Retirement Services

401(k)ology – Breaking Up is Hard to Do - Exiting a Retirement Plan MEP or PEP

There are many reasons that plan sponsors may decide to join a MEP, a PEO plan or a PEP, all of which are a type of Multiple Employer Plans (“MEP”). There are an equal number of reasons why a plan sponsor may decide it is time to exit the MEP. Perhaps the company has grown and the employer desires more flexibility, the company is purchased and needs to spin-off to merge into the buyer’s plan, the level of service desired is not being met, or the plan sponsor wants to terminate the plan. No matter the reason, breaking up (with a MEP) is hard to do.  

No one plans for divorce as they are getting married. However, things do not always work out as intended and as many of us have experienced, breaking up is hard to do. It can also come with a cost. Unfortunately, plan sponsors who join a MEP may experience the same heartbreak when they decide to move to a stand-alone (single employer) plan. Before joining a MEP, plan sponsors should understand the requirements and costs to cease participation in the MEP regardless of the reason for the separation.  

Let’s take a look at some of the issues we have discovered while assisting plan sponsors through transitions out of a Multiple Employer Plan. 

For purposes of this blog, the term “MEP” will be used to encompass Multiple Employer Plans (i.e., Corporate MEPs), PEO-Type “Open” MEPs and Pooled Employer Plans. See 401(k)ology – A Primer on MEPs, PEPs and GoPs for more information on these plan types. 

Exiting a Corporate or Trade Association MEP 

A Corporate or Trade Association MEP is a plan in which multiple unrelated (i.e., not within the same controlled group) employers participate. The unrelated employers typically have some business nexus such as the same trade, industry, line of business, or profession. The MEP structure differs from a single employer plan that includes more than one entity within the same controlled group because those entities are related employers.  In a MEP, there is not enough common ownership or control among the participating employers to be related, and therefore each is treated as a single employer when applying the nondiscrimination and coverage testing rules. 

Generally speaking, exiting a Corporate or Trade Association MEP is relatively easy because the employers in the MEP have some common ownership or business nexus. In most cases, the entity desiring to leave the MEP will need to both cease participation in the existing MEP and establish a new plan so that there is not an overlap in coverage between the two plans.  

Once the new plan is established, the assets in the MEP attributable to the employees of the exiting entity are spun off from the MEP into the newly established stand-alone plan. The process is often referred to as a “spin-off” and should include an Asset & Transfer Agreement between the trustees of the two plans. Spin-off agreements should not be overlooked, as the agreement documents important contractual items that are required to effectuate the transfer of the assets from one qualified plan to another qualified plan and that address any protected benefits that must follow the assets. In effect, the trustee(s) of one plan is passing the assets and liabilities of the applicable accounts to another trustee(s), subject to certain terms and conditions. 

The Spin-Off Asset Transfer Agreement may include provisions that: 

  • Identifies both the Transferring Plan and the Recipient Plan 

  • Identifies the asset transfer date 

  • Identifies any costs associated with the transfer and how those will be paid 

  • States that the transferred assets will equal the amount credited to the participants in the new plan  

  • Addresses how terminated employees with account balances will be handled and dates that distribution requests in progress will be treated 

  • Agrees that the recipient plan will assume all assets and liabilities of the transferred assets and that the transferring plan is thus relieved of any liabilities or obligations to those assets. 

  • Recipient plan agrees to preserve benefits protected under IRC Section 411(d)(6) such as vesting schedules, distribution options and normal retirement ages. 

  • If participant loans will be included in the transfer, the requirements to do so 

Practice Note: Service providers and/or ERISA counsel may provide a sample Asset and Transfer Agreement. It is critically important that the agreement be reviewed by ERISA counsel to ensure that the spun off assets remain compliant with the Internal Revenue Code and ERISA (Employee Retirement Income Security Act). 

In a spin-off, there is no distributable event – meaning that the employees do not have a right to take a distribution unless they are otherwise entitled to do so before the transfer (i.e., upon death, termination of employment or attainment of normal retirement age). In addition, an employee’s vested balance after the transfer must be equal to or greater than the vested amount just before the transfer.  

