Merging 401(k) Plans

The first thing they feel is ‘something awful is going to happen,’ “says Nancy Lazgin, describing the sinking feeling many employees have when theircompany is acquired. The most common concerns are about compensation andbenefits. “There’s a feeling that you’re going to take something away.But if you gain trust early on, you achieve success more easily,” she says.

Lazgin is the director of corporate benefits for Staples Inc., an officesupply retailer. She knows a lot about what happens when benefit plans areacquired, because Staples has been busy buying companies during the last fewyears. Most recently, Staples acquired Quill Corp., a catalog business, in May1998; Ivan Allen, an office furniture company, in November 1998; and ClaricomHoldings Inc., a telecommunications company, in March 1999.

Clearly, many issues arise when one company buys another. But one of the mostimportant to employees is what happens to their benefit plans. As Lazginobserves, people often are uncomfortable with the prospect that features andbenefits in their 401(k), for example, might change for the worse. That’s whyit’s important to plan and communicate well.

According to Phil Petrilli, a human resources executive at Quill, employees’chief concern during their company’s merger with Staples was the treatment oftheir retirement plan. But, “with the transition laid out and communicated,our employees tended to be more receptive to other benefits changes,” hesays.

With the guidance of 401(k) plan administrators New York Life BenefitServices LLP, based in Norwood, Massachusetts, Staples goes through anexhaustive comparison of the acquiring 401(k) plan and the plan to be merged in.Legally, the qualification status of both plans is on the line, so protectingthe necessary benefits of the merging plan is crucial.

On a more personal level, a thorough examination smoothes out the transition.As Lazgin says, “When dollars are involved and people are involved, we mustdeal with these issues with a great deal of sensitivity.”

To better understand the differences between plans, and how to successfullycombine them, here are several questions to ask yourself in order to make aneasier 401(k) plan transition during a merger or acquisition.

As in any conversion, it’s important to evaluate the accuracy of data froman acquired plan. Information like employee contribution amounts andpercentages, loan repayment amounts, employer match and profit-sharing amounts,compensation, dates of birth, dates of hire, dates of termination, and hoursworked should all be correct when passed to the acquiring plan’s recordkeeper.”If they’re doing daily valuation, chances are it’s a pretty cleanplan,” says Lazgin. “But if it’s monthly or quarterly, it’s moredifficult.”

Daily plans are usually cleaner because information is likely to be updatedmore often. Also, daily recordkeepers have information that’s more visible toparticipants through the Internet, voice response systems, and participantservice centers, so inaccuracies are cleared up faster. But whether an acquiredplan is valued daily or quarterly, there are bound to be imperfections in thedata that need to be fixed. If the information has errors, cleaning it upinvolves going back through each employee’s records and finding mistakes andomissions. The process can be time consuming, but merging the plans with cleaninformation is essential.

ERISA, the Employee Retirement Income Security Act of 1974, requires certainretirement plan features to be maintained upon acquisition or merger. Plansponsors need to evaluate each of these protected benefits in the acquired planin order to take the appropriate steps with the merger.

• Vesting: When Staples bought Claricom, the merging plans had different vesting schedules. And since vesting is a protected benefit, Staples had to be careful in merging these two different plan features.

  
  

  Staples, a retailer that tends to employ young and shorter-service employees,designed its vesting schedule to reward longer-service employees. Its plan,therefore, has a graded five-year vesting schedule. After the first year ofservice, employees are 20 percent vested, and every year after that they gainanother 20 percent vesting. This way, even short-term employees receive some ofthe company match when they leave. But if they choose to stay longer, they willbenefit even more.

  
  

  Claricom had had four-year graded vesting before merging with Staples. Giventhe nature of the two businesses, and the need to add incentives for Staples’48,000 mainly retail employees for longer service, Lazgin decided to keepStaples’ five-year schedule. But because vesting is a protected benefit,Claricom’s four-year vesting schedule was rolled into the merged plan forformer Claricom employees.

  
  

  According to Tracy Mignone, benefits manager at Claricom (now called StaplesCommunications), this transition wasn’t problematic. Employees who had beenvested remained so; those who weren’t stayed on their old schedules; newemployees had another year to wait but received other benefits, such as highermatching, in the Staples plan.

• In-Service Withdrawals: All in-service withdrawal options are protected benefits except for hardship withdrawals. The most common allows employees to withdraw 401(k) contributions (and, at times, company contributions) after age 591⁄2. Other in-service withdrawal features can relate to rollover and company contributions.

  
  

  Quill, the company Staples bought two years ago, had an in-service withdrawaloption at age 65. Many of the employees at Quill were long-term, according toLazgin, and an age 65 in-service withdrawal option made sense for that plan.

  
  

  But Staples’ retirement plan had no such feature. Staples employees areyoung — the average age of the entire company is 32. Lazgin says most Staplesemployees rarely even think about being 65. So this protected benefit was notbeneficial to the overall Staples plan and was not adopted upon the merger. Butsince it had been a protected benefit, this feature was “grandfathered,”or rolled in, for existing Quill employees.

• Distribution Options: Distribution options — or the way in which plan participants will receive assets on termination or retirement — are also protected. For instance, the plan might allow a lump sum distribution, installments, or the establishment of an annuity that pays out retirement income. Since many plans differ in the way distribution options are set up, protecting this benefit for “merged” employees can prove administratively difficult.

