Nondiscrimination Requirements for
Certain Defined Contribution Retirement Plans
DEPARTMENT OF THE TREASURY
Internal Revenue Service 26 CFR Part 1 [TD 8954] RIN 1545-AY36
TITLE: Nondiscrimination Requirements for Certain Defined
Contribution Retirement Plans
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
SUMMARY: This document contains final regulations that permit
certain defined contribution retirement plans to demonstrate
compliance with the nondiscrimination requirements based on plan
benefits rather than contributions. Under the final regulations, a
defined contribution plan can test on a benefits basis if it
provides broadly available allocation rates, age-based allocations,
or passes a gateway requiring allocation rates for nonhighly
compensated employees to be at least 5% of pay or at least 1/3 of
the highest allocation rate for highly compensated employees. The
regulations also permit qualified defined contribution and defined
benefit plans that are tested together as a single, aggregated plan
(and that are not primarily defined benefit or broadly available
separate plans) to test on a benefits basis after passing a similar
gateway, under which the allocation rate for nonhighly compensated
employees need not exceed 7½ % of pay. These final
regulations affect employers that maintain qualified retirement
plans and qualified retirement plan participants.
DATES: Effective Date: These regulations are effective June 29,
2001..2 Applicability Date: These regulations apply for plan years
beginning on or after January 1, 2002.
FOR FURTHER INFORMATION CONTACT: John T. Ricotta, 202-622-6060 or
Linda S. F. Marshall, 202-622-6090 (not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Background
This document contains amendments to 26 CFR part 1 under section
401(a)(4) of the Internal Revenue Code of 1986 (Code).
Section 401(a)(4) provides that a plan or trust forming part of a
stock bonus, pension, or profit-sharing plan of an employer shall
not constitute a qualified plan under section 401(a) of the Code
unless the contributions or benefits provided under the plan do not
discriminate in favor of highly compensated employees (HCEs) (within
the meaning of section 414(q)). Whether a plan satisfies this
requirement depends on the form of the plan and its effect in
operation.
Section 415(b)(6)(A) provides that the computation of benefits under
a defined contribution plan, for purposes of section 401(a)(4),
shall not be made on a basis inconsistent with regulations
prescribed by the Secretary. The legislative history of this
provision explains that, in the case of target benefit and other
defined contribution plans, "regulations may establish reasonable
earnings assumptions and other factors for these plans to prevent
discrimination." Conf. Rep. No. 1280, 93d Cong., 2d Sess. 277
(1974)..3
Under the section 401(a)(4) regulations, a plan can demonstrate that
either the contributions or the benefits provided under the plan are
nondiscriminatory in amount. Defined contribution plans generally
satisfy the regulations by demonstrating that contributions are
nondiscriminatory in amount, through certain safe harbors provided
for under the regulations or through general testing.
A defined contribution plan (other than an ESOP) may, however,
satisfy the regulations on the basis of benefits by using cross-
testing pursuant to rules provided in §1.401(a)(4)-8 of the
regulations. Under this cross-testing method, contributions are
converted, using actuarial assumptions, to equivalent benefits
payable at normal retirement age, and these equivalent benefits are
tested in a manner similar to the testing of employer-provided
benefits under a defined benefit plan.
In Notice 2000-14 (2000-10 I.R.B. 737), released February 24, 2000,
the IRS and the Treasury Department initiated a review of issues
related to use of the cross-testing method by so-called new
comparability plans and requested public comments on this plan
design from plan sponsors, participants and other interested
parties. In general, new comparability plans are defined
contribution plans that have built-in disparities between the
allocation rates for classifications of participants consisting
entirely or predominantly of HCEs and the allocation rates for other
employees.
In a typical new comparability plan, HCEs receive high allocation
rates, while nonhighly compensated employees (NHCEs), regardless of
their age or years of service, receive comparatively low allocation
rates. For example, HCEs in such a plan might receive allocations of
18 or 20% of compensation, while NHCEs might receive.4 allocations
of 3% of compensation. A similar plan design, sometimes known as a
super-integrated plan, provides for an additional allocation rate
that applies only to compensation in excess of a specified
threshold, but the specified threshold (e.g., $100,000) or the
additional allocation rate (e.g., 10%) is higher than the maximum
threshold and rate allowed under the permitted disparity rules of
section 401(l).
These new comparability and similar plans rely on the cross-testing
method to demonstrate compliance with the nondiscrimination rules by
comparing the actuarially projected value of the employer
contributions for the younger NHCEs with the actuarial projections
of the larger contributions (as a percentage of compensation) for
the older HCEs. As a result, these plans are able generally to
provide higher rates of employer contributions to HCEs, while NHCEs
are not allowed to earn the higher allocation rates as they work
additional years for the employer or grow older. Notwithstanding the
analytical underpinnings of cross-testing, the IRS and Treasury
Department became concerned that new comparability and similar plans
were not consistent with the basic purpose of the nondiscrimination
rules under section 401(a)(4).
After consideration of the comments received in response to Notice
2000-14, the IRS and Treasury issued proposed regulations on this
subject (REG-114697-00), which were published in the Federal
Register on October 6, 2000 (65 FR 59774). The proposed regulations
preserved the cross-testing rules of the section 401(a)(4)
regulations, but prescribed a gateway condition for new
comparability and similar plans to meet in order to be eligible to
use cross-testing to satisfy the nondiscrimination rules on the
basis of benefits. However, defined contribution plans that provide
broadly.5 available allocation rates, as defined in the proposed
regulations, did not have to satisfy the gateway. The definition of
broadly available allocation rates under the proposed regulations
covered plans that provide different allocation rates to different,
nondiscriminatory groups of employees. Under the proposed
regulations, the definition also covered plans that base allocations
or allocation rates on age or years of service, that, in contrast to
new comparability plans, provide an opportunity for participants to
"grow into" higher allocation rates as they age or accumulate
additional service.
The proposed regulations also addressed a new comparability-type
plan design that aggregates a defined benefit plan that benefits
primarily HCEs with a defined contribution plan that benefits
primarily NHCEs. This design would permit an employer to circumvent
the minimum allocation gateway by aggregating (for purposes of the
nondiscrimination rules) a new comparability or similar defined
contribution plan with a defined benefit plan that provides only
minimal benefits to NHCEs or covers only a relatively small number
of NHCEs. In addition, a defined benefit plan that benefits
primarily HCEs, and that is aggregated with a defined contribution
plan for nondiscrimination testing, could produce results similar to
a new comparability plan but with a potential for substantially more
valuable benefits for HCEs. The proposed regulations provided a
gateway for testing the aggregated plans on the basis of benefits
that must be satisfied unless the aggregated defined contribution
and defined benefit plan (the DB/DC plan) is primarily defined
benefit in character (as defined in the proposed regulations), or
unless each of the defined contribution and defined benefit.6
portions of the DB/DC plan is a broadly available separate plan (as
defined in the proposed regulations).
Written comments responding to the notice of proposed rulemaking
were received, and a public hearing was held on January 25, 2001, at
the request of one commentator. After consideration of the comments,
the proposed regulations are adopted as revised by this Treasury
decision. Explanation of Provisions
A. Overview
Like the proposed regulations, these final regulations permit
defined contribution plans with either broadly available allocation
rates or certain age-based allocation rates to test on a benefits
basis (cross-test) in the same manner as under current law, and
permit other defined contribution plans to cross-test once they pass
a gateway that prescribes minimum allocation rates for NHCEs.
Similarly, these final regulations retain the rule in the proposed
regulations that permits a DB/DC plan to test on a benefits basis in
the same manner as under current law if the DB/DC plan either is
primarily defined benefit in character or consists of broadly
available separate plans. Other DB/DC plans are permitted to test on
a benefits basis once they pass a corresponding gateway prescribing
minimum aggregate normal allocation rates for NHCEs.
B. Gateway for Cross-Testing of New Comparability and Similar Plans
These final regulations retain the rule in the proposed regulations
that requires a defined contribution plan that does not provide
broadly available allocation rates or certain age-based allocation
rates (as these terms are defined in these final.7 regulations) to
satisfy a gateway in order to be eligible to use the cross-testing
rules to meet the nondiscrimination requirements of section 401(a)
(4). Under these final regulations, as under the proposed
regulations, a plan satisfies this minimum allocation gateway if
each NHCE in the plan has an allocation rate that is at least one
third of the allocation rate of the HCE with the highest allocation
rate, but a plan is deemed to satisfy the gateway if each NHCE
receives an allocation of at least 5% of the NHCE's compensation
(within the meaning of section 415(c)(3)).
