Amy Barber, JD
Director of Technical Services
Mergers and acquisitions of businesses are not simple processes, and it’s easy to forget to take a close look at the retirement plans involved when they are not fundamental to how each business runs. However, a qualified plan on either party’s part can leave some undesired consequences if they are not reviewed and discussed early in the process. If either party sponsors one, it’s best to make strategic decisions before the transaction is completed, since once the ink is dry, options will be limited.
This white paper offers some key considerations for retirement plans when going through a business transaction, and how the type of acquisition (asset or stock) affects what decisions are available. The focus of this paper is primarily on 401(k) plans, and will not cover factors that should be considered for types of plans. In the end, it’s best to get service providers and advisers involved early on so your unique situation can be assessed.
Asset and Stock Sales
The first point of consideration is whether an acquisition is that of a business’ assets or ownership. An asset sale is the purchase of one business’ underlying assets, which may or may not include an agreement for certain liabilities. The original owners still maintain the entity, which is sometimes wound down as all assets are sold, or they may sell only a portion of their assets and maintain their business with a new focus. Since the entity is still intact, even if only for a short time, the original owners are still responsible for winding down or maintaining not only the business but any outstanding programs and liabilities, including any qualified plan they sponsor. In other words, they stay in their own shoes.
A stock sale is the purchase of the ownership of an entity. Along with the ownership, the buyer assumes the underlying business, assets, and liabilities. They essentially step into the shoes of the prior owner and take of the entity as-is. This type of transaction requires significant due diligence to understand all aspects of the history of the business, outstanding obligations, and expected income and obligations. As we’ll see, this includes the seller’s retirement plan if they sponsor one (or more).
For the purpose of this whitepaper, a merger has many similarities to a stock sale. In discussions below, we assume that the ownership acquired is 100%, or enough that it creates a controlled group or affiliated service group situation for the buyer. We will not discuss partial purchases of ownership or merging portions of the seller’s plan. If you experience a situation with partial purchases or plan mergers, a knowledgeable service provider can walk you through the implications for the portion that is sold versus maintained by the original owners..
What Happens to a Seller's Plan?
The options and timing depends on the type of sale and what the agreement entails. If the goal is to…
If the goal of the seller is to close their doors post-asset acquisition, or they simply do not see the need to continue their retirement plan at that time, they would want to get the ball rolling on a plan termination as soon as possible. The timing though, does not specifically need to relate to the date of the business transaction. The important thing for the seller to remember is that in an asset sale, unless specifically assumed in writing as part of the transaction, the role of the plan sponsor does not move to the buyer and the seller must determine what their goals are related to the plan. In the confusion of asset sales, where the intent is to sell certain assets and shut down the business, sellers (as plan sponsors) often neglect to formally terminate their plan or assume the buyer will take on that role. The seller must realize that until they formally terminate, distribute all assets of the plan, and file any required government reporting, they are still responsible for maintaining all aspects of the plan.
If, as part of a stock acquisition, the buyer does not want to assume ownership of the plan sponsorship role, they must require the seller to formally terminate the plan prior to the sale date. This means, at a minimum, a resolution should be made to terminate the plan with an effective date prior to the transaction. Oftentimes, this step is missed (especially if plan sponsors on either side of the table don’t bring up the acquisition intent with service providers) until after the date of the transaction. Once the sale has gone through, the buyer is now in the role of the plan sponsor (as owner of that entity). The buyer may be able to terminate the plan if they do not maintain a similar plan that would be considered a successor plan. However, if they maintain their own 401(k) plan, for example, this would prevent them from formally terminating the acquired plan. At that time, they are only left with the options to freeze the seller’s plan, merge it into their own, or continue the separate plan’s operations.
If an acquisition relates to the assets of the seller and not the ownership, and assuming the buyer has no inclination to take on the ownership of the seller’s plan, the seller is still the plan sponsor and can opt to continue operation of the plan. As long as the seller continues to do business under the current entity (the plan’s sponsor) they can continue the plan. However, if the business stays open and the plan is continued, they should watch out for a partial plan termination. Often, a significant number of employees leave along with an asset sale, whether it’s to go work for the buyer or because the seller will not continue that portion of the business. This often results in a partial plan termination, which means all affected participants must be granted 100% vesting in their plan benefits.
Under a stock sale, the buyer can continue the retirement plan as the new owner of the plan sponsor. Nondiscrimination and coverage testing will apply and can become complicated if there are related entities following the transaction and other retirement plans to consider. Note that the buyer may have time to consider if they would like to continue, freeze, or merge the plan into their own. Often, transition relief for coverage under each plan is available for the year of the business transaction and the plan year following1 (this does not generally negate the need for nondiscrimination testing). The buyer will need to review whether plans can be maintained separately, and if there are coverage issues due to varied benefits, rights, and features under separate plans. Testing aggregation and permissive disaggregation will apply under controlled group rules.
