A financial advisor recently asked: “What is the successor plan rule and to which plans does it apply?”
ERISA consultants at the Retirement Learning Center (RLC) Resource Desk 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 and income plans, including nonqualified plans, stock options, and Social Security and Medicare. 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.
Highlights of the Discussion
- The successor plan rule of IRC 401(k)(10)(A) and Treasury Regulation Section (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).
- 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.
- The successor plan rule was created to prevent employers from circumventing the age 59 ½ 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.
- 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 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, treasury regulations state that the following defined contribution plans are not considered as successor plans: a(n)
- Employee stock ownership plan (ESOP),
- Simplified employee pension (SEP) plan,
- Savings incentive match plan for employees (SIMPLE) IRA plan,
- 403(b) plan, or
- 457(b) or (f) plan (Treasury Regulation 1.401(k)-1(d)(4)(i)].
- 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) [or 403(b)] 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 within the allotted timeframe. The definition of successor plan is important.