Plan Termination Primer – Considering a Plan Termination

This section is strictly for review purposes. It is not to be used as a legal or consultative opinion as to the decisions you make regarding plan design, service providers, or the termination process.

Before terminating your plan, please make sure this is the best decision for company. You may have other alternatives related to plan design and expenses that will allow you to retain the plan with your original goals (see Section A). If a company terminates a plan, the company cannot start a successor plan within 12 months of terminating the current plan (SEP IRA’s are allowed).

Contact your recordkeeping service provider, ERISA Consultant/attorney, and/or TPA immediately if you are considering a plan termination (or if you have already decided). Do not make the mistake of terminating the plan by simply processing distribution forms, as this may immediately disqualify your plan as all out outgoing monies must be an approved IRS distributable event. In addition, you must make sure the plan document is up to date for all required remedial amendments and all final compliance work is complete. Before making the decision, make sure you know everything that is involved with a plan termination, including the long term impact on your retirement planning. This section will walk you through the process.

Is terminating the plan the right step?

1. If the plan is not accomplishing the goals of the owners as originally thought, can you accomplish the goals of the plan through a plan design change and/or improved participant communications? To determine this, ask your recordkeeping service provider or ERISA Consultant for a plan design projection report that considers other company contribution types or designs.

2. If the plan is cost prohibitive, can you accomplish the goals of the plan through other administrative/service provider alternatives? To determine this, we recommend reading the ‘Defined Contribution Handbook’.

3. If the services are not up to par from your perspective (or as promised or researched), can you receive these services from another service provider?

4. A plan can not start a successor plan within 12 months of terminating the current plan (SEP’s are allowed). Will terminating this plan have a negative impact on the owners, key employees, and the company?

I am considering selling my company, what happens to the plan?

For an asset sale, the selling corporation remains as a separate corporation; it may not have assets or employees, but it continues to exist as an entity (similar rules apply to a non corporate employer). If there is a plan, the plan continues to be sponsored by the seller, even if there are no employees left after the sale. The employees who are hired by the purchaser of the assets are terminated with regard to the seller and the seller’s plan, and are therefore entitled to distributions from the seller’s plan. The purchaser of the assets can arrange to assume sponsorship of the seller’s plan, at the time the assets are acquired, but this is a separate transaction; it is not automatic, or required. The default would be that the purchaser does not assume sponsorship of the seller’s plan.

For a stock acquisition, the only change is with regard to the ownership of the (selling) employer’s stock. The employer continues to exist as it had before the sale, and the plan continues to cover the same employees it did prior to the change in ownership. Again, the only change here is with regard to who owns the shares of the employer.

You are leaning towards terminating the plan, what should I be aware of related to formally terminating the plan?

When terminating a plan, the following must be resolved/addressed:

1. Forfeiture Account – The plan document will dictate how to allocate the forfeitures (if any)
2. Tracking Lost Participants – The plan sponsor must find everyone.
3. 100% Vesting – All participants are 100% vested.
4. Outstanding Participant Loans – All loans will become taxable events to the participant.
5. Required Company Contributions (simply terminating the plan does not alleviate the company of certain contributions, especially the Safe Harbor NEC).
6. Current Year Discrimination Testing – If any HCE’s contributed to the plan during the plan year, the ADP/ACP or top heavy tests may fail.
7. The plan document must be updated for all remedial required amendments (potentially including upcoming required remedial amendments)

A plan that is a safe harbor NEC can not terminate the plan mid-year unless it meets stringent financial hardship requirements. A safe harbor company match plan can terminate mid-year with proper notice.

What is the process of terminating a plan?

As a plan sponsor, you have two options:

Option 1 – Formally filing for a determination letter (not required although strongly encouraged as the IRS has recently stated at industry functions that companies that terminate plans without filing for a determination letter will most likely be audited). Please allow 3-5 weeks for your attorney or ERISA Consultant to prepare the Form 5310 filing and up to 6 months for the IRS to respond to your determination letter request (this response may request additional information or clarification). All distribution checks are processed and delivered after the determination letter is received!

