[Federal Register Volume 65, Number 195 (Friday, October 6, 2000)]
[Proposed Rules]
[Pages 59774-59780]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-25652]
[[Page 59774]]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[REG-114697-00]
RIN 1545-AY36
Nondiscrimination Requirements for Certain Defined Contribution
Retirement Plans
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking and notice of public hearing.
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SUMMARY: This document contains proposed regulations that would
prescribe conditions under which certain defined contribution
retirement plans (sometimes referred to as ``new comparability'' plans)
are permitted to demonstrate compliance with applicable
nondiscrimination requirements based on plan benefits rather than plan
contributions. This document also provides notice of a public hearing
on these proposed regulations.
DATES: Written comments, requests to speak and outlines of oral
comments to be discussed at the public hearing scheduled for January
25, 2001, at 10 a.m., must be received by January 5, 2001.
ADDRESSES: Send submissions to: CC:M&SP:RU (REG-114697-00) room 5226,
Internal Revenue Service, POB 7604, Ben Franklin Station, Washington,
DC 20044. Submissions may be hand delivered Monday through Friday
between the hours of 8 a.m. and 5 p.m. to: CC:M&SP:RU (REG-114697-00),
Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue NW.,
Washington, DC. Alternatively, taxpayers may submit comments
electronically via the Internet by selecting the ``Tax Regs'' option of
the IRS Home Page, or by submitting comments directly to the IRS
Internet site at: http://www.irs.gov/tax_regs/reglist.html. The public
hearing will be held in the IRS Auditorium (7th Floor), Internal
Revenue Building, 1111 Constitution Avenue NW., Washington, DC.
FOR FURTHER INFORMATION CONTACT: Concerning the regulations, John T.
Ricotta, 202-622-6060 or Linda S. F. Marshall, 202-622-6090; concerning
submissions and the hearing, and/or to be placed on the building access
list to attend the hearing, Sonya Cruse, 202-622-7180 (not toll-free
numbers).
SUPPLEMENTARY INFORMATION:
Background
This document contains proposed 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).
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 Sec. 1.401(a)(4)-8 of the
regulations. Under this cross-testing method, contributions are
converted to equivalent benefits payable at normal retirement age and
tested on the basis of these equivalent benefits. The conversion is
done by making an actuarial projection of the benefits payable at
normal retirement age that are attributable to the contributions. Thus,
this cross-testing method effectively permits nonelective employer
contributions under a defined contribution plan to be tested on the
basis of the benefits attributable to those contributions, 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, plan 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 predominately 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 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 the Treasury Department are concerned whether new
comparability and similar plans are consistent with the basic purpose
of the nondiscrimination rules under section 401(a)(4).
A variety of public comments were submitted in response to Notice
2000-14. Some comments expressed the view that changes in the
application of the nondiscrimination rules to new comparability plans
are unnecessary. These comments noted that in some cases such plans are
adopted by employers that previously had no retirement plan for their
employees. At the same time, many of these comments advanced
suggestions as to the types of
[[Page 59775]]
conditions that might be imposed on new comparability plans if changes
in the rules are in fact proposed.
Other comments expressed the view that the rules need to be changed
to increase the contributions made for NHCEs in new comparability plans
and similar tax-qualified plan designs. These comments suggested
various methods for ensuring that NHCEs receive larger allocations of
employer contributions under new comparability plans, including
imposing a maximum ratio of the allocation rates for HCEs to those for
NHCEs or requiring a minimum allocation rate for the NHCEs.
Still other comments questioned the policy justification for
permitting new comparability plans under the nondiscrimination rules
governing tax-qualified plans because new comparability plan designs
often provide such an overwhelming percentage of total plan allocations
to HCEs, with only a modest percentage of the plan allocations going to
the NHCEs. Some of these comments expressed concern that new
comparability plans in some instances have been marketed as a technique
for limiting most employees to lower allocation rates than they would
receive under other defined contribution plan designs (such as salary
ratio or age-weighted) and allocating the difference to one or more
HCEs. They noted that, in some cases, the percentage of total plan
allocations provided to the HCEs can exceed 90%.
