Addressing 401(k)s, health benefits and compensation after a merger or acquisition

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Integrating the employee benefits of the acquired employees following an acquisition is of critical importance, but it can be a difficult task for a buyer of a business from legal, administrative and employee relations perspectives. When buyer and seller wish to combine operations, assimilating the newly acquired employees into the new environment requires coordination with payroll, HR and other components of the buyer's business.

Making the transition a smooth one requires careful consideration and planning. Below are some important benefits issues that organizations should consider in connection with an acquisition.

1. 401(k) Plans

When the buyer and seller both sponsor a 401(k) plan, a common integration strategy is for the buyer to continue its plan for both its employees and the employees it acquires in the transaction. This strategy is often used where there is a desire to make the employees of the seller feel comfortable about their integration as employees of the buyer and can be especially effective if the buyer's retirement benefits are more robust than the seller's benefits.

There are two different ways to accomplish this result. The first is for the seller to terminate its plan. Termination triggers full vesting of any unvested amounts held in an employee's account and a distribution of the plan account to each plan participant. Each participant may then retain his or her plan balance, transfer it to an IRA or transfer it to the buyer's plan. Most participants seeking continued tax deferral will transfer their account into the buyer's plan.

The second way is for the buyer to assume sponsorship of the seller's plan. The buyer can either maintain the seller's plan as a separate plan or merge it into their own. Maintaining the seller's plan as a separate plan provides continuity for the seller's former employees, but is costly and complicated for the seller, as separate plans require separate plan documents, nondiscrimination testing and Form 5500 filings. As a result, maintaining separate plans usually does not make sense unless the seller's operations are separate and two plans are more appropriate from an employee relations perspective.

Merging the seller's plan into the buyer's plan simplifies administration but can have a significant downside: if the seller's plan has compliance issues, it will “infect” the buyer's plan. This means that if the IRS or DOL audits the merged plan and finds a defect attributable to the seller's plan, the penalty may be based upon the total assets in the merged plan. Also, the buyer's plan is usually more complex post-merger, as any “protected” benefits under the seller's plan must be maintained. For these reasons, the buyer should conduct a compliance review of the administrative and fiduciary operations of the seller's plan prior to the merger.

Given the drawbacks of assuming sponsorship of the seller's plan, many buyers prefer plan termination with distribution of participant accounts (rather than plan-to-plan transfers), which limits the liabilities assumed by the buyer and is usually the simplest approach from an administrative perspective. However, the buyer must decide what to do about loans if the seller's plan permits them. In order to avoid putting outstanding loans into default (which generally occur automatically when employment is terminated or accounts are distributed), buyers often make arrangements to transfer the loans to the buyer's plan. The buyer should also be certain that the seller's former employees understand the tax implications of their distributions and know how to roll over their distributions into the buyer's plan.

If the transaction is an asset acquisition, the buyer and seller may provide for a transition period during which the seller's former employees continue to participate in the seller's plan. This arrangement may be desirable if the buyer does not have time to establish the administrative structure necessary to enroll the seller's former employees in the buyer's plan right away. Because Internal Revenue Code rules prohibit the termination of a 401(k) plan (and consequent distribution of accounts) if an employer maintains more than one 401(k) plan, this strategy does not work if the transaction is a stock acquisition.

Where there is a transition period after the closing, the parties should enter into a transition services agreement outlining their rights and responsibilities during the transition period. In some instances, the seller provides all payroll and benefits during the transition period while it “leases” its former employees to the buyer.

Once a decision about whether to maintain, merge or terminate the seller's plan is made, the buyer should notify its 401(k) plan service providers as soon as possible (and before any applicable deadlines specified in the service agreements) and begin planning for the administrative mechanics of the transition, including determining what resolutions and plan amendments are necessary.

As discussed above, if the buyer has decided to merge its plan with the seller's, it should perform due diligence on the seller's plan (or review an already-prepared diligence report) and correct any compliance issues before the merger. If compliance issues emerge during that diligence (as they often do), the buyer may have some recourse via representations and warranties insurance or the purchase agreement's indemnification provisions, assuming that the agreement included a representation that the plan was in material compliance with applicable law.

Buyers should also review the benefits provided by the seller's plan and consider the employee relations consequences of any differences between the two plans. If the seller's plan is more generous, adding a matching or profit-sharing contribution to the buyer's plan or the merged plan at the time of the transition may make sense. Whether benefit levels will be adjusted or not, employees on both the buyer and seller side will have questions about the transaction's impact on their benefits. Employee communications explaining the transition should be prepared in advance, if possible, and sent soon after the transaction is announced.

2. Health Benefits

The seller's former employees are usually transferred to the buyer's health plans effective upon the closing. Therefore, buyers should notify their insurers (for plans that are insured) or claims administrators and stop-loss insurers (for plans that are self-insured) about the transaction as early as possible. Often, the purchase agreement provides that the buyer will credit the seller's former employees with any spending they have already done toward plan deductibles and out-of-pocket expense limits for the year. In order to accomplish this, buyers should require the seller to transfer the appropriate records to the insurer or claims administrator.

The buyer should also require that the seller provide complete records with respect to its compliance with the Affordable Care Act. In particular, the buyer should obtain the information necessary to fulfill ACA reporting requirements for the next year as well as the data necessary to transition the seller's former employees onto the buyer's hours tracking system for purposes of ACA's “pay or play” employer mandate.

When the seller sponsors a flexible spending account (FSA), the parties must decide whether the buyer will transmit contributions to the seller's plan for the remainder of the year or transfer the seller's employees (along with their elections and account balances) to the buyer's plan.

As with other benefit plans, the buyer should compare its health plans to the seller's and consider whether adjustments should be made to reduce any discrepancies. The buyer should also prepare employee communications explaining the transition and the benefits provided under its plans.

It is also critically important for buyers to understand if any retiree medical or other post-termination health benefits have been promised to employees. If such commitments have been made, then it is key to understand whether they will be transferred to the buyer and, if so, the extent to which the buyer will be obligated to continue providing the benefits.

3. Executive Compensation

Executive compensation arrangements vary widely, as do the issues encountered in integrating them following a transaction, but the first task for every buyer is understanding exactly what deferred compensation, equity awards and perks have been promised to executives. This task is difficult but important, as executive compensation arrangements are frequently unfunded. The buyer should consider how its executive compensation package compares to the seller's and whether changes are necessary or appropriate. The comparison should also be taken into account in negotiating the employment terms of the seller's executives.

There are a multitude of factors relating to benefits that must be taken into account when a business is acquired. Careful planning and knowledge of the acquired business's benefits plans are critical to accomplishing a smooth transition and the successful integration of acquired employees.


This article was written by Emily Payne from BenefitsPro and was legally licensed through the NewsCred publisher network. Please direct all licensing questions to

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