Top of Mind

Plan Termination or Merger?

Whether an organization is looking to scale back the number of defined contribution retirement plans it maintains in order to simplify administration, or is forced to do so due to a merger or acquisition, understanding the difference between types of plan terminations is important. In some situations, a plan merger may not be an option (or a practical option), and in others, the exact opposite may the case. Here are some Top of Mind thoughts on mergers, terminations, and choosing between the two:

In a plan termination, the plan and its assets cease to exist. All assets are distributed to the individual participants that own them, and the plan is no longer maintained. In a merger, the plan ceases to exist, but the assets remain and are absorbed into another plan.

Organizations can almost always terminate a plan. Until recently, it was difficult to terminate certain 403(b) plans; however, guidance has been issued that addresses those challenges. The exception is when an organization looks to start a brand new plan of the same type. For example, if a 401(k) plan is terminated, the same organization cannot establish a new 401(k) plan during the next twelve months. Since plan termination results in distributions to participants who would not ordinarily be eligible for a distribution, the IRS does not want plan sponsors circumventing normal distribution restrictions by terminating plans solely to provide employee access to retirement funds. However, an exception to this is for organizations where fewer than 2% of employees would be eligible to participate in the replacement plan (or what the IRS calls a “successor” plan).

Since all employees, whether active or terminated, must take a distribution, plan terminations can result in leakage of assets that were supposed to be used for retirement. Of course, these distributions can be rolled over to the replacement plan or an IRA, but participants are not required to do so, and can instead elect a taxable distribution, never using the funds for retirement.

By contrast, in a plan merger, there is no distributable event. All funds are moved to another plan, and participants do not receive distributions unless they were entitled to one in the first place. However, not all plan types can be merged into one another. For example, a 401(k) plan cannot be merged into a 403(b) plan, and vice versa. Thus, in these situations, plan termination is the only option to reduce the number of plans. In most situations, if a merger in permitted, the plan that is being merged out of existence will adopt most, if not all, of the new plan provisions (except when it is legally required to retain certain plan provisions, such as when a money purchase plan is merged into a non-money purchase plan). This plan “assimilation” may result in some employee disruption.

For organizations with a choice between the two, plan mergers are typically preferred, as they tend to avoid the plan leakage described above. Mergers can also be less complicated than terminations, requiring a simple board resolution and amendments to the merging plans. By contrast, the asset distribution process in a plan termination can be a chore, and for large plans, an IRS filing may even be prudent (an application for determination upon termination is an optional IRS filing).

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Note: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice. Opinions expressed are those of the author, and do not necessarily represent the opinions of Cammack Retirement Group.

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