Several commentators raised questions about the interaction of the
requirements under the proposed regulations and other regulatory
rules relating to testing for nondiscrimination. For example, some
commentators asked what was intended by the gateway requirement that
all NHCEs receive the minimum required allocation. Except as
specifically provided, the regulatory definitions and rules that
apply for purposes of section 401(a)(4) also apply for purposes of
these regulations. For example, the term employee, as used in these
regulations, is defined in §1.401(a)(4)-12 as an employee
(within the meaning of §1.410(b)-9) who benefits as an employee
under the plan for the plan year, and an NHCE is defined in
§1.401(a)(4)-12 as an employee who is not an HCE. Thus, an
individual who does not otherwise benefit under the plan for the
plan year is not an employee under these regulations, hence not an
NHCE, and need not be given the minimum required allocation under
the gateway. Similarly, the allocation rate referred to in the
gateway is determined under §1.401(a)(4)-2(c) as the
allocations to an employee's account for a plan year, expressed
either as a percentage of plan year compensation (which must be
calculated.8 using a definition of compensation that satisfies the
requirements of section 414(s)) or as a dollar amount.
The general rules and regulatory definitions applicable under
section 410(b) apply also for purposes of these regulations. For
example, these regulations do not change the general rule
prohibiting aggregation of a 401(k) plan or 401(m) plan with a plan
providing nonelective contributions. Accordingly, matching
contributions are not taken into account for purposes of the
gateway. Similarly, pursuant to §1.410(b)-6( b)(3), if a plan
benefits employees who have not met the minimum age and service
requirements of section 410(a)(1), the plan may be treated as two
separate plans, one for those otherwise excludable employees and one
for the other employees benefitting under the plan. Thus, if the
plan is treated as two separate plans in this manner, cross-testing
the portion of the plan benefitting the nonexcludable employees will
not result in minimum required allocations under the gateway for the
employees who have not met the section 410(a)(1) minimum age and
service requirements.
One commentator suggested that the regulatory provision that permits
a plan to satisfy the gateway requirement by providing an allocation
of at least 5% of compensation within the meaning of section 415(c)
(3) not require that the allocation be based on a full year's
compensation in the case of an employee who participates in the plan
for only a portion of the plan year. The final regulations modify
this requirement as suggested. The final regulations allow a plan to
satisfy the gateway by providing an allocation of at least 5% of
compensation within the meaning of section 415(c)(3), limited to a
period otherwise permissible under the timing rules applicable under
the.9 definition of plan year compensation, in the same manner as
the general rules under the section 401(a)(4) regulations. The
definition of plan year compensation permits use of amounts paid
only during the period of participation within the plan year. Some
commentators questioned whether it was necessary to require the use
of compensation within the meaning of section 415(c)(3) for purposes
of the 5% of compensation component of the minimum allocation
gateway. One of these commentators argued that using compensation
within the meaning of section 414(s) would be more appropriate. Two
other commentators argued that, for this purpose, plans should be
able to use a definition of compensation that would be a reasonable
definition of compensation for purposes of section 414(s) without
regard to whether the definition of compensation meets the
nondiscrimination standard under the section 414(s) regulations.
After consideration of these comments, the requirement that section
415(c)(3) compensation be used for purposes of the 5% of
compensation component of the minimum allocation gateway has been
retained. For purposes of the "one third" component of the gateway,
a definition of compensation that satisfies section 414(s) is an
appropriate measure because this component is based on the ratio of
HCE allocation rates to NHCE allocation rates. By contrast, the 5%
of compensation component of the gateway does not reflect a
comparison of NHCE allocations to HCE allocations, but is based on a
particular level of NHCE allocations. Without the comparison between
HCE and NHCE allocations, a rule permitting the use of a definition
of compensation that satisfies section 414(s), but is less inclusive
than total.10 compensation, could lead to NHCE allocations that are
significantly smaller than the minimum that is contemplated by the
regulations. Therefore, it is appropriate to require the use of
total compensation, as defined in section 415(c)(3), for the 5%
allocation component of the gateway. Furthermore, permitting the use
of a potentially discriminatory definition of compensation would be
inconsistent with the nondiscrimination requirements in general,
including the minimum allocation gateway.
C. Plans with Broadly Available Allocation Rates
Like the proposed regulations, these final regulations provide that
a plan that has broadly available allocation rates need not satisfy
the minimum allocation gateway. In order to be broadly available,
each allocation rate under the plan must be currently available to a
group of employees that satisfies section 410(b) (without regard to
the average benefit percentage test). Thus, if, within one plan, an
employer provides different allocation rates for nondiscriminatory
groups of employees at different locations or different profit
centers, the plan would not need to satisfy the minimum allocation
gateway in order to use cross-testing.
For purposes of determining whether an allocation rate that was
available only to employees who satisfied an age or service
condition was currently available to a section 410(b) group, the
proposed regulations allowed such a condition to be disregarded if
certain standards were met. The final regulations retain this
exception from the application of the minimum allocation gateway.
However, this exception has been relocated and is now part of an
expanded provision for plans with age-based allocations (see Plans
with Age-Based Allocations portion of this preamble)..11 In response
to comments, the final regulations also liberalize the determination
of whether a plan has broadly available allocation rates. First, the
final regulations permit two allocation rates to be aggregated in a
manner similar to the rule that permits aggregation of certain
benefits, rights or features. This rule permits excess NHCEs with a
higher allocation rate to be used to support a lower allocation
rate. For example, under this rule, if under a plan there are two
groups of participants, one group that receives an allocation rate
of 10% and another that receives an allocation rate of 3%, and if
the group of employees who receive the 10% allocation rate satisfies
section 410(b) (without regard to the average benefit percentage
test), then the 10% rate and the 3% rate can be aggregated and
treated as a single allocation rate for purposes of determining
whether the plan has broadly available allocation rates. In
addition, the final regulations provide that, in determining whether
a plan provides broadly available allocation rates, differences in
allocation rates resulting from any method of permitted disparity
provided for under the section 401(l) regulations are disregarded.
D. Transition Allocations
Several commentators raised the concern that a defined contribution
plan may fail the broadly available test because of grandfathered
allocation rates provided to employees who formerly participated in
a defined benefit plan or provided to a group of employees in
connection with a merger, acquisition, or other similar transaction.
In response to these comments, the final regulations permit an
employee's allocation to be disregarded, to the extent the
employee's allocation is a transition allocation (as defined in the
regulations) for the plan year. Transition allocations which can
be.12 disregarded can be defined benefit replacement allocations,
pre-existing replacement allocations, or pre-existing merger and
acquisition allocations (as defined in the regulations).
In each case, the transition allocations must be provided to a
closed group of employees and must be established under plan
provisions. Once the allocations are established under the plan,
they cannot be modified, except to reduce allocations for HCEs, or
because of de minimis changes (such as a change in the definition of
compensation to include section 132(f) elective reductions). A plan
also does not violate this requirement because of an amendment that
either adds or removes a provision applicable to all employees in
the group eligible for the allocations under which each employee who
is eligible for a transition allocation receives the greater of the
transition allocation or another allocation for which the employee
would otherwise be eligible. If the plan provides that all employees
who are eligible for the transition allocation receive the greater
of the transition allocation or an otherwise available allocation,
the otherwise available allocation is considered currently available
to all such employees, including employees for whom the transition
allocation is greater.
These final regulations set forth basic conditions for defined
benefit replacement allocations. These conditions provide a
framework that is designed to ensure that these allocations are
provided in a manner consistent with the general principles
underlying the provisions for broadly available allocation rates
under these regulations. The regulations then delegate authority to
the Commissioner to prescribe rules for defined benefit replacement
allocations in revenue rulings, notices, and other guidance.13
published in the Internal Revenue Bulletin. Rev. Rul. 2001-30
(2001-29 I.R.B.), dated July 16, 2001, published in conjunction with
these final regulations, prescribes specific conditions for defined
benefit replacement allocations that relate to the basic conditions
set forth in the regulations. This division of the medium of
guidance is designed to provide ongoing flexibility to the IRS and
Treasury to respond to changing circumstances, or additional
information relating to defined benefit replacement allocations.