Option 2 – Follow a practical and prudent approach, ensuring all participants are treated fairly in the termination process. Typically this includes making sure all participants are paid at the same time upon completion of all compliance and document activities and after all distribution forms have been received. The plan will be terminated when a Form 5500 has a zero ending balance (this approach should only be used if the plan is in good standing with the government).

These options are discussed more in depth in other articles.

Plan Termination Tips/Pitfalls

The key decision related to terminating a plan are weighing the benefits to the costs. For small companies, the benefits include the owners deferrals and company contributions, whereas the costs are the company contributions to the non owners plus service provider costs (generally out of pocket). The following points are important to remember:

1. If the company chooses to terminate the plan; the company cannot start another qualified retirement plan for 12 months (the twelve month clocks starts when all assets leave the plan)
2. A company can not offer a defined contribution plan and an IRA (SIMPLE or SEP) in the same year.
3. The plan is responsible for the Form 5500 for every year there are assets (so at minimum a 2009 Form 5500 will be required)
4. All participants are automatically 100% vested (this often includes participants with that were not 100% vested at the time of their termination but have not requested a distribution AND any includes participants that may have terminated on or near the plan termination date)
5. If the plan has a forfeiture account, the plan must allocate the forfeitures per the plan (as often asked, these do not go back to the owner)
6. The plan is subject to the ADP/ACP testing for the final year (if the plan has salary deferrals and is not a safe harbor plan)
7. If the plan is a safe harbor non elective plan (SH NEC), the plan must terminate on the plan year end as the IRS views the SH NEC as an accrued benefit. Exceptions are made for companies with a financial hardship.

The typical audit trigger is the plan did not file a final Form 5500! Plan sponsors that typically receive the IRS audit are those that thought they could simply process distributions and walk away from the plan (often times without settling up with their service providers). In the rare cases, some owners take their monies and the plan enters ‘orphaned status’. This is another audit trigger, as the participants in these events usually end up calling the Department of Labor.

When the plan is audited, the issues are typically:

1. No final Form 5500 filed
2. Straggling participant accounts
3. No formal termination resolution/amendment nor is the plan document up to date for required remedial amendments
4. Final year compliance and company contributions not completed (the IRS reviews all employees to make sure they received the benefits as promised, eligibility determinations are often discovered)

Companies cannot terminate a plan retroactively hence it is best to terminate your plan right away the first time (it most likely will cost less in the long run).

Minimum Requirements for Terminating a Plan (No Determination Letter)

This is option two described in the Plan Termination Primer. Please note the IRS has verbally stated that plans that go this route have a higher chance of being audited! The minimum requirements to terminate a plan that is in good standing from a compliance perspective are outlined below.

Note: Safe Harbor NEC plans can not be terminated mid-year unless the plan sponsor meets stringent financial hardship criteria.

Plan Design – ERISA Requirements

1. All accounts are 100% vested (if the plan includes a vesting schedule for company monies)
2. The forfeiture account must allocated per the plan document (if applicable)
3. All final company contributions are made (including the required top heavy, company contribution, or SH NEC contribution)
4. Form 5500 must be completed for each year until the plan has zero assets
5. The plan sponsor signs a termination amendment/resolution
6. The plan document is updated for all required remedial amendments

Participant Notification

Although not required (does not include plans with a required company match), we recommend the plan sponsor notify each eligible participant. Each participant should receive a plan termination package that includes:

1. Notice of Plan Termination (including the reason)
2. A distribution form
3. The required IRS Special Tax Notice (explains the tax consequences of the distribution)

The notice should be sent to all eligible participants including the reason for the plan termination, the requirement that each participant must complete a distribution form, rollover options, and the timing (as in the distributions will be processed when all forms have been received, as opposed to processed individually as received, which can take up to 180 days after notifications).

This notice/letter is not required, but is highly suggested.

We can not stress this next point enough, it is important to inform all participants the timing of the plan termination process. This process generally takes 90 – 120 days for the plan sponsor to collect all distribution forms. It is highly recommed that all distributions are processed at the same time as it is required in the determination letter process and is a practice that should be followed to avoid discrimination and fee issues.

