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401K merger


Buying a company is an exciting experience.  However, many companies during a merger or acquisition fail to address the issues surrounding the seller’s retirement plan which can come back to haunt the buyer in a big way.   I completely understand why this happens.  Purchase price, valuations, tax issues, terms, holdbacks, and new employment agreements tend to dominate the conversations throughout the business transaction.   But lurking in the dark, below these main areas of focus, lives the seller’s 401(k) plan.  Welcome to the land of unintended consequences where unexpected liabilities, big dollar outlays, and transition issues live.

Asset Sale or Stock Sale


Whether the transaction is a stock sale or asset sale will greatly influence the series of decisions that the buyer will need to make regarding the seller’s 401(k) plan.  In an asset sale, it is common that employees of the seller’s company are terminated from employment and subsequently “rehired” by the buyer’s company.  With asset sales, as part of the purchase agreement, the seller will often times be required to terminate their retirement plan prior to the closing date.

Terminating the seller’s plan prior to the closing date has a few advantages from both the buyer’s standpoint and from the standpoint of the seller’s employees. Here are the advantages for the buyer:

Advantage 1:  The Seller Is Responsible For Terminating Their Plan


From the buyer’s standpoint, it’s much easier and cost effective to have the seller terminate their own plan.  The seller is the point of contact at the third party administration firm, they are listed as the trustee, they are the signer for the final 5500, and they typically have a good personal relationship with their service providers.  Once the transaction is complete, it can be a headache for the buyer to track down the authorized signers on the seller’s plan to get all of the contact information changed over and allows the buyer’s firm to file the final 5500.

The seller’s “good relationship” with their service providers is key. The seller has to call these companies and let them know that they are losing the plan since the plan is terminating.  There are a lot of steps that need to be completed by those 401(k) service providers after the closing date of the transaction.  If they are dealing with the seller, their “client”, they may be more helpful and accommodating in working through the termination process even though they losing the business. If they get a random call for the “new contact” for the plan, you risk getting put at the bottom of the pile

Part of the termination process involves getting all of the participant balances out of the plan. This includes terminated employees of the seller’s company that may be difficult for the buyer to get in contact with.   It’s typically easier for the seller to coordinate the distribution efforts for the terminated plan.

Advantage 2:  The Buyer Does Not Inherit Liability Issues From The Seller’s Plan


This is typically the main reason why the buyer will require the seller to terminate their plan prior to the closing date.  Employer sponsored retirement plans have a lot of moving parts.  If you take over a seller’s 401(k) plan to make the transition “easier”, you run the risk of inheriting all of the compliance issues associated with their plan. Maybe they forgot to file a 5500 a few years ago, maybe their TPA made a mistake on their year-end testing last year, or maybe they neglected to issues a required notice to their employees knowing that they were going to be selling the company that year.  By having the seller terminate their plan prior to the closing date, the buyer can better protect themselves from unexpected liabilities that could arise down the road from the seller’s 401(k) plan.

Now, let’s transition the conversation over to the advantages for the seller’s employees.

Advantage 1: Distribution Options


A common goal of the successor company is to make the transition for the seller’s employees as positive as possible right out of the gate.  Remember this rule:  “People like options”.  Having the seller terminate their retirement plan prior to the closing date of the transactions gives their employees some options. A plan termination is a “distributable event” meaning the employees have control over what they would like to do with their balance in the seller’s 401(k) plan.  This is also true for the employees that are “rehired” by the buyer.  The employees have the option to:

  • Rollover their 401(k) balance in the buyer’s plan (if eligible)
  • Rollover their 401(k) balance into a rollover IRA
  • Take a cash distribution
  • Some combination of options 1, 2, and 3

The employees retain the power of choice.

If instead of terminating the seller’s plan,  what happens if the buyer decides to “merge” the seller’s plan in their 401(k) plan?  With plan mergers, the employees lose all of the distribution options listed above. Since there was not a plan termination, the employees are forced to move their balances into the buyer’s plan.

Advantage 2:  Credit For Service With The Seller’s Company


In many acquisitions, again to keep the new employees happy, the buyer will allow the incoming employee to use their years of service with the seller’s company toward the eligibility requirements in the buyer’s plan.  This prevents the seller’s employees from coming in and having to satisfy the plan’s eligibility requirements as if they were a new employee without any prior service.  If the plan is terminated prior to the closing date of the transaction, the buyer can allow this by making an amendment to their 401(k) plan.

If the plan terminates after the closing date of the transaction, the plan technically belonged to the buyer when the plan terminated.  There is an ERISA rule, called the “successor plan rule”, that states when an employee is covered by a 401(k) plan and the plan terminates, that employee cannot be covered by another 401(k) plan sponsored by the same employer for a period of 12 months following the date of the plan termination.  If it was the buyer’s intent to allow the seller’s employees to use their years of service with the selling company for purposes of satisfy the eligibility requirement in the buyer’s plan, you now have a big issue. Those employees are excluded from participating in the buyer’s plan for a year.  This situation can be a speed bump for building rapport with the seller’s employees.

