[Federal Register Volume 66, Number 126 (Friday, June 29, 2001)]
[Rules and Regulations]
[Pages 34535-34545]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-16326]
=======================================================================
-----------------------------------------------------------------------
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 8954]
RIN 1545-AY36
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 one-third 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 7\1/2\% 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.
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).
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, 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 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
[[Page 34536]]
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 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 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 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 Sec. 1.401(a)(4)-12 as an employee (within
the meaning of Sec. 1.410(b)-9) who benefits as an employee under the
plan for the plan year, and an NHCE is defined in Sec. 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
Sec. 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 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
Sec. 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 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
[[Page 34537]]
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 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).
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 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 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.
[[Page 34538]]
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 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 Sec. 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 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.
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 Sec. 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 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)
[[Page 34539]]
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 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 Sec. 1.401(a)(4)-8(b)(3).\1\ A plan has allocation rates based on a
uniform target benefit allocation if it would comply with the
requirements for a safe harbor target benefit plan in Sec. 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.
---------------------------------------------------------------------------
\1\ No exception to the minimum allocation gateway is needed for
target benefit plans that comply with the safe-harbor testing
provisions of Sec. 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.
---------------------------------------------------------------------------
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). 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
Sec. 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 Sec. 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 one-third 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%).
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 7\1/2\% 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 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
[[Page 34540]]
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 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 Sec. 1.401(a)(4)-
1(b)(2), 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
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 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 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 Amendments to the 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 Sec. 1.401(a)(4)-0, the entry for Sec. 1.401(a)(4)-
8(b)(1), is revised to read as follows:
Sec. 1.401(a)(4)-0 Table of contents.
* * * * *
Sec. 1.401(a)(4)-8 Cross-testing.
* * * * *
(b) * * *
(1) General rule and gateway.
* * * * *
Par. 3. 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
(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 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, if two
allocation rates could be permissively aggregated under
Sec. 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 Sec. 1.401(a)(4)-4(b)(2)(ii)(A)
[[Page 34541]]
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.
(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.
(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
Sec. 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;
(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 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 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
[[Page 34542]]
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--
(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
minimum allocation 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
(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 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.
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 Sec. 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:
------------------------------------------------------------------------
Ratio of
allocation
rate for
Allocation band to
Completed years of service rate (in allocation
percent) rate for
immediately
preceding
band
------------------------------------------------------------------------
0-5........................................... 3.0 (\1\)
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
------------------------------------------------------------------------
\1\ Not applicable.
(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 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)(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 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
[[Page 34543]]
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:
------------------------------------------------------------------------
Ratio of
allocation
rate for
Allocation band to
Completed years of service rate (in allocation
percent) rate for
immediately
preceding
band
------------------------------------------------------------------------
0-5........................................... 2.5 (\1\)
6-10.......................................... 4.5 1.80
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
------------------------------------------------------------------------
\1\ Not applicable.
(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 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)(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 following schedule:
------------------------------------------------------------------------
Ratio of
allocation
rate for
Allocation band to
Age rate (in allocation
percent) rate for
immediately
preceding
band
------------------------------------------------------------------------
Under 25...................................... 3.0 (\1\)
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
------------------------------------------------------------------------
\1\ Not applicable.
(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 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)(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:
------------------------------------------------------------------------
Ratio of
allocation
rate for
Allocation band to
Age rate (in allocation
percent) rate for
immediately
preceding
band
------------------------------------------------------------------------
Under 40...................................... 3 (\1\)
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
------------------------------------------------------------------------
\1\ Not applicable.
(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 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
Sec. 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
[[Page 34544]]
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
Sec. 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 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 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. 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:
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--(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 7\1/2\% 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.
(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 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 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:
[[Page 34545]]
------------------------------------------------------------------------
Equivalent Equivalent
normal normal
allocation accural
rates for rates for
the 1% the 15%/3%
Employee accural allocation
under plan under plan P
O (defined (defined
benefit contribution
plan) (in plan) (in
percent) percent)
------------------------------------------------------------------------
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 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)(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 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 are permitted to demonstrate
satisfaction of 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 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 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)), determining whether a plan has a
gradual age or service schedule (as defined in Sec. 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
Sec. 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
Sec. 1.401(a)(4)-8(b)(1)(vi) 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.
* * * * *
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:
Sec. 1.401(a)(4)-12 Definitions.
* * * * *
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 A. Weinberger,
Assistant Secretary of the Treasury.
[FR Doc. 01-16326 Filed 6-28-01; 8:45 am]
BILLING CODE 4830-01-P