After consideration of the comments received, the IRS and Treasury
are issuing these proposed regulations, which would prescribe
conditions that new comparability and similar plans must satisfy if
they are to use the cross-testing method. The proposed regulations
preserve the existing cross-testing rules of the section 401(a)(4)
regulations, and would not affect cross-tested defined contribution
plans that provide broadly available allocation rates, as defined in
the proposed regulations. The definition of broadly available
allocation rates includes plans that base allocations or allocation
rates on age or service. In contrast to new comparability plans, these
plans provide an opportunity for participants to ``grow into'' higher
allocation rates as they age or accumulate additional service.
These proposed regulations would continue to permit new
comparability plans. As suggested in various comments, the proposed
regulations would set forth a minimum allocation ``gateway'' that would
constrain the plan designs with the greatest disparity in favor of
HCEs, while leaving many new comparability plan designs unchanged. A
new comparability plan that satisfies the minimum allocation gateway
could continue to use the existing cross-testing rules of the section
401(a)(4) regulations.
The proposed regulations also would prevent circumvention of the
minimum allocation gateway by aggregating (for purposes of satisfying
the nondiscrimination rules) a new comparability defined contribution
plan with a defined benefit plan that provides only minimal benefits or
covers only a relatively small number of the employees, or by
aggregating a defined contribution plan with a defined benefit plan
that benefits primarily HCEs. However, an aggregated defined
contribution and defined benefit plan that is primarily defined benefit
in character (as defined in the proposed regulations) could test for
nondiscrimination on the basis of benefits in the same manner as under
current law. Similarly, the ability to test for nondiscrimination on a
benefits basis as under current law would be unrestricted if each of
the defined contribution and defined benefit portions of the aggregated
plan is a broadly available separate plan (as defined in the proposed
regulations).
The proposed regulations would not affect defined benefit plans
except where a defined contribution plan is aggregated with a defined
benefit plan for nondiscrimination purposes and thus is a part of a DB/
DC plan (as defined in Sec. 1.401(a)(4)-9). The proposed regulations
would not apply merely because a plan sponsor maintains both a defined
contribution plan and a defined benefit plan. The proposed regulations
would not require aggregation of a defined contribution plan with a
defined benefit plan or otherwise modify the existing rules regarding
when plans are required or permitted to be aggregated.
Explanation of Provisions
A. Overview
The basic structure of the proposed regulations permits defined
contribution plans with broadly available allocation rates to test on a
benefits basis (``cross-test'') in the same manner as under current
law, and permits other defined contribution plans to cross-test once
they pass a gateway that prescribes minimum allocation rates for NHCEs.
Similarly, the proposed regulations permit 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
The proposed regulations would require that a defined contribution
plan that does not provide broadly available allocation rates (as
defined in these proposed regulations) satisfy a gateway in order to be
eligible to use the cross-testing rules to meet the nondiscrimination
requirements of section 401(a)(4). A plan would satisfy 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; \1\ however, a plan would be deemed to satisfy
this minimum allocation gateway if each NHCE received an allocation of
at least 5% of the NHCE's compensation (within the meaning of section
415(c)(3)).
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\1\ For example, if any HCE had an allocation of 12% of
compensation, all NHCEs in the plan would be required to have an
allocation of at least 4% of compensation.
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The proposed regulations would not change the general rule
prohibiting aggregation of a 401(k) plan or 401(m) plan with a plan
providing nonelective contributions. Accordingly, elective
contributions and matching contributions would not be taken into
account for purposes of the gateway. If an employer also provides a
401(k) plan, however, then to the extent the HCEs are electing
contributions under that plan, the highest HCE allocation rate may be
lower than it otherwise would be, which, in turn would lower the
minimum required allocation for the NHCEs under the gateway. Further,
if the employer sponsors a safe harbor 401(k) plan that provides for 3%
nonelective contributions, then, as noted in Notice 98-52 (1998-2 C.B.
634), those nonelective contributions may be taken into account in
determining the allocation rates for the NHCEs under section 401(a)(4),
including the minimum allocation gateway.