Often, the entity which is leaving the Corporate MEP will continue to use the same Third-Party Administrator, Recordkeeper and other service providers, which makes the transition from the MEP to a stand-alone plan fairly easy to navigate. It is also common for the newly established stand-alone plan to mirror the provisions contained in the Corporate MEP. The non-discrimination testing is already handled at the Participating Employer level, so the fact that the assets are in a different trust has no impact on the testing for the year of the spin-off. 

Safe Harbor Plans: Extra care should be given to spin-offs that include safe harbor 401(k) provisions. Safe harbor 401(k) plans must meet certain requirements to maintain the safe harbor status, including restrictions on mid-year changes that could be implicated in a spin-off. If the spin-off is not concurrent with the first day of the next plan year, it is vitally important to ensure that the new plan does not violate any of the prohibited changes to a safe harbor plan, which will require practically all provisions in the newly established spin-off plan to be the same as in the MEP. Failure to address this issue could result in the plan losing safe harbor status and being subject to ADP/ACP Testing and Top-Heavy contribution requirements, if applicable. 

Exiting a PEO-Type MEP or a PEP 

The mechanics of leaving a PEO MEP or a PEP are about the same as above, but there are some additional considerations that typically do not impact Corporate MEPs. For starters, when exiting a PEO Plan, plan sponsors should review the service agreements with the PEO carefully, as the PEO likely provides HR and payroll services in addition to retirement services. Clients have experienced some unexpected outcomes when the payroll withholding/reporting services ended abruptly on the date the provider was notified the retirement plan would be spinning out to another provider. For more information on PEO Exits and HR considerations see The Ultimate Guide to PEOs – and When it’s Time to Exit

In addition, plan sponsors choosing to exit a PEO MEP or PEP may be assessed a “deconversion fee” which covers the expenses incurred by the MEP provider in transitioning the participant accounts to a new provider. Actual deconversion fees will vary depending on the contract terms outlined in the PEO/MEP/PEP agreement. We have seen deconversion fees varying from $0 up to $2,500. Some providers will automatically deduct the fees from plan assets according to the contract terms or will collect the fees from the employer before transferring the assets.  

Exiting a PEO MEP (or a PEP) with Safe Harbor 401(k) Provisions 

There are annoying little rules that apply when exiting a PEO MEP with safe harbor 401(k) provisions mid-year that can wreak havoc on your plan’s compliance and nondiscrimination testing: 

  • The successor plan rules prohibit plan sponsors from establishing a new plan with safe harbor 401(k) provisions if the same employer previously maintained a safe harbor 401(k) plan in the prior year and the new plan will cover at least 50% of the same employees 

  • Safe harbor plans, by design, must run for a full 12-month period (with limited exceptions) 

Unfortunately, the IRS has not issued guidance on how plan sponsors can exit a PEO MEP with safe harbor provisions mid-year and maintain safe harbor status. Spin-off plans can be designed to be a continuation of the plan maintained by the employer in the MEP, but this requires careful consideration and documentation in the newly established plan. 

Practice Note: Engage with experienced professionals and service providers who can assist in navigating these complex rules. Spin-off agreements can be drafted by legal counsel and language may be added in the plan document of the newly established plan to memorialize the intent of the plan sponsor to satisfy the safe harbor requirements for the full plan year of the spin-off. 

Exiting a PEO MEP (or a PEP) in the M&A Context 

Corporate transactions often involve a larger employer purchasing a small employer that participates in a PEO MEP 401(k) plan. In this M&A context, the buyer typically has two options for how to address the seller exiting the PEO MEP: 

  1. Spin-off the plan of the entity that will be acquired and immediately terminate the plan before the closing date of the business transaction to avoid any successor plan (i.e., “alternative defined contribution plan”) issues. Typically, the PEO MEP will offer the ability to spin-off assets to create a single employer plan for termination. The plan termination would be treated in the same way as any other plan termination, including full vesting. 

  2. A plan merger that includes an asset and transfer agreement after the closing date of the stock acquisition. One important note here is that protected benefits must be preserved in the surviving plan. There is no distributable event, and the PEO MEP typically has some restricted time limit (e.g., six months) that the employer can keep its assets in the PEO’s plan after ceasing participation.  

