Ensuring a Smooth Combination Of Benefit Plans:Companies face penalties and low employee morale if this sensitive issue is not handled properly before the deal closes.

Failure to aggressively manage a company’s retirement plans before completing a merger or acquisition can result in potentially far-reaching financial and psychological consequences, such as penalties for noncompliance and dampened employee morale. A recent article in the May/June 1997 issue of Mergers & Acquisitions explains the importance of addressing issues regarding defined benefit plans early in the process and the consequences for not doing so. Because of the stiff penalties that companies face for noncompliance, defined benefit plans, which employers fund annually to achieve a “defined” annual benefit for each employee after retirement, are normally dealt with before the deal is completed. However, the other half of the retirement plan picture defined contribution plans are often a low priority, and not handled until after the deal has been completed. Defined contribution plans are those to which both employers and employees contribute, such as a 401(k) plan. Apart from financial and technical considerations, the disposition of the defined contribution program can also be an extremely sensitive issue for employees, who have a strongly vested interest in these plans because they contribute a great deal of their own money to them. Therefore, any perception of cutbacks or changes to these plans can further demoralize a work force that is concerned about potential layoffs, pay cuts, and the impact of the transaction on their jobs following a deal. Existing defined contribution plans must comply with a number of federal regulations as a result of the merger, and the parties must determine whether they will maintain each organization’s existing plans, amend them and merge them into one master plan for the new entity, or terminate them. Regardless of which option merging companies choose, careful pre-deal planning can help smooth the transition of these very complex employee benefits into the new company structure. Defined contribution plans differ in many ways from defined benefit plans. In defined benefit plans, the employer bears all the associated investment risk. In defined contribution plans, both the employer and/or the employee can contribute a specific “defined” amount of money to the plan each year on a pre-tax basis. Typically, the employee chooses how to invest these contributions from a menu of mutual funds, variable annuities, or similar investment vehicles. While assets accumulate in the plan, they earn a variable rate of return; thus the participating employee bears all the associated investment risk. The most familiar defined contribution plan types are 401(k) and 403(b) plans. These plans are very similar in nature. However, 401(k) plans are usually sponsored by corporate employers; 403(b) plans can only be sponsored by certain eligible not-for-profit organizations. Defined benefit plans (often referred to as pension plans) require the employer to annually fund the plan to achieve a specific “defined” annual benefit for each employee after retirement. For a number of reasons, parties to a deal will want to evaluate their defined contribution retirement plans before the transaction, because consequences for noncompliance with existing laws can be stiff. Plans must satisfy the minimum coverage or nondiscriminator tests as a result of changes in the employer’s population due to mergers and acquisitions. Plan disqualification, refunds of excess contributions, and excise taxes are just a few of the possible consequences companies face if their plans do not meet strict requirements. Because of the tax-advantages they afford, and to prevent potential fraud and abuse by plan sponsors, defined contribution programs are tightly regulated by both the Internal Revenue Service (IRS) and the Department of Labor (DOL). Myriad regulations cover a wide range of issues, such as requiring that a minimum percentage of total employees be covered by the plan. Employers are also required to prevent high-paid employees from benefiting disproportionately from these plans in relation to their lower-paid colleagues. Other statutes limit the overall amount any individual can set aside annually in a tax-advantaged retirement plan. Reporting and disclosure of plan information to employees is also the subject of the most significant body of pension law, the Employees Retirement Income Security Act (ERISA) of 1974. For example, if a Money Purchase Defined Contribution plan is involved in the merger, plan participants must be notified prior to the plan merger. ERISA also requires that employers disclose to employees any “material modifications” made to a retirement plan within a certain period of time. Since the restructuring of a retirement program can take months, even years, of planning, it is wise to get a head start on this very complex and time-consuming process. For example, it may be necessary to file a notice of an impending plan merger with the IRS at least 30 days in advance of the deal. This filing, however, can possibly be avoided if certain conditions are currently being met, including: 1. The sum of the account balances in each plan prior to the merger must equal the fair market value of the entire plan assets. 2. The assets of each plan are combined to form the assets of the plan as merged. 3. Immediately after the merger, participants in the merged plans must have account balances equal to the sum of the account balances they had in the plans immediately before the merger. 