401(k) Plan Mergers and Updated IRS Determination Letters
As part of an M&A transaction, your company may assume a new 401(k) plan that is sponsored by the acquired business. This article includes some common questions addressing considerations related to maintaining multiple 401(k) plans within a single company and post-closing 401(k) plan mergers.
Our company acquired a new business and as part of the acquisition we acquired a new 401(k) plan. Can we continue to operate two separate 401(k) plans after the transaction?
The short answer is yes. A company may sponsor two (or more) separate 401(k) plans, as long as each of the 401(k) plans can independently satisfy certain tax rules and pass what the IRS calls annual “coverage testing” to ensure that a sufficient percentage of non-highly compensated employees participate in each plan as compared to highly-compensated employees.
In the context of a corporate transaction, the company may also take advantage of a special transition tax rule that allows the company to maintain the separate newly-acquired 401(k) plan through the end of the year following the year of the acquisition without needing to pass the “coverage test,” as long as certain rules are satisfied. For more information on these rules, see our previous article: Can We Sponsor Two 401(k) Plans?
If the company can maintain more than one 401(k) plan after the transaction, then why would we want to merge the plans into a single plan? Is there a time by when we must merge the acquired 401(k) plan into our already-existing 401(k) plan?
After a corporate acquisition, many companies eventually choose to merge the acquired 401(k) plan into the company’s current 401(k) plan. There are many reasons a company may make this decision, including:
the plans may not pass coverage testing on their own once the transition rule described above no longer applies;
the company might wish to take a more universal approach to its employee benefit programs (including 401(k) benefits) across the company (e.g., standardizing the employer matching contribution or eligibility requirements into a single approach across the business);
the company may be able to advantage of “economies of scale” by combining plan assets under a single 401(k) plan to secure better investment options and fees; or
the company may realize certain administrative and cost efficiencies by streamlining the company’s retirement plan recordkeeping and other administrative services and fees.
While there is no hard and fast rule that requires a company to merge 401(k) plans by a certain time, the special transition rule timing (discussed above) or general company benefit program considerations will typically impact the decision about when to merge the plans. In addition, when dealing with 401(k) plans that operate on a calendar year basis, having a plan merger occur on December 31 of any particular year is useful from an administrative perspective to (i) avoid having to complete a short plan year Form 5500 annual report for the 401(k) plan that is being merged out of existence (for example, if the plan merger is effective on January 1, then technically that merged plan was in existence during that subsequent plan year and a Form 5500 is needed for that one day) and (ii) allow plan participants of the merged plan to make the transition to a new 401(k) plan at the beginning of a new year.
What is an IRS determination letter and why would we want one?
For those of you who have worked with 401(k) plans for more than 5 years, you will “fondly” remember the days when you could submit your individually-designed 401(k) plan document to the IRS every 5 years to obtain the magical “IRS determination letter.” During the process the IRS reviews your plan documents to make sure that the plan includes all legally required provisions for a tax-qualified retirement plan and the determination letter is essentially the IRS’ “seal of approval” on the form of that particular plan document. About 5 years ago, the IRS did away with its general determination letter program and now a company may only obtain an updated 401(k) plan determination letter in very limited circumstances. One of those limited circumstances is when you merge two 401(k) plans in connection with a recent merger or acquisition of a business!
While a 401(k) plan is not legally required to obtain an IRS determination letter, getting an updated 401(k) plan IRS determination letter can be a very useful and important document for your 401(k) plan files.
The letter provides the plan with a specific determination from the IRS on the tax-qualified status of the plan document. You will also have an opportunity to correct any document issues the IRS may identify during its review.
In the event of a later IRS audit of your the 401(k) plan, having a more recent determination letter should also make the IRS audit process a bit easier as the IRS will have already reviewed and approved most of your plan document already.
The plan’s financial auditors will be able to review and rely on that IRS determination letter as part of their financial audit of the plan for Form 5500 annual reporting.
In the event of a later M&A transaction where a potential buyer is completing diligence on your 401(k) plan, having an updated IRS determination letter can ease the buyer’s diligence process related to that plan (which will make the process easier for you as well).
When you merge a 401(k) plan that was acquired in a corporate transaction into your company’s current 401(k) plan, we recommend considering whether to submit the surviving 401(k) plan to the IRS for an updated IRS determination letter. Keeping in mind, of course, that getting an updated IRS determination letter is always optional; it is not a legal requirement.
OK, we are going to merge the acquired 401(k) plan into our main 401(k) plan. What do I need to know so that I do not miss the deadline to submit an IRS determination letter application on the surviving 401(k) plan?
The IRS has provided certain rules about when and how you can seek an updated IRS determination letter in the context of a 401(k) plan merger:
The 401(k) plan merger must be one that is (i) combining two or more 401(k) plans that were previously sponsored by “unrelated entities” (basically, meaning not part of the same controlled group) and (ii) related to a corporate merger or acquisition among those unrelated entities.
The 401(k) plan merger must occur by the last day of the first plan year that begins after the date the business was acquired in the corporate transaction.
The company must submit the IRS determination letter application by the last day of the first plan year of the surviving 401(k) plan that begins after the date of the 401(k) plan merger.
For example: Assume that the 401(k) plans are both calendar year plans, your company acquires the new business in August 2021, and you merge the acquired 401(k) plan into your company’s current 401(k) plan effective on December 31, 2021. You must submit the IRS determination letter application on the surviving 401(k) plan by no later than December 31, 2022.
Bottom Line? M&A activity can create some challenges for post-closing 401(k) plan administration, but it also provides opportunities for planning, including an opportunity to obtain an updated IRS determination letter for your 401(k) plan.