By Kim Flett and Beth Garner
Employee benefits should be an important consideration for both buyers and sellers as they prepare for a merger or acquisition. Once the due diligence is completed and the transaction closes, however, there is still much work that needs to be done to ensure that the transition to the new benefits plan goes smoothly.
In addition to educating employees of the seller about their new benefits, the buying company needs to think about compliance and accounting issues. While this is true for all types of benefits, compliance is especially important when it comes to retirement benefits.
In most acquisitions, buyers have three options for how to handle the seller’s retirement plan: terminate it, continue operating it as a separate plan or merge it with the buyer’s plan. (When the transaction is structured as an asset sale instead of a stock sale, however, merging the plans usually isn’t an option.)
For each of these three options, we examine some of the rules and situations that buying companies need to consider.
Terminate the Buying Company’s Plan
- Participants become 100% vested due to plan termination.
- The terminating plan must notify all plan participants and others who have a connection to the plan, such as beneficiaries of deceased participants and alternate payees under qualified domestic relations orders (QDROs).
- 401(k) “successor plan” rules may prohibit distributions from the terminating plan if the plan is terminated after the deal closes, so buyers often terminate 401(k) plans pre-close so plan termination distributions can be made.
- Participants must decide whether to take a distribution or roll the assets into an Individual Retirement Account (IRA) or the new organization’s plan. A final Form 5500 will need to be filed for the terminated plan after all plan assets have been distributed. Failing to check the “final” box at the top of the first page of Form 5500 is likely to result in an inquiry from the DOL when future Form 5500s are no longer filed for the terminated plan.
Operate Both Plans Separately
- Under a special M&A transition rule, if the buyer doesn’t make any changes to the seller’s plan and operates it separately, the buyer can avoid aggregating its plans with the acquired plan for IRS testing purposes during a limited timeframe.
- Companies can conduct separate non-discrimination tests for the plan year of the transaction as well as the following year; the plans must be aggregated for testing starting in the third year. As long as they pass the required tests, the plans could continue to be kept separate (or could be merged later). But in many cases, the separate plans cannot satisfy the testing rules and would need to be merged.
Merge the Plans
- Buying companies need to determine whether the combined plan triggers an independent audit; generally, plans that have 100 or more employees are required to have an independent audit, and a transaction may cause the new combined plan to jump above this threshold.
- Certain benefits are considered protected and are not allowed to be reduced or eliminated when plans merge; these include accrued benefits, early retirement benefits, more favorable vesting schedules, and some distribution options. Unprotected benefits include the right to take hardship withdrawals and loans and the right to have certain investment options.
- If the seller’s plan had forfeiture accounts those would need to be analyzed to determine how those assets can be used.
- Before the deal closes, the plan should communicate to participants with outstanding plan loans what will happen to their loans under the merged plan when the deal closes.
Insight: Use the Transition as an Opportunity for Improvement
Going through an acquisition can be very stressful for employees of the selling company. They may worry about whether their jobs will be eliminated or how the acquisition will affect their career prospects. Trying to understand how their benefits will change as a result of the acquisition can be another layer of stress.
Buying companies can mitigate much of the worry about benefits by developing an effective communication strategy to help the selling company’s employees understand their new benefits and get on-boarded smoothly. These efforts can go a long way in strengthening employee morale.
Mergers also provide companies the opportunity to strengthen employee benefits. It can be an opportune time to implement design features such as automatic enrollment, Roth options, matching contributions, new vesting schedules or improved investment lineups.
When it comes to transitions as monumental as an acquisition, having a roadmap is essential—both before the transaction closes and after.
This article originally appeared in BDO USA, LLP’s “EBP Audits” newsletter (May 2019). Copyright © 2019 BDO USA, LLP. All rights reserved. www.bdo.com