Our company has been growing over the last couple of years, which is a good thing. However, after seeing your last two Questions of the Week (here and here), I am concerned about the need to have our 401(k) plan audited. We are committed to keeping the plan in compliance, but I cringe at the thought of searching for an auditor and dealing with the related costs.
I’ve heard that it is possible to split a plan into two separate plans, each of which covers half of the participants so that both plans are well below the 100/120-participant audit threshold. Is that actually allowed?
The short answer is “yes” but the devil is in the details. Before we get into some of those details, we first want to mention that there might be several easier ways to reduce your participant count including paying out former employees who still have balances in the plan or making the plan’s eligibility requirements more restrictive so that shorter-service employees do not become eligible. Both of those strategies are discussed in more detail here.
If neither of those do the trick, it is possible to split your plan in two (or three, or four, etc.). The first thing to keep in mind is that this path also comes with added costs in both dollars and time. The reason is that each separate plan must be maintained just as your existing plan is. That means separate plan documents, separate testing, separate 5500 filings, separate participant statements, etc. Add that you must also keep straight which employees are eligible for which plan, and it's a little bit less of a no-brainer. In our experience, the cost of maintaining two plans is often less expensive than paying for an audit, but if you’re thinking of splitting into three or four plans, then the value proposition starts to get pretty watered-down.
If the two-plan option still sounds like a good one, the next thing to consider is how to design the plans to ensure that they both satisfy the minimum coverage test. As a general rule, if the two plans have provisions that are exactly alike, they can be tested as if they are a single plan. In that scenario, since everyone receives the same benefits regardless of which plan they are in, the minimum coverage test is much more likely to pass with ease. If the plans do not mirror each other, then each one must be tested separately to ensure that enough non-highly compensated employees benefit relative to the number of highly compensated employees who benefit.
Regardless of the testing methodology, each plan must be written so that it clearly identifies which employees can participant in which plan. This can be done using valid business classifications such as job title, job location, etc., but is important that the wording be precise enough to avoid any ambiguity or misunderstanding. In addition, it is also a good idea to determine at the outset when or how transfers between plans will be permitted for employees who change job classifications and switch plans as a result.
Now comes the “just because you can, doesn’t necessarily mean you should” part of the conversation. Apart from the ongoing maintenance required with the dual-plan setup, there are costs associated with setting it up and then collapsing it all back into a single plan if subsequent growth pushes you over the audit limit in a future year. In fact, if both plans grow at the same pace, not merging the plans back into a single plan at just the right time could result in needing two audits as both plans grow past the 120-participant threshold. If your projected workforce growth is expected to put one or both plans in need of an audit within only a year or two, it might be more cost-effective in the long run to embrace the audit now and forgo the split-apart-and-merge-back-together dance altogether.
As your plan grows and inches towards 100 participants, there are numerous design opportunities you can leverage to maintain small-plan-filer status. The winning combination of provisions will vary for each plan sponsor, plan demographics, and foreseeable growth. If this sounds like something you would like to explore further, please give us a call or email us and we would be glad to discuss your options in more detail.