There are so many important parts to a stock acquisition—pricing, holdbacks, who will stay, who will go, contracts, liabilities, and on and on—that employee benefits often take a back seat during the crush of the due diligence and closing phase. Surely something as secondary as employee benefits can be figured out after the close! And while it is important to have the benefits part up and running for continuing employees as soon as possible, it is generally true that many of these things can be resolved post-close.
But one aspect of the transition that is vital to resolve before the closing is what to do with the seller’s retirement plan. If that plan is not terminated before the closing, then the buyer is stuck with the plan after the closing. Being stuck with the seller’s plan means taking on the problems in that plan, as well as possibly having to make changes to the buyer’s plan to accommodate differences in the seller’s plan. Both of these outcomes can be costly and result in more complicated administration (which also can add to administrative expenses).This can be a nasty surprise if the buyer does not go into the acquisition with eyes wide open.
When the Target’s Plan is Terminated Prior to Closing
Terminating the seller’s plan prior to closing gives the buyer more flexibility going forward. When a plan is terminated, as long as there is no other retirement plan in the same related employer group, the assets of the plan can be distributed. This means each plan participant will have the option to:
- Take a distribution of their account and pay income taxes on the distribution
- Take a distribution of their account and then, within 60 days, deposit that distribution into an IRA or another qualified plan (an “indirect rollover”); or
- Have their account rolled directly into an IRA or another qualified plan
Besides offering participants several choices, this also means that the qualified plan that accepts the rollover (indirectly or directly), in this case the buyer’s plan, does not have to concern itself with protected benefits and cutbacks that would have to be preserved under its plan if the assets were transferred in a merger or spin-off. while compliance issues in the seller’s plan that are not corrected prior to closing will most likely be the buyer’s responsibility after closing, those compliance issues will stay with the seller’s plan and will not taint the buyer’s plan as they would in a transfer of assets.
When the Target’s Plan is not Terminated Prior to Closing
If not terminated prior to closing, then upon closing, the seller’s plan is in the same related employer group as the buyer’s plan and cannot be terminated; its assets must be merged into the buyer’s plan, if any.
Note that if the buyer does not have a plan already, the seller’s plan can be terminated after closing, but the buyer will be prohibited from starting a new plan for twelve months following the termination of the seller’s plan.
Best Option: Terminate the Seller Plan Prior to Close
The best option is to terminate the seller’s plan effective no later than the day prior to the close. Termination resolutions can be adopted contingent on the closing. When terminating the plan prior to the closing, the plan sponsor’s related employer group is also determined as of that date for purposes of establishing whether there are any other qualified plans in that group. Obviously, it can get more tricky if the seller’s related group does have other plans.
If this is done, then the buyer is not stuck with the seller’s plan and any issues that could affect the buyer’s plan. While thorough due diligence is always a good idea, it becomes less critical in this situation.
Next Best Option: Perform Thorough Due Diligence and then Decide Whether to Terminate or Merge
If there is some reason to consider merging the seller’s plan into the buyer’s plan—maybe for employee relations purposes or because the seller’s plan is more attractive and the buyer wants to merge its plan into the seller’s plan with the seller’s plan being the surviving plan—then several steps should be taken:
- Thorough due diligence must be done to identify any protected benefits or impermissible cutbacks that will need to be carried over to the buyer’s plan and whether there are any compliance or qualification failures in the seller’s plan.
- Correct any compliance or qualification failures that can be self-corrected, preferably prior to closing, filing a voluntary correction program submission to the IRS for any qualification failures that cannot be self-corrected, and ensuring the purchase agreement takes into account any costs that will be incurred by the buyer after the close.
- Terminate the seller’s plan prior to closing if the issues identified in due diligence are unpalatable to the buyer.
Least Best Option: Merge the Seller Plan into the Buyer Plan Post Close
If what to do with the seller’s plan is not addressed prior to close, then the buyer is stuck with the plan post-close, warts and all, and will have to perform a review of the seller’s plan if that was not done thoroughly during due diligence.
- Do an internal audit of the seller’s plan compliance
- Do a comparison of the buyer and seller plans to determine if there are protected benefits that must be preserved, impermissible cutbacks that must be addressed, or other differences that may need to be managed for employee relations purposes.
- Amend the buyer’s plan for any needed provisions as determined in the plan comparison analysis
- Correct (either under self-correction or voluntary correction program) any qualification failures discovered in the internal audit.
- Work with recordkeeper to transfer the assets of the seller’s plan into the buyer’s plan, including participant loans.
- Ensure that all of this is completed by the end of the plan year following the close of the transaction (known as the “410(b)(6) transition period”).
The Really Least Best Option: Keep Both Plans
Some buyers may think: Why not just keep both plans and maintain them separately? The answer to that is that it really generally isn’t work doing. If a related employer group maintains two separate plans, then they will have to be tested together. If the plans have different provisions, then in order to pass coverage testing, a special test, called the “Benefits, Rights, and Features test” must be performed. Special testing can be expensive, and if testing isn’t passed, then in order to correct the situation, participants in one plan may have to made eligible under the other plan to pass. It is advisable to make sure that all of the benefits, rights, and features are identical in both plans to ensure passage of the coverage testing. If you then have two identical plans, what is the point of paying for the administration of two plans when you could merge them and only have to expense of maintaining one plan? Some employers are willing to pay the cost of maintaining two identical plans for some employee-relations purposes, which is a valid business decision. However, absent such a business reasoning, it does not seem the most prudent of choices to incur unnecessary expenses for the plan administration of two identical plans.
The point of this discussion is to emphasize that retirement plans should be carefully considered in a stock deal, otherwise a buyer can be stuck with an unexpected headache that could have been planned for before it became their problem.