What Happens to Profit Sharing When a Company Is Sold?

A profit-sharing plan gives employees a share in company profits. When a company is sold, the plan’s future depends on decisions made by the buyer and seller, and the structure of the sale itself. For employees, this event directly affects their retirement savings, making it important to understand the potential outcomes.

Initial Company Decisions and Sale Structure Impact

When a company with a profit-sharing plan is sold, the new and old owners must decide the plan’s fate. The most frequent choice is to terminate the plan, which involves officially closing it and paying out all money to the participants. This is often the cleanest administrative path, especially if the buyer already has a different retirement plan.

Another option is to merge the seller’s profit-sharing plan into the buyer’s existing retirement plan, such as a 401(k). Less commonly, a buyer might choose to continue the seller’s plan as a separate entity or “freeze” it. A frozen plan accepts no new contributions but continues to manage and invest the existing assets on behalf of the participants.

The structure of the business sale plays a large role in determining who is responsible for these decisions. In a stock sale, the buyer purchases the entire company, including all its assets and liabilities. This means the buyer inherits the profit-sharing plan and must decide whether to terminate, merge, or continue it.

Conversely, in an asset sale, the buyer only purchases specific assets of the business, and the original company entity remains, along with its liabilities, including the profit-sharing plan. In this scenario, the selling company is responsible for formally terminating the plan and ensuring all assets are distributed.

Key Employee Considerations Upon Plan Termination

When a company decides to terminate its profit-sharing plan as part of a sale, there are two immediate financial consequences for employees. The first is accelerated vesting. Upon the official termination of a profit-sharing plan, all participants must become 100% vested in their account balances, regardless of their length of service. This means an employee is entitled to all employer contributions made on their behalf, even if they had not yet met the plan’s standard vesting schedule.

For example, if a plan required five years of service for full vesting and an employee with only three years of service had a $10,000 balance consisting of $4,000 in unvested employer contributions, plan termination would make that full $10,000 immediately theirs.

A second consideration is the handling of the final profit-sharing contribution. The company is required to make a prorated contribution for the period leading up to the plan’s termination date. This final contribution is calculated based on compensation paid during that short plan year and is deposited into each employee’s account before the final balance is calculated for distribution.

Employee Distribution Options and Procedures

Once the plan is officially terminated and the final, fully vested account balance is determined, employees will receive a detailed distribution packet from the plan administrator. This packet contains the necessary forms and a legally required document called a Special Tax Notice Regarding Plan Payments, which explains the tax consequences of the different distribution options available.

The most common and tax-efficient choice is a direct rollover. In this process, the funds are moved from the terminated plan directly to another qualified retirement account, such as a personal Individual Retirement Account (IRA) or a 401(k) plan at a new job. Because the employee never takes possession of the money, this transfer is not a taxable event, and no taxes are withheld.

An alternative is the indirect rollover. Here, the plan administrator sends a check directly to the employee, but only after withholding a mandatory 20% for federal income taxes. The employee then has 60 days to deposit the full original amount into another retirement account. To accomplish this, the employee must use their own money to make up for the 20% that was withheld, which can be recovered when filing their annual tax return.

The final option is to take a lump-sum cash distribution. The distribution is subject to the same mandatory 20% federal withholding, and the entire amount is considered taxable income for that year. Furthermore, if the employee is under the age of 59½, they will face an additional 10% early withdrawal penalty from the IRS.

Required Plan Administration and Filings

To properly conclude a profit-sharing plan, the employer or plan administrator must follow several formal procedural steps. The process begins when the company’s leadership adopts a written resolution that formally amends the plan document to establish a specific termination date. Following this, the plan administrator must provide official written notice to all plan participants, informing them of the termination and the impending distribution of their assets.

A core requirement of termination is that all assets held in the plan’s trust must be distributed to participants. According to IRS guidance, these distributions must occur “as soon as administratively feasible” after the termination date, which is generally interpreted as being within one year.

The final step to officially close the plan is the filing of a final Form 5500 with the Department of Labor. This annual report of the plan’s financial condition must be filed for the last time, with a specific box checked to indicate it is the final return. This filing formally concludes the plan’s existence from a regulatory standpoint.