Controlled Group Coverage Testing

The lines of business ownership have become increasingly more complicated in the modern business climate.  This may have a significant impact on the ability of employers to maintain separate retirement plans due to the requirements of the nondiscrimination regulations.  The purpose of this article is to describe how coverage testing is performed when an employer is a member of a controlled group.
 

A Controlled Group Adopting A Prototype Plan

The employer members of a controlled group may adopt a single prototype plan. To do this, each employer must sign the adoption agreement as a participating employer.  Unrelated employers may not be participating employers in the same prototype plan.  Instead, they can either each adopt a prototype plan on a single employer basis, or, they may collectively adopt an individually designed plan document, commonly known as a Multiple Employer Plan.

One Plan Per Company Versus One Plan for the Entire Controlled Group
The principal advantage of having separate plans for a controlled group is that each member has the option to maintain a retirement plan with its own distinct benefit structure.  Conversely, adoption of a single plan offers economies of scale, and the potential for the use of profits of the more profitable members to fund plan benefits across-the-board.  In prototypes, if separate plans are desired, this is accomplished by the use of nonstandardized adoption agreements, with appropriate eligibility exclusions for the other members of the group.  However, this will only work if each plan can pass coverage requirements separately when its demographics are compared to the demographics of the entire group. Passing the test generally requires at least a 70% coverage ratio in each plan.
 

Performing Coverage Testing for a Controlled Group

Example of Coverage for a Two Company Controlled Group With One Company Excluded.
Testing is accomplished by comparing the group of highly and non-highly compensated employees covered by the plan against the total group of highly and non-highly compensated employees within the controlled group.  Thus, the numerator is the group in one company of HCEs and the denominator is the group of HCEs for all companies. The NHCEs are tested the same way; that is, the numerator is the NHCEs in the company being tested and the denominator is the total of all NHCEs from all companies in the controlled group.  The following is a coverage example in which Company A and Company B are a controlled group, but only Company A has a plan. 

RESULTS
The percentage of HCEs benefiting is 80%. This is arrived at by dividing the total benefiting from line 3 (16 HCEs) by the total of all HCEs (20) in both companies A and B to arrive at 16/20 = 80%. The next step is to perform the same test for the NHCEs.  Divide the NHCEs benefiting (160 NHCEs, line 7) by the total of all NHCEs in both companies A and B (280, line 5 total) to arrive at 160/280 = 57% of NHCEs participating. The final step in the coverage test is to divide the percentage of NHCEs benefiting by the percentage of HCEs benefiting. If the result is 70% or greater, the coverage test is passed. In our example we divide 57% (NHCEs percentage) by 80% (HCEs percentage) to arrive at a result of 71%, which passes.

** These employees do not meet the plan’s eligibility requirements because of insufficient hours, or termination during the year, or they are excluded for non-statutory classification reasons.
 

Coverage Transition Period for a Company Joining or Leaving a Controlled Group
Business reorganizations occur at an increasingly rapid pace.  This presents problems for coverage testing of controlled groups.  Fortunately, IRC §410(b)(6)(C) provides a transition period beginning on the date of the change of the members of a group and ending on the last day of the 1^st plan year beginning after the date of such change.  For example, if the employer has a calendar year plan and was in a transaction in the 2002 year, they would not have to be considered on a controlled group basis until the 2004 plan year.  During this period, coverage is satisfied if coverage requirements were met immediately before such change, and the coverage under such plan is not significantly changed during the transition period other than by reason of the change in the members of the group.