  
  

  Claricom allowed participants to receive retirement assets either in a lumpsum or in installments, whereas Staples provided a lump sum option only. Uponits merger with Claricom, Staples amended its plan to include both options forall employees.

What are non-protected benefits?

Even though non-protected benefits are not, as their name indicates, legallyprotected, how these benefits are handled in a merger can make a big differenceto an acquired company’s employees. Lazgin describes her philosophy onintegrating non-protected benefits as a best practice. “If there’s a goodreason for changing our plan to make it more attractive, then we would certainlyconsider it, as we did with our change in eligibility,” she explains.

• Eligibility: Until its acquisition of Ivan Allen, Staples required one year of service before employees could participate in its 401(k) plan. But it thought the acquired plan’s provision, which allowed immediate entry, was more employee friendly.

  
  

  “Why are we making them wait a year when we want new employees to feel apart of the company from the start? My mandate is to gain synergies from theacquisition. We maximize benefit programs by doing that,” reasons Lazgin.This acquisition prompted Staples to change its plan to six months of servicefor eligibility. Those who had been in the Ivan Allen plan were allowed inimmediately.

  
  

  One eligibility issue that Staples had not encountered until the Claricommerger is that of coverage. What if the acquiring plan doesn’t cover a certainclass of workers (hourly employees, for instance) but the acquired plan does?Since eligibility is not a protected benefit, it may be legal to exclude the newclass of employees, but their reaction to that must be considered.

• Company Match: One of the significant provisions for “acquired” employees is how their new employer matches 401(k) contributions. Keith Onysio, assistant controller at Quill, describes the feeling well. “Since I’m a financial guy, I was looking first at what the investment options were and what the matching looked like.”

  
  

  Onysio says he was very pleased with the changeover in investment options –from five no-name funds to nine brand-name options plus a match in Staplesstock. Quill would match 50 percent of employee contributions up to 5 percent ofpay. Staples matches 25 percent of employee contributions up to 6 percent ofpay, but also has a discretionary 20 percent match based on company performance.So if the company opts for this match, employees can receive a full45-cents-on-the-dollar match up to 6 percent of their pay. Staples has awardedthis match for the last six years.

  
  

  But even so, Onysio says, the word “discretionary” added someuncertainty to the picture. This is the type of thing that makes mergersdifficult for an acquired company’s employees. For Claricom, Staples’ matchand discretionary match were icing on the cake. Before the merger, Claricomwould match 25 percent of employee contributions with a maximum company paymentof $660. Tracy Mignone says employees “were ready to stand up and shouthooray” at the increased Staples match.

• Loans and Hardship Withdrawals: Loans and hardship withdrawals aren’t protected benefits, so acquiring companies can abandon them at any time. But luckily for employees acquired by Staples, its corporate plan is quite generous. Many plans offer these benefits, even though they aren’t required by law. Loan and hardship withdrawal features allow access to 401(k) funds for expenses such as down payment on a house or in the event of serious illness. Staples allows loans to be given for any reason with no fee to the participant. It allows participants to withdraw pre-tax contributions and any rollovers from their 401(k) accounts in the event of a hardship.

• Crediting Prior Service: There are two ways to credit prior service: the”hours of service” method or the “elapsed time” method. Theelapsed time method determines vesting by charting service from date of hire todate of termination. The hours of service method measures hours of serviceduring a 12-month period. If each plan in a merger credits service differently,a transition rule applies to convert one plan to the other’s method.
  
  

  This transition took place in merging Quill into the Staples plan. Staplesuses the hours of service method and Quill used elapsed time. “Shiftingfrom elapsed time to hours of service in the Staples plan was not anissue,” says Petrilli of Quill. “Expectations were managed, and newemployees come in knowing the ground rules.”

How do you communicate these changes?

Keeping lines of communication open with employees — old and new — is alsocrucial to a plan merger. Since new employees will have access to a differentfund lineup, they’ll need to decide how to transfer their assets and meetdeadlines for doing so.

Onysio of Quill says merger communication was handled both by onsite HRprofessionals and by Staples. This hand-in-hand style made him and other Quillemployees feel as if the acquiring company was working with, not dictating to,Quill. “I was kept in the loop and was given information in a timelymanner,” he says.

An important aspect of communicating a plan merger is to inform newparticipants about the so-called “blackout period.” The blackout, ortransition, is a period during which 401(k) contributions and loan repaymentswill continue to be deducted from paychecks and invested into the new plan, butparticipants cannot reallocate assets, request loans, or make withdrawals.Employees in quarterly valued plans will notice little difference since, for themost part, they could make changes only once in a period (i.e., month, quarter)before.

The blackout is most difficult for plans already in a daily environment, eventhough the overall time frame will be shorter. Participants may get nervous whenthey can’t touch their 401(k) money for approximately one to two months. A new401(k) provider should communicate and reassure employees through magazines,posters, memos, and/or employee meetings before and during the blackout period.

The most important thing a plan sponsor can do is analyze each plan carefullyto be sure nothing is missed, and communicate effectively with new employees.According to Nancy Lazgin, plan sponsors should “manage for success.”This includes being respectful of the participants as well as the prior planvendors. Without the help of all these parties, the transition can have greathuman and financial costs.

Workforce, May 2000, Vol. 79, No. 5, pp. 40-44— Subscribenow!