An important part of managing your company’s 401(k) is to meet all employer requirements set by the IRS. One of those requirements is making sure that a business owner properly uses what’s called the controlled group 401(k) designation. In layman terms, a controlled group is a set of companies with shared ownership that eligible to pool its employee base into a single 401(k) plan.
Think of Elon Musk and the string of companies that he has helped to build up and holds a stake in (Zip2, PayPal, SpaceX, Tesla, SolarCity). You may not be exactly like Elon Musk, but if you are part-owner of a few different businesses, or your family owns several businesses, this article will help you identify whether you are or aren’t considered a controlled group and all that that entails. With a controlled group 401(k), a business owner could simplify retirement planning and use a single plan to cover eligible employees across all companies.
What are the criteria to determine if a company is part of a controlled group?
There are three scenarios in which companies represent a controlled group.
If you fall in to any one of these three categories (Parent-subsidiary, Brother-sister, Attributed ownership), you are considered a controlled group.
Type 1: Parent-subsidiary Controlled Group
In the most straightforward scenario, a parent company owns at least 80 percent of a subsidiary company. Think of Procter & Gamble (P&G), one of the largest multinational consumer goods corporations in the world. P&G holds a large stake in several companies, such as Charmin, Crest, and Dawn.
As long as a parent company maintains 80 percent of ownership on a subsidiary, the parent company can use a controlled group 401(k) to cover employees from both the parent and subsidiary.
Type 2: Brother-sister Controlled Group
Since not all companies have a single owner, the IRS has set rules that allow companies with several owners to qualify for controlled group status. Brother-sister controlled groups must meet qualifications for both Identical & Common ownership; not one or the other
Identical ownership: Common owners hold at least 50 percent ownership on all companies within the group.
|Owner||Ownership in Company #1||Ownership in Company #2||Identical Ownership in #1 & #2|
Michael and Tanya own at least 50 percent of companies #1 and #2 so they can set up a controlled group 401(k) to cover all employees of both companies.
Common ownership: 5 or fewer owners hold at least 80 percent ownership of companies within the group.
|Owner||Ownership in Company #1||Ownership in Company #2|
|Common Ownership in #1 & #2||90%||80%|
Michael, Tanya, Jamal, and Maria have common ownership of at least 80 percent of companies #1 and #2 so they can set up a controlled group 401(k) to cover all employees of both companies.
Type 3: Attributed Ownership Controlled Group: Parents, Spouses, etc.
Certain family relationships allow direct family members to achieve common or identical ownership controlled group status.
Prenuptial agreements for married couples, as well as common law marriages (depending on the state you live in) need to be assessed on an individual basis to determine whether a controlled group is necessary.
While there are brother-sister controlled groups, siblings are never attributed the ownership of other siblings under IRS rules. There are specific rules that attribute ownership of companies to other family members. For example, a parent or legal guardian is always attributed the ownership of a minor child (under age 21).
U.S. Code 1563 provides the specifics for attributed ownership controlled groups. Here is a quick summary:
Is a controlled group 401(k) subject to nondiscrimination testing?
Yes. Under U.S. code 1410(b)(2), a controlled group 401(k) must benefit at least 70 percent of an employer’s non-highly compensated employees (NHCEs) within the controlled group. Since controlled group status involves owner/employees that may have ownership well above 5 percent to qualify for parent-subsidiary or brother-sister controlled group status, nondiscrimination testing is a key area to prevent hefty IRS fines. Almost 60,000 plans across the country failed their most recent nondiscrimination tests, resulting in $794 million in corrective refunds to employees!
If you’d like more context on non-discrimination testing in general, here are some more general articles (we recommend starting with the first one!):
- Non-Discrimination Testing: The Basics of IRS 401(k) Compliance
- Non-Discrimination Testing Deadlines
- Non-Discrimination Testing for Startups
What are the pros and cons of a controlled group 401(k)?
Implementing a controlled group 401(k) can deliver some advantages to both employer and employees.
Pro #1: Lower fees
Leveraging a larger pool of employees, a business owner can secure lower total fees compared to what he would pay by maintaining several plans. Some 401(k) plans can have a miscellaneous fee category on top of sales and account maintenance charges. Such miscellaneous fees range from recordkeeping to legal to furnishing statement expenses! By combining plans, both employees and employers pay less for the plan.
Pro #2: More investment options
The bigger the total account balance held in a plan, the larger the number of investment options available. Many funds require a minimum investment so combining assets grants plan holders access to more options.
There’s a plethora of investment options out there:
- Beyond Equity Index Funds: Bonds, International Stocks, and Real Estate
- How and Why to Invest in Real Estate Investment Funds with REITs
- Socially Responsible Investing: A Beginner’s Guide to Choosing Ethical Funds
- Target Date Funds in 401(k) Plans: Good or Bad Idea?
- What’s the Difference Between Mutual Funds and ETFs?
Pro #3: Simplified plan management
One plan, one set of rules. This surely makes the plan administrator happy as it results in streamlined plan management and employee education across all subsidiary companies.
Pro #4: Make most of plan startup tax credit
Qualifying businesses can receive a tax credit for up to 50% of startup costs, up to $500 a year for three years (for a total of $1,500). The credit can be used to offset expenses needed to set up, administer, and educate employees about the plan.
Having a controlled group 401(k) allows the owner(s) to stretch out this tax credit and provides an incentive to deliver a comprehensive employee education program about the new plan (more tax credits to offset education costs for a single program instead of many).
However, controlled group retirement plans have disadvantages, too.
Con #1: More compliance testing
In addition to the necessary 401(k) compliance testing, the plan administrator needs to keep an eye on assessing controlled group status. Some controlled groups can be more complicated than others with more than one type of brother-sister relationship. Adequate recordkeeping may be beyond the ability of the current administrator.
Con #2: One size may not fit all
The final set of features of the controlled group 401(k) may not meet the unique needs of every company within the group, let alone of every employee. Remember that a retirement plan is a key way to attract and retain talent. If the plan doesn’t deliver on that promise, employees may no longer be fully satisfied with their company benefits (yikes!) .
Where can employers find more information about setting up a controlled group 401(k)?
Human Interest has helped several eligible companies to set up, implement, and maintain a controlled group 401(k). We’ll take care of creating employee accounts, processing contributions every pay period and syncing them with your payroll provider, and ensuring that compliance testing and paperwork is completely taken care of.
If you would like to learn more about the process of setting up a controlled group 401(k) or any other plan that better suits to your organization’s needs, please click here to contact us and we’d be happy to help!