Defined Contribution Plans in an M&A: What Plan Sponsors Need to Know
Should ERISA retirement plans be part of early merger and acquisition (M&A) discussions? Ideally, yes, given their complexity and the financial and regulatory implications of the plan’s final disposition. However, amid the competing priorities that sellers and buyers face during an M&A, tax-qualified retirement plans can become an afterthought.
This article highlights key issues that may arise in a business transition and offers guidance for plan sponsors.
What can happen to a defined contribution retirement plan during an M&A?
-
Company A is negotiating the terms of an M&A with Company B, which has maintained an ERISA-related defined contribution retirement plan for some years. What are Company A’s options for the eventual disposition of the plan? Who should be at the table during M&A planning, and what sort of issues should they discuss?
It is important to include stakeholders knowledgeable about each organization’s retirement plans in the earliest discussion and decision-making stages of an M&A. The transaction structure can affect how the plan is handled; for example, the plan might be treated differently in an asset sale than in a stock sale.
Assumptions and expectations can change throughout negotiations, but the plan most likely will be treated in one of the ways listed below.
Termination: The seller terminates its plan before closing (typically contingent on and effective immediately before the formal deal closing date). Participants receive distributions or rollovers from the seller’s plan and then usually join the buyer’s plan.
Merger: The buyer merges the seller’s plan into its own, paying close attention to eligibility rules, vesting, and communications, including sending required notices. Unlike a plan termination, there is no distributable event for participants.
Continuation: The seller’s plan operates side by side with the buyer’s plan with no significant changes to either plan for an agreed time to provide continuity of coverage for the seller’s employees. This might be a short-term solution put in place until the buyer provides a more permanent solution. Generally, separate plans can be maintained until the last day of the plan year after the year when the corporate transaction occurred. Beyond that time frame, aggregated testing of the plans would generally be required.
Acceptance: The buyer adopts the seller’s plan, possibly because it contains more favorable terms than the buyer’s current plan or because the buyer does not have a defined contribution retirement plan.
There’s a lot of “if this, then that” involved in M&As: If both parties have benefit plans, then it is important to identify plan differences and similarities. If Company A keeps its benefit plan, then careful steps must be taken to bring in Company B’s employees.
Plan sponsors must stay on top of myriad interconnected issues during an M&A. Recordkeepers and third-party administrators can help evaluate the plans and offer practical advice. Accepting or merging plans that carry unresolved issues can increase risk for the buyer.
What if the buyer terminates a defined contribution retirement plan during an M&A?
-
As part of its preacquisition due diligence, Company A thoroughly reviewed Company B’s employee benefits, including its defined contribution retirement plans. Company A decided to keep its own plans, which fit well with its business strategies, and required Company B to terminate its plan.
Timing is critical. It is best to consider all issues that surround terminating a defined contribution plan before the transaction closes. Terminating the plan after the close can trigger IRS successor plan rules that could result in the plan not being considered fully terminated, invalidating full vesting, and distributions being treated as impermissible or premature. Plan sponsors might also face plan disqualification if ongoing compliance items, such as required plan amendments and filing Form 5500, are not met.
Fiduciaries’ responsibilities to participants continue while the terminated plan winds down and all plan assets are fully distributed, creating additional administrative and fiduciary risks. As a best practice, plan sponsors should provide timely notice of the plan termination and details on distribution options.
What are some key concerns when merging benefit plans?
-
As Company A moved toward finalizing its acquisition of Company B, questions arose about how to handle each company’s defined contribution retirement plans. On the surface, the two defined contribution plans seemed similar enough that Company A considered merging them. However, during due diligence, Company A conducted a thorough review of each plan’s provisions. That deeper dive revealed significant differences in benefits, eligibility and vesting, and treatment of participant loans, factors that complicated the decision of whether to merge.