C. Plans With Broadly Available Allocation Rates
As suggested in Notice 2000-14, a plan that has broadly available
allocation rates would not need to satisfy the minimum allocation
gateway and may continue to be tested for nondiscrimination on the
basis of benefits as under current law. In order to be broadly
available, each allocation rate under the plan must be currently
available to a group of employees that
[[Page 59776]]
satisfies section 410(b) (without regard to the average benefit
percentage test). Thus, for example, 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.
In addition, a plan that provides allocation rates that increase as
an employee ages or accumulates additional service would be treated as
having broadly available allocation rates, if the schedule of
allocation rates satisfies certain conditions that permit participants
to ``grow into'' higher allocation rates. The conditions are that the
same schedule of allocation rates is available to all employees in the
plan and that the schedule provides for smoothly increasing allocation
rates at regular intervals of age or service.
The proposed regulation would provide that in order for a schedule
of allocation rates to increase smoothly, the allocation rate for each
age or service band cannot be more than 5 percentage points higher than
the allocation rate for the immediately preceding band and cannot be
more than twice that allocation rate. For example, if the allocation
rate for an age or service band were 6%, the allocation rate for the
next higher age or service band could not exceed 11% (i.e., the lesser
of 11% (6% plus 5%) and 12% (2 times 6%)).
Further, in order for a schedule of allocation rates to be
considered to be increasing smoothly, the ratio of the allocation rate
for any age or service band to the allocation rate for the immediately
preceding band cannot exceed the ratio of the allocation rates between
the two immediately preceding bands. The proposed regulations would
provide that the intervals for the age or service bands are regular if
they are all of the same length (although this requirement generally
would not apply to the first and last bands).
The definition of broadly available allocation rates is designed to
be sufficiently flexible to accommodate a wide variety of age- and
service-based plans (including age-weighted profit-sharing plans that
provide for allocations that result in the same equivalent accrual rate
for all employees).
The conditions described above relating to a plan's schedule of
age-based or service-based allocation rates are intended to exempt from
the minimum allocation gateway those plans in which NHCEs actually
receive the benefit of higher rates as they attain higher ages or
complete additional years of service. Without conditions such as these,
plans can be designed to backload allocation rates excessively,
providing for lengthy plateau periods in which rates increase little if
at all, followed by sharp increases.
Comments are invited on whether there are plans using schedules of
allocation rates (such as schedules of rates based on points or
otherwise combining age and service) that would fall outside the
definition of broadly available allocation rates but that do afford
sufficient opportunity for NHCEs to ``grow into'' higher allocation
rates.
D. Application to Defined Contribution Plans That Are Combined With
Defined Benefit Plans
The proposed regulations would prescribe rules for testing defined
contribution plans that are aggregated with defined benefit plans for
purposes of sections 401(a)(4) and 410(b). These rules would 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.
1. Gateway for Benefits Testing of Combined Plans
Under the proposed regulations, the combination of a defined
contribution plan and a defined benefit plan may demonstrate
nondiscrimination on the basis of benefits if the combined plan is
primarily defined benefit in character, consists of broadly available
separate plans (as these terms are defined in the proposed
regulations), or satisfies a gateway requirement. This minimum
aggregate allocation gateway is generally similar to the minimum
allocation gateway for defined contribution plans that are not combined
with a defined benefit plan. To apply this minimum aggregate allocation
gateway, the employee's aggregate normal allocation rate is determined
by adding the employee's allocation under the defined contribution plan
to the employee's equivalent allocation under the defined benefit plan.
The use of aggregation would allow an employer that provides both a
defined contribution and a defined benefit plan to the NHCEs 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 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%, etc.).
In addition, 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'' feature inherent in traditional defined benefit plans (i.e., the
defined benefit plan provides higher equivalent allocation rates at
higher ages).
Comments are invited on possible special situations involving DB/DC
plans, such as situations arising as a result of a merger or
acquisition or a situation in which some HCEs in a DB/DC plan have
unusually high equivalent normal allocation rates for reasons other
than the design of the plan. Comments are invited as to whether the
regulations should address such special circumstances and, if so, how
(e.g., through a maximum required rate for NHCEs under a DB/DC plan or
other approaches).
2. Primarily Defined Benefit in Character
A combined plan that is primarily defined benefit in character
would not be subject to the gateway requirement and may continue to be
tested for nondiscrimination on the basis of benefits as under current
law. A combined plan would be 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 would be 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.
