What can you do if your company finds itself stuck with the seller’s retirement plan after an acquisition or merger? It’s often wiser to require the seller to terminate their plan before the closing to avoid this situation (see our prior blog post), but if that does not work out, what then? Fortunately, a nice feature of the Code called the “410(b) Transition Period” can ease the compliance burden following a transaction. This post will discuss the specifics of a 410(b) Transition Period, including what requirements are needed to be eligible for this transition period and to maintain it for the maximum period.
What is a “410(b) Transition Period”?
A 410(b) Transition Period is a period following a transaction in which a company that maintains a qualified plan (the “Buyer”) merges with or acquires another company with a qualified plan (the “Acquired Company”) (the “Transaction”), during which coverage may be tested separately rather than on an aggregated basis (the “Transition Period”). This Transition Period allows time for the plans to be merged or amended to ensure that the plans pass coverage testing on an aggregated basis. Without this Transition Period, qualified plans that have different benefits, rights, and features would need special testing and may not pass coverage.
What are the requirements to qualify for a Transition Period?
All of the following criteria must be satisfied to qualify for a Transition Period:
- Coverage is being evaluated related to a change in the controlled or affiliated service group status of a company (i.e., a mere change in some ownership may not be sufficient).
- Buyer’s plan must have met the coverage requirements under Code Section 410(b) immediately prior to the closing of the Transaction.
- Acquired Company’s plan must have met the coverage requirements under Code Section 410(b) immediately prior to the closing of the Transaction.
Are there any requirements to maintain the Transition Period?
All of the following criteria must be satisfied to maintain the Transition Period for its maximum period:
- No substantial amendments may be made to the terms of the Buyer’s plan during the maximum Transition Period
- No substantial amendments may be made to the terms of the Acquired Company’s plan during the maximum Transition Period
- No substantial changes in coverage under the Buyer’s plan may occur during the Transition Period (other than as a result of the transaction)
- No substantial changes in coverage under Acquired Company’s plan may occur during the Transition Period (other than as a result of the transaction)
How long does a Transition Period last?
- Maximum: From the date of the closing of the Transaction to the end of the Plan Year following the year in which the Transaction closed. Example: Transaction closed June 1, 2023, the maximum Transition Period would be from June 1, 2023 to December 31, 2024.
- Shortened: From the date of the closing of the Transaction to the date that there was a substantial change to the terms of either plan or coverage under either plan (other than as a result of the Transaction). Example: Transaction closed June 1, 2023, plan amended to cease matching contributions effective October 1, 2023, the Transition Period would be from June 1, 2023 to October 1, 2023.
What are the consequences of failing coverage testing?
If coverage testing is failed, then the plan or plans would no longer meet the qualification requirements for qualified plans. This results in the following tax consequences to participants:
- Highly compensated employees are taxed on full amount of benefits as though they received a full distribution in the year of the disqualification.
- Non-highly compensated employees are not taxed on benefits as though they received a distribution unless there is an additional reason for disqualification other than the failed coverage test.
Can a failed coverage test be corrected?
Yes. In order to correct a failed coverage test, the correction generally involves retroactively amending the plan to provide for broader coverage, and making contributions for the increased coverage group. This can be self-corrected if done within 9 1/2 months after the end of the plan year, or under the IRS’ voluntary correction program after that.
In the excitement of an M&A transaction, qualified retirement plans may seem like something that can be put on the back burner, but careful attention and planning should be given. The 410(b) Transition Period gives some breathing room to deal with qualified plan issues, but even so, it must be managed thoughtfully and intentionally.