The basic conditions that allocations must satisfy in order to be
defined benefit replacement allocations are as follows: (1) The
allocations are provided to a group of employees who formerly
benefitted under an established nondiscriminatory defined benefit
plan of the employer or of a prior employer that provided age-based
equivalent allocation rates; (2) the allocations for each employee
were reasonably calculated, in a consistent manner, to replace the
retirement benefits that the employee would have been provided under
the defined benefit plan if the employee had continued to benefit
under the defined benefit plan; (3) no employee who receives the
allocation receives any other allocations under the plan for the
plan year (except as provided in these regulations); and (4) the
composition of the group of employees who receive the allocations is
nondiscriminatory.
Rev. Rul. 2001-30 fleshes out these basic conditions for determining
whether an allocation is a defined benefit replacement allocation.
Under the revenue ruling, the defined benefit plan's benefit formula
applicable to the group of employees must be one that generated
equivalent normal allocation rates (determined without regard to.14
changes in accrual rates attributable to changes in an employee's
years of service) that increased from year to year as employees
attained higher ages. Further, if the defined benefit plan was
sponsored by the employer, the defined benefit plan satisfied
sections 410(b) and 401(a)(4), without regard to section 410(b)(6)
(C) and without aggregating with any other plan, for the plan year
which immediately precedes the first plan year for which the
allocations are provided. Finally, the defined benefit plan must be
one that has been established and maintained without substantial
change for at least the 5 years ending on the date benefit accruals
under the defined benefit plan cease (with one year substituted for
5 years in the case of a defined benefit plan of a former employer).
In order to be defined benefit replacement allocations for the plan
year, the allocations for each employee in the group must be
reasonably calculated, in a consistent manner, to replace the
employee's retirement benefits under the defined benefit plan based
on the terms of the defined benefit plan (including the section
415(b)(1)(A) limit) as in effect immediately prior to the date
accruals under the defined benefit plan cease. In addition, the
group of employees who receive the allocations in a plan year must
satisfy section 410(b) (determined without regard to the average
benefit percentage test of §1.410(b)-5).
Although the regulations and Rev. Rul. 2001-30 prescribe conditions
for the defined benefit replacement allocations, they still leave
employers with flexibility in structuring these benefits. For
example, there is more than one way in which the.15 allocations may
reasonably be calculated, such as a level percentage of pay for each
year or an amount that increases as the employee ages.
The final regulations provide special rules applicable to
allocations that are either pre-existing replacement allocations or
pre-existing merger and acquisition allocations. Allocations are
pre-existing replacement allocations if the allocations are provided
pursuant to a plan provision adopted before June 29, 2001, are
provided to employees who formerly benefitted under a defined
benefit plan and are reasonably calculated, in a consistent manner,
to replace some or all of the retirement benefits that the employee
would have received under the defined benefit plan and any other
plan or arrangement of the employer if the employee had continued to
benefit under such defined benefit plan and such other plan or
arrangement. Allocations are pre-existing merger and acquisition
allocations if the allocations were established in connection with a
stock or asset acquisition, merger, or other similar transaction
occurring prior to August 28, 2001, for a group of employees who
were employed by the acquired trade or business prior to a specified
date, provided that the class of employees eligible for the
allocations is closed no later than two years after the transaction
(or January 1, 2002, if earlier), the allocations are provided
pursuant to a plan amendment adopted by the date the class was
closed, and the allocations for each employee in the group are
reasonably calculated, in a consistent manner, to replace some or
all of the retirement benefits that the employee would have received
under any plan of the employer if the new employer had continued to
provide the retirement benefits that the prior employer was
providing for employees of the trade or business..16
E. Plans with Age-Based Allocations
These final regulations provide a separate exception from the
application of the minimum allocation gateway for certain plans with
age-based allocation rates. This provision incorporates the
exception under the proposed regulations for plans with gradual age
or service schedules, and expands the exception to include plans
that provide for allocation rates based on a uniform target benefit
allocation. A plan has a gradual age or service schedule if the
schedule of allocation rates under the plan's formula is available
to all employees in the plan and provides for allocation rates that
increase smoothly at regular intervals. The rules applicable to the
schedule of allocation rates are designed to be sufficiently
flexible to accommodate a wide variety of age- or service-based
plans (including age-weighted profit-sharing plans that provide for
allocations resulting in the same equivalent accrual rate for all
employees). The final regulations clarify that a plan projecting
future age or service may not use imputed disparity in determining
whether the allocation rates under the schedule increase smoothly at
regular intervals. In response to comments, the final regulations
also accommodate smoothly increasing schedules of allocation rates
that are based on the sum of age and years of service. In addition,
to conform with the rules for computation of service under
§1.401(a)(4)-12, references to service have been changed to
years of service.
The requirement that the allocation rates under a schedule increase
smoothly at regular intervals provides important protection for
employees, because this requirement limits the exception from the
minimum allocation gateway to plans in which NHCEs.17 actually
receive the benefit of higher rates as they attain higher ages or
complete additional years of service. Some commentators expressed
concern that employers could be forced to reduce allocations to
younger or shorter-service NHCEs in order to satisfy the conditions
for allocation rates that increase smoothly at regular intervals. In
response to these comments, the final regulations provide that a
plan's schedule of allocation rates does not fail to increase
smoothly at regular intervals merely because a specified minimum
uniform allocation rate is provided for all employees or because the
minimum benefit described in section 416(c)(2) is provided for all
non-key employees (either because the plan is top heavy or without
regard to whether the plan is top heavy) if one of two alternative
conditions is satisfied. These two alternative conditions are
intended to limit the potential use of a minimum allocation to
provide a schedule of rates that delivers allocations similar to
those under a new comparability plan (i.e., a flat allocation rate
applicable for all employees below a certain age, followed by a
sharply increasing schedule of rates that effectively benefits only
HCEs) without satisfying the minimum allocation gateway.
A plan satisfies the first alternative condition if the allocation
rates under the plan that exceed the specified minimum rate could
form part of a schedule of allocation rates that increase smoothly
at regular intervals (as defined in these regulations) in which the
lowest allocation rate is at least 1% of plan year compensation. The
second alternative condition, available for a plan using an age-
based schedule, allows the use of a minimum allocation rate if, for
each age band above the minimum allocation rate, the allocation rate
applicable for that band is less than or equal to the allocation
rate.18 No exception to the minimum allocation gateway is needed for
target benefit 1 plans that comply with the safe-harbor testing
provisions of §1.401(a)(4)-8(b)(3), because they are deemed to
satisfy section 401(a)(4) with respect to an equivalent amount of
benefits.
that would yield an equivalent accrual rate at the highest age in
the band that is the same as the equivalent accrual rate determined
for the oldest hypothetical employee who would receive just the
minimum allocation rate. Thus, under this condition, the allocation
rates above the minimum allocation rate do not rise more steeply
than expected under an age-weighted profit-sharing plan generally
intended to provide the same accrual rate at all ages.
The exception to the minimum allocation gateway for plans with age-
based allocation rates also applies to certain uniform target
benefit plans that do not comply with the safe-harbor testing method
provided in §1.401(a)(4)-8(b)(3). A plan has 1 allocation rates
based on a uniform target benefit allocation if it would comply with
the requirements for a safe harbor target benefit plan in
§1.401(a)(4)-8(b)(3) except that the interest rate for
determining the actuarial present value of the stated plan benefit
and the theoretical reserve is lower than a standard interest rate,
the stated benefit is calculated assuming compensation increases, or
the plan computes the current year contribution using the actual
account balance instead of the theoretical reserve.
F. Application to Defined Contribution Plans That Are Combined with
Defined Benefit Plans (DB/DC Plans)
These regulations prescribe rules for testing defined contribution
plans that are aggregated with defined benefit plans for purposes of
sections 401(a)(4) and 410(b)..19 These rules apply in situations in
which the employer aggregates the plans because one of the plans
does not satisfy sections 401(a)(4) and 410(b) standing alone. These
rules do not apply to safe harbor floor-offset arrangements
described in §1.401(a)(4)-8( d), or to the situation in which
plans are aggregated solely for purposes of satisfying the average
benefit percentage test of §1.410(b)-5. These regulations
retain the rule of the proposed regulations that the combination of
a defined contribution plan and a defined benefit plan may
demonstrate nondiscrimination on the basis of benefits if the
combined plan (the DB/DC plan) is primarily defined benefit in
character, consists of broadly available separate plans (as these
terms are defined in the regulations), or satisfies a minimum
aggregate allocation gateway requirement that is generally similar
to the minimum allocation gateway for defined contribution plans
that are not combined with a defined benefit plan.
