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When a company acquires a business through an equity sale, the buyer steps into the shoes of that target company’s employee benefit plans, including any 401(k) plan. For buyers that already sponsor their own 401(k) plan, this creates practical questions: Can we terminate the target’s 401(k) plan? Should we merge it into ours? What happens to participant loans, investment options, and ongoing compliance obligations? Buyers should carefully assess how to address the target’s 401(k) plan early in the transaction, as failing to act before the transaction closes can cause unintended consequences for post-closing benefit plans and overall HR integration.

This article walks through key decisions and common issues when a buyer acquires a target company in an equity purchase and both companies sponsor 401(k) plans.

Why Timing Matters: The Successor Plan Rule and Pre-Closing 401(k) Plan Termination

A common (and most risk-averse) approach is to require the seller to terminate its 401(k) plan at least one business day before the closing date of the sale. This timing is critical because of the Internal Revenue Code “successor plan” rule. In simple terms, this rule provides that if an employer terminates a 401(k) plan but maintains another 401(k) plan simultaneously in its controlled group, participants in the terminated plan cannot receive distributions of their elective deferral accounts as part of the plan’s termination.

In an equity acquisition where the buyer already sponsors its own 401(k) plan, this means the buyer’s 401(k) plan will be treated as a “successor” plan if the target’s 401(k) plan is terminated after closing. The consequence is significant, as participants could be stuck with account balances in a terminated plan that cannot be distributed, creating an administrative headache for the buyer and frustration for employees.

By terminating the target’s 401(k) plan before closing (and before the buyer and target become members of the same ERISA-controlled group), these successor plan rules should be avoided. However, this pre-closing termination strategy requires careful coordination:

• The target company (as plan sponsor) must adopt board resolutions at least one day before closing to terminate the plan, stop contributions, and begin the wind-down process.
• Participants must be fully vested in all employer contributions upon termination as required by law.
• The purchase agreement should include a covenant or closing deliverable requiring the seller to adopt the necessary termination resolutions effective no later than one day before closing.

Importantly, terminating the target’s plan pre-closing does not relieve the buyer of its obligation to ensure the plan is timely and properly wound down post-closing.

• The wind-down requires active fiduciary supervision and can take up to a year or more, as all assets must be distributed to participants. Upon termination, participants may elect to roll over their account balances into the buyer’s 401(k) plan or an IRA, or receive their benefits in cash as a taxable distribution.
• The terminated plan must be properly amended to bring the plan document up to date with any required amendments through the date of termination. After all distributions are complete, a “final” Form 5500 must be timely filed with the DOL.
• The buyer should confirm that eligible target employees can enroll in the buyer’s plan at or shortly after closing, that the buyer’s plan can accept rollovers of account balances from the seller’s plan (including any timing constraints), and whether the buyer’s plan can accept rollovers of outstanding participant loans to avoid triggering adverse tax consequences to the seller’s employees. These issues may require plan amendments or administrative changes.
• The buyer will also need to coordinate between recordkeepers of both plans if the buyer’s plan will accept rollovers (including loans) from the target’s plan.

Buyer’s Post-Closing Options If the Plan Is Not Terminated Before Closing

If the target’s 401(k) plan is not terminated before closing, the buyer’s post-closing options are generally limited to three alternatives: continue the target’s plan (usually temporarily under a special Internal Revenue Code transition rule), freeze the target’s plan, or merge the target’s plan into the buyer’s plan. Often, buyers use more than one of these alternatives as part of overall strategy for HR and benefits integration.