[[Page 59777]]
3. Broadly Available Separate Plans
A combined plan that consists of broadly available separate plans
would not be subject to the gateway requirement and may continue to be
tested for nondiscrimination on the basis of benefits as under current
law. A DB/DC plan consists of broadly available separate plans if the
defined contribution plan and the defined benefit plan each would
satisfy the requirements of section 410(b) and the nondiscrimination in
amount requirement of Sec. 1.401(a)(4)-1(b)(2) if each plan were tested
separately, assuming satisfaction of the average benefit percentage
test of Sec. 1.410(b)-5. Thus, the defined contribution plan must
separately satisfy the nondiscrimination requirements (taking into
account these proposed 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 would be 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, where the group of employees covered by each plan is a 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.
E. Use of Component Plans and Permitted Disparity
Component plans under the restructuring rules cannot be used for
the determination of whether a defined contribution plan provides
broadly available allocation rates or satisfies the minimum allocation
gateway, or the determination of whether a DB/DC plan satisfies the
minimum aggregate allocation gateway, is primarily defined benefit in
character, or consists of broadly available separate plans. For
purposes of the two gateways and determining whether a DB/DC plan is
primarily defined benefit in character, allocation rates and equivalent
allocation rates are determined without the use of permitted disparity.
For purposes of determining whether a DB/DC plan consists of broadly
available separate plans, permitted disparity may be used in the
defined contribution plan or the defined benefit plan but not in both
plans with respect to each employee who participates in both.
Proposed Effective Date
The regulations are proposed to be applicable for plan years
beginning on or after January 1, 2002.
Special Analyses
It has been determined that this notice of proposed rulemaking 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, these proposed
regulations will be submitted to the Chief Counsel for Advocacy of the
Small Business Administration for comment on their impact on small
business.
Comments and Public Hearing
Before these proposed regulations are adopted as final regulations,
consideration will be given to any electronic or written comments
(preferably a signed original and eight (8) copies) that are submitted
timely to the IRS. In addition to the other requests for comments set
forth in this document, the IRS and Treasury also request comments on
the clarity of the proposed rule and how it may be made easier to
understand. All comments will be available for public inspection and
copying.
A public hearing has been scheduled for January 25, 2001, at 10
a.m. in the IRS Auditorium (7th Floor), Internal Revenue Building, 1111
Constitution Avenue NW., Washington, DC. Due to building security
procedures, visitors must enter at the 10th street entrance, located
between Constitution and Pennsylvania Avenues, NW. In addition, all
visitors must present photo identification to enter the building.
Because of access restrictions, visitors will not be admitted beyond
the immediate entrance area more than 15 minutes before the hearing
starts. For information about having your name placed on the building
access list to attend the hearing, see the FOR FURTHER INFORMATION
CONTACT section of this preamble.
The rules of 26 CFR 601.601(a)(3) apply to the hearing.
Persons who wish to present oral comments at the hearing must
submit written comments and submit an outline of the topics to be
discussed and the time to be devoted to each topic (signed original and
eight (8) copies) by January 5, 2001.
A period of 10 minutes will be allotted to each person for making
comments.
An agenda showing the scheduling of the speakers will be prepared
after the deadline for receiving outlines has passed. Copies of the
agenda will be available free of charge at the hearing.
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.
Proposed Amendments to the Regulations
Accordingly, 26 CFR part 1 is proposed to be 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 Sec. 1.401(a)(4)-8, paragraph (b)(1) is revised to read
as follows:
Sec. 1.401(a)(4)-8 Cross-testing.
* * * * *
(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 Sec. 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
[[Page 59778]]
(B) For plan years beginning on or after January 1, 2002, if the
plan does not have broadly available allocation rates (within the
meaning of paragraph (b)(1)(iii) of this section) for the plan year,
the plan satisfies the minimum allocation gateway of paragraph
(b)(1)(iv) 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 current-age rule in paragraph (4)
of the definition of testing age in Sec. 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 Sec. 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 Sec. 1.410(b)-5). For this purpose, the
disregard of age and service conditions described in Sec. 1.401(a)(4)-
4(b)(2)(ii)(A) applies only if the plan provides an allocation formula
under which the allocation rates for all employees benefitting under
the plan are determined using a single schedule of rates that are based
solely on either age or service, and only if the allocation rates under
the schedule increase smoothly at regular intervals, within the meaning
of paragraphs (b)(1)(iii)(B) and (C) of this section. A plan does not
fail to provide broadly available allocation rates merely because it
provides the minimum benefit described in section 416(c)(2).
