Successor plan rule

What the successor plan rule is

Deferrals can normally be paid out only on events such as leaving the company or reaching age 59½. Plan termination is one of those events, but only if the employer does not maintain an “alternative defined contribution plan” at any time from the termination date through 12 months after all assets are paid out. Employee stock ownership plans, SEPs, SIMPLE IRAs, 403(b) and 457 plans do not count. Neither does another plan if fewer than 2% of the terminated plan’s eligible employees are eligible for it.

Why it matters to employers

The rule comes up in three situations: changing providers, mergers and acquisitions, and redesigning a plan. If you want a new provider, convert the plan; do not terminate it. In a stock acquisition the buyer and the target become one employer at closing, so the target’s plan has to be terminated before closing if its employees are to receive distributions.

Example

A company terminates its 401(k) on June 30, pays everyone out by September 30, and wants a new 401(k) on January 1. Because the new plan starts within 12 months of the payout, the terminated plan could not properly distribute deferrals to employees who still work there.

Common mistakes

• Terminating a plan to “start fresh” with a new provider.

• Closing an acquisition before the target adopts its termination resolution.

• Looking only at one company when the rule applies across the whole controlled group.