1. Gateway for benefits testing of combined plans
In order to apply this minimum aggregate allocation gateway, the
employee's aggregate normal allocation rate is determined by adding
the employee's allocation rate under the defined contribution plan
to the employee's equivalent allocation rate under the defined
benefit plan. This aggregation allows an employer that provides
NHCEs with both a defined contribution and a defined benefit plan to
take both plans into account in determining whether the minimum
aggregate allocation gateway is met. Under the gateway, if the
aggregate normal allocation rate of the HCE with the highest
aggregate normal allocation rate under the plan (HCE rate) is less
than 15%, the aggregate normal allocation rate for all NHCEs must be
at least 1/3 of the HCE.20 rate. If the HCE rate is between 15% and
25%, the aggregate normal allocation rate for all NHCEs must be at
least 5%. If the HCE rate exceeds 25%, then the aggregate normal
allocation rate for each NHCE must be at least 5% plus one
percentage point for each 5-percentage-point increment (or portion
thereof) by which the HCE rate exceeds 25% (e.g., the NHCE minimum
is 6% for an HCE rate that exceeds 25% but not 30%, and 7% for an
HCE rate that exceeds 30% but not 35%).
Several commentators expressed a concern that the minimum aggregate
allocation gateway in the proposed regulations could require
contributions for NHCEs that would make DB/DC plans too expensive
for employers in certain circumstances. This could occur in cases
where one HCE had a very high equivalent allocation rate on account
of age or some other factor, and could prompt such an employer to
redesign its plans in ways that could disadvantage NHCEs. In
response to these comments, these final regulations provide that a
plan is deemed to satisfy this minimum aggregate allocation gateway
if the aggregate normal allocation rate for each NHCE is at least
7½% of compensation within the meaning of section 415(c)(3),
determined over a period otherwise permissible under the timing
rules applicable under the definition of plan year compensation.
These regulations retain the rule that, in determining the
equivalent allocation rate for an NHCE under a defined benefit plan,
a plan is permitted to treat each NHCE who benefits under the
defined benefit plan as having an equivalent allocation rate equal
to the average of the equivalent allocation rates under the defined
benefit plan for all NHCEs benefitting under that plan. This
averaging rule recognizes the grow-in.21 feature inherent in
traditional defined benefit plans (i.e., the defined benefit plan
provides higher equivalent allocation rates at higher ages).
2. Primarily defined benefit in character
Like the proposed regulations, these final regulations provide that
a DB/DC plan that is primarily defined benefit in character is not
subject to the gateway requirement and may continue to be tested for
nondiscrimination on the basis of benefits as under former law. A
DB/DC plan is primarily defined benefit in character if, for more
than 50% of the NHCEs benefitting under the plan, the normal accrual
rate attributable to benefits provided under defined benefit plans
for the NHCE exceeds the equivalent accrual rate attributable to
contributions under defined contribution plans for the NHCE. For
example, a DB/DC plan is primarily defined benefit in character
where the defined contribution plan covers only salaried employees,
the defined benefit plan covers only hourly employees, and more than
half of the NHCEs participating in the DB/DC plan are hourly
employees participating only in the defined benefit plan.
Some comments suggested a loosening of the standard as to when a
DB/DC plan is primarily defined benefit in character, but no changes
have been made. The Treasury and IRS believe that the determination
of whether a DB/DC plan is primarily defined benefit in character
should be based on the relative size of the defined benefit accruals
and the defined contribution allocations for individual employees,
as reflected in the actual benefits testing that is being done under
section 401(a)(4). In particular, the actuarial assumptions used to
determine whether a DB/DC plan is primarily defined.22 benefit in
character must be the same assumptions that are used to apply the
cross-testing rules.
3. Broadly available separate plans
Like the proposed regulations, these final regulations provide that
a DB/DC plan that consists of broadly available separate plans may
continue to be tested for nondiscrimination on the basis of benefits
as under current law, even if it does not satisfy the gateway
requirement. A DB/DC plan consists of broadly available separate
plans if the defined contribution plan and the defined benefit plan,
tested separately, would each satisfy the requirements of section
410(b) and the nondiscrimination in amount requirement of
§1.401(a)(4)-1(b)(2), assuming satisfaction of the average
benefit percentage test of §1.410(b)-5. Thus, the defined
contribution plan must separately satisfy the nondiscrimination
requirements (taking into account these regulations as applicable),
but for this purpose assuming satisfaction of the average benefit
percentage test. Similarly, the defined benefit plan must separately
satisfy the nondiscrimination requirements, assuming for this
purpose satisfaction of the average benefit percentage test. In
conducting the required separate testing, all plans of a single type
(defined contribution or defined benefit) within the DB/DC plan are
aggregated, but those plans are tested without regard to plans of
the other type.
This alternative is useful, for example, where an employer maintains
a defined contribution plan that provides a uniform allocation rate
for all covered employees at one business unit and a safe harbor
defined benefit plan for all covered employees at another unit, and
where the group of employees covered by each of those plans is a.23
group that satisfies the nondiscriminatory classification
requirement of section 410(b). Because the employer provides broadly
available separate plans, it may continue to aggregate the plans and
test for nondiscrimination on the basis of benefits, as an
alternative to using the qualified separate line of business rules
or demonstrating satisfaction of the average benefit percentage
test.
G. Use of Component Plans
As under the proposed regulations, the rules set forth in these
final regulations cannot be satisfied using component plans under
the restructuring rules. Although some commentators requested that
restructuring be permitted for this purpose, the IRS and Treasury
have determined that such use of component plans would be
inconsistent with the purpose of these regulations.
Effective Date
These regulations apply for plan years beginning on or after January
1, 2002.
Special Analyses
It has been determined that this Treasury decision is not a
significant regulatory action as defined in Executive Order 12866.
Therefore, a regulatory assessment is not required. It also has been
determined that section 553(b) of the Administrative Procedure Act
(5 U.S.C. chapter 5) does not apply to these regulations, and
because the regulation does not impose a collection of information
on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter
6) does not apply. Pursuant to section 7805(f) of the Code, the
notice of proposed rulemaking preceding these regulations was
submitted to the Chief Counsel for Advocacy of the Small Business
Administration.24 for comment on its impact on small business.
Drafting Information
The principal authors of these regulations are John T. Ricotta and
Linda S. F. Marshall of the Office of the Division Counsel/Associate
Chief Counsel (Tax Exempt and Government Entities). However, other
personnel from the IRS and Treasury participated in their
development.
List of Subjects in 26 CFR Part 1 Income taxes, Reporting and
recordkeeping requirements. Adoption of Am ndm nts to th Regulations
Accordingly, 26 CFR part 1 is amended as follows:
PART 1 -- INCOME TAXES Paragraph 1. The authority citation for part
1 continues to read in part as follows: Authority: 26 U.S.C. 7805 *
* * Par. 2. In §1.401(a)(4)-0, the entry for §1.401(a)
(4)-8(b)(1) is revised to read as follows: §1.401(a)(4)-0 Table
of contents. * * * * * §1.401(a)(4)-8 Cross-testing. * * * * *
(b) * * * (1) General rule and gateway. * * * * * Par. 3. In
§1.401(a)(4)-8, paragraph (b)(1) is revised to read as follows:
§1.401(a)(4)-8 Cross-testing..25 * * * * * (b)
Nondiscrimination in amount of benefits provided under a defined
contribution plan--(1) General rule and gateway--
(i) General rule. Equivalent benefits under a defined contribution
plan (other than an ESOP) are nondiscriminatory in amount for a plan
year if--
(A) The plan would satisfy §1.401(a)(4)-2(c)(1) for the plan
year if an equivalent accrual rate, as determined under paragraph
(b)(2) of this section, were substituted for each employee's
allocation rate in the determination of rate groups; and
(B) For plan years beginning on or after January 1, 2002, the plan
satisfies one of the following conditions--
(1) The plan has broadly available allocation rates (within the
meaning of paragraph (b)(1)(iii) of this section) for the plan year;
(2) The plan has age-based allocation rates that are based on either
a gradual age or service schedule (within the meaning of paragraph
(b)(1)(iv) of this section) or a uniform target benefit allocation
(within the meaning of paragraph (b)(1)(v) of this section) for the
plan year; or
(3) The plan satisfies the minimum allocation gateway of paragraph
(b)(1)(vi) of this section for the plan year.
(ii) Allocations after testing age. A plan does not fail to satisfy
paragraph (b)(1)(i)(A) of this section merely because allocations
are made at the same rate for employees who are older than their
testing age (determined without regard to the.26 current-age rule in
paragraph (4) of the definition of testing age in §1.401(a)
(4)-12) as they are made for employees who are at that age.
