401(k) Plan Termination: Steps, Vesting, and Distributions

A 401(k) plan termination is complete only when you have formally set a termination date, fully vested every participant, distributed all plan assets as soon as administratively feasible (generally within 12 months), and filed a final Form 5500. Requesting an IRS determination letter on Form 5310 is available but not required.¹

Everyone Becomes Fully Vested on the Termination Date

The Internal Revenue Code will not let a 401(k) plan keep its tax-qualified status through termination unless every participant becomes 100% vested in their accrued benefits on the termination date.² That covers employer matching contributions, profit-sharing contributions, and any other employer money in the account, regardless of what the plan’s normal vesting schedule would have said. Employee salary deferrals were already fully vested from day one.

The acceleration is automatic. A participant hired two months before termination has the same ownership rights as one who has been there fifteen years. The employer cannot reclaim unvested employer contributions once the termination date arrives; every dollar credited to a participant’s account belongs to that participant permanently.²

Steps to Terminate the Plan

The IRS treats a plan as terminated only when two conditions are met: the termination date has been formally established, and all plan assets have been distributed as soon as administratively feasible.¹ Until both are done, the plan continues to exist for regulatory purposes.

Amend the plan document to establish the termination date, cease future contributions, provide for full vesting, and authorize distribution of all benefits. A board resolution or similar corporate action typically handles this.³
Update the plan document to reflect every qualification requirement in effect on the termination date. If interim amendments have lagged, adopt them before closing the plan out.³
Notify participants and beneficiaries that the plan is terminating, what distribution options are available, and the timeline.
Provide the special tax notice required under IRC Section 402(f), explaining rollover options. It must be delivered no earlier than 180 days and no later than 30 days before the distribution date.
Fund any outstanding employer contributions owed through the termination date.
Distribute all plan assets to participants and beneficiaries as soon as administratively feasible, generally within 12 months of the termination date.⁴
File a final Form 5500 for the last plan year, checking the final return box once all assets are out.

Electronic delivery of the required notices is permitted if participants have consented or have effective access to the electronic medium, and the system alerts the recipient to the significance of the document.⁵ A former employee who has lost access to your email system needs paper.

Watch for the Successor Plan Trap

Terminating the plan does not automatically make elective deferrals distributable if you maintain or start another defined contribution plan. Under IRS regulations, a “successor plan” is any alternative defined contribution plan in existence from the termination date through 12 months after all assets have been distributed. If a successor plan exists, the termination is not a distributable event for elective deferrals, and participants have to wait for a separate qualifying event such as separation from service or reaching age 59½.

Some plan types are carved out. A SEP, SIMPLE IRA, 403(b), 457(b), or ESOP does not count as a successor. A plan maintained by a different employer also does not count, though controlled group and affiliated service group rules apply. And if fewer than 2% of employees eligible under the terminated plan are eligible under the new plan during a 24-month window starting 12 months before the termination date, the new plan is not a successor. If you want immediate distributions and a clean termination, either wait the full 12 months after final distribution before starting a new defined contribution plan or make sure you fit one of these exceptions.

Distributing the Assets

Rollovers

Participants can roll their entire balance directly into an IRA or another employer’s qualified plan with no immediate tax hit. A direct rollover moves money from the plan trust straight to the receiving account without passing through the participant’s hands.⁶ This is the cleanest exit for anyone who doesn’t need the cash.

Small Balance Cashouts

Under SECURE 2.0, if a participant’s balance is $7,000 or less and the participant does not respond with distribution instructions, the plan can force a distribution. For balances between $1,000 and $7,000, the plan administrator should roll the money into an IRA on the participant’s behalf. Balances of $1,000 or less can be paid out directly in cash, subject to the 20% federal withholding on taxable distributions.

Missing Participants

You will always have a few people you can’t locate. The Department of Labor gives fiduciaries a safe harbor for terminated defined contribution plans. Make reasonable efforts to find the participant, including checking plan records and updated contact information.⁷ If those efforts fail, roll the balance into an individual retirement plan in the participant’s name and you have satisfied your fiduciary duties under the safe harbor.⁸ For very small balances no IRA provider will accept, the money can go to a federally insured bank account or the state’s unclaimed property fund.

