In connection with a merger or acquisition, an acquiring company may end up assuming sponsorship of a tax-qualified retirement plan that covers employees of the acquired company.  Basic due diligence on the plan likely was done during the acquisition.  But if the plan will continue to be maintained following the acquisition, this is the perfect time to establish procedures to ensure that the numerous administrative and fiduciary requirements involved in maintaining a qualified retirement plan will continue to be met on an ongoing basis.  Following is a brief summary of some key issues that a company should focus on after it assumes a new qualified retirement plan.

Review Compliance with Coverage and Nondiscrimination Testing

In order for the plan to retain its tax-qualified status, the Internal Revenue Code requires that a qualified retirement plan be tested periodically to ensure that it does not discriminate in favor of highly compensated employees.  Two of the most important tests to be monitored are:  (i) the coverage test, to ensure that the plan covers a stated minimum number of non-highly compensated employees on a controlled group (employer-wide) basis, and (ii) the nondiscrimination test, to ensure that the formula for determining the amount of contributions and benefits a particular participant receives does not discriminate in favor of highly compensated employees.  Advance planning should be done to determine the impact of the acquisition on these tests, both for the new plan and any existing plans within the controlled group.  Different rules may apply for determining which employees are highly compensated, depending on the type of transaction.

Become Familiar with the Plan’s Investments and Investment Policy

The acquiring company, or more typically a committee appointed by the acquiring company, will have fiduciary responsibility for selecting the plan’s investments, including the investment funds offered under a 401(k) or other individual account retirement plan.  Plan fiduciaries, who likely will be newly appointed following the acquisition, must familiarize themselves with the fund lineup, obtain information to evaluate the funds and document how they monitor and select funds to ensure compliance with U.S. Department of Labor requirements.  Plan fiduciaries also should familiarize themselves with the plan’s written investment policy or guidelines, refer to the investment policy or guidelines when meeting to discuss changes to plan investments and update the policy or guidelines, as needed.

Understand Plan Fees and Revenue Sharing

New plan fiduciaries should carefully review any revenue-sharing arrangements related to the plan and understand the plan’s use of so-called “12b-1 fees” and other revenue-sharing payments.  Plan fiduciaries must understand the formula, methodology and assumptions used to determine the respective share of any revenue generated from plan investments by the plan’s service provider.  Plan fiduciaries also must monitor the arrangement and the service provider’s performance to ensure that the revenue owed to the plan is calculated correctly and that the amounts are applied properly (for example, for payment of proper plan expenses or for reallocation to participants’ plan accounts).

Review Consultant, Investment Manager and Service Provider Agreements

Qualified retirement plan fiduciaries typically have agreements with various consultants, investment managers and service providers that carry over following an acquisition.  This is a good time to review these agreements, both to understand the service providers (and whether they are still needed) and to make sure plan fiduciaries are set up to properly monitor and select new service providers, as needed.  In particular, plan fiduciaries should understand whether the consultant or advisor represents itself to be a fiduciary or co-fiduciary of the plan, whether the consultant or advisor maintains adequate insurance coverage, whether fees are reasonable and whether any conflicts of interest exist.

Ensure the Plan’s Eligibility Provisions Reflect the New Controlled Group

The plan document will specify precise rules for employee eligibility.  Following an acquisition, the acquiring company often must update the plan’s eligibility provisions to reflect the new controlled group.  In addition, with new administrators and new human resources personnel likely to be looking at the plan, this is an ideal time to make sure the plan is following the eligibility and enrollment rules set forth in the plan document, including:  (1) eligibility for or exclusion of part-time employees; (2) proper classification of independent contractors; (3) adherence to hours-of-service counting rules or the elapsed-time alternative; (4) re-enrollment of rehired participants; and (5) for automatic enrollment plans, proper automatic enrollment for eligible employees on a timely basis.

Check the Plan’s Definition(s) of Compensation

A plan’s definition of compensation is used for a variety of important purposes, including the calculation of an employee’s allocation in a defined contribution plan or benefit accruals in a defined benefit plan, adherence to limitations on allowable compensation and performing nondiscrimination testing.  The plan document must specify precise definitions for applicable compensation for each purpose.  Problems frequently arise following an acquisition because the payroll provider may change or key personnel who understood how compensation was applied under the plan may be gone.  Also, the transaction agreement may require the continuation of certain benefit levels for a period of time, which in practice may require that the plan continue to apply the same definition of eligible compensation as before the transaction.  Plan administrators should review payroll codes against the plan’s definition of compensation and make adjustments to either the plan or the payroll codes, as needed.

Review the Distribution Paperwork

The acquiring company will usually update the plan’s summary plan description and employee communications to reflect the new employer.  However, distribution paperwork, including benefit election and rollover forms that the employee must complete, as well as descriptions of optional forms of benefits and other required disclosures, is often overlooked in the due diligence and transition process.  If election forms are not periodically reviewed and updated, the plan may fail to provide all the correct options (for example, installments, annuities and lump sums, where available) or fail to require spousal consent for distributions, where it is required under plan rules. 

Update ERISA Fidelity Bonds and Fiduciary Insurance Coverage

One of the most common failures noted by the Department of Labor during audits is a plan’s maintenance of an Employee Retirement Income Security Act (ERISA) fidelity bond.  ERISA generally requires that every fiduciary of an employee benefit plan and every person who handles funds or other property of such a plan be bonded (for at least 10 percent of the amount of funds he or she handles, subject to a $500,000 maximum per plan for plans that do not hold employer securities) to protect from risk of loss due to fraud or dishonesty on the part of persons who “handle” plan funds or other property.  The period after an acquisition is an excellent time to make sure the plan maintains appropriate bonds, as well as to make sure the company is adequately protected with fiduciary insurance coverage, which may be with the same insurer as the fidelity bond.