(iii) Broadly available allocation rates--(A) In general. A plan has
broadly available allocation rates for the plan year if each
allocation rate under the plan is currently available during the
plan year (within the meaning of §1.401(a)(4)-4(b)(2)), to a
group of employees that satisfies section 410(b) (without regard to
the average benefit percentage test of §1.410(b)-5). For this
purpose, if two allocation rates could be permissively aggregated
under §1.401(a)(4)-4(d)(4), assuming the allocation rates were
treated as benefits, rights or features, they may be aggregated and
treated as a single allocation rate. In addition, the disregard of
age and service conditions described in §1.401(a)(4)-4(b)(2)
(ii)(A) does not apply for purposes of this paragraph (b)(1)(iii)
(A).
(b) Certain transition allocations. In determining whether a plan
has broadly available allocation rates for the plan year within the
meaning of paragraph (b)(1)(iii)(A) of this section, an employee's
allocation may be disregarded to the extent that the allocation is a
transition allocation for the plan year. In order for an allocation
to be a transition allocation, the allocation must comply with the
requirements of paragraph (b)(1)(iii)(C) of this section and must be
either--
(1) A defined benefit replacement allocation within the meaning of
paragraph(b)(1)(iii)(D) of this section; or
(2) A pre-existing replacement allocation or pre-existing merger and
acquisition allocation, within the meaning of paragraph (b)(1)(iii)
(E) of this section..27
(C) Plan provisions relating to transition allocations--
(1) In general. Plan provisions providing for transition allocations
for the plan year must specify both the group of employees who are
eligible for the transition allocations and the amount of the
transition allocations.
(2) Limited plan amendments. Allocations are not transition
allocations within the meaning of paragraph (b)(1)(iii)(B) of this
section for the plan year if the plan provisions relating to the
allocations are amended after the date those plan provisions are
both adopted and effective. The preceding sentence in this paragraph
(b)(1)(iii)(C)(2) does not apply to a plan amendment that reduces
transition allocations to HCEs, makes de minimis changes in the
calculation of the transition allocations (such as a change in the
definition of compensation to include section 132(f) elective
reductions), or adds or removes a provision permitted under
paragraph (b)(1)(iii)(C)(3) of this section.
(3) Certain permitted plan provisions. An allocation does not fail
to be a transition allocation within the meaning of paragraph (b)(1)
(iii)(B) of this section merely because the plan provides that each
employee who is eligible for a transition allocation receives the
greater of such allocation and the allocation for which the employee
would otherwise be eligible under the plan. In a plan that contains
such a provision, for purposes of determining whether the plan has
broadly available allocation rates within the meaning of paragraph
(b)(1)(iii)(A) of this section, the allocation for which an employee
would otherwise be eligible is considered currently available to the
employee, even if the employee's transition allocation is
greater..28
(D) Defined benefit replacement allocation. An allocation is a
defined benefit replacement allocation for the plan year if it is
provided in accordance with guidance prescribed by the Commissioner
published in the Internal Revenue Bulletin (see § 601.601(d)(2)
(ii)(b) of this chapter) and satisfies the following conditions--
(1) The allocations are provided to a group of employees who
formerly benefitted under an established nondiscriminatory defined
benefit plan of the employer or of a prior employer that provided
age-based equivalent allocation rates;
(2) The allocations for each employee in the group were reasonably
calculated, in a consistent manner, to replace the retirement
benefits that the employee would have been provided under the
defined benefit plan if the employee had continued to benefit under
the defined benefit plan;
(3) Except as provided in paragraph (b)(1)(iii)(C) of this section,
no employee who receives the allocation receives any other
allocations under the plan for the plan year; and
(4) The composition of the group of employees who receive the
allocations is nondiscriminatory.
(e) Pre-existing transition allocations--(1) Pre-existing
replacement allocations. An allocation is a pre-existing replacement
allocation for the plan year if the allocation satisfies the
following conditions--
(i) The allocations are provided pursuant to a plan provision
adopted before June 29, 2001;.29
(ii) The allocations are provided to employees who formerly
benefitted under a defined benefit plan of the employer; and
(iii) The allocations for each employee in the group are reasonably
calculated, in a consistent manner, to replace some or all of the
retirement benefits that the employee would have received under the
defined benefit plan and any other plan or arrangement of the
employer if the employee had continued to benefit under such defined
benefit plan and such other plan or arrangement.
(2) Pre-existing merger and acquisition allocations. An allocation
is a pre-existing merger and acquisition allocation for the plan
year if the allocation satisfies the following conditions--
(i) The allocations are provided solely to employees of a trade or
business that has been acquired by the employer in a stock or asset
acquisition, merger, or other similar transaction occurring prior to
August 28, 2001, involving a change in the employer of the employees
of the trade or business;
(ii) The allocations are provided only to employees who were
employed by the acquired trade or business before a specified date
that is no later than two years after the transaction (or January 1,
2002, if earlier);
(iii) The allocations are provided pursuant a plan provision adopted
no later than the specified date; and
(iv) The allocations for each employee in the group are reasonably
calculated, in a consistent manner, to replace some or all of the
retirement benefits that the employee would have received under any
plan of the employer if the new employer had continued.30 to provide
the retirement benefits that the prior employer was providing for
employees of the trade or business.
(f) Successor employers. An employer that accepts a transfer of
assets (within the meaning of section 414(l)) from the plan of a
prior employer may continue to treat any transition allocations
provided under that plan as transition allocations under paragraph
(b)(1)(iii)(B) of this section, provided that the successor employer
continues to satisfy the applicable requirements set forth in
paragraphs (b)(1)(iii)(C) through (E) of this section for the plan
year.
(iv) Gradual age or service schedule--(A) In general. A plan has a
gradual age or service schedule for the plan year if the allocation
formula for all employees under the plan provides for a single
schedule of allocation rates under which--
(1) The schedule defines a series of bands based solely on age,
years of service, or the number of points representing the sum of
age and years of service (age and service points), under which the
same allocation rate applies to all employees whose age, years of
service, or age and service points are within each band; and
(2) The allocation rates under the schedule increase smoothly at
regular intervals, within the meaning of paragraphs (b)(1)(iv)(B)
and (C) of this section.
(b) Smoothly increasing schedule of allocation rates. A schedule of
allocation rates increases smoothly if the allocation rate for each
band within the schedule is greater than the allocation rate for the
immediately preceding band (i.e., the band with the next lower
number of years of age, years of service, or age and service points)
but by no more than 5 percentage points. However, a schedule of
allocation rates will not.31 be treated as increasing smoothly if
the ratio of the allocation rate for any band to the rate for the
immediately preceding band is more than 2.0 or if it exceeds the
ratio of allocation rates between the two immediately preceding
bands.
(c) Regular intervals. A schedule of allocation rates has regular
intervals of age, years of service or age and service points, if
each band, other than the band associated with the highest age,
years of service, or age and service points, is the same length. For
this purpose, if the schedule is based on age, the first band is
deemed to be of the same length as the other bands if it ends at or
before age 25. If the first age band ends after age 25, then, in
determining whether the length of the first band is the same as the
length of other bands, the starting age for the first age band is
permitted to be treated as age 25 or any age earlier than 25. For a
schedule of allocation rates based on age and service points, the
rules of the preceding two sentences are applied by substituting 25
age and service points for age 25. For a schedule of allocation
rates based on service, the starting service for the first service
band is permitted to be treated as one year of service or any lesser
amount of service.
(d) Minimum allocation rates permitted. A schedule of allocation
rates under a plan does not fail to increase smoothly at regular
intervals, within the meaning of paragraphs (b)(1)(iv)(B) and (C) of
this section, merely because a minimum uniform allocation rate is
provided for all employees or the minimum benefit described in
section 416(c)(2) is provided for all non-key employees (either
because the plan is top heavy or without regard to whether the plan
is top heavy) if the schedule satisfies one of the following
conditions--.32
(1) The allocation rates under the plan that are greater than the
minimum allocation rate can be included in a hypothetical schedule
of allocation rates that increases smoothly at regular intervals,
within the meaning of paragraphs (b)(1)(iv)(B) and (C) of this
section, where the hypothetical schedule has a lowest allocation
rate no lower than 1% of plan year compensation; or
(2) For a plan using a schedule of allocation rates based on age,
for each age band in the schedule that provides an allocation rate
greater than the minimum allocation rate, there could be an employee
in that age band with an equivalent accrual rate that is less than
or equal to the equivalent accrual rate that would apply to an
employee whose age is the highest age for which the allocation rate
equals the mini mum al l ocati on rate.