Loan Issue


If a company allows 401(k) loans and the plan terminates, it puts the employee in a very bad situation. If the employee is unable to come up with the cash to payoff their outstanding loan balance in full, they get taxed and possibly penalized on their outstanding loan balance in the plan.

Example: Jill takes a $30,000 loan from her 401(k) plan in May 2017.  In August 2017, her company Tough Love Inc., announces that it has sold the company to a private equity firm and it will be immediately terminating the plan.  Jill is 40 years old and has a $28,000 outstanding loan balance in the plan.  When the plan terminates, the loan will be processed as an early distribution, not eligible for rollover, and she will have to pay income tax and the 10% early withdrawal penalty on the $28,000 outstanding loan balance. Ouch!!!

From the seller’s standpoint, to soften the tax hit, we have seen companies provide employees with a severance package or final bonus to offset some of the tax hit from the loan distribution.

From the buyer’s standpoint, you can amend the plan to allow employees of the seller’s company to rollover their outstanding 401(k) loan balance into your plan.  While this seems like a great option, proceed with extreme caution.  These “loan rollovers” get complicated very quickly.  There is usually a window of time where the employee’s money is moving over from seller’s 401(k) plan over to the buyer’s 401(k) plan, and during that time period a loan payment may be missed.  This now becomes a compliance issue for the buyer’s plan because you have to work with the employee to make up those missed loan payments.  Otherwise the loan could go into default.

Example, Jill has her outstanding loan and the buyer amends the plan to allow the direct rollover of outstanding loan balances in the seller’s plan.  Payroll stopped from the seller’s company in August, so no loan payments have been made, but the seller’s 401(k) provider did not process the direct rollover until December.  When the loan balance rolls over, if the loan is not “current” as of the quarter end, the buyer’s plan will need to default her loan.

Our advice, handle this outstanding 401(k) loan issue with care.  It can have a large negative impact on the employees. If an employee owes $10,000 to the IRS in taxes and penalties due to a forced loan distribution, they may bring that stress to work with them.

Stock Sale


In a stock sale, the employees do not terminate and then get rehired like in an asset sale.  It’s a “transfer of ownership” as opposed to “a sale followed by a purchase”.  In an asset sale, employees go to sleep one night employed by Company A and then wake up the next morning employed by Company B.  In a stock sale, employees go to sleep employed by Company A, they wake up in the morning still employed by Company A, but ownership of Company A has been transferred to someone else.

With a stock sale, the seller’s plan typically merges into the buyer’s plan, assuming there is enough ownership to make them a “controlled group”.  If there are multiple buyers, the buyers should consult with the TPA of their retirement plans or an ERISA attorney to determine if a controlled group will exist after the transaction is completed.   If there is not enough common ownership to constitute a “controlled group”, the buyer can decide whether to continue to maintain the seller’s 401(k) plan as a standalone plan or create a multiple employer plan.    The basic definition of a “controlled group” is an entity or group of individuals that own 80% or more of another company.

Stock Sales: Do Your Due Diligence!!!


In a stock sale, since the buyer will either be merging the seller’s plan into their own or continuing to maintain the seller’s plan as a standalone, you are inheriting any and all compliance issues associated with that plan.  The seller’s issues become the buyer’s issues the day of the closing.   The buyer should have an ERISA attorney that performs a detailed information request and due diligence on the seller’s 401(k) plan prior the closing date.

Seller Uses A PEO


Last issue.  If the selling company uses a Professional Employer Organization (PEO) for their 401(k) services and the transaction is going to be a stock sale, make sure you get all of the information that you need to complete a mid-year valuation or the merged 5500 for the year PRIOR to the closing date.  We have found that it’s very difficult to get information from PEO firms after the acquisition has been completed.

The Transition Rule


There is some relief provided by ERISA for mergers and acquisitions.  If a control group exists, you have until the end of the year following the year of the acquisition to test the plans together.  This is called the “transition rule”.   However, if the buyer makes “significant” changes to the seller’s plan during the transition period, that may void the ability to delay combined testing.  Unfortunately, there is not clear guidance as to what is considered a “significant change” so the buyer should consult with their TPA firm or ERISA  attorney before making any changes to their own plan or the seller’s plan that could impact the rights, benefits, or features available to the plan participants.

Horror Stories


There are so many real life horror stories out there involving companies that go through the acquisition process without conducting the proper due diligence and transition planning with regard to the seller’s retirement plan.  It never ends well!!  As the buyer, it’s worth the time and the money to make sure your team of advisors have adequately addressed any issues surrounding the seller’s retirement plan prior to the closing date.


Michael Ruger

About Michael………

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

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