Replacing one 401(k) plan with another

[Santo Gold]

I talked with a doc's office who just recently discovered that their 401(k) plan has been top heavy since inception (mid 90's) and they have not been making the required 3% contribution for all non-key's (the 3 keys have 401(k) contributions well over 3% of pay). They are in the process of determining the liability for all of those years and turning themselves into the IRS.

In the meantime, they's like to start a second 401(k) plan with the goal of eventually terminating plan #1. I assume they want to "freeze" if you will 401k #1, with no new money coming into it. Keep it around until they resolve matters with the IRS. Starting in 2005, they want to start 401(k) #2, for the same group of ee's (all employees) with probably the same or similar plan specs.

Other than plan #2 not really being necessary, is there anything wrong with this scenario? Am I correct that they should not terminate #1 until after the problems are resolved?

[MWeddell]

There's a rule in the 401(k) regulations that prohibits distributing plan assets attributable to 401(k) elective contributions due to the termination of the plan if the same employees are eligible for another 401(k) plan sponsored by the same "employer." Check out Treas. Reg. 1.401(k)-1(d)(3) for more details.