As many of my plan sponsors are serial entrepreneurs or have financial interests in multiple companies, it's important that you learn the rules of Controlled Groups and Affiliated Service Groups when setting up or maintaining a retirement plan. I generally suggest learning about these rules and structuring your 401(k) accordingly as opposed to understanding them later and potentially paying the price for it down the road.
First, what exactly is a Controlled Group? Also known as a Controlled Ownership, the term refers to aggregating multiple companies under one 401(k) Plan as a result of the organizations’ ownership structures. The rules of Controlled Groups state that any organizations with 80% (or more) common ownership between the entities should have one 401(k) Plan to cover the eligible employees of each company. If individual plans are maintained for each company, certain tests are required between the different companies. Therefore, if Jane owns 100% of Company A and 85% of Company B, Company A and B are to offer the same 401(k) Plan to the employees of both organizations or test the plans together.

Likewise, if Joe, Kate, and Tom collectively own 80% of Company X and all three owners also collectively own 80% in Company Y, one 401(k) Plan should be offered to both organizations or the plans should be tested together. So why is this the case? Let's use the example of Tony and Gina who are business owners. Tony and Gina are married and own 100% of both Tony's Pizza and Gina's Hair Salon. Tony runs the pizzeria and Gina runs the hair salon. Tony decides that he'd like to set up a 401(k) for himself and his family members but doesn't necessarily wish to contribute to his employees. Although Tony has multiple employees at the pizzeria, he decides to put his employees on Gina's payroll and place Gina and their three children on the pizzeria’s payroll. In Tony's mind, only his family is now eligible for the Tony’s Pizza 401(k) and he doesn't have to contribute to the employees who are now being paid from the hair salon as it doesn't appear that they are employees of the pizzeria. Due to the rules of Controlled Ownership, the 401(k) would actually extend over to all eligible employees of Gina's Hair Salon. Likewise, employers who set up holding companies and try to design a 401(k) specifically for certain employees or certain family members should know these rules before implementing a plan.

Affiliated Service Groups have a similar concept of aggregating multiple employers under one 401(k) Plan but this rule is less contingent upon the ownership structure and more focused upon the relationship between the entities. This rule states that if one entity derives its revenues predominantly or exclusively from another company, one 401(k) Plan should be offered to all eligible employees of both companies or the plans should be tested together. Let's use the example of a small medical group to illustrate Affiliated Service Groups. Dr. Spock & Dr. Seuss provide services for the S&S Medical Practice. The doctors are 50-50 partners in the practice and they employ a staff of administrators and medical practitioners to treat their patients. Each doctor has also established an LLC to receive revenues from S&S Medical Practice. Since Dr. Spock LLC and Dr. Seuss LLC purely exist to receive revenues from S&S Medical Practice, all three entities would be considered an Affiliated Service Group and, therefore, should have one 401(k) offered to all eligible employees of the three entities.

Having worked with business owners for over 20 years, I've run into countless situations where the business owner also has financial interests in other entities or with multiple business partners. If you do not properly understand the rules of Controlled Groups and Affiliated Service Groups, you may find that a plan can become extremely expensive if you need to retroactively contribute to the employees who should have been deemed eligible for the 401(k) from the start.

For those who have been attending the last 10 classes, congratulations on completing your sophomore year! Join us next week when we’ll transition from the concepts of plan design to fiduciary best practices and how to run your 401(k) Plan in the best interests of your participants. Enjoy the break and we'll see you then!

 
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