This is known as a determination letter filing. To do this, you will need to pay fees for the filing preparation as well as for the filing itself. The IRS will issue a determination letter between six weeks and 12 months approving the plan. Keep in mind that this part of the process is not necessary, but many businesses choose to do this because it helps ensure that their termination plan meets IRS standards.
Once you have drafted a formal corporate resolution that establishes the date of termination, you’ll need to notify all of your service providers, including third-party administrators, recordkeepers, investment providers, accountants, attorneys, and trustees.
When you notify your investment custodian of your plan to terminate, they will begin implementing procedures to discontinue your contract with them. There will likely be termination-related fees that you will need to pay.
You will need to inform all of your employees who are participating in the plan so that they are aware of the termination date and of their payment options.
Everyone, including both current and past employees, should be presented with a set of distribution election forms. This will allow them to choose how they receive their account balance.
Employees should be informed of the date of termination, the fact that they’re entitled to all of the funds within their account, and the time period within which they can expect their funds (funds must be sent out to plan participants within one year following the date of termination).
Before all of your plan’s assets can be distributed, make sure all of your ex-employees have been found and that they have been sent distribution election forms. All of these forms will have to be completed and returned to you before you can begin distributing your assets (since these forms include how participants want to receive their account balance). All the fees relating to the termination must be paid before you can begin asset distribution as well.
Certain plan investments can make it challenging to terminate. All of your assets need to be liquidated and independent appraisals will be needed to determine the fair market value of assets that you can’t sell. Low-interest environments can affect investments as well and can require additional benefits, which, in turn, would require the owner (or owners) to reduce their benefits to cover the shortfall.
Terminating your 401(k) plan can take some time, especially since you’ll want to remain compliant and do everything the right way. Allow plenty of time to track down your plan participants and send out your distribution election forms as well as to receive those forms back. To ensure everything goes smoothly, create a timeline for the termination of your retirement fund.
Give yourself at least six months to get into contact with everyone participating in the plan. It may be difficult to track down ex-employees, but you need to show that you took every step you could to do so. Calculate the contributions you still need to make as well as any investments that need liquidation. You will need time to execute these tasks. Creating a timeline for completing these tasks will help to keep you on track to get everything done by the agreed upon termination date.
Seriously consider filing a determination letter to ensure that your termination plan meets IRS standards (which can help prevent all kinds of issues). While this can take as little as six weeks, it’s also been known to take up to a year. Of course, depending on how pressed for time your company is, you may not be able to wait that long. Fortunately, it’s not required.
This blog post is intended for informational purposes only and does not constitute legal advice. No attorney-client relationship is created between the author and reader of this blog post, and its content should not be relied upon as legal advice. Readers are urged to consult legal counsel when seeking legal advice.