Tax Consequences Participants Should Understand

Any taxable distribution paid directly in cash carries mandatory 20% federal income tax withholding, even if the participant plans to roll it over within 60 days. On a $50,000 cash distribution, the participant receives $40,000 and $10,000 goes to the IRS.⁶ To complete a rollover of the full $50,000, the participant would have to come up with that $10,000 from other funds and claim the withheld amount as a credit at tax time. Direct rollovers avoid the whole problem.

Participants under age 59½ who take cash also owe a 10% additional tax on early distributions when they file their return.⁶ A plan termination on its own does not create an exception to that penalty. Combined with regular income tax, a participant in the 22% bracket who cashes out early can lose about a third of the balance to taxes and penalties.

The plan administrator must issue a Form 1099-R to each participant showing the gross distribution and federal income tax withheld.⁹

Form 5310 Determination Letter Is Optional

Filing Form 5310 is optional. You can terminate the plan, distribute assets, and file the final Form 5500 without ever requesting a determination letter.¹⁰ A favorable determination letter gives the sponsor formal IRS confirmation that the plan document was qualified at the time of termination, which is useful if the plan’s amendment history has any gaps.

If you file, Form 5310 must be submitted electronically through Pay.gov.¹¹ Register for a Pay.gov account, search for “5310,” and complete the form online. You will need the plan sponsor’s nine-digit Employer Identification Number and the three-digit plan number used on Form 5500 filings.¹² A user fee applies, set by the most recent IRS revenue procedure; check the IRS user fees page before submitting.

Filing the Final Form 5500

Every plan must file a final annual return on Form 5500 (or Form 5500-SF for eligible smaller plans) once all assets have been distributed. The administrator checks the “final return/report” box in Part I to signal that the plan has no remaining assets. Do not check the box if the plan still holds assets or participant balances at the end of the reporting period.¹³

If the plan terminates midyear but distributions aren’t finished by year-end, you still owe a Form 5500 for that year, and you keep filing for each subsequent year until the trust is completely empty. The filing deadline is the last day of the seventh month after the plan year ends, which is July 31 for calendar-year plans.¹⁴ Form 5558 extends the deadline if you need more time.

Smaller plans may qualify for the simplified Form 5500-SF if they covered fewer than 100 participants at the start of the year, held no employer securities, were invested entirely in eligible plan assets like mutual funds and insurance contracts, and met the small-plan audit waiver.¹⁵ Plans that were ever required to have an independent audit should expect to include the audit report with the final filing if they can’t use the SF.

A Note on Partial Terminations

A full termination isn’t the only event that forces accelerated vesting. If your workforce shrinks enough in a plan year, the IRS may treat it as a partial plan termination and require full vesting for the affected employees. A turnover rate of 20% or more among plan participants during the applicable period creates a presumption that a partial termination has occurred under Revenue Ruling 2007-43.¹⁶ The presumption is rebuttable, and a partial termination can occur below 20% if you amend the plan to exclude a group of employees or significantly curtail future contributions.¹⁷ If you’re planning layoffs alongside or instead of a full plan termination, run the math before assuming you can forfeit unvested balances.

1
Internal Revenue Service. 401(k) Plan Termination
2
Office of the Law Revision Counsel. 26 USC 411 – Minimum Vesting Standards – Section: Special Rules
3
Internal Revenue Service. Terminating a Retirement Plan
4
Internal Revenue Service. Retirement Topics – Termination of Plan
5
eCFR. 26 CFR 1.401(a)-21 – Rules Relating to the Use of an Electronic Medium
6
Internal Revenue Service. 401(k) Resource Guide – Plan Participants – General Distribution Rules
7
U.S. Department of Labor. Missing Participants – Best Practices for Pension Plans
8
eCFR. 29 CFR 2550.404a-3 – Safe Harbor for Distributions From Terminated Individual Account Plans
9
Internal Revenue Service. 2025 Instructions for Forms 1099-R and 5498
10
Internal Revenue Service. Form 5500 Plan Terminations Without a Form 5310 Filing
11
Internal Revenue Service. About Form 5310 – Application for Determination for Terminating Plan
12
Internal Revenue Service. Instructions for Form 5310 – Application for Determination for Terminating Plan
13
U.S. Department of Labor. Form 5500 Annual Return/Report Instructions
14
Internal Revenue Service. Form 5500 Corner
15
U.S. Department of Labor. 2025 Instructions for Form 5500-SF
16
Internal Revenue Service. Partial Termination of Plan
17
Internal Revenue Service. Retirement Plan FAQs Regarding Partial Plan Termination