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Terminating a plan – what you need to know

In an effort to save money, some companies are terminating their retirement plan options. However, as long as funds are still present in a plan, companies with more than 100 eligible participants remain required to have an annual audit even if the plan is terminated.

The key word is ‘eligible.’ If a plan is active, participants are considered eligible if they have an opportunity to participate, even if they do not elect to do so. If you terminate your plan due to reduction in force, you need to know how many participants (present and former employees and beneficiaries of deceased former employees receiving benefits) you have to determine if you still need an audit. A reduction in force that creates a 20% or greater drop in participants is called a ‘partial termination.’

One important consideration about full or partial termination of a plan is that the matching contributions and other employer contributions must be fully vested for all participants when a plan is terminated. This rule applies regardless of the vesting schedule. A participant’s elective deferrals in a 401(k) plan are always fully vested, but the employer portion is based on the plan document provisions.

Here are the criteria for a fully terminated plan:

–         An established date of termination

–         A description of the benefits and liabilities of the plan as of the termination date

–         Distribution of plan assets as soon as administratively feasible, typically within one year after the termination date

If a plan is a qualified plan, then participants will have tax-favored status for the distribution amount. Otherwise, participants are liable for taxes, or can designate a rollover account to defer taxes on the distribution amount.

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