An important part of managing your company’s 401(k) is to meet all of the qualified plan requirements in the Employee Retirement Income Security Act (“ERISA”) and the Internal Revenue Code (“IRC”). Special requirements apply to plans sponsored by a business owner that is a member of a controlled group. Familiarizing yourself with the controlled group rules can help save your company money and empower your employees.
What is a controlled group for 401(k) purposes?
In layman’s terms, the 401(k) controlled group definition is a set of companies with shared ownership that are treated as a single company for 401(k) plan purposes. IRC Section 414(b) and (c) define controlled groups as two or more trades, corporations, and/or businesses with specific relationships. We’ll break down those relationships in the next section.
When a controlled group exists, the employees of all the companies within the controlled group must be considered when conducting certain required plan testing. This means that each company within the controlled group can have its own 401(k) plan, or choose not to have a plan at all, but information about the other controlled group company’s employees will be required to properly administer each plan. As an alternative, a controlled group is eligible to use a single plan to cover eligible employees across all companies.
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Additional reading: What happens to 401(k) plans in mergers & acquisitions?
What are the criteria to determine if a company is part of a controlled group?
There are three scenarios in which companies are in a controlled group. If your company belongs to any one of these categories, it is considered a controlled group.
Type 1: Parent-subsidiary controlled group
A parent-subsidiary controlled group exists when a parent company owns at least 80% of a subsidiary company. For example, if Company A owns 90% of its subsidiary Company B. Companies A & B are in a controlled group since A owns at least 80% of B.
As long as a parent company maintains 80% of the ownership of a subsidiary, the parent company can use a single, controlled group 401(k) plan to cover employees from both the parent and subsidiary.
Type 2: Brother-sister controlled group
Since not all companies have a single owner, the IRC 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 and common ownership, not one or the other.
Controlling Interest (Common Control): The same five or fewer owners hold at least 80% total ownership of companies within the group.
| Owner | Ownership in Company #1 | Ownership in Company #2 |
|---|---|---|
| Tanya | 20% | 30% |
| Michael | 30% | 30% |
| Jamal | 0% | 10% |
| Maria | 40% | 10% |
| Common Ownership in #1 & #2 | 90% | 80% |
Together, Michael, Tanya, Jamal, and Maria have common ownership of at least 80% of companies #1 and #2. If the Effective Control test (discussed below) is passed, the companies are treated as a brother-sister controlled group.
Effective Control: The same five or fewer persons used to meet the Controlling Interest requirement hold at least 50% ownership of all companies within the group. When testing for effective control, a person’s ownership is taken into account only to the extent they have that great ownership in each of the companies being tested (referred to as identical ownership).
| Owner | Ownership in Company #1 | Ownership in Company #2 | Identical Ownership in #1 & #2 |
|---|---|---|---|
| Tanya | 20% | 30% | 20% |
| Michael | 30% | 30% | 30% |
| Other Owners | 50% | 40% | - |
| Total | 100% | 100% | 50% |
Michael and Tanya own at least 50% of companies #1 and #2. If the Common Ownership test is passed, the companies are treated as a brother-sister controlled group.
Type 3: Combined controlled group
Combined controlled groups are groups of three or more corporations, trades, and/or businesses in which (i) the companies have either brother-sister or parent-subsidiary controlled groups and (ii) one company is a common member in two groups.
Is a controlled group 401(k) subject to coverage testing?
Yes. Under U.S. Code 1.410(b)(2), a controlled group 401(k) must benefit at least 70% of an employer’s non-highly compensated employees (NHCEs) within the controlled group. This means that all employees of all controlled group companies are counted to see if the plan passes coverage testing. Other nondiscrimination testing will apply to a controlled group plan as well. This testing is more complicated if there is more than one 401(k) plan within the controlled group.
If you’d like more context on nondiscrimination testing in general and as part of the IRS-controlled group rules, here are some more general articles:
What are the pros and cons of a controlled group 401(k)?
Implementing a controlled group 401(k) can deliver some advantages to both the employer and the employees.
Pro #1: Lower fees
By leveraging a larger pool of employees, a business owner may be able to 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 that range from recordkeeping to legal to furnishing statement expenses. By combining plans, both employees and employers may pay less for the plan.
Read more about the fees associated with launching and maintaining a 401(k) plan for your business.
Pro #2: More investment options
Plans with more assets under management may be able to access more investment options for their fund lineup.
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 controlled group companies. Controlled group plans have only one recordkeeping service provider, so there are fewer relationships, plans, and contracts to manage.
On the flip side, if multiple plans are sponsored within the controlled group, each company sponsoring a plan will have to gather information about the other company’s employees and provide it to their recordkeepers so that testing can be performed. This can be an administrative headache for all members of the controlled group.
Con #1: The initial setup requires more work
The plan sponsor must determine the status of the company or companies controlled group before implementing a plan. They must also organize centralized administration and control of the plan to best meet the maintenance and reporting requirements.
Con #2: Risk of becoming a Multiple Employer Plan (MEP)
A careful eye must be kept on changes to the controlled group. If a business participating in the plan drops out of the controlled group and is not removed immediately, the plan will become a MEP. MEPs have different nondiscrimination testing and reporting requirements and not all service providers will work with MEPs. The plan administrator needs to keep an eye on assessing controlled group status and communicate any changes to the recordkeeper as soon as possible so issues can be identified and appropriate steps taken.
Con #3: Plan Size
Plans with 100 or more participants are subject to an annual, independent audit. This is an additional administrative step for the plan administrator to coordinate and an additional expense to the business. Combining controlled group members into a single plan may create a plan that is large enough to require an audit.
Con #4: 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 not be fully satisfied with their company benefits.
The IRC does allow companies in a controlled group to treat themselves as a separate company for testing purposes. Plan managers can request treatment as a Separate Line of Business. However, these businesses must meet these four requirements
The separate line of business must have a valid business purpose.
There must be at least 50 employees.
The IRS must be notified and approve the request.
The organization must meet the restrictions on HCE ratios in each separate line of business.
Learn more about our affordable, full-service 401(k) solution.
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.
Ensuring that compliance testing and paperwork is completely taken care of.
Get in touch to learn more about the process of setting up a controlled group 401(k) or any other plans that suit the needs of your business.
Start a 401(k) with Human Interest
A Human Interest 401(k) plan can connect directly with your favorite payroll provider and has zero transaction fees.
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The Human Interest TeamWe believe that everyone deserves access to a secure financial future, which is why we make it easy to provide a 401(k) to your employees. Human Interest offers a low-cost 401(k) with automated administration, built-in investment education, and integration with leading payroll providers.
