Small business 401k plan terminations can happen for reasons other than going-out-of-business or a business sale. Sometimes, even successful businesses decide to terminate their plan due to a cash crunch or poor employee participation.
Typically, the process for terminating a 401k plan is straight-forward because the IRS considers a plan termination a distributable event. That means 401k participant accounts become immediately distributable upon the termination date established by the employer. Once that happens, 401k participants can roll their account to a new retirement plan or take a cash distribution.
However, this simple termination process is not available when a 401k plan is part of a Multiple Employer Plan (MEP). Why? Employers lack the authority to terminate their portion of a MEP. With no distributable event triggered by a plan termination, 401k accounts can be trapped in a MEP until the participant terminates employment or becomes eligible for an in-service distribution.
Trapping 401k accounts in a MEP can be problematic for 401k participants and fiduciaries. 401k fiduciaries must understand this issue if they are considering a MEP for their small business.
ERISA requires every 401k plan to be sponsored (i.e., established and operated) by an employer or employer organization. ERISA Section 3(5) defines an employer as “any person acting directly as an employer, or indirectly in the interest of an employer, in relation to an employee benefit plan; and includes a group or association of employers acting for an employer in such capacity.”
Most MEP 401k providers meet this ERISA requirement by adopting their MEP for their employees. They then open up the MEP for adoption by other employers. As the “lead” MEP sponsor, only the MEP 401k provider can terminate their plan. Unfortunately, a partial plan termination isn’t triggered when an employer leaves a MEP either.
When 401k accounts are trapped in a MEP following an employer’s exit from the plan, it’s bad for participants and fiduciaries. Some key problems include:
- Angry employees – Employees typically want control of their 401k account when their employer’s 401k plan is discontinued. When these accounts are trapped, 401k participants can be angry.
- Ongoing fiduciary liability – An employer retains fiduciary liability for 401k accounts trapped in a MEP. That means an ongoing responsibility to monitor the MEP for fee reasonableness and competence.
- No liability deadline – when an employer terminates a single-employer 401k plan, there is an outer bound for their fiduciary liability – the 6 year ERISA statute of limitations. This 6-year clock keeps ticking as long as employees are trapped in a MEP.
A complicated solution
There is a way for 401k fiduciaries to avoid trapped MEP participant accounts - they can establish a brand new single-employer 401k plan, transfer the MEP accounts to that plan, and then terminate it. Once this process is done, participants will be eligible for a distribution.
That’s a pretty complicated solution. After all, a whole new 401k must be created solely for the purpose of terminating it. That means a new plan document and 5500 will be necessary. It also means participant sources (e.g., 401k, rollover, employer match) and investments will need to be mirrored. A plan blackout may also be required.
This solution probably isn’t going to be cheap either – it requires a lot of technical, detail-oriented work to start a new 401k plan and transfer participant balances to it without any problems.
Two bad options
It’s not easy for small businesses to make a clean break from a MEP 401k plan. The only definitive way to do it is to transfer participant accounts to a brand new single-employer 401k plan and then terminate that plan. That can be difficult and pricey.
However, the alternative is worse. When 401k participant accounts are trapped in a MEP, employees are angered and employers are stuck with ongoing fiduciary liability.