How to Terminate a Retirement Plan

A step by step guide including tax protection, determining rollover eligibility, notifying plan participants, and more

Send Mail Online MailformTerminating a retirement plan means that you won’t be offering the plan to your employees any longer. There are several different situations in which you might choose this route, including:

Whatever the reason, your company has the right to cancel your retirement plan whenever the plan no longer suits business needs. But be aware, your right to terminate is from a legal standpoint. It’s still your responsibility to make sure you go through the proper internal channels.  

What Termination Does

When you terminate a retirement plan through the IRS, it stops all contributions and establishes employees as fully vested as of the termination date that you specify. [1] Termination also authorizes the distribution of benefits as soon as possible after the plan becomes inactive.

To make sure all of this happens as you expect, you need to follow the IRS's defined process.

Steps to Terminate a Retirement Plan  

First, make sure that you’ve informed everyone who will need to participate in the termination. That includes the plan administrator as well as attorneys, accountants, HR personnel, and investment contacts.

In terms of notifying and working with plan subscribers, the IRS tells you exactly how you need to terminate your plan correctly under the law. [2] Be warned: the material they provide isn’t always as user-friendly as you’d like it to be. Here, we’ve collected the basics without the tax law jargon, starting from the beginning of the termination process.

Step 1: Amend the Plan and Establish a Termination Date  

The IRS likes things to be in writing, so you’ll have to officially amend the plan to set your termination date. [3] This is mandatory because it protects your employees' assets.

Tax Protection

By setting a termination date, you make sure that the plan stays tax-favored. Otherwise, the plan could end up being disqualified, meaning that it loses its tax-exempt status. [4]

The IRS can do this retroactively. If your plan terminates on September 3, the IRS could decide that the plan is disqualified back to the beginning of the calendar year. Your employees then have to claim all of your contributions as income for that year.

Rollover Eligibility

Chances are good that you’re terminating a retirement plan to pick up another one. In that case, you’ll want your employees to be able to roll over their distributions if they choose to do so. [5] You also want them to have the option to roll over those distributions should they choose to leave the company.

Without the option for rollover, your employees would get the money in their retirement accounts as a straight distribution. In that case, it would be taxable unless it comes from a qualified Roth account or has already had taxes applied to it. Rollovers let employees move that money directly into another retirement account without paying taxes.

Determining Amendment Status

Whether you’ve correctly amended your plan or not depends on whether you comply with all relevant amendments on the Cumulative and/or Required Amendments List. [6]

These documents can be difficult to read and understand, so the IRS allows you to ask for a determination letter. [3] This will tell you if your plan is updated according to federal requirements.  

Step 2: Notify participants  

Once the plan is updated and the termination date is officially set, you need to send two notices. The first is a notice of intent to terminate and should include the following:

This notice has to go out 60 to 90 days before the plan terminates.

After the termination date and no later than the benefits distribution date, you also need to send a notice of benefits. This will include:

Both notices are the responsibility of the plan administrator. [7]

How to Send Participant Notices

Termination notices must be issued in writing. The safest and most secure way to do this is through the US mail using a bulk mail service.

With Mailform’s Bulk Mail solution, for example, you can connect your address book and the service will send out the correct notice to the people you specify. [8] All you have to do is:

  1. Upload a file with the text of the notice

  2. Upload a CSV file with the addresses of affected employees. You may also enter the addresses manually, but the chance of error is lower when you upload a file.

  3. Choose your print options. Because these notices are required by law, you’ll be safest if you send them by USPS Certified Mail.

You can even link the service to your Google Docs, enabling you to merge individual account data and send personalized notices. [9]

Automated solutions like these are not only easier; they’re also more reliable. You don’t have to worry about forgetting someone or copying information wrong, because the service does it for you.

Step 3: Issue a rollover notice  

If you’re proposing that your employees roll over their distributions to a different retirement account type, such as from a 401(k) to an IRA, the law requires that you send a notice explaining the tax implications.

The IRS provides you with the text for this notice, one version for members with eligible Roth accounts and one for members with other accounts. [10] If you’re not sure which notice applies to your employees, consult with a corporate accountant or tax professional.

Again, you’ll need to send this information in a secure format, ideally by USPS Certified Mail. These notices are particularly easy to send via bulk mail because they don’t need to contain any individually specific information.

Step 4: Budget for any outstanding required contributions  

For a retirement plan to maintain its IRS qualification, it has to meet several contribution requirements. [11] These requirements may mandate certain contributions by you, possibly even after you’ve decided to terminate the plan.

