Reasons for terminating a qualified retirement plan
Generally, plan sponsors are free to decide when to terminate a plan. Some reasons to do so may be because their business has been acquired, or they’re experiencing a financial downturn; however, as mentioned, the IRS expects a plan to be permanent, not temporary. The regulations state that if a plan is terminated for any reason other than business necessity within a few years of taking effect, it may not be considered a qualified plan.
Commonly asked questions
While not exhaustive, the following questions can help you understand what’s involved with terminating a qualified retirement plan.
What date should be used for the retirement plan termination date?
Although the termination process may continue for some time, the termination date should be when (1) all participants are 100% vested, and (2) all plan transactions, such as contributions, are discontinued. This date should be stated in any document (e.g., board resolution) needed to address the plan termination.
Why is vesting accelerated to 100% for participants in the plan?
The law requires that all plan benefits be fully vested when a plan terminates, with a few exceptions. Therefore, if your plan doesn’t already provide for 100% vesting of all employer contributions, participants must be 100% vested on the chosen termination date.
Do you need to amend your plan document at the time of termination?
For many plan sponsors, the actions required to terminate the plan should already be outlined in their plan document. Therefore, a board resolution is all that’s needed to address the plan termination; however, if legislative or regulatory changes have occurred since the plan was last amended or restated, you might need to amend your plan to bring it up to date. The board resolution and any needed amendments must be executed by the plan termination date.
Do you need to file for a letter of determination with the IRS at the time of termination?
You’re not required to file for a letter of determination at the time of termination. Although filing may ensure that the termination is done in accordance with IRS regulations, you’ll have to pay filing costs, and the IRS may take over a year to make a determination, during which time the plan must remain open.
When is a plan finally considered terminated?
A plan is considered terminated when all participants are paid out and a final Form 5500 is filed. The form is due within seven months of the end of the month in which all plan funds have been paid out.
Other compliance considerations
Additionally, you’ll want to consider:
- Loan repayments—Loan repayments will cease on the termination date. If the termination is due to the acquisition of your plan, you may be allowed to roll over the loan to a successor 401(k) plan.
- Annual testing—The plan termination will generally create a short plan year. As a result, the plan will need to have all annual testing (ADP/ACP, top heavy, annual additions, and more) prepared before any distributions can be issued.
- Participant notice—Participants should be provided notice of the plan termination and distribution instructions, including the deadline for making a distribution election. If no election is received by the deadline, the account balance should be rolled over to an IRA or successor plan, if applicable.
- Missing participants—Some participant data may be problematic. For example, there may be terminated participants with bad addresses. If you have trouble locating a participant, you should follow the U.S. Department of Labor’s procedure for missing participants.
- Successor plan—Be aware of the timing requirements set forth in the IRS’ successor plan rules if you intend to establish a new DC plan after terminating your 401(k) plan.
Retirement plan terminations—more than ceasing contributions and distributing funds
Although DC plans are intended to be permanent, there may come a time when a plan no longer suits your business needs. If that time comes, it’s important to follow certain steps and be aware of all compliance requirements. We recommend working with your legal counsel and plan consultant to determine what needs to be done to formalize the termination.
THIS IS INTENDED FOR A PLAN SPONSOR AUDIENCE.
The content of this document is for general information only and is believed to be accurate and reliable as of the posting date, but may be subject to change. It is not intended to provide investment, tax, plan design, or legal advice (unless otherwise indicated). Please consult your own independent advisor as to any investment, tax, or legal statements made.