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Good Luck Escaping a Pooled Employer 401(k) Plan (PEP)

Eric Droblyen

December 29, 2022


While 401(k) plans must be established with the intention of continuing indefinitely, the IRS does allow employers to terminate their plan when it no longer suits their business needs. Terminating most 401(k) plans is a straight-forward process. A notable exception is Pooled Employer Plans (PEPs) – a form of “open” Multiple-Employer Plan that pools the 401(k) assets of unrelated employers. This distinction can impose serious hardships on plan participants.

PEPs are a problem because employers lack the power to terminate their portion. 401(k) plans can only be terminated by their sponsor. That means the employer for single-employer plans and the Pooled Plan Provider (PPP) for PEPs.

This issue matters because a 401(k) plan termination is considered a distributable event by the IRS, allowing participants to rollover or cash out their account upon the termination date. With no distributable event triggered by a plan termination, participants can be trapped in a PEP until they quit their employer or become eligible for an in-service distribution.

Business owners should understand this issue if they are considering a PEP for their company.

High 401(k) Fees

Only the Plan Sponsor Can Terminate their 401(k) Plan

401(k) plans can only be terminated their sponsor. More specifically, the lead sponsor. Employers that co-sponsor a 401(k) plan – called participating employers - lack the power to terminate the portion attributable to their employees.

This is true for all 401(k) plans, including single-employer plans co-sponsored by a controlled group of employers, MEPs co-sponsored by members of a PEO or association, and PEPs co-sponsored by unrelated employers.

There’s a Workaround – But it’s Complicated

While employers cannot terminate their portion of PEP directly, there is a way they can create a distributable event for employees with a PEP account short of going out of business:

  1. Establish a brand new single-employer 401(k) plan
  2. Transfer employee 401(k) accounts from the PEP to the new plan
  3. Terminate the new plan.

That’s a pretty complicated solution. After all, a whole new 401(k) plan must be created solely for the purpose of terminating it. That means a new plan document and 5500 will be necessary. It also means participant sources (e.g., 401(k), rollover, employer match) and investments will need to be mirrored. A plan blackout may also be required.

This solution probably isn’t going to be cheap either – it requires a lot of technical, detail-oriented work to start a new 401(k) plan and transfer participant balances to it without any problems.

Trapping 401(k) Accounts Can Have Consequences

When 401(k) accounts are trapped in a PEP, the consequences can be severe. Some possibilities include:

  • Angry employees – Employees typically want control of their 401(k) account when their 401(k) plan is discontinued. When they can’t get control, bad feelings are often the result.
  • Ongoing fiduciary liability – I think it’s safe to assume employers retain some fiduciary liability for 401(k) accounts trapped in a PEP. That means an ongoing responsibility to monitor the MEP for fee reasonableness and competence.
  • No liability deadline – when employers terminate a single-employer 401(k) plan, there is an outer bound for their fiduciary liability – the 6-year ERISA statute of limitations. I think it’s safe to assume this 6-year clock keeps ticking as long as employees are trapped in a PEP.

Trapped by Design?

For almost 10 years, the financial services industry lobbied Congress hard to expand small business access to MEPs. The industry got its wish when the SECURE Act created PEPs – a form of “open” MEP that allows employers with nothing in common to participate.

This support can seem odd when you understand that PEPs are more difficult for 401(k) providers to administer correctly than a single-employer plan. It makes perfect sense when you understand that PEPs can be more profitable for providers by trapping accounts within the plan, collecting fees on those assets.

Business owners should understand this issue when weighing their 401(k) provider options.

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