We get this question a lot from our clients. Sometimes, the answer is a clear “yes”, and, in other cases, the answer is a “maybe.” Below are three typical Q&As that highlight the most common scenarios where this question arises.
Question #1: We are opening a non-union facility in another state and the cost structure of that new facility has to be kept to a minimum for it to be profitable. Can we set up a separate 401(k) plan for employees at the new facility with a lower matching contribution than we provide under the 401(k) plan that covers the rest of our employees?
Answer #1: MAYBE; it depends on whether both of the plans can pass a “coverage test.”
At its most basic, the coverage test compares the percentage of non-highly compensated employees (NHCEs) who are eligible for the plan to the percentage of highly compensated employees (HCEs) who are eligible for the plan. In general, if a plan’s result is at least 70% (when tested every day of the year), then the plan passes the test.
Let’s assume that the employer who asked the question employs a total of 340 NHCEs and 32 HCEs. Under the main 401(k) plan, 300 of the NHCEs and 30 of the HCEs are eligible to participate. Under the new 401(k) plan, the remaining 40 NCHEs and 2 HCEs will be eligible. Here is how the coverage test would play out:
| % of Total
|% of Total
|Ration of NHCEs
|Main 401(k) Plan||88% (300 out of 340 total)||94% (30 out of 32 total)||88/94||93% Test Passes!|
|New 401(k) Plan||12% (40 out of 340 total)||6% (2 out of 32 total)||12/6||200% Test Passes!|
Since the result for both plans is above 70%, they both pass their test. In this case, then, it would be OK to maintain two separate 401(k) plans.
Note the following important points:
Question #2: We just bought a company that has its own 401(k) plan. Can we just keep that plan in place for the employees of the acquired entity, while continuing to maintain our 401(k) plan for everyone else?
Answer #2: YES, for a limited period of time, and then MAYBE after that. There is a special transition rule in the Internal Revenue Code that allows you to maintain an acquired company’s 401(k) plan for the year of the acquisition and the entire following year (the “transition period”) without needing to worry about performing the coverage test, as long as:
After the transition period ends, you guessed it – in order to continue to maintain separate plans, you have to ensure that the two plans can pass their coverage tests, as described in Q&A #1.
Question #3: Our union just negotiated in their new collective bargaining agreement to have a 401(k) plan, but it has different rules (e.g., a different eligibility period and a different employer matching contribution) than the rules for our regular 401(k) plan. Can I set up a separate 401(k) plan for this union group?
Answer #3: Yes. It is not a problem to have one 401(k) plan for union employees and a different 401(k) plan for non-union employees. In fact, if you have 5 different unions, you could set up 5 different plans for each union group. Union employees are ignored in the coverage test, which is why it is always OK to have different plans for union employees.
|As part of Foley’s ongoing commitment to provide legal insight to our clients and colleagues, our Employee Benefits and Executive Compensation Group has a monthly newsletter we call “Employee Benefits Insights,” where we provide you with updates on the most recent and pressing matters concerning employee benefits and other related topics. Click here or click the button to the left to subscribe.|