Despite fiscal and monetary stimulus measures, many U.S. companies are struggling with the extraordinary economic and business impact of Covid-19. Many have been forced to close temporarily, some have reduced the size of their workforces and engaged in other cost-cutting measures. A growing number has been declaring bankruptcy.
The steps taken to keep businesses in business (or help them liquidate in an orderly way) can have unexpected consequences for qualified retirement plans. As a result, there is a need for timely and insightful advice about the ways in which business decisions affect qualified retirement plans.
Employee layoffs may result in partial plan termination
The coronavirus pandemic has created exceptional challenges for businesses. Since March, many have urgently adopted cost containment measures, including layoffs. In May, 31% of U.S. CFOs and finance leaders expected to lay off employees during the following month, according to PwC’s 2020 COVID-19 CFO Pulse Survey. The percentage declined to 24% in the June survey, although the percentage varied by industry.
Few executives making difficult workplace reduction decisions think about the potential consequences for their companies’ qualified retirement plans. When a company lays off a significant number of employees who are plan participants, the IRS may decide it has experienced a partial plan termination.
Internal Revenue Service (IRS) guidance states that there is a presumption of partial termination when an employer experiences 20% or higher turnover. The determination is made using the IRS turnover rate formula. Furloughed employees, typically, are not included in the calculation.
If the IRS determines that a partial plan termination occurred, participants in the terminated portion of the plan become fully vested, regardless of the plan’s vesting schedule or the employee’s years of service.
Plans should be terminated before Chapter 7 bankruptcy filing
The pandemic has forced many companies to consider bankruptcy. Some will rely on the Chapter 11 process to restructure and continue operating. Others will file Chapter 7, liquidate assets, and cease to exist.
When a business is in serious distress and its owners or executives are focused on dissolution, qualified retirement plans are rarely top of mind. However, it’s vital for companies that will be closing to address retirement plan termination prior to bankruptcy. Otherwise, the responsibility for plan termination falls to bankruptcy trustees, which may take time.
“Retirement plans are subject to complex regulatory requirements enforced by three different federal agencies. Accordingly, the trustee must proceed carefully—and with competent professional assistance—in carrying out its plan termination responsibilities,” explained Gayle L. Skolnik, Esq., Elizabeth M. Little, Esq., and Faegre Baker Daniels LLP in a 2020 NABT article.
When a retirement plan is terminated prior to bankruptcy, a variety of conditions must be met. In broad terms, termination requires plan sponsors to:
- Amend plan documents,
- Issue notices to participants and beneficiaries,
- Provide a distribution election and rollover notice,
- Plan to pay required contributions,
- Have recordkeepers update vesting schedules,
- Distribute plan assets,
- File form 5500, and
- Request an IRS determination letter.
In addition, plan termination requires that all assets be distributed—even to missing and unresponsive participants.
Consequently, plan sponsors that have yet to adopt Safe Harbor IRAs may want to amend their plan documents. Automatic rollovers make it possible for fiduciaries of terminating plans to roll over missing participants’ account balances into IRAs. This ensures all assets can be distributed. Without such an option, plans that cannot locate all participants will find it difficult to terminate plans.
M&A deal structure can limit retirement plan options
The pandemic has slowed or ended some M&A activity. However, it has also created, “…a once-in-a-generation sea change in the market landscape and potential target companies that may be available,” according to a source cited by Mark Herndon and John Bender of the M&A leadership Council.
As deals are made, qualified retirement plans should be part of the conversation. That’s because the type of sale structure chosen can have serious consequences for plan sponsors. In some cases, acquiring companies could find themselves with multiple 401(k) plans.
For example, typically, a stock sale results in one company purchasing another in its entirety. The acquiring employer becomes the sponsor of the purchased company’s qualified retirement plan. If both companies have 401(k) plans, successor plan rules may prevent the termination of either plan once the deal has been completed.
Often, a broader range of options is available when the qualified plan belonging to the purchased or acquired company is terminated before the deal is completed.
The pandemic has created exceptional challenges and opportunities. Plan advisors and consultants have the knowledge to guide companies that survive and thrive, as well as those that are struggling. Both will need help.
Kevin Clark is senior vice president and business development director of Retirement Services at Millennium Trust Company, LLC. Mr. Clark has over 30 years of experience with employee benefits and retirement services. Millennium Trust Company performs the duties of a directed custodian, and as such does not offer or sell investments or provide investment, legal or tax advice.