How a Solo 401(k) Plan Works for a Controlled Group

A solo 401(k) plan is a retirement savings option for self-employed individuals or small business owners with no employees, aside from a spouse. When an individual owns multiple businesses or has a controlling interest in more than one company, these businesses may be considered a controlled group under IRS rules. That can affect eligibility for a solo 401(k) because all businesses within the group must participate in the same retirement plan. If you’re a business owner who wants to remain compliant with IRS regulations and maximize your retirement savings options, it may be important to understand how a solo 401(k) functions within a controlled group.

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Understanding Controlled Groups in Relation to a Solo 401(k)

In the context of retirement plans, a controlled group exists when multiple businesses are considered one entity due to shared ownership or control. The IRS sets specific guidelines to identify controlled groups and these classifications affect the businesses’ ability to establish retirement plans independently.

If a business owner or group of related individuals owns multiple businesses that qualify as a controlled group, all employees of these businesses must be considered when setting up a retirement plan. So if you own more than one business, you must determine whether your businesses fall under the controlled group classification to establish a compliant solo 401(k).

Types of Control Groups

Controlled groups are classified into different types based on ownership and control. Here are the main types:

Parent-Subsidiary Controlled Group: This type occurs when a parent company owns at least 80% of one or more subsidiary companies. In this case, the parent company and its subsidiaries are considered a single controlled group, meaning that they must collectively comply with retirement plan regulations. Even if one subsidiary has no employees, the parent company’s ownership stake can impact the overall group’s eligibility for a Solo 401(k).
Brother-Sister Controlled Group: This type of controlled group exists when five or fewer individuals, estates or trusts have at least 80% ownership across two or more companies. Additionally, these same owners must have at least 50% identical ownership in each company. For example, if an individual owns 90% of Company A and 60% of Company B, these businesses may be classified as a brother-sister controlled group, which impacts retirement plan requirements.
Combined Controlled Group: A combined controlled group is a combination of a parent-subsidiary and brother-sister controlled group. For instance, if a parent company has at least 80% ownership in a subsidiary, and this subsidiary is also part of a brother-sister controlled group with another company, these companies form a combined controlled group. In this case, all businesses within the combined controlled group must adhere to unified retirement plan guidelines.
Affiliated Service Group: An affiliated service group consists of related organizations that provide services together, even if they do not have direct ownership stakes in each other. This type often applies to professional firms like accounting, law or medical practices that work closely with one another. If two businesses are considered an affiliated service group, they may be required to share retirement plans, impacting the Solo 401(k) setup.

Pros and Cons of a Controlled Group 401(k)

How a Solo 401(k) Plan Works for a Controlled Group

Establishing a controlled group solo 401(k) can offer benefits, but there are also potential drawbacks to consider:

Pros:

Consistent Retirement Savings: By consolidating retirement plans across controlled group businesses, business owners can streamline their retirement savings strategy and provide consistent benefits to all eligible employees.
Increased Contribution Limits: A controlled group solo 401(k) may allow higher total contributions if multiple businesses contribute to the plan, potentially increasing overall retirement savings.
Tax Benefits: Contributions to a controlled group 401(k) can provide significant tax advantages, especially for owners who contribute on behalf of themselves and their employees across multiple businesses.

Cons:

Compliance Complexity: Controlled group classification increases the complexity of maintaining a solo 401(k) plan, as it requires following IRS rules that apply to multiple businesses.
Higher Administrative Costs: Extending the solo 401(k) to cover employees in a controlled group may increase administrative costs and compliance requirements.
Potential for Loss of Solo 401(k) Status: If one of the businesses in the controlled group has employees, the Solo 401(k) may lose its status and require conversion to a traditional 401(k), which has stricter compliance standards.

How to Determine Controlled Group Status

To determine whether your businesses form a controlled group, evaluate ownership and operational relationships according to IRS criteria. Here are the factors used to determine the controlled group status:

Ownership Percentage: For a parent-subsidiary controlled group, the parent company must own at least 80% of each subsidiary. Ownership structure and voting power are used to indicate whether businesses meet the controlled group classification.
Family Relationships: The IRS considers family members’ ownership when determining control group status. For example, if a business owner shares ownership with their spouse, children or parents, these family members’ combined ownership stakes may affect the controlled group status.
Identical Ownership: For a brother-sister controlled group, five or fewer individuals must have 80% combined ownership and at least 50% identical ownership across two or more companies. This criterion applies even if the ownership percentages vary slightly between companies, as long as the minimum thresholds are met.
Affiliation and Business Purpose: If two or more businesses provide affiliated services, they may be considered an affiliated service group even without direct ownership. Companies that collaborate closely on similar services, such as accounting or legal practices, may fall under this category because of their operational ties.

Frequently Asked Questions

How Do I Set Up a Controlled Group Solo 401(k)?

To set up a controlled group solo 401(k), first verify if your businesses qualify as a controlled group under IRS rules. Then, consult with a financial advisor or retirement plan provider to create a compliant solo 401(k) that accommodates all employees across the controlled group.

Can a Controlled Group Solo 401(k) Include Employees?

Yes, if a business within the controlled group has employees, they must be included in the retirement plan. In such cases, a traditional 401(k) plan may be more suitable than a solo 401(k) due to regulatory requirements.

What Happens If I Don’t Comply with Controlled Group Rules?

Failing to follow controlled group regulations can result in IRS penalties and disqualification of the retirement plan. Ensuring your solo 401(k) adheres to controlled group requirements is crucial to maintaining its tax-advantaged status.

Bottom Line

For business owners with multiple entities, understanding how a solo 401(k) plan works in a controlled group setting is essential for ensuring compliance and optimizing retirement savings. Controlled group rules can impact the tax-advantaged status of a solo 401(k) and also to administrative costs. By following IRS guidelines and seeking professional advice, business owners can establish a retirement plan that aligns with their financial goals while meeting regulatory requirements.

Tips for Retirement Planning

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