(v) Uniform target benefit allocations. A plan has allocation rates
that are based on a uniform target benefit allocation for the plan
year if the plan fails to satisfy the requirements for the safe
harbor testing method in paragraph (b)(3) of this section merely
because the determination of the allocations under the plan differs
from the allocations determined under that safe harbor testing
method for any of the following reasons--
(A) The interest rate used for determining the actuarial present
value of the stated plan benefit and the theoretical reserve is
lower than a standard interest rate;
(B) The stated benefit is calculated assuming compensation increases
at a specified rate; or.33
(C) The plan computes the current year contribution using the actual
account balance instead of the theoretical reserve.
(vi) Minimum allocation gateway--
(A) General rule. A plan satisfies the minimum allocation gateway of
this paragraph (b)(1)(vi) if each NHCE has an allocation rate that
is at least one third of the allocation rate of the HCE with the
highest allocation rate.
(b) Deemed satisfaction. A plan is deemed to satisfy the minimum
allocation gateway of this paragraph (b)(1)(vi) if each NHCE
receives an allocation of at least 5% of the NHCE's compensation
within the meaning of section 415(c)(3), measured over a period of
time permitted under the definition of plan year compensation.
(vii) Determination of allocation rate. For purposes of paragraph
(b)(1)(i)(B) of this section, allocations and allocation rates are
determined under §1.401(a)(4)-2(c)(2), but without taking into
account the imputation of permitted disparity under §1.401(a)
(4)-7. However, in determining whether the plan has broadly
available allocation rates as provided in paragraph (b)(1)(iii) of
this section, differences in allocation rates attributable solely to
the use of permitted disparity described in §1.401(l)-2 are
disregarded.
(viii) Examples. The following examples illustrate the rules in this
paragraph (b)(1):
Example 1.
(i) Plan M, a defined contribution plan without a minimum service
requirement, provides an allocation formula under which allocations
are provided to all employees according to the following
schedule:.34 Completed Years of Allocation Rate Ratio of Allocation
Rate for Service Band to Allocation Rate for Immediately Preceding
Band 0- 5 3.0% not applicable 6-10 4.5% 1.50 11-15 6.5% 1.44 16-20
8.5% 1.31 21-25 10.0% 1.18 26 or more 11.5% 1.15 (ii) Plan M
provides that allocation rates for all employees are determined
using a single schedule based solely on service, as described in
paragraph (b)(1)(iv)(A)(1) of this section. Therefore, if the
allocation rates under the schedule increase smoothly at regular
intervals as described in paragraph (b)(1)(iv)(A)(2) of this
section, then the plan has a gradual age or service schedule
described in paragraph (b)(1)(iv) of this section.
(iii) The schedule of allocation rates under Plan M does not
increase by more than 5 percentage points between adjacent bands and
the ratio of the allocation rate for any band to the allocation rate
for the immediately preceding band is never more than 2.0 and does
not increase. Therefore, the allocation rates increase smoothly as
described in paragraph (b)(1)(iv)(B) of this section. In addition,
the bands (other than the highest band) are all 5 years long, so the
increases occur at regular intervals as described in paragraph (b)
(1)(iv)(C) of this section. Thus, the allocation rates under the
plan's schedule increase smoothly at regular intervals as described
in paragraph (b)(1)(iv)(A)(2) of this section. Accordingly, the plan
has a gradual age or service schedule described in paragraph (b)(1)
(iv) of this section.
(iv) Under paragraph (b)(1)(i) of this section, Plan M satisfies the
nondiscrimination in amount requirement of §1.401(a)(4)-1(b)(2)
on the basis of benefits if it satisfies paragraph (b)(1)(i)(A) of
this section, regardless of whether it satisfies the minimum
allocation gateway of paragraph (b)(1)(vi) of this section.
Example 2.
(i) The facts are the same as in Example 1, except that the 4.5%
allocation rate applies for all employees with 10 years of service
or less.
(ii) Plan M provides that allocation rates for all employees are
determined using a single schedule based solely on service, as
described in paragraph (b)(1)(iv)(A)(1) of.35 this section.
Therefore, if the allocation rates under the schedule increase
smoothly at regular intervals as described in paragraph (b)(1)(iv)
(A)(2) of this section, then the plan has a gradual age or service
schedule described in paragraph (b)(1)(iv) of this section.
(iii) The bands (other than the highest band) in the schedule are
not all the same length, since the first band is 10 years long while
other bands are 5 years long. Thus, the schedule does not have
regular intervals as described in paragraph (b)(1)(iv)(C) of this
section. However, under paragraph (b)(1)(iv)(D) of this section, the
schedule of allocation rates does not fail to increase smoothly at
regular intervals merely because the minimum allocation rate of 4.5%
results in a first band that is longer than the other bands, if
either of the conditions of paragraph (b)(1)(iv)(D)(1) or (2) of
this section is satisfied.
(iv) In this case, the schedule of allocation rates satisfies the
condition in paragraph (b)(1)(iv)(D)(1) of this section because the
allocation rates under the plan that are greater than the 4.5%
minimum allocation rate can be included in the following
hypothetical schedule of allocation rates that increases smoothly at
regular intervals and has a lowest allocation rate of at least 1% of
plan year compensation:
Completed Years of Allocation Rate Ratio of Allocation Rate for
Band to Allocation Rate for
Immediately Preceding Band
0- 5 2.5% not applicable
6-10 4.5% 1.80
11-1 6.5% 1.44
16-20 8.5% 1.31
21-25 10.0% 1.18
26 or more 11.5% 1.15
(v) Accordingly, the plan has a gradual age or service schedule
described in paragraph (b)(1)(iv) of this section. Under paragraph
(b)(1)(i) of this section, Plan M satisfies the nondiscrimination in
amount requirement of §1.401(a)(4)-1(b)(2) on the basis of
benefits if it satisfies paragraph (b)(1)(i)(A) of this section,
regardless of whether it satisfies the minimum allocation gateway of
paragraph (b)(1)(vi) of this section.
Example 3.
(i) Plan N, a defined contribution plan, provides an allocation
formula under which allocations are provided to all employees
according to the.36 following schedule:
Age Allocation Rate Ratio of Allocation Rate for
Band to Allocation Rate for
Immediately Preceding Band
under 25 3.0 % not applicable
25-34 6.0 % 2.00
35-44 9.0 % 1.50
45-54 12.0% 1.33
55-64 16.0% 1.33
65 or older 21.0% 1.31
(ii) Plan N provides that allocation rates for all employees are
determined using a single schedule based solely on age, as described
in paragraph (b)(1)(iv)(A)(1) of this section. Therefore, if the
allocation rates under the schedule increase smoothly at regular
intervals as described in paragraph (b)(1)(iv)(A)(2) of this
section, then the plan has a gradual age or service schedule
described in paragraph (b)(1)(iv) of this section.
(iii) The schedule of allocation rates under Plan N does not
increase by more than 5 percentage points between adjacent bands and
the ratio of the allocation rate for any band to the allocation rate
for the immediately preceding band is never more than 2.0 and does
not increase. Therefore, the allocation rates increase smoothly as
described in paragraph (b)(1)(iv)(B) of this section. In addition,
the bands (other than the highest band and the first band, which is
deemed to be the same length as the other bands because it ends
prior to age 25) are all 5 years long, so the increases occur at
regular intervals as described in paragraph (b)(1)(iv)(C) of this
section. Thus, the allocation rates under the plan's schedule
increase smoothly at regular intervals as described in paragraph (b)
(1)(iv)(A)(2) of this section. Accordingly, the plan has a gradual
age or service schedule described in paragraph (b)(1)(iv) of this
section.
(iv) Under paragraph (b)(1)(i) of this section, Plan N satisfies the
nondiscrimination in amount requirement of §1.401(a)(4)-1(b)(2)
on the basis of benefits if it satisfies paragraph (b)(1)(i)(A) of
this section, regardless of whether it satisfies the minimum
allocation gateway of paragraph (b)(1)(vi) of this section.
Example 4.