Your recordkeepig service provider will most likely charge their normal distribution fee. Therefore if your plan has any participant balances less than the distribution fee, it is important for you to work with the recordkeeping service provider to best handles these monies (many plan sponsors elect to offset these monies against recordkeeping fees).

Form 5500 Process

A Form 5500 is required for every year there are monies in the plan/trust. Plans with a Title I exemption (solok’s) are required to complete a final Form 5500 (however we recognize many plan sponsors choose to ignore this requirement as they feel the exemption applies to the final year as well).

If your plan is a calendar year plan end, the plan sponsor is required to complete a Form 5500 for every year there are assets in the plan. If monies are not out of the plan by year-end, the plan sponsor will be required to complete a Form 5500 for that year as well (no matter how low the balance is). The final Form 5500 typically cannot be completed until the first quarter followign the plan year end due to the IRS release timing of the Form 5500.

Paying the Participants – Estimated Timeline

The timeline is dependent on three key variables:

1. Turnaround time of completed distribution forms (100% of all forms) with the key variable as ‘lost participants’
2. Providing the ERISA Consultant timely information including the final census in order to complete final compliance testing, company contribution calculations, and allocating forfeitures.
3. Involvement of the plan sponsor in the process, especially following up with participants on distribution forms (the more active, the faster the process goes)

Key issues that drag the process out are lost participants and plan sponsors trying to shortcut the process. See ‘Plan Termination Pitfalls’ for further discussion. Plan sponsors that are terminating their plan often become frustrated due to the length of time to terminate a plan, especially related to lost participants. For those plan sponsors who get frustrated at the ERISA Consulant, attorney, or TPA…………..please remember it is not the fault of any of these parties that these accounts are still on file and eligible for a distribution.

When all of the required plan termination steps are completed and the plan sponsor has received all of the distribution forms, the plan sponsor should send the following to their recordkeeping service provider (and the TPA/ERISA Consultant if applicable):

1. A Signed copy of the termination resolution
2. 100% of the Distribution Forms

Your recordkeeping service provider will process the distributions within 1-3 weeks, as they will want to make sure all fees have been paid.

The most popular question we receive related to plan terminations is how long will it take to terminate the plan in this process? This is difficult to answer as it ranges from 30 – 200 days. For small plans with no lost participants and the plan sponsor actively involved (including calling/emailing the participants with balances), the process can be completed within 30 business days. For plans with lost participants and/or plan sponsors not actively involved, they tend to last 120-200 days. The average timeframe is 60 days (from date of starting process through the checks cut) for those plans with no lost participants.

Searching Requirements for Lost Participants

For discussion purposes, lets presume the bad address was an old one without any attempts made to get the correct address after they left they firm. The plan sponsor must make a reasonable attempt to locate the accurate address of the participant and be able to document this. This section highlights the recommended methods as outlined by the government in relation to terminated plans.

A plan fiduciary must always, regardless of the size of the participant’s account balance, make reasonable attempts to locate lost participants. A plan fiduciary cannot distribute a missing participant’s benefits under FAB 2004-02 unless they attempt to locate the lost participant using each of the first four methods described below.

1. Certified Mail to last known address.

2. Check Other Plan Records such as the group insurance plans. To address privacy concerns, the fiduciary can request the employer or other plan fiduciary to contact or forward a letter on behalf of the plan to the participant or beneficiary, requesting the participant or beneficiary to contact the plan fiduciary.

3. Check With Designated Plan Beneficiary. In connection with a search of the terminated plan’s records or the records of related plans, plan fiduciaries must attempt to identify and contact any individual that the missing participant has designated as a beneficiary (e.g., spouse, children, etc.) for updated information concerning the location of the missing participant. Again, if there are privacy concerns, the plan fiduciary can request the designated beneficiary to contact or forward a letter on behalf of the terminated plan to the participant, requesting the participant or beneficiary to contact the
plan fiduciary.