Arguably, the most important thing a buyer should to know when a seller has a plan - is the history that comes with it. In a stock sale, the buyer becomes the plan sponsor (or will own the entity which is the plan sponsor) and becomes fully liable for any plan errors. This becomes problematic in terms of both time spent (consider having to go back to the old owners of a company for records 3 years back on whether contributions were made in accordance with the plan document) and possible money owed (consider a series of missed deferrals from the past, the correction of which would likely require employer contributions). It is important to collect as much as possible in the way of plan records if a plan is going to be assumed by the buyer. Oftentimes, this realization pushes the buyer to request that the seller terminate their retirement plan prior to the transaction. Hopefully, this realization comes in time!
Merge into Buyer’s Plan
Assuming the buyer has a plan, the goal may be to merge the seller’s plan into the buyer’s. This is the least often used method we see, and while it may meet certain goals, the buyer should be aware of several potential issues.
In an asset sale, the plan is still sponsored by the original entity and owners. Part or all of the assets under the seller’s plan can be spun-off and merged into the buyer’s plan by written agreement (both parties must sign off on such transfer). In a stock sale, the new owners of the plan sponsor can make that decision after the sale (without involving the prior owners), but again there must be a written spin-off and transfer or merger agreement to recognize the movement of assets between plans.
Those plan assets carry with them their full history (plan basis, liabilities, et cetera), and must maintain other protected features2. For example, any money purchase plan assets must continue to offer Qualified Joint and Survivor Annuities3, requiring spousal consent for lump sum distributions. Additionally, participants cannot lose vesting due to the merger. If the vesting in the buyer’s plan is less generous, participants will maintain their current vesting (on accrued benefits) until they reach a higher level in the new plan. And for participants with at least three years of service, they must be provided a 60-day window to opt into keeping their old vesting schedule4.
Merged assets also carry with them their history of plan errors. If an error from the past is detected, the new plan sponsor will be liable for any correction. This is similar to the buyer taking over a plan in a stock sale. However, it can create more difficulty since an audit may then require looking into the history of two separate plans when one is pulled for review.
How Are Employees Handled in a Buyer's Plan?
The buyer in an acquisition must also be aware of the impact on their own retirement plan (if they currently sponsor one) when they have new employees as part of the transaction.
In an asset sale, the companies remain unrelated. An employee brought over to the buyer’s entity as part of the transaction is essentially hired as a new employee of the buyer, regardless of if they are walking into the same building to the same desk to do the same work. The buyer in this case bought the operations and kept the same staff in place, but issues payroll under their own entity now. With no changes to the buyer’s plan, the employees from the seller are treated as any other individual hired off the street – they must meet the same eligibility and start from day one earning credit for vesting. If the goal is to provide employees brought over from the seller with credit for their prior service under the buyer’s plan, the plan must be amended. The amendment can either:
If service records are spotty on the seller’s end, the buyer may be better off to use a special entry date for those hired as part of the transaction. If the amendment recognizes past service and names the seller’s entity, they must be able to provide a full working history for those that are hired by the buyer. Note that depending on how the amendment is written, this could require the seller to acquire historical data on not only those former employees of the seller hired at the time of the acquisition, but former employees of the seller hired at any time in the future. This can be problematic, so the goals and amendments must be carefully discussed and written.
If a stock sale results in a controlled group or affiliated service group situation, the historical records become imperative as the newly acquired entity is now considered related to the buyer’s entity. This can create issues if the seller was used to tracking plan records on an elapsed time basis, for example, and the buyer’s plan tracks service on an hours basis. Additionally, this doesn’t automatically mean that employees of the seller in an acquisition are automatically eligible to join the buyer’s plan.
If the buyer maintains the seller’s entity as a wholly owned subsidiary or brother-sister organization (owned by the same individual or group but keeping the seller’s entity open), those employees are likely not considered eligible to participate in the plan as currently written, though it’s very important to review the plan documents ahead of time. Many documents are written such that only the sponsoring organization is considered as participating in the plan unless any other affiliated or related organizations complete a participation or joinder agreement. Keep in mind that if the goal is not to have new employees eligible for the plan, the document must be reviewed in advance. Some documents are written in a different manner, such that all related employers are considered to be participating in the plan as a default. As in the separate plan continuation noted earlier, the transition relief may apply to allow the buyer to take some time to determine if the newly related entity should be added to the buyer’s plan or not.
On the other hand, if the buyer does not continue the seller’s entity as a separate organization but rather closes it down and moves operations under its own umbrella, the employees brought over from the seller’s entity are now directly employees of the buyer with service from the seller recognized5. They could become eligible from day one of working for the buyer’s entity. Again it is important to be able to ascertain the years of service applicable for acquired employees.
There are many elements of retirement plans affected by a business transaction, on both sides of the table. The important thing to remember is that the conversation around each plan is best had prior to the transaction (and even before the deal is fully negotiated, as added liability may drive higher consideration in the deal). Contact your service providers as soon as a transaction is being considered to see how a retirement plan on either side can affect the decision or timing. Below is a brief summary of the impact on a plan and employees of a buyer or seller under a stock or asset sale.
For more information on retirement plan considerations in mergers and acquisitions, please view our recorded webinar.
2Treas. Reg. §1.411(d)-4 / Code Section 411(d)(6)
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