4. The plans do not have unallocated funds. Careful evaluation of the plans at the beginning of the merger is essential to determine whether these conditions are currently being met. Aside from financial and technical considerations, the disposition of the defined contribution program can also be an extremely sensitive issue because of their visibility. For many American workers, defined contribution plans represent the single largest source of income in retirement. Employees are painfully aware that the other potential sources of retirement income, such as the employer’s defined benefit plan or Social Security benefits, will not be enough to ensure a comfortable retirement. Employees have a strongly vested interest in these plans because they contribute a great deal of their own money to them. Also, the employee is usually in control of how the money in the plan is invested and is intimately concerned with the plan’s features and how it performs. Therefore, any perception of cutbacks or changes to these plans can further upset a work force that is worried about the impact of the transaction on their jobs following a deal. If the parties decide to merge their existing plans, they must determine whether the existing plans’ minimum coverage, participation rules, and general nondiscrimination requirements will continue to be met. As long as each plan meets the coverage and participation requirements prior to the transaction, it will generally continue to be in compliance throughout the plan year in which the deal takes place and in the following year. If not, plans must be brought into compliance right away. The merging of plans can be made even more difficult when two sets of plans have different features which is often the case. For example, if the plans have different vesting schedules, eligibility requirements, distribution options, or different plan accounting years, it may be necessary to amend the plans so participants’ valuable rights and appropriate employment history are credited. Generally, if distribution options or any other optional forms of benefit, such as a lump-sum distribution, are different, these optional forms of benefits may not be eliminated or reduced. Also, if a 401(k) plan merges with a non-401(k) defined contribution plan, the 401(k) plan assets must be segregated, so elective contributions are not available for immediate distribution to active employees. If a non-401(k) plan is merged into a 401(k) plan, the non-401(k) plan may include a spousal consent requirement (known as a qualified joint and survivor requirement) not found in the 401(k) plan. In this case, spousal consent is required for the distribution of the non-401(k) benefits. Similarly, if a non-401(k) plan is changed into a 401(k) plan, the non-401(k) plan may continue to include a qualified joint and survivor requirement not found in the 401(k) plan. In that case, spousal consent is required for the distribution of the non-401(k) benefits. It is useful to examine this problem more closely by looking at an example from the health care industry, which has been affected in recent years by a plethora of mergers and acquisitions. In 1996 there were 768 hospitals involved in merger or acquisition activity, with a total of 235 deals. The hospital model is particularly complex in light of the fact that hospitals operate as both for-profit and not-for-profit entities, under section 501(c)(3) of the Internal Revenue Code. Historically, not-for-profit organizations could only sponsor 403(b) plans as the primary defined contribution vehicle, while corporations could sponsor 401(k) plans. Now that the two types of organizations are increasingly merging, the retirement plan picture is further complicated. In a recent situation, a for-profit hospital merged with a not-for-profit hospital, with the resulting entity operating as a for-profit organization. The non-profit hospital sponsored a 403(b) plan and a defined benefit plan. The for-profit hospital maintained a 401(k) plan for its employees. After the merger, the hospital had to scramble to quickly reconfigure its retirement programs. Because it was operating as a for-profit entity, government regulations dictated that it could no longer sponsor a 403(b) program. However, it became eligible for a 401(k) plan. So, it had to immediately “freeze” new contributions to the existing 403(b) plan. In addition, IRS regulations prohibit employees from “rolling over” their existing 403(b) account balances to a 401(k) plan. Since the employer had not planned more carefully or communicated the potential plan changes more diligently, employees were distracted and disrupted during the transition. This was disastrous for employee relations. The already shell-shocked employees mistakenly believed that the employer had cut back on their benefits and was misappropriating their 403(b) account balances. This confusion led to a severe labor relations crisis at the hospital. From a compliance perspective, maintaining a 401(k) plan in the future would entail more stringent non-discrimination requirements and lower contributions for highly paid employees, since actual deferral percentage (ADP) testing is required under a 401(k) plan. That test ensures that highly compensated employees are not deferring too much of their salary as compared with lesser-compensated employees. If the hospital had spent more time before the merger evaluating the relative merits of each plan, it would have met both the employer and the employees’ objectives more effectively and efficiently. The concerns that employees may have with a new organization are many, such as displacement, changes to their daily routine, changes in management and administration, and salary reductions, and are all common results of a merger. In addition to employee confusion, the rumor mill brims with a variety of tall tales that serve to make employees even more anxious. Communication strategies must be carefully orchestrated and developed so that a clear and consistent message is provided to everyone. The sooner employees are informed of how structural changes will affect them, the better. And, the more the message is tailored to individual employees, the better the chances are that it will be well received. In order to construct a benefit program that works well for all employees and ensures compliance, an organization should start with an objective review of the programs already in place and ask the following questions: What are they? Who do they cover? What are they attempting to accomplish? Are they serving the needs of employees? A review by an objective third party can be of great help. Many benefit consultants or specialists are experienced in analyzing current programs and making recommendations for change. The time to involve them is before the merger is completed so they can conduct a thorough review of these valuable programs. Getting the new organization up and running is a daunting task, but careful planning for the retirement plan transition can alleviate many problems.