(B) Smoothly increasing schedule of allocation rates. A plan uses a
single schedule of allocation rates that are based solely on age or
service if it uses a single schedule of allocation rates that consists
of a series of either age or service bands under which the same
allocation rate applies to all employees whose age is within each age
band or whose years of service are within each service band. A schedule
of allocation rates increases smoothly if the allocation rate for each
age or service band within the schedule is greater than the allocation
rate for the immediately preceding band (i.e., the age or service band
with the next lower number of years of age or service) but by no more
than 5 percentage points. However, a schedule of allocation rates will
not be treated as increasing smoothly if the ratio of the allocation
rate for any age or service 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 or service if each age or service band, other than the
band associated with the highest age or years of service, is the same
length. For this purpose, if the schedule is based on age, the first
age band will be 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.
(iv) Minimum allocation gateway. A plan satisfies the minimum
allocation gateway of this paragraph (b)(1)(iv) 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. However, a plan is deemed to
satisfy this minimum allocation gateway if each NHCE receives an
allocation of at least 5% of the NHCE's compensation within the meaning
of section 415(c)(3).
(v) Determination of allocation rates. For purposes of this
paragraph (b)(1), allocations and allocation rates are determined under
Sec. 1.401(a)(4)-2(c)(2), but without taking into account the
imputation of permitted disparity under Sec. 1.401(a)(4)-7 in applying
the minimum allocation gateway of paragraph (b)(1)(iv) of this section.
(vi) Examples. The following examples illustrate the rules in this
paragraph (b)(1):
Example 1. (i) Plan M is a defined contribution plan that
provides an allocation formula under which allocations are provided
to all employees according to the following schedule:
------------------------------------------------------------------------
Ratio of
allocation
rate for
Allocation band to
Years of service rate allocation
(percent) rate for
immediately
preceding
band
------------------------------------------------------------------------
0-5........................................... 3.0 N/A
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) Because Plan M provides that allocation rates for all
employees are determined using a single schedule based solely on
service, the plan is permitted to disregard the service requirement
in determining whether the allocation rates are broadly available
(within the meaning of paragraph (b)(1)(iii) of this section), if
the allocation rates under the schedule increase smoothly at regular
intervals.
(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. In
addition, the bands (other than the highest band) are all 5 years
long, so the increases occur at regular intervals. Accordingly, the
service requirement is disregarded and each allocation rate is
broadly available within the meaning of paragraph (b)(1)(iii) of
this section, as each allocation rate is currently available to all
employees in the Plan.
(iv) Under paragraph (b)(1)(i) of this section, Plan M satisfies
the nondiscrimination in amount requirement of Sec. 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)(iv) of this section.
Example 2. (i) Plan N is a defined contribution plan that
provides an allocation formula under which allocations are provided
to all employees according to the following schedule:
------------------------------------------------------------------------
Ratio of
allocation
rate for
Allocation band to
Age rate allocation
(percent) rate for
immediately
preceding
band
------------------------------------------------------------------------
under 25...................................... 3.0 N/A
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) Because Plan N provides that allocation rates for all
employees are determined using a single schedule based solely on
age, the plan is permitted to disregard the age requirement in
determining whether the allocation rates are broadly available
(within the meaning of paragraph (b)(1)(iii) of this section), if
the allocation rates under the schedule increase smoothly at regular
intervals.
(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. In
addition, the bands are all 10 years long (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), so the increases
occur at regular intervals. Accordingly, the age requirement is
disregarded and each allocation rate is broadly available within the
meaning of paragraph (b)(1)(iii) of this section, as each
[[Page 59779]]
allocation rate is currently available to all employees in the Plan.