• Continue the Target’s 401(k) Plan. An employer maintaining two 401(k) plans in its controlled group must ensure each plan satisfies coverage requirements under Internal Revenue Code rules, which are designed to prevent plans from disproportionately favoring highly compensated employees. Meeting these requirements on an aggregated testing basis for the controlled group can be difficult or impossible. However, the transition rule under Internal Revenue Code Section 410(b)(6) gives buyers a grace period from closing through the end of the first plan year beginning after the sale, provided neither plan significantly changes its coverage rules. This gives buyers approximately 12-24 months to continue the target’s plan, depending on closing timing. This approach allows buyers time to evaluate the target’s plan, compare its terms to the buyer’s plan, and make thoughtful decisions about the long-term benefits strategy for the combined workforce.
• Freeze the Target’s 401(k) Plan. A less common alternative is for the buyer to freeze the target’s plan at or after closing. This typically involves amending the plan to stop new contributions and close the plan to new participants. This results in additional ongoing administrative costs while the frozen plan remains outstanding, and a frozen plan still carries ongoing fiduciary and administrative obligations, including filing Form 5500 reports, distributing participant notices, facilitating ordinary course distributions, and monitoring plan investments and service providers. This approach is sometimes used as a bridge strategy when the target’s employees start participating in the buyer’s plan but a plan merger cannot be completed simultaneously, or where surrender charges or market adjustments applicable to the plan’s investment contracts would be detrimental to plan participants.
• Merge the Target’s 401(k) Plan into the Buyer’s 401(k) Plan. This alternative, typically used with one or both of the other approaches, involves merging the target’s plan (and all related assets) directly into the buyer’s plan. This consolidates plan administration, reduces costs, and brings all employees under one plan. However, a merger risks “tainting” the buyer’s plan’s tax-qualified status if there are outstanding compliance issues under the target’s plan. Detailed substantive due diligence of the target’s 401(k) plan during the sale transaction is critical for determining any issues that may arise with this approach. The buyer and its plan administrators will need to review both plans to identify differences in eligibility, vesting schedules, contribution formulas, distribution options, and loan provisions. This review is critical to preserve any “protected benefits” (as required under Internal Revenue Code rules) and to inform plan design decisions for administrative simplicity going forward. In addition, various administrative actions and participant notices may be required to complete a plan merger, creating additional administrative burdens and costs.

A Few Practical Issues and Potential Complications for Buyers to Consider

Here are a few issues for buyers to consider early in the transaction process that may affect which approach to take with the target’s 401(k) plan.

• Outstanding Participant 401(k) Plan Loans
  Participant loans can create headaches in plan transitions. If the target’s plan is terminated, outstanding loans not repaid upon plan termination are generally treated as a “deemed distribution,” which is taxable to the participant (including potential early distribution penalties for participants under age 59½). A buyer’s plan may be able to accept rollovers of outstanding loans from the target’s 401(k) plan if the employee also rolls over his or her full account balance into the buyer’s plan. However, the buyer will need to confirm this is possible under the buyer’s plan and with its administrator, as the process typically requires significant data coordination between the buyer and the target’s 401(k) plan recordkeepers. A buyer should involve its recordkeeper early to understand the feasibility, requirements, and timeline for transferring loans.
• Recordkeeper Requirements
  Third-party administrators for both plans may impose their own requirements as a condition of administering a plan termination, merger, freeze, or asset transfer, which can create administrative hurdles. For example, a recordkeeper may insist on receiving specific board resolutions, officer certifications, or documentation that is consistent with the recordkeeper’s forms. These requirements are commonly driven by the recordkeeper’s internal policies and contractual terms, not necessarily general legal requirements, but they can delay the process if the buyer or target is unprepared. For example, although a timely and properly adopted board resolution terminating the target’s plan should establish the plan’s effective termination date for legal purposes, recordkeepers may try to require other documentation or notices to implement the termination process. Early engagement with both the buyer’s and the target’s plan administrators is important to eliminate speed bumps.
• Plan Investment Options with Unique Potential Costs or Timing Considerations
  Some 401(k) plans, particularly smaller plans, use investment options such as group annuity contracts or stable value funds that may carry surrender charges or market value adjustments. In that circumstance, if the buyer terminates the target’s plan and liquidates these investments on a compressed timeline, participants may face significant financial penalties on their plan investments. Surrender charges can reduce participant account balances, and market value adjustments can result in participants receiving less than the book value of their accounts.
  Buyers should review the target’s investment lineup during due diligence to identify products with these features and determine the proper path for addressing additional fees or costs.

Conclusion

When a buyer with an existing 401(k) plan acquires a company that sponsors a 401(k) plan, it adds meaningful complexity to the transaction that demands early attention and careful planning. Thorough due diligence on the target’s plan is essential. Buyers who engage their employee benefits counsel, advisors, and third-party administrators early are far better positioned to navigate these issues efficiently and avoid surprises that can create unintended consequences, frustrate and delay HR integration efforts, or create unnecessary administrative costs.