(i) Plan O, a defined contribution plan, provides an allocation
formula under which allocations are provided to all employees
according to the following schedule:.37
Age Allocation Rate Ratio of Allocation Rate for
Band to Allocation Rate for
Immediately Preceding Band
under 40 3% not applicable
40-44 6% 2.00
45-49 9% 1.50
50-54 12% 1.33
55-59 16% 1.33
60-64 20% 1.25
65 or older 25% 1.25
(ii) Plan O provides that allocation rates for all employees are
determined using a single schedule based solely on age, as described
in paragraph (b)(1)(iv)(A)(1) of this section. Therefore, if the
allocation rates under the schedule increase smoothly at regular
intervals as described in paragraph (b)(1)(iv)(A)(2) of this
section, then the plan has a gradual age or service schedule
described in paragraph (b)(1)(iv) of this section.
(iii) The bands (other than the highest band) in the schedule are
not all the same length, since the first band is treated as 15 years
long while other bands are 5 years long. Thus, the schedule does not
have regular intervals as described in paragraph (b)(1)(iv)(C) of
this section. However, under paragraph (b)(1)(iv)(D) of this
section, the schedule of allocation rates does not fail to increase
smoothly at regular intervals merely because the minimum allocation
rate of 3% results in a first band that is longer than the other
bands, if either of the conditions of paragraph (b)(1)(iv)(D)(1) or
(2) of this section is satisfied.
(iv) In this case, in order to define a hypothetical schedule that
could include the allocation rates in the actual schedule of
allocation rates, each of the bands below age 40 would have to be 5
years long (or be treated as 5 years long). Accordingly, the
hypothetical schedule would have to provide for a band for employees
under age 30, a band for employees in the range 30-34 and a band for
employees age 35-39.
(v) The ratio of the allocation rate for the age 40-44 band to the
next lower band is 2.0. Accordingly, in order for the applicable
allocations rates under this hypothetical schedule to increase
smoothly, the ratio of the allocation rate for each band in the
hypothetical schedule below age 40 to the allocation rate for the
immediately preceding band would have to be 2.0. Thus, the
allocation rate for the hypothetical band.38 applicable for
employees under age 30 would be .75%, the allocation rate for the
hypothetical band for employees in the range 30-34 would be 1.5% and
the allocation rate for employees in the range 35-39 would be 3%.
(vi) Because the lowest allocation rate under any possible
hypothetical schedule is less than 1% of plan year compensation,
Plan O will be treated as satisfying the requirements of paragraphs
(b)(1)(iv)(B) and (C) of this section only if the schedule of
allocation rates satisfies the steepness condition described in
paragraph
(b)(1)(iv)(D)(2) of this section. In this case, the steepness
condition is not satisfied because the equivalent accrual rate for
an employee age 39 is 2.81%, but there is no hypothetical employee
in the band for ages 40-44 with an equal or lower equivalent accrual
rate (since the lowest equivalent accrual rate for hypothetical
employees within this band is 3.74% at age 44).
(vii) Since the schedule of allocation rates under the plan does not
increase smoothly at regular intervals, Plan O's schedule of
allocation rates is not a gradual age or service schedule. Further,
Plan O does not provide uniform target benefit allocations.
Therefore, under paragraph (b)(1)(i) of this section, Plan O cannot
satisfy the nondiscrimination in amount requirement of
§1.401(a)(4)-1(b)(2) for the plan year on the basis of benefits
unless either Plan O provides for broadly available allocation rates
for the plan year as described in paragraph (b)(1)(iii) of this
section (i.e., the allocation rate at each age is provided to a
group of employees that satisfies section 410(b) without regard to
the average benefit percentage test), or Plan O satisfies the
minimum allocation gateway of paragraph (b)(1)(vi) of this section
for the plan year.
Example 5.
(i) Plan P is a profit-sharing plan maintained by Employer A that
covers all of Employer A's employees, consisting of two HCEs, X and
Y, and 7 NHCEs. Employee X's compensation is $170,000 and Employee
Y's compensation is $150,000. The allocation for Employees X and Y
is $30,000 each, resulting in an allocation rate of 17.65% for
Employee X and 20% for Employee Y. Under Plan P, each NHCE receives
an allocation of 5% of compensation within the meaning of section
415(c)(3), measured over a period of time permitted under the
definition of plan year compensation.
(ii) Because the allocation rate for X is not currently available to
any NHCE, Plan P does not have broadly available allocation rates
within the meaning of paragraph (b)(1)(iii) of this section.
Furthermore, Plan P does not provide for age based-allocation rates
within the meaning of paragraph (b)(1)(iv) or (v) of this section.
Thus, under paragraph (b)(1)(i) of this section, Plan P can satisfy
the nondiscrimination in amount requirement of §1.401(a)
(4)-1(b)(2) for the plan year on the basis of benefits only if Plan
P satisfies the minimum allocation gateway of paragraph (b)(1)(vi)
of this section for the plan year.
(iii) The highest allocation rate for any HCE under Plan P is 20%.
Accordingly, Plan P would satisfy the minimum allocation gateway of
paragraph (b)(1)(vi) of this.39 section if all NHCEs have an
allocation rate of at least 6.67%, or if all NHCEs receive an
allocation of at least 5% of compensation within the meaning of
section 415(c)(3) (measured over a period of time permitted under
the definition of plan year compensation).
(iv) Under Plan P, each NHCE receives an allocation of 5% of
compensation within the meaning of section 415(c)(3) (measured over
a period of time permitted under the definition of plan year
compensation). Accordingly, Plan P satisfies the minimum allocation
gateway of paragraph (b)(1)(vi) of this section.
(v) Under paragraph (b)(1)(i) of this section, Plan P satisfies the
nondiscrimination in amount requirement of §1.401(a)(4)-1(b)(2)
on the basis of benefits if it satisfies paragraph (b)(1)(i)(A) of
this section.
* * * * *
Par. 4. Section 1.401(a)(4)-9 is amended by adding paragraph (b)(2)
(v) and revising paragraph (c)(3)(ii) to read as follows:
§1.401(a)(4)-9 Plan aggregation and restructuring.
* * * * *
(b) * * *
(2) * * *
(v) Eligibility for testing on a benefits basis--
(A) General rule. For plan years beginning on or after January 1,
2002, unless, for the plan year, a DB/DC plan is primarily defined
benefit in character (within the meaning of paragraph (b)(2)(v)(B)
of this section) or consists of broadly available separate plans
(within the meaning of paragraph (b)(2)(v)(C) of this section), the
DB/DC plan must satisfy the minimum aggregate allocation gateway of
paragraph (b)(2)(v)(D) of this section for the plan year.40 in order
to be permitted to demonstrate satisfaction of the nondiscrimination
in amount requirement of §1.401(a)(4)-1(b)(2) on the basis of
benefits.
(b) Primarily defined benefit in character. A DB/DC plan is
primarily defined benefit in character if, for more than 50% of the
NHCEs benefitting under the plan, the normal accrual rate for the
NHCE attributable to benefits provided under defined benefit plans
that are part of the DB/DC plan exceeds the equivalent accrual rate
for the NHCE attributable to contributions under defined
contribution plans that are part of the DB/DC plan.
(c) Broadly available separate plans. A DB/DC plan consists of
broadly available separate plans if the defined contribution plan
and the defined benefit plan that are part of the DB/DC plan each
would satisfy the requirements of section 410(b) and the
nondiscrimination in amount requirement of §1.401(a)(4)-1(b)(2)
if each plan were tested separately and assuming that the average
benefit percentage test of §1.410(b)-5 were satisfied. For this
purpose, all defined contribution plans that are part of the DB/DC
plan are treated as a single defined contribution plan and all
defined benefit plans that are part of the DB/DC plan are treated as
a single defined benefit plan. In addition, if permitted disparity
is used for an employee for purposes of satisfying the separate
testing requirement of this paragraph (b)(2)(v)(C) for plans of one
type, it may not be used in satisfying the separate testing
requirement for plans of the other type for the employee..41
(D) Minimum aggregate allocation gateway--(1) General rule. A DB/DC
plan satisfies the minimum aggregate allocation gateway if each NHCE
has an aggregate normal allocation rate that is at least one third
of the aggregate normal allocation rate of the HCE with the highest
such rate (HCE rate), or, if less, 5% of the NHCE's compensation,
provided that the HCE rate does not exceed 25% of compensation. If
the HCE rate exceeds 25% of compensation, then the aggregate normal
allocation rate for each NHCE must be at least 5% increased by one
percentage point for each 5- percentage-point increment (or portion
thereof) by which the HCE rate exceeds 25% (e.g., the NHCE minimum
is 6% for an HCE rate that exceeds 25% but not 30%, and 7% for an
HCE rate that exceeds 30% but not 35%).