(iv) Under paragraph (b)(1)(i) of this section, Plan N satisfies
the nondiscrimination in amount requirement of Sec. 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)(iv) of this section.
Example 3. (i) Plan O 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 17.6% for Employee X and 20% for Employee Y. Under Plan O,
each NHCE receives an allocation of 5% of compensation within the
meaning of section 415(c)(3).
(ii) Because the allocation rate for X is not currently
available to any NHCE, Plan O does not have broadly available
allocation rates and must satisfy the minimum allocation gateway of
paragraph (b)(1)(iv) of this section.
(iii) The highest allocation rate for any HCE under Plan O is
20%. Accordingly, Plan O would satisfy the minimum allocation
gateway of paragraph (b)(1)(iv) of this 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).
(iv) Under Plan O, each NHCE receives an allocation of 5% of
compensation within the meaning of section 415(c)(3). Accordingly,
Plan O satisfies the minimum allocation gateway of paragraph
(b)(1)(iv) of this section.
(v) Under paragraph (b)(1)(i) of this section, Plan O satisfies
the nondiscrimination in amount requirement of Sec. 1.401(a)(4)-
1(b)(2) on the basis of benefits if it satisfies paragraph
(b)(1)(i)(A) of this section.
* * * * *
Par. 3. Section 1.401(a)(4)-9 is amended by adding paragraph
(b)(2)(v) and revising paragraph (c)(3)(ii) to read as follows:
Sec. 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 in order to be permitted to demonstrate
satisfaction of the nondiscrimination in amount requirement of
Sec. 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 Sec. 1.401(a)(4)-1(b)(2) if each plan were tested
separately and assuming that the average benefit percentage test of
Sec. 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.
(D) Minimum aggregate allocation gateway. A DB/DC plan satisfies
the minimum aggregate allocation gateway of this paragraph (b)(2)(v)(D)
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 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%). 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.
(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 Sec. 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 not covered by
Plan N. All NHCEs of Employer A are covered by Plan N (at a 3%
allocation rate), but 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 to satisfy the nondiscrimination in amount
requirement of Sec. 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:
------------------------------------------------------------------------
Equivalent Equivalent
normal normal
allocation accrual
rates for rates for
the 1% the 15%/3%
Employee accrual allocations
under Plan under Plan P
O (defined (defined
benefit contribution
plan) plan)
percent percent
------------------------------------------------------------------------
HCE A (age 55)............................... 3.93 3.82
HCE B (age 50)............................... 2.61 5.74
[[Page 59780]]
C (age 60)................................... 5.91 .51
D (age 45)................................... 1.73 1.73
E (age 35)................................... .77 3.90
F (age 25)................................... .34 8.82
------------------------------------------------------------------------
(ii) Although all of the NHCEs benefit under the 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 all 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 only available to HCEs, the defined contribution
plan cannot satisfy the requirements of Sec. 1.401(a)(4)-2 and does
not have broadly available allocation rates within the meaning of
Sec. 1.401(a)(4)-8(b)(1)(iii). Further, the defined contribution
plan does not satisfy the minimum allocation gateway of
Sec. 1.401(a)(4)-8(b)(1)(iv) (3% is less than \1/3\ of the 15% HCE
rate). Therefore, the defined contribution plan within the DB/DC
plan cannot separately satisfy Sec. 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 can satisfy the nondiscrimination in amounts requirement of
Sec. 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 NHCE who benefits under the
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 the NHCEs under Plan O is 2.19%
(the sum of 5.91%, 1.73%, .77%, and .34%, divided by 4).
Accordingly, Employer B is permitted to treat all the NHCEs as
having an equivalent allocation rate attributable to Plan O equal to
2.19%. Thus, all 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 Sec. 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 Sec. 1.401(a)(4)-8(b)(1)(iii)), 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 Sec. 1.401(a)(4)-8(b)(1)(iv) and the minimum
aggregate allocation gateway of paragraph (b)(2)(v)(D) of this
section cannot be satisfied on the basis of component plans. See
Secs. 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.
David A. Mader,
Acting Deputy Commissioner of Internal Revenue.
[FR Doc. 00-25652 Filed 10-5-00; 8:45 am]
BILLING CODE 4830-01-P