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A Better Partnership


Apr 2017
April 07, 2017

The Forgotten Subsidiary Retirement Plan

Retirement plans of subsidiaries are often afterthoughts for parent companies. It’s easy for the plan of a subsidiary owned by the parent to slip down the list of priorities or, similarly, for the plan of a brother-sister company (while this article does not specifically address brother-sister companies, the issues raised are similar) to slip down the list or escape attention.

Waiting too long, though, can lead to problems that could have been avoided. We often find this is due to a lack of awareness of the risks involved with delaying. The risks include:
  • Jeopardizing the tax qualification of the subsidiary’s plan and the parent’s plan;
  • Fiduciary risk for low quality investments and/or higher pricing; and 
  • The inability to later assimilate the plans without changing the design of the parent’s plan.
Tax qualification can be a problem if the plan documents have inconsistent terms. For example, it’s often missed that the definition of a “highly compensated employee” (HCE) must be the same across all plans of related companies. 

We also regularly see small subsidiary plans using a prototype plan document that says all employees of all related companies (meaning the parent’s employees too) are eligible when that is not the intent. 

If the IRS identifies this, it may force the companies to make extra contributions for employees.

Tax qualification is also tied to the operation of both plans. Regular coverage testing must be done looking at data of all related companies, even if those companies have different plans. Frequently at least one of the plans is at risk of failing (which can be costly to fix).

Another challenge is managing fiduciary risk. Small subsidiary plans are often invested in lower quality investments and paying higher fees for recordkeeping and investment advice because the parent’s bargaining power hasn’t been tapped. 

The parent and subsidiary both need to consider whether they can defend such a difference and they should expect this issue to be raised if the plan comes under scrutiny by a court or on an audit.

Once you have a situation where a parent and subsidiary have different plans, it’s challenging to merge the plans without having to change the parent’s plan to carry forward terms of the subsidiary’s plan (which was probably designed with less thought about administration for a large group). Often it’s difficult to change the terms. Federal law limits the changes that can be made to benefits that are “protected.” What is protected can be fairly broad. Terminating the subsidiary plan generally doesn’t avoid this problem because the special protections may still carry over to the parent’s plan.

Here are some tips for dealing with a subsidiary’s plan.
  • Try to avoid the situation: 
    • If you’re acquiring a company, terminate the seller’s plan before closing. 
    • If you’re setting up a subsidiary, consider whether a separate plan is necessary. Within one plan it’s sometimes possible to have different contributions and provide different summary plan descriptions. Those aren’t necessarily reasons for separate plans.
  • If separate plans are unavoidable, you might try some or all of the following:
    • Compare plan terms to achieve uniformity where required and consistency where possible.
    • Regularly run coverage testing with data from all related companies (as soon as you realize you may have this situation).
    • Consolidate services for the plans with the same providers and explore ways to avoid less favorable investments or higher pricing for the smaller plan. 
    • Consider shifting HCEs between plans.
This list isn’t exhaustive. These situations can be complicated and require analysis of the specific facts. The key is recognizing there are reasons to prioritize a subsidiary’s plan and planning helps avoid costly problems. 

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