(2) Deemed satisfaction. A plan is deemed to satisfy the minimum
aggregate allocation gateway of this paragraph (b)(2)(v)(D) if the
aggregate normal allocation rate for each NHCE is at least 7½
% of the NHCE's compensation within the meaning of section 415(c)
(3), measured over a period of time permitted under the definition
of plan year compensation.
(3) Averaging of equivalent allocation rates for NHCEs. For purposes
of this paragraph (b)(2)(v)(D), a plan is permitted to treat each
NHCE who benefits under the defined benefit plan as having an
equivalent normal allocation rate equal to the average of the
equivalent normal allocation rates under the defined benefit plan
for all NHCEs benefitting under that plan..42 (E) Determination of
rates. For purposes of this paragraph (b)(2)(v), the normal accrual
rate and the equivalent normal allocation rate attributable to
defined benefit plans, the equivalent accrual rate attributable to
defined contribution plans, and the aggregate normal allocation rate
are determined under paragraph (b)(2)(ii) of this section, but
without taking into account the imputation of permitted disparity
under §1.401(a)(4)-7, except as otherwise permitted under
paragraph (b)(2)(v)(C) of this section.
(f) Examples. The following examples illustrate the application of
this paragraph (b)(2)(v):
Example 1.
(i) Employer A maintains Plan M, a defined benefit plan, and Plan N,
a defined contribution plan. All HCEs of Employer A are covered by
Plan M (at a 1% accrual rate), but are not covered by Plan N. All
NHCEs of Employer A are covered by Plan N (at a 3% allocation rate),
but are not covered by Plan M. Because Plan M does not satisfy
section 410(b) standing alone, Plans M and N are aggregated for
purposes of satisfying sections 410(b) and 401(a)(4).
(ii) Because none of the NHCEs participate in the defined benefit
plan, the aggregated DB/DC plan is not primarily defined benefit in
character within the meaning of paragraph (b)(2)(v)(B) of this
section nor does it consist of broadly available separate plans
within the meaning of paragraph (b)(2)(v)(C) of this section.
Accordingly, the aggregated Plan M and Plan N must satisfy the
minimum aggregate allocation gateway of paragraph (b)(2)(v)(D) of
this section in order be permitted to demonstrate satisfaction of
the nondiscrimination in amount requirement of §1.401(a)
(4)-1(b)(2) on the basis of benefits.
Example 2.
(i) Employer B maintains Plan O, a defined benefit plan, and Plan P,
a defined contribution plan. All of the six employees of Employer B
are covered under both Plan O and Plan P. Under Plan O, all
employees have a uniform normal accrual rate of 1% of compensation.
Under Plan P, Employees A and B, who are HCEs, receive an allocation
rate of 15%, and participants C, D, E and F, who are NHCEs, receive
an allocation rate of 3%. Employer B aggregates Plans O and P for
purposes of satisfying sections 410(b) and 401(a)(4). The equivalent
normal allocation and normal accrual rates under Plans O and P are
as follows:
Employee Equivalent Normal Accrual Equivalent Normal Accrual
Plan for the 1% Accrual Plan Rates of 15%/3% Allocations
()(defined benefit plan) Under Plan P (defined
contribution plan)
HCE A (age 55) 3.93% 3.82%
HCE B (age 50) 2.61% 5.74%
C (age 60) 5.91% .51%
D (age 45) 1.74% 1.73%
E (age 35) .77% 3.90%
F (age 25) .34% 8.82%
(ii) Although all of the NHCEs benefit under Plan O (the defined
benefit plan), the aggregated DB/DC plan is not primarily defined
benefit in character because the normal accrual rate attributable to
defined benefit plans (which is 1% for each of the NHCEs) is greater
than the equivalent accrual rate under defined contribution plans
only for Employee C. In addition, because the 15% allocation rate is
available only to HCEs, the defined contribution plan cannot satisfy
the requirements of §1.401(a)(4)-2 and does not have broadly
available allocation rates within the meaning of §1.401(a)
(4)-8(b)(1)(iii). Further, the defined contribution plan does not
satisfy the minimum allocation gateway of §1.401(a)(4)-8(b)(1)
(vi) (3% is less than 1/3 of the 15% HCE rate). Therefore, the
defined contribution plan within the DB/DC plan cannot separately
satisfy §1.401(a)(4)-1(b)(2) and does not constitute a broadly
available separate plan within the meaning of paragraph (b)(2)(v)(C)
of this section. Accordingly, the aggregated plans are permitted to
demonstrate satisfaction of the nondiscrimination in amounts
requirement of §1.401(a)(4)-1(b)(2) on the basis of benefits
only if the aggregated plans satisfy the minimum aggregate
allocation gateway of paragraph (b)(2)(v)(D) of this section.
(iii) Employee A has an aggregate normal allocation rate of 18.93%
under the aggregated plans (3.93% from Plan O plus 15% from Plan P),
which is the highest aggregate normal allocation rate for any HCE
under the plans. Employee F has an aggregate normal allocation rate
of 3.34% under the aggregated plans (.34% from Plan O plus 3% from
Plan P) which is less than the 5% aggregate normal allocation rate
that Employee F would be required to have to satisfy the minimum
aggregate allocation gateway of paragraph (b)(2)(v)(D) of this
section.
(iv) However, for purposes of satisfying the minimum aggregate
allocation gateway of paragraph (b)(2)(v)(D) of this section,
Employer B is permitted to treat each.44 NHCE who benefits under
Plan O (the defined benefit plan) as having an equivalent allocation
rate equal to the average of the equivalent allocation rates under
Plan O for all NHCEs benefitting under that plan. The average of the
equivalent allocation rates for all of the NHCEs under Plan O is
2.19% (the sum of 5.91%, 1.74%, .77%, and .34%, divided by 4).
Accordingly, Employer B is permitted to treat all of the NHCEs as
having an equivalent allocation rate attributable to Plan O equal to
2.19%. Thus, all of the NHCEs can be treated as having an aggregate
normal allocation rate of 5.19% for this purpose (3% from the
defined contribution plan and 2.19% from the defined benefit plan)
and the aggregated DB/DC plan satisfies the minimum aggregate
allocation gateway of paragraph (b)(2)(v)(D) of this section.
* * * * *
(c) * * *
(3) * * *
(ii) Restructuring not available for certain testing purposes. The
safe harbor in §1.401(a)(4)-2(b)(3) for plans with uniform
points allocation formulas is not available in testing (and thus
cannot be satisfied by) contributions under a component plan.
Similarly, component plans cannot be used for purposes of
determining whether a plan provides broadly available allocation
rates (as defined in §1.401(a)(4)-8(b)(1)(iii)), determining
whether a plan has a gradual age or service schedule (as defined in
§1.401(a)(4)-8(b)(1)(iv)), determining whether a plan has
allocation rates that are based on a uniform target benefit
allocation (as defined in §1.401(a)(4)-8(b)(1)(v)), or
determining whether a plan is primarily defined benefit in character
or consists of broadly available separate plans (as defined in
paragraphs (b)(2)(v)(B) and (C) of this section). In addition, the
minimum allocation gateway of §1.401(a)(4)-8(b)(1)(vi) and the
minimum aggregate allocation gateway of paragraph (b)(2)(v)(D) of
this section.45 cannot be satisfied on the basis of component plans.
See §§1.401(k)-1(b)(3)(iii) and 1.401(m)-1(b)(3)(iii) for
rules regarding the inapplicability of restructuring to section
401(k) plans and section 401(m) plans.
* * * * *
Par. 5. Section 1.401(a)(4)-12 is amended by adding a sentence to
the end of the definition of Standard mortality table to read as
follows: §1.401(a)(4)-12 Definitions.
* * * * *
The final regulations explain when certain defined contribution
retirement plans (sometimes referred to as "new comparability"
plans) would be eligible to satisfy the nondiscrimination
requirements of section 401(a)(4) on the basis of plan benefits
rather than plan contributions. The regulations would affect some
businesses and qualified retirement plans. The regulations apply for
plan years beginning on or after January 1, 2002..46
Standard mortality table. * * * The applicable mortality table under
section 417(e)(3)(A)(ii)(I) is also a standard mortality table.
* * * * *
Robert E. Wenzel
Deputy Commissioner of Internal Revenue
Approved: June 21, 2001
Mark Weinberger
Assistant Secretary of the Treasury
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