Can We Sponsor Two 401(k) Plans?

17 March 2020 Legal News: Employee Benefits Insights Publication
Author(s): Leigh C. Riley

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
NHCEs Eligible
% of Total
HCEs Eligible 
Ration of NHCEs
to HCEs 
 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:

  • As you can see, whether the tests pass is dependent on the demographics of the employees covered by each plan.
  • In general, this test should be performed annually.  
  • The fact that the employees are employed by separate corporate entities generally won’t make a difference. In general, entities connected through 80% ownership are considered one employer, meaning all of the employees of those connected entities have to be counted in the tests. In addition, certain entities that are not connected through ownership, such as a management services company and the entity for which it performs services, are treated as one employer. So, make sure you check with qualified ERISA counsel to make sure you are counting the right employees in the tests.
  • The above example is an overly simplified version of the test. In actuality, there are many more rules that have to be taken into account to properly run the test. There is even a second, different test that you can use if you cannot pass this “simple” one. The point of the example is to simply highlight that it is possible to have multiple 401(k) plans if your numbers work out.
  • These same rules theoretically apply to an unlimited number of plans. You could have 15 different 401(k) plans as long as each passes their coverage test.

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:

  • Each plan passed its coverage test before the acquisition, and
  • You don’t significantly change the coverage of either plan during the transition period. So, be careful when the highly compensated employees at the acquired entity try to talk you into moving them into your main 401(k) plan; changing the coverage of the plans in that manner would almost certainly disqualify you from using this transition rule.

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.


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