Failing to uncover incomplete documentation, operational errors, or regulatory noncompliance can increase the buyer’s fiduciary, tax compliance and audit risk. Plan sponsors that consider consolidating retirement plans must carefully evaluate myriad factors, including those listed below:
Regulatory and ERISA compliance: Have both plans been operating in compliance with ERISA and the Internal Revenue Code? Noncompliance and operational failures can transfer to the surviving plan. During the transition, plan sponsors must continue to follow rules governing plan amendments, protected benefits, nondiscrimination testing, and fiduciary responsibilities.
Eligibility and vesting differences: When the plans merge, will employees be eligible for the same benefits and vesting schedule? Merging the plans without considering those important issues can create additional risk and raise concerns for participants in both plans.
Treatment of accrued benefits in the seller’s plan: Is there a process to manage participant accounts accrued under the seller’s plan? Careful review of plan documents and clear communication with participants can help avoid unintended taxable events.
Participant loans: Loan policies vary from plan to plan and should be addressed early. The buyer should determine the status of participant loans in the seller’s plan and how they will be handled in the surviving plan. With careful planning, outstanding loans in the seller’s plan often can be rolled over into outstanding loans in the buyer’s plan instead of triggering a loan default or taxable deemed distribution. Differences in maximum loan amounts, repayment terms, and treatment of loans on termination can create administrative and compliance challenges for the surviving plan.
Merging retirement plans after an M&A involves strategic, well-informed choices. Engaging a third-party advisor or leveraging existing providers can help the buyer identify risks and make informed decisions.
Can operating side-by-side defined contribution retirement plans affect the buyer’s risk?
-
The acquiring organization, Company A, began comparing its employee benefit plan to the seller’s plan late in the M&A negotiation period. Lacking time for deep analysis that could unveil serious issues — including unresolved regulatory tasks and operational failures — Company A elected not to merge the plans at closing. Instead, it chose to run the two retirement plans simultaneously while it determined a better long-term strategy.
Continuing to operate the seller’s plan after the merger can operate as a temporary risk-management measure that allows the buyer time to identify and resolve benefit issues and noncompliance before finding a more permanent solution. It also helps avoid interruption of benefits for the seller’s employees.
However, maintaining two separate retirement plans, even for a short time, can increase administrative burdens and fiduciary responsibilities. Third-party administrators, recordkeepers, and interim staffing resources could help the buyer with the additional workload. After closing, people often lose track of time and might not realize that the special M&A transition period that allows each plan to be tested separately has expired. Plans have only until the last day of the plan year after the plan year when the transaction occurred to treat the grandfathered plans as separate plans. Thereafter, aggregated testing is required and frequently fails, causing technical disqualification for both plans.
Can the buyer accept and operate the seller’s defined contribution plan?
-
Because it did not currently sponsor a defined contribution plan, Company A formally adopted Company B’s employee retirement plan after the M&A closed. As a result, Company A became the new plan sponsor and its employees became participants in the acquired company’s plan, which seemed to be a positive outcome for the employees. However, before plan operations began, Company A needed to fully understand its fiduciary responsibilities.
As the new plan sponsor, the buyer needs to seek answers to critical questions, including the following:
Are plan documents and amendments current?
Who serves as fiduciaries for the plan, and will those roles continue?
Have new participants received all mandatory communications and been properly enrolled in the retirement plan?
Did the seller file timely and accurate Forms 5500 and complete any required audits?
That list is by no means comprehensive. Plan sponsors must adhere to strict laws and regulations governing the operation of defined contribution plans. Failure to do so can result in regulatory investigations, penalties, and potential plan disqualification. External third-party providers can help identify and mitigate the risks involved in accepting and operating a retirement benefits plan.
Are employee benefit plans a critical part of M&A due diligence?
Overlooking defined contribution plans during business transitions increases fiduciary risk and costs, whether administrative or as a result of regulatory noncompliance.
Our skilled Assurance team can assess your plan, provide actionable guidance, and help your organization be prepared for the increased scrutiny during the M&A process. We invite you to start the conversation today.
Some content borrowed with permission from BDO USA.
