Reasons for Terminating a 401(k) Plan – and the Challenges That Come With It

Terminating a 401(k) plan affects current and former employees, who are understandably concerned about the stability of their retirement funds. It also affects the employer sponsoring the plan, as terminating a plan presents significant challenges. The decision should not be taken lightly, but a plan termination may be prudent or unavoidable. The following are several of the most common reasons for terminating a 401(k) plan, along with the accompanying difficulties that accompany that decision.

Business Closure

When a company shuts down operations, maintaining a 401(k) retirement plan no longer makes sense. The company ceases to exist, leaving no one to oversee the plan. As a general rule, when a company ends, so too does its retirement plan for former employees.

• Challenge: Plan fiduciaries need to follow proper steps to terminate a 401(k) plan as the company’s operations wind down. Before dissolution, all participant accounts must be distributed. Employers are also responsible for completing Form 5500 filings – the annual plan report required by the Internal Revenue Service (IRS) and Department of Labor (DOL) – and upholding fiduciary duties, regardless of financial hardship.

Mergers and Acquisitions

When a company merges with or is acquired by another, the surviving company is unlikely to want the administrative burden of maintaining multiple plans. Consolidating all affected retirement benefits into a new plan or incorporating participants from acquired company plans into a single existing plan often makes sense in this scenario. Redundant plans are then terminated.

• Challenge: Combining plans is complex. Employers must assess plan compatibility and determine if they will terminate the inherited plan all together.  Either avenue represents a risk as the employers are bringing new employees into their existing benefits structure.

High Administrative Costs

For small employers, 401(k) plan administration costs for necessities such as recordkeeping, audits, compliance testing and fiduciary oversight can become unsustainable. If the cost of running the plan exceeds the benefits of offering it as an employee benefit, termination may be a reasonable business decision.

• Challenge: Terminating the plan may reduce costs, but employers must handle final contributions, notices and distributions correctly to avoid violating fiduciary obligations. Participants may also view termination negatively, which can affect employee morale, performance and stability.

Low Participation

401(k) plans must undergo nondiscrimination testing annually to verify that plans don’t unduly favor highly compensated employees. Plans with low participation may fail this testing, creating administrative burdens and additional costs for refunds or corrections. Companies may address low participation by implementing auto-enrollment or redesigning the plan to make it more appealing to a broader group of employees. If those efforts are impractical, termination may be the best option.

• Challenge: Careful communication is required to explain the reasoning and future alternatives for employees’ retirement savings. Like plans that close due to high administrative costs, participating employees may be left dissatisfied, which can affect their work quality and their decision to continue working for that employer.

Switching to a Different Retirement Plan

Depending on a company’s specific workforce, employers sometimes consider replacing their 401(k) with another retirement plan type, such as a SIMPLE IRA or SEP IRA. These options may be a better fit and simplify operations.

• Challenge: When an employer shifts to a new retirement plan model, it must meet strict IRS timing rules. For example, a 401(k) must be formally terminated before establishing a SIMPLE IRA. Overlapping contributions can cause potentially costly compliance violations.

Compliance or Fiduciary Issues

Plan sponsors are required to comply with an array of regulatory requirements. If a plan repeatedly fails IRS or DOL audits, or the company cannot adequately manage fiduciary responsibilities, plan termination may be necessary to mitigate further risk.

• Challenge: Terminating a plan under government investigation or facing unresolved compliance issues can delay the process. Employers must correct all outstanding violations through the IRS Voluntary Correction Program or the DOL’s Delinquent Filer Voluntary Compliance Program before finalizing termination.

Strategic Restructuring

Sometimes, 401(k) plan termination aligns with broader business goals, such as outsourcing human resources functions, restructuring corporate entities or converting to a new benefit model.

• Challenge: Even if the decision is strategic, the process of terminating a 401(k) plan remains heavily regulated. Employers must issue formal resolutions, provide timely participant notices and ensure all plan assets are distributed within one year of termination.

The Bottom Line

Terminating a 401(k) plan is a major fiduciary event, not a simple administrative task. Employers must follow specific steps to ensure compliance. Among the obligations for plan sponsors deciding whether to terminate a 401(k) plan is locating missing plan participants and correctly distributing their account balances. The DOL’s Field Assistance Bulletin No. 2014-01 was issued to help plan sponsors understand and meet these fiduciary responsibilities by following the required steps outlined in its release.

Working with reputable vendors to navigate a 401(k) plan termination can help alleviate the administrative burden of winding down a retirement plan. It is strongly recommended that employers will need to work with  ERISA counsel, existing recordkeeper(s) and tax advisor(s) to ensure proper execution of the termination process.

Assistance is also available to handle the process by retaining the services of a reputable vendor partner, such as MarketSphere Retirement Reunification Services.  They can help employers navigate complex compliance requirements for terminating a 401(k) plan, avoid costly errors, communicate effectively with participants, coordinate multiple stakeholders, and bring peace of mind and fiduciary protection. To start the conversation, learn about MarketSphere’s Retirement Reunification Services and contact our team today.