Can A 401k Plan Be Temporarily Frozen?

[mming]

A company sponsors a 401k plan where the two owners are the only participants (they are the only employees). They are planning on hiring dozens of people within the next few months and were wondering whether it was possible to "freeze" the plan via amendment so that these employees cannot become participants even if they would otherwise satisfy the plan's eligibility requirements. They do not want to terminate the plan because they will probably be back to just employing the owners in about 5 years, at which point they would "unfreeze" the plan and resume making deferrals and profit sharing contributions. Even though it's very likely that the overwhelming majority of these new employees will not defer and, therefore, not have any account balances in the plan, they would rather not have them participate as it would significantly increase the plan's administrative cost. Is it possible to do this?

[ESOP Guy]

How much does it cost to allow people to defer in terms of recordkeeping?

That issue aside I think the best way to do what they want is to amend the plan into a Profit Sharing plan with no 401(k) provisions. You make the PS contribution discresionary and if they never decide to put one in for a few years that is fine.

However, one of the requirements for a plan is some kind of "on going" requirement. (Forget the legal term) If you go too many years and don't make a contribution and it starts to look like you are never going to one again I seem to recall that can be an issue. It has been a few years since I have had that issue come up in a plan.

I would not make the plan such that the rank and file can not become eligible to enter the plan and only the owners are allowed to enter the plan. Beside making it a Profit Sharing plan with no 401(k) allows them to change their mind at a later date. If after a few years they decide the employees are going to be around for a while they can add the 401(k) provision back or start making PS contributions.

[jpod]

If they are willing to incur the expense and burden of maintaining a frozen plan (e.g., Form 5500 filings, amendments to reflect changes in law, etc.), I don't understand the reluctance to let the employees contribute.

On the other hand, if I am to take it as a given that they don't want the employees to be able to contribute, then I don't understand the reluctance to terminate the plan and get rid of the expense and burden for the next five years or so.

[rcline46]

There are Top Heavy issues as well as ongoing contribution requirements. They are better off terminating the plan.

[jpod]

Why t-h issues if nothing is going in for the keys (elective or non-elective)? That was my understanding of the facts. Still, I agree termination is best.

[ESOP Guy]

Ok, let me be clear. I didn't suggest termination becasue the orginal questions seemed to reject the idea. I think a strong case for termination can be made I simply gave what I thought was the best answer if termination was rejected.

[masteff]

Depending on the investment firm they're using, they could amend the current plan (if needed) to permit in-kind distribution, which would mean they wouldn't even have to liquidate assets to rollover out of the terminating plan.

I think the real question is what would they gain by paying 5 years of plan fees. Only thought is if one or both have an outstanding loan and can't afford/don't want to repay it currently. I suppose the calculation is ( cost of 5 years admin + 2 amendments to freeze/unfreeze ) vs ( plan termination + new plan setup ). You might show the breakeven of how many years of admin is cheaper than termination.

Anecdotally speaking, I can point you to two plans (one DB and one DC) that were frozen in 1997 and are still in existence. Of course those employees are unionized and now actively participate in other plans of the employer. The 401(k) continues to permit loans and other distributions.

[david rigby]

There may be other issues when comparing a terminated plan (presumably with rollover to IRA) vs. frozen plan. For example, the bankruptcy protections differ for IRA vs. qualified plan.

[BG5150]

I suppose the calculation is ( cost of 5 years admin + 2 amendments to freeze/unfreeze ) vs ( plan termination + new plan setup ). You might show the breakeven of how many years of admin is cheaper than termination.

Don't forget PPA restatement in a couple years....

[mming]

Thank you all for your responses. The permanence aspect is a valid point and the employer has been informed that they shouldn't go more than just a few years before they make another contribution.

At the heart of the issue is how the administrative cost will increase exponentially if the plan goes from having just 2 participants to several hundred. To Masteff's point, a cost analysis has determined that it would be less expensive to pay for the ongoing admin on a 2-life plan than to terminate the plan and then start up a new one once the employer goes back to just having 2 employees.

As mention of a frozen DC plan was made, it appears that doing so is possible. However, since I've heard people refer to a plan as being frozen only because contributions are not being made, can this be taken to mean that it's OK for an amendment to also prohibit new employees from entering the plan?