Terminating a 401(k) Plan: IRS Rules, Common Pitfalls, and Abandoned Plan Options

Terminating a 401(k) plan is more than a paperwork exercise. Under IRS rules, a plan is not considered terminated simply because an employer decides to end it. Until plan assets are properly distributed, the IRS generally treats the plan as ongoing—with continuing compliance, amendment, and filing obligations.

That distinction matters. Poorly executed terminations can result in delayed distributions, missed contributions, late Form 5500 filings, and unnecessary fiduciary exposure.

This article explains how to properly terminate a 401(k) plan under IRS rules, including:

• • Voluntary plan terminations
  • Abandoned plan terminations through the DOL’s Qualified Termination Administrator (QTA) process
  • Why Pooled Employer Plans (PEPs) often complicate plan termination

What Is a 401(k) Plan Termination?

A 401(k) plan termination occurs when the sponsoring employer formally decides to end the plan and distribute all plan assets to participants and beneficiaries in accordance with IRS and Department of Labor rules. Importantly, a plan is not considered terminated until assets are fully distributed, required amendments are adopted, and final reporting is completed.

Employers terminate 401(k) plans for a variety of legitimate business reasons, including:

• • Business closure: When a company is closing operations or going out of business, the sponsoring employer will cease to exist, making plan termination necessary.
  • Acquisition or merger: If a company is acquired, the acquiring employer may choose not to continue the seller’s 401(k) plan or merge it into their plan.
  • Bankruptcy: In bankruptcy or similar proceedings, a company may terminate its 401(k) plan as part of an effort to limit future expenses.
  • Low employee participation: If few or no employees participate, a company may determine a 401(k) plan is not cost-effective.

Regardless of the reason, the same IRS and DOL rules apply. A plan must be properly terminated to avoid ongoing compliance obligations.

Common 401(k) Plan Termination Pitfalls

Even well-intentioned employers can run into trouble during plan termination. Most problems don’t stem from bad faith—they result from misunderstandings about IRS timing rules, overlooked administrative steps, or assumptions that “stopping the plan” automatically ends compliance obligations.

The following pitfalls show up repeatedly in IRS audits and DOL inquiries and are often what turn an otherwise straightforward termination into a prolonged and costly cleanup:

• • Stopping plan operations without distributing assets
  • Missing final employer contributions or true-ups
  • Failing to adopt required plan amendments before termination
  • Failing to accelerate vesting
  • Processing distributions individually instead of as a coordinated event
  • Filing a “final” Form 5500 too early
  • Assuming PEP exits function like plan terminations

Understanding these risks upfront makes the step-by-step termination process much smoother.

Voluntary 401(k) Plan Terminations: A Step-by-Step Overview

A voluntary termination occurs when the sponsoring employer decides to formally end the plan. While each plan is fact-specific, a compliant termination typically follows these steps:

1. Formally Adopt a Plan Termination Date

The process begins with documented employer action—usually board minutes or a written resolution—establishing the plan’s termination date.

Clear documentation is essential. The IRS expects employers to be able to demonstrate when and how the plan was terminated.

2. Amend the Plan for All Required Law Changes

Under IRS rules, a terminating plan must be updated for all required law changes in effect as of the plan’s termination date.

This includes:

• • Interim amendments for recent legislation (e.g., SECURE Act and SECURE 2.0 provisions that are effective before termination)
  • Required regulatory amendments
  • Any discretionary amendments that were adopted operationally but never formally executed

A plan that is not “up to date” at termination is not considered properly terminated, even if assets are distributed. In an audit, the IRS can treat the plan as ongoing and require corrective action under their Employee Plans Compliance Resolution System (EPCRS).

This step is frequently overlooked—especially by employers that believe a terminating plan no longer needs amendments. In reality, termination accelerates the amendment obligation rather than eliminating it.

3. Stop Contributions and Freeze Plan Activity

After the termination date:

• • Employee deferrals must stop
  • Employer contributions stop, except for amounts attributable to compensation earned before the termination date

Operationally, many administrators temporarily pause distributions (including loans, hardships, and in-service withdrawals) to allow the plan to be tested, reconciled, and distributed in an orderly manner.

4. Complete Stub-Year Compliance Testing

If the plan terminates mid-year, it generally has a short plan year (often called a “stub year”). Required testing—such as ADP/ACP and coverage—must still be performed for that short period.