4. Use A Letter-Forwarding Service. Both the Internal Revenue Service (IRS) and the Social Security Administration (SSA) offer letter-forwarding services. Plan fiduciaries must choose one service and use it in attempting to locate a missing participant or beneficiary. The IRS has published guidelines under which it will forward letters for third parties for certain “humane purposes,” including a qualified plan administrator’s attempt to locate and pay a benefit to a plan participant. The SSA’s letter forwarding service may be used for similar purposes. To use either the IRS or SSA program, the plan fiduciary/requestor must submit a written request for letter forwarding to the agency, and must provide the missing participant’s social security number or certain other identifying information. Both the IRS and SSA will search their records for the most recent address of the missing participant and will forward a letter from the plan fiduciary/requestor to the missing participant if appropriate. In using these letter-forwarding services to notify a missing participant that he or she is entitled to a benefit, the plan fiduciary’s letter should provide contact information for claiming the benefit. This notice may also suggest a date by which the participant must respond, as neither the IRS nor the SSA will notify the plan fiduciary as to whether the participant was located.

5. Commercial Search Services. In addition to using the search methods discussed above, a plan fiduciary should consider the use of Internet search tools, commercial locator services, and credit reporting agencies to locate a missing participant. Depending on the facts and circumstances concerning a particular missing participant, it may be prudent for the plan fiduciary to use one or more of these other search options. If the cost of using these services will be charged to the missing participant’s account, plan fiduciaries will need to consider the size of the participant’s account balance in relation to the cost of the services when deciding whether the use of such services is appropriate.

Terminating a Plan (Filing for a Determination Letter)

As discussed this is not required, however strongly encouraged. The ‘determination letter’ process will cost you anywhere from $3,000 – $30,000 (dependent on size of plan, complexity, and organization of plan materials). At minimum in order to complete the Determination Letter process will require the following:

1. Completion of Form 5310
2. Customized Participant Notice/Distribution Form
3. Patience and excellent communications with the participants during the process

The Form 5310 and its process are rigorous and if completed accurately act as an insurance policy (although not a foolproof policy) against any claims or audits after the plan is terminated. This task will involve reviewing and producing prior year compliance work and company contribution calculations. The timing of the determination letter is at the mercy of the IRS, so it is important to make sure the participants know the monies may not be sent for up to a year. Simply following the process described in this article does not mean the process flows smoothly as the government may request additional information during the process.

The customized notice provides their rollover options and timing of the plan termination. There is no specific timing or methodology that is required for the notice, other than we recommend it is sent 10 – 24 days before the Form 5310 is filed. The notice should include the reason for the termination, timing, vesting explanation, and rollover options. We also recommend creating and delivering a customized distribution form (as opposed to the normal distribution form your recordkeeping service provider uses).

If you choose this process, you will need to hire an ERISA consultant or attorney to handle. Fees are typically charged on an hourly basis, ranging from $150 – $500. Your recordkeeping service provider/TPA may perform these services as well, and may be the best entity to perform this from a plan document perspective.

The suggested process/timeline can be as follows:

Week 1 – Review meeting with the recordkeeping service provider/TPA, consultant, and/or outside consultant/attorney. Topics include creating the project schedule, discussing recordkeeping items (forfeiture accounts, vesting, lost participants), final company contribution, fees (all service providers), formal termination date, and Form 5310 process.

Week 2 – Complete the termination amendment/resolution, create the participant termination package (customized participant notice and distribution form), and the plan document should be updated for any required remedial amendments.

Week 3 – Send the participant termination package registered mail

Week 5 – File the Form 5310. The process to complete the Form 5310 will take 2-4 weeks (sometimes longer).

The government will generally provide the determination letter OR send you additional questions within 3-6 months. If the latter is provided, you will have to provide further information before receiving the plan determination letter. Once the plan determination letter is received, instruct the recordkeeping service provider to process the distributions.


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2 Responses to Plan Termination Primer – Considering a Plan Termination

  1. I was reading some of your articles on this website and I think this site is rattling instructive! Retain putting up.

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