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April 6, 2021
Acquisition Transition Period
ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business.
A recent call with an advisor in Kentucky is representative of a common question related plans involved in a merger or acquisition. The advisor asked: “My client is merging two companies—each with a 401(k) plan. In light of the merger, how long does my client have to make a decision regarding the operation of the 401(k) plans?”
Highlights of Discussion
Typically, the merger agreement will specify how the new owner will deal with the retirement plans. The business owner will have to make a decision regarding whether to continue to maintain the acquired company’s 401(k) plan separately or merge it into his existing plan. The IRS has special rules regarding plan operations in these circumstances.
The IRS requires qualified plans to meet minimum coverage requirements under Internal Revenue Code (IRC) Section 410(b). Under these rules, the plan must cover all employees of the company, except for certain permitted employee class exclusions.
Minimum coverage testing is usually conducted on an annual basis, as of the last day of the plan year.
A special rule applies for minimum coverage testing in the case of acquisitions and mergers; the employer is given a “transition period” to make decisions regarding the plan and get the plan documents in order to meet the minimum coverage requirements [IRC Sec. 410(b)(6)(C)]. To qualify for coverage testing relief under IRC §410(b)(6)(C), the plan must satisfy IRC §410(b) immediately before the transaction, and the coverage under the plan must not “significantly change” during the transition period (other than by reason of the change in the members of the group).
Clearly, a change in eligibility requirements that affects the covered group would be a significant change; and Revenue Ruling 2004-11 indicates that that a substantial amendment to a plan’s benefit formula would be a significant change as well.
The transition period is defined as beginning on the date of the change (acquisition/merger date) and ending on the last day of the first plan year beginning after the date of change. For example, if a business maintains its plan on a calendar-year basis, and is acquired on May 19, 2021, the plan would be deemed in compliance of the minimum coverage rules until December 31, 2022.
Conclusion
Company acquisitions and mergers can be complicated—especially when they involve qualified plans. The transition period allows the owner some time to make decisions regarding the qualified plans and still meet the minimum coverage requirements.