Controlled Groups FAQ

It seems that businesses of all sizes are more frequently being structured using multiple companies and/or that business owners are acquiring interests in other companies. With the implementation of the Affordable Care Act, some companies actively restructured to stay below the 50-employee coverage threshold. Regardless of the reason, there are complex IRS rules that must be considered when it comes to both the retirement and health benefits being offered to employees.

During the mid-1980s, Congress created a series of complex rules that require all companies in a related group to be combined when determining whether employee benefit plans are providing adequate benefits to enough of the employee population. While this may sound onerous, with some careful planning, these rules can also be used to provide retirement benefits to multiple companies more cost effectively.

The introductory paragraphs mention related companies. What exactly does that mean?

Although there are many ways in which companies can be related to each other, in this context, we are referring to overlapping ownership between companies and situations in which two or more businesses have formal working or management relationships. There are two broad categories of related companies — controlled groups and affiliated service groups. (See Internal Revenue Code sections 414(b) and (c) for more information.)

The remainder of this FAQ will focus on controlled groups.

We have prepared a separate FAQ on affiliated service groups, available here. 

What do you mean by ownership?

Ownership in this context is more of a generic term that refers to not only shares in a corporation but also to membership in an LLC, partnership interest in a partnership or LLP, and composition of the Board of Directors in a not-for-profit organization.

Perhaps more important, there are instances in which the ownership held by one person or entity is attributed to another person or entity. One of the most common forms of attribution is among family members. While we will spare you the gory details here, we have prepared a separate FAQ on the ownership attribution rules. 

My tax advisor told me the other companies I own are disregarded entities. Doesn’t that mean I can disregard them for my benefit plans also?

Actually, no. Even though certain companies may be disregarded for other tax or financial reporting purposes, there is no such exclusion in the context of the controlled group and affiliated service group rules. In other words, just because an entity may be disregarded for some purposes does not mean it can be disregarded for all purposes.

What is a controlled group?

Controlled groups are driven completely by overlapping ownership, and there are two types — the parent/subsidiary-controlled group and the brother/sister-controlled group.

• Parent/subsidiary: Exists when one entity owns 80% or more of another entity, e.g. Company A owns at least 80% of Company B.
• Brother/sister: Exists when the ownership structure meets two thresholds. 
  • Common Ownership: The same five or fewer individuals must own 80% or more of each company under consideration; and
  • Identical Ownership: The same five or fewer individuals from the previous step have identical ownership of more than 50%.

Common and identical ownership sound kinda like the same thing. Can you explain in more detail?

Common ownership is a little easier to explain, so we’ll start there. Basically, you start by identifying those people who have ownership in both companies. The sum of their ownership percentages is common ownership.

Identical ownership is a little trickier and is probably best explained using a short example. If Jane owns 10% of one company and 5% of another company, her identical ownership is the lowest common denominator among the two - 5%.

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Suit Says Fiduciaries of $700 Million 401(k) Fell Short

BY NEVIN E. ADAMS, JD

Plan Sponsor

A 401k plan sponsor is an employer or organization that establishes and maintains a 401k retirement plan for the benefit of its employees or members. The plan sponsor is responsible for selecting the investment options available in the plan, determining the plan's administrative and operational features, and ensuring that the plan complies with applicable laws and regulations.

The plan sponsor may also hire third-party service providers, such as recordkeepers and investment advisors, to assist with the administration and management of the plan. However, the plan sponsor retains ultimate responsibility for the plan's operation and fiduciary duties.

Plan sponsors have a legal obligation to act in the best interests of plan participants and beneficiaries and to fulfill their fiduciary responsibilities under the Employee Retirement Income Security Act (ERISA). This includes ensuring that fees and expenses associated with the plan are reasonable and disclosing all relevant information to plan participants.

401k Match

Employers are not required by law to offer matching contributions in a 401k plan. However, many employers choose to do so as a way to encourage employee participation and help employees save for retirement.

If an employer does offer a matching contribution, the terms of the match can vary. Some employers match a percentage of the employee's contributions, while others may match a specific dollar amount. Additionally, there may be restrictions on when the matching contributions are fully vested, meaning when the employee has full ownership of the funds.

It's important to carefully review the terms of your employer's 401k plan to understand if and how they offer a match, and if there are any conditions or restrictions on the matching contributions. If your employer does offer a match, it's generally recommended to contribute at least enough to receive the full match, as it is essentially free money that can help grow your retirement savings faster.

