Case of the Week: Plan Termination and Successor Plans

The ERISA consultants at the Retirement Learning Center Resource regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings plans. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

A recent call with an advisor in Ohio is representative of a common question on plan termination and successor plans. The advisor asked: 

“What is the successor plan rule and to which plans does it apply?”

Highlights of the Discussion 

• The successor plan rule of IRC § 401(k)(10)(A) and Treas. Reg. § 1.401(k)-1(d)(4)(i) provides that a 401(k) plan which is terminated cannot distribute participants’ elective deferrals if the employer maintains or establishes a “successor plan” (a.k.a., an alternative defined contribution plan) within a certain period of time following the termination.
• A similar rule exists for 403(b) plans in Treas. Reg. § 1.403(b)-10(a)(1).   
• The successor plan rule was created to prevent employers from circumventing the age-59½ early-distribution restriction that applies to salary deferrals by simply terminating a 401(k) [or 403(b)] plan to allow for withdrawals and immediately establishing a new successor plan.  
• When a 401(k) or a 403(b) plan is terminated, a successor plan would be one that exists at any time during the period beginning on the date of plan termination and ending 12 months after all the assets from the terminated plan are distributed.
• Consequently, a terminated 401(k) plan could not be replaced by another 401(k) plan within the waiting period. Similarly, a terminated 403(b) plan could not be replaced by another 403(b) plan within the waiting period. (But, for example, if an employer terminates its 403(b) plan, it may set up a 401(k) plan with no waiting period if it is otherwise eligible to do so, and vice versa.)
• For a 401(k) plan, Trea. Reg. § 1.401(k)-1(d)(4)(i) states that the following defined contribution plans are not considered successor plans:

1. Employee stock ownership plans (ESOPs)  
2. Simplified employee pension (SEP) plans
3. Savings incentive match plan for employees (SIMPLE) IRA plans
4. 403(b) plans
5. 457(b) or (f) plans 

• There is one more exception. Plans that otherwise would be considered a successor plan are not if at all times during the 24-month period beginning 12 months before the date of plan termination, fewer than two percent of the employees eligible to participate in the 401(k) plan at the time of its termination are eligible to participate in the new defined contribution plan.  

The successor plan rules prevent 401(k) plans and 403(b) plans that are terminated from distributing employee salary deferrals as a result of the termination if the employer maintains or establishes a successor plan. The definition of successor plan is important. 

Any information provided is for informational purposes only. It cannot be used for the purposes of avoiding penalties and taxes. Consumers should consult with their tax advisor or attorney regarding their specific situation. 

©2021, Retirement Learning Center, LLC. Used with permission.