As an example, plans that include matching contributions must pass the IRS Actual Contribution Percentage (ACP) test to ensure that very highly paid employees aren’t benefiting disproportionately. [12] When a plan fails the test, the employer has to make remediating contributions the following year.

You need to know if the IRS requires you to make any contributions before you fully terminate the plan. If so, you’ll need to budget for these required payments and make sure you pay them on time.  

Step 5: Fully vest all participants  

The law states that when you terminate a retirement plan, you must vest all affected participants, including any former employees that still have active account balances. [2]

When someone is fully vested in their retirement plan, they own 100% of the account balance and the employer has no legal right to reclaim it. Employee contributions are almost always fully vested right away. Employer contributions may be vested depending on the plan. [1]

Everyone has to be 100% vested in their plan by the time they reach retirement age or when the plan is terminated. Verify with the plan administrator that vesting has happened, or will have happened, by the termination effective date.  

Step 6: Distribute assets as soon as possible  

Federal guidelines tell you to distribute all of the plan’s assets “as soon as administratively feasible.” The IRS considers 12 months to be a reasonable timeline, and even that can be tight if you have to track people down.

Missing or Uncontactable Participants  

Employers are legally obligated to present all plan participants with payment options, even if initial notices are returned as undeliverable. The Pension Benefit Guaranty Corporation has issued a 134-page document explaining the steps you have to take to find these non-responsive participants. [13] It applies to all plans covered under the Employee Retirement Income Security Act (ERISA), not just to pensions.

The IRS publishes required and recommended search steps that can help you to comply with applicable regulations. Certain steps are required if your efforts are to be considered exhaustive. These include:

You also have to consider whether further efforts, such as the use of credit reporting agencies or commercial locators, would be appropriate if standard search techniques are not successful.

Even if all reasonable efforts fail to reach the participant, you still have to distribute those assets. The standard strategy is to roll over the funds directly into another account with the person’s name. If that’s not possible, you can create a new interest-bearing federally insured bank account in their name or consider transferring the money into state unclaimed property funds. [14]

You need to record all transfers, whether paid out directly or rolled over, on IRS Form 1099-R and file the completed form. [15]


Step 7: File a Form 5500 Series

When you file your taxes for the plan’s final year, you need to complete and submit a Form 5500. You need to file this document by the last day of the seventh month after the end of the plan year. If your plan follows the calendar year, that translates to July 31 of the following year.

Most employers or plan administrators will file the Standard Form 5500. However, if your plan has fewer than 100 participants, you can file the short version, Form 5500-SF. Both forms get filed electronically through the Employee Benefits Security Administration’s EFAST2 system. [16]

There are some plans, such as one-participant plans, that require different forms and get filed separately. Always check IRS requirements before filing. [17]

Plan-Specific Termination Rules  

Some retirement plans have additional rules that must be followed for termination.  Here are just a few. You'll want to check IRS documentation if you offer other kinds of plans.

Terminating the 401(k) Plan

Fortunately, 401(k) termination mostly follows the same rules as the termination of any other retirement plan. For example, your 401(k) cancellation form is still the 5500-series form, but you may want to fill out a Form 5310 if you want the IRS to rule on your plan qualification. [18]

If you’re terminating a 401(k) plan and starting a new one, you have to tell subscribers whether there will be any tax repercussions. A 401(k) plan is tax-deferred, so if you choose a non-tax-deferred plan as your next option, subscribers may not want to participate.

You’ll want to be aware of how 401(k) termination distribution of assets work. If the distribution doesn’t happen within a year, the IRS will treat the plan as ongoing. Keep detailed terminated 401(k) plan financial statements so you know you’re doing everything by the book.

Be sure to record your 401(k) plan termination fees, including any funds you pay to third-party administrators. The law allows you to use plan assets for this purpose, but you’ll need to document it. [19]

Terminating an IRA Plan  

To cancel an IRA or Roth IRA, you’ll just need to follow the rules set forth for retirement plans in general.

There are additional rules for SIMPLE IRAs. The most important one is that you have to keep the plan active for the full calendar year and continue your contributions. After that, you just have to tell your bank that you’re terminating. You don’t need to tell the IRS. [20]

Defined Benefit Pension Plan Termination  

Termination of a Defined Benefit Pension Plan requires the following additional paperwork [2]:

For additional information on terminating pension plans, consult the Pension Benefit Guaranty Corporation. [21]

A Final Word

Terminating a retirement plan isn’t something your company should take lightly. Only do it if it’s necessary, and if it is, check carefully with the IRS and your attorneys to make sure you’ve completed all steps.
























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