Importantly, safe harbor protections do not automatically apply in a stub year. Depending on the facts, refunds or corrective contributions may be required before distributions can occur.

5. Fund All Outstanding Employer Contributions

Before assets can be distributed, the employer must fund:

• • Any required matching or nonelective contributions
  • Match “true-ups”
  • Corrections identified during testing

Unfunded obligations are one of the most common causes of delayed plan terminations.

6. Accelerate Vesting and Eliminate Forfeitures

Upon plan termination, all affected participants must become 100% vested in their account balances. Any forfeiture or suspense accounts must be fully eliminated—typically by allocating amounts to participants or using them to pay permissible plan expenses.

A plan shouldn’t distribute assets until forfeitures are resolved.

7. Provide Participant Notices and Distribution Election Materials 

Participants and beneficiaries must be notified of the plan termination and provided with:

• • Distribution election forms
  • Required rollover notices

These materials are typically mailed on the same day to ensure consistent notice timing. Participants must be given adequate time—generally at least 30 days—to return elections before distributions occur.

8. Distribute Assets as a Coordinated “Common Event”

Best practice is to process distributions as a coordinated event:

• • Elections are collected
  • Assets are liquidated
  • Trailing dividends or capital gains are captured
  • Distributions are issued at the same time

Processing distributions piecemeal increases operational risk and can leave residual balances that delay plan closure.

If a participant does not respond, their balance is typically rolled into an involuntary Individual Retirement Account (IRA) on their behalf, regardless of amount.

9. File the Final Form 5500

Once all assets are distributed and the plan account is zeroed out, the employer files a final Form 5500 for the plan year in which distributions were completed.

Checking the “final return” box while assets remain in the plan is a common—and costly—mistake.

Abandoned 401(k) plans: the QTA process

Sometimes a plan cannot be voluntarily terminated because the employer no longer exists, cannot be located, or refuses to act. In these cases, the Department of Labor’s Abandoned Plan Program provides a solution.

When a Plan May be Considered Abandoned

A plan may qualify as abandoned when:

• • No contributions or distributions have occurred for at least 12 months, and
  • There has been no meaningful communication with the plan sponsor

Only the plan custodian can make the initial declaration of abandonment, subject to DOL review and acceptance.

The Role of the Qualified Termination Administrator (QTA)

Once abandonment is declared, a QTA may be appointed to:

• • Locate and notify the employer
  • File a Notice of Abandonment with the DOL
  • Determine fees, participant counts, and plan assets
  • Administer distributions and final reporting

DOL review can take anywhere from weeks to many months.

Distributions and Final Reporting

After DOL acceptance:

• • Participants receive special QTA distribution notices
  • Elections are collected
  • Assets are distributed as a common event

The QTA then files a final Form 5500 using the Special Terminal Report for Abandoned Plans (STRAP) by paper mail. The DOL issues a formal receipt confirming completion.

Pooled Employer Plans (PEPs) Complicate Plan Terminations

In 2019, the original SECURE Act created Pooled Employer Plans (PEPs) – a form of “open” Multiple-Employer Plan that pools the 401(k) assets of multiple unrelated employers.

PEPs complicate plan termination because an employer cannot terminate its portion of a PEP—it can only exit the plan by ceasing future contributions. With no distributable event triggered by a plan termination, the accounts of active employees may remain in the PEP until the employee terminates employment or becomes eligible for an in-service distribution.

To create a distributable event for active employees, an employer may need to:

1. 1. Establish a new single-employer plan
   2. Transfer the PEP assets to that plan
   3. Terminate the newly established plan

This additional complexity can be time-consuming and costly—and is often not fully understood at the time an employer joins a PEP.

Staying Out of Trouble Is Easy with Some Expert Help!

A properly executed 401(k) termination is a process, not a single decision. Whether a plan is voluntarily terminated, abandoned, or exited through a PEP, the goal is the same: distribute assets cleanly, document every step, and close the plan in a way that satisfies IRS and DOL expectations.

Getting it right protects participants, limits fiduciary exposure, and ensures the plan truly comes to an end. A qualified 401(k) provider like Employee Fiduciary can help make the process efficient, compliant, and far less stressful.