M&A transactions are complex and require special consideration when there are multiple retirement plans in place; therefore, it is always a best practice to engage ERISA counsel to assist with the impact on the retirement plans before the closing date of the business transaction. 

Exiting a PEO MEP (or a PEP) subject to ADP/ACP Testing 

We are frequently asked how the non-discrimination testing is handled when the employees are covered by a PEO Plan for a portion of the year and a stand-alone plan for the remainder of the year. The short answer is it depends. PEO arrangements are structured as a co-employer relationship. Likely, there will be compliance testing for two short plan year periods if the spin-off does not occur on the first day of a plan year. 

Here are just a few issues that need to be considered beforehand: 

  • Short plan years require proration of both the annual additions limitation under §415(c) and the compensation limit in effect for the year under §401(a)(17).  

  • Required true ups of the annual matching contribution may be limited to the period of time the newly established plan is in existence for the year, unless it is clear that the newly established plan is a continuation of the participating employer’s sponsorship of the MEP. While it may be the intent of the employer to provide the match true-up on a full 12-month plan year, the newly established plan may not recognize deferrals and match made to the MEP (unless properly documented). 

  • Highly Compensated Employee determination (the compensation component) is based on the look-back year. Therefore, a newly established plan effective July 1, 2024 would have a look-back period from July 1, 2023 to June 30, 2024 (rather than January 1, 2023 to December 31, 2023). 

Deferral and Investment Elections and Beneficiary Designations 

Employee elections are specific to an individual retirement plan. Often, plan sponsors are surprised to learn that new deferral elections, investment elections and beneficiary designations will need to be obtained from all of the participants in the plan. 

There are different ways to approach investment elections and the transfer of assets from a MEP to a new plan with a different fund line-up. Investment holdings in funds under the MEP can be mapped to similar fund strategies in the new plan, or the plan sponsor may wish to re-enroll all participants and have the liquidated funds from the MEP be allocated according to the new investment elections. Your dedicated Registered Investment Advisor can assist with these decisions, including any communications with the participants. 

The deferral elections and beneficiary designations are slightly more challenging, as the participants will need to complete new elections with the new service provider. Getting new deferral elections from participants is important because the provisions in the newly established plan may differ from what was offered in the MEP. Beneficiary designations are specific to a named retirement plan. One cannot assume that a spouse that was designated years ago will be the beneficiary in a completely different retirement plan. Not only that, but a beneficiary designation for a MEP would not hold up against a claim for benefits in the newly established plan, resulting in the participant’s account not being paid to whom they intended. Consider this a perfect opportunity to have all participants review and update their designations. Employee communication is key in making this a smooth process. 

How Newfront Retirement Services can help with MEP exits 

The key to a successful exit from a MEP is having a great partner who will identify the plan sponsor’s intent and help connect the dots between the MEP and the standalone plan. Our retirement services team is stacked with experts who have experience in navigating the complexities of exiting a MEP. 

We also have a dedicated conversion team that focuses solely on the conversion process, helping you every step of the way. Coupled with ERISA compliance and investment advisory services, we will lead you through a positive transition experience. Meet our experts: 

  • Michael Forney, Investment Adviser and Employee Education Specialist 

  • Jenn Sommerville, Manager, Client Success 

  • Brittany McChristian, Conversion Project Manager 

  • Joni Jennings, ERISA Compliance Manager 

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Newfront Retirement Services, Inc. is an investment adviser registered with the U.S. Securities and Exchange Commission. Registration as an investment adviser does not imply any level of skill or training, and does not constitute an endorsement by the SEC. For a copy of Newfront Retirement Services disclosure brochure, which includes a description of the firm’s services and fees, please access or click HERE for the disclosures on our website. 

Joni L. Jennings
The Author
Joni L. Jennings, CPC, CPFA™

Chief Compliance Officer, Newfront Retirement Services, Inc.

Joni Jennings, CPC, CPFA is Newfront Retirement Services, Inc. Chief Compliance Officer. Her 30 years of ERISA compliance experience expands value to sponsors of qualified retirement plans by offering compliance support to our team of advisors and valued clients. She specializes in IRS/DOL plan corrections for 401(k) plans, plan documents and plan design.

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