Loan Provisions

A 401k plan is a retirement savings plan sponsored by an employer that allows employees to save a portion of their income before taxes are taken out. While contributions to a 401k plan are meant for retirement, the IRS allows certain provisions for borrowing or withdrawing funds under certain circumstances.

The loan provisions of a 401k plan allow an employee to borrow a portion of their vested account balance, up to a maximum of $50,000 or 50% of their vested account balance, whichever is less. The loan must be repaid with interest, typically within five years, although longer repayment periods may be allowed for loans used to purchase a primary residence. The interest rate for the loan is usually tied to the prime rate and may be slightly higher than the current prime rate.

It's important to note that not all 401k plans allow for loans, and even those that do may have specific rules and limitations, so it's important to check with your plan administrator for details.

In addition to loans, a 401k plan may also allow for hardship withdrawals, which are withdrawals made from the plan due to an immediate and heavy financial need, such as medical expenses, funeral costs, or the purchase of a primary residence. Hardship withdrawals may be subject to income taxes and a 10% penalty if the employee is under age 59½.

It's important to remember that while loans and hardship withdrawals may provide a source of short-term financial relief, they can have a significant impact on an employee's retirement savings, as they reduce the amount of money that can continue to grow tax-deferred in the account. Therefore, it's generally recommended that these options be used only as a last resort after all other options have been exhausted.

Auto Escalation

Auto escalation in a 401k plan refers to a feature that allows participants to automatically increase their contributions to the plan over time. With this feature, a participant can elect to have their contributions increase by a certain percentage or dollar amount each year, typically up to a predetermined maximum.

The purpose of auto escalation is to help participants save more for retirement by gradually increasing their contributions without requiring them to take any action. By automatically increasing their contributions, participants can benefit from compounding returns and potentially achieve their retirement savings goals more quickly.

Auto escalation can be a valuable tool for retirement savers, especially for those who struggle with saving consistently or who may forget to increase their contributions over time. It can also help employees who are automatically enrolled in a plan to start saving at a higher rate without having to actively make that decision.

Automatic 401k Enrollment

Automatic 401k enrollment is a feature offered by some employers that automatically enrolls employees in their 401k retirement savings plan. With this feature, new employees are enrolled in the plan by default, and they must take action to opt out of the plan if they choose not to participate.

The idea behind automatic enrollment is to encourage more employees to save for retirement by making it easier and more convenient for them to participate. Many employees fail to enroll in their employer's retirement plan simply because they never get around to it or find the process confusing.

Automatic enrollment aims to overcome these obstacles by making enrollment automatic and straightforward, often using default investment options and contribution rates. It is important to note that employees can still adjust their contribution rates or investment options once enrolled in the plan.

Can I Make Roth Contributions in a 401k Plan?

Yes, some 401k plans offer a Roth option that allows you to make after-tax contributions. These contributions are then invested and grow tax-free, and you won't have to pay taxes on the money when you withdraw it during retirement.

However, not all 401k plans offer a Roth option, so you should check with your plan administrator to see if it's available. Also, there are limits to how much you can contribute to a Roth 401k each year, just like with traditional 401k contributions. In 2023, the annual contribution limit for both traditional and Roth 401k contributions is $22,500, with an additional catch-up contribution of $7,500 for those age 50 and older.

Simple IRA vs. 401k

A Simple IRA (Savings Incentive Match Plan for Employees) is typically used by small businesses with fewer than 100 employees. It allows employees to contribute a portion of their pre-tax income to the plan, up to a certain limit, and employers are required to make either a matching contribution or a non-elective contribution. Contributions to a Simple IRA are tax-deductible, and the money grows tax-deferred until it's withdrawn in retirement. Simple IRA plans have lower contribution limits than 401k plans, which can make them a good choice for small businesses that want to offer retirement benefits without incurring high administrative costs.

A 401k is a retirement savings plan offered by larger employers. It allows employees to contribute a portion of their pre-tax income to the plan, up to a certain limit, and employers may also make contributions to the plan. The money in a 401k grows tax-deferred until it's withdrawn in retirement, and contributions to a 401k are tax-deductible. 401k plans typically have higher contribution limits than Simple IRA plans, and some employers may also offer matching contributions, profit-sharing contributions, or other incentives to encourage employees to save for retirement.

In summary, while both a Simple IRA and a 401k are retirement savings plans, the Simple IRA is typically used by small businesses with lower contribution limits and required employer contributions, while the 401k is more commonly offered by larger employers with higher contribution limits and optional employer contributions.