78144 Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 

DEPARTMENT OF THE TREASURY

Internal Revenue Service 

26 CFR Parts 1 and 601 

[TD–9169] 

RIN 1545–AX26 and 1545–AX43 

Retirement Plans; Cash or Deferred 

Arrangements Under Section 401(k) 

and Matching Contributions or 

Employee Contributions Under Section 

401(m) Regulations

AGENCY: Internal Revenue Service (IRS), 

Treasury.

ACTION: Final regulations.

SUMMARY: This document contains final 

regulations that provide guidance for 

certain retirement plans containing cash 

or deferred arrangements under section 

401(k) and providing for matching 

contributions or employee contributions 

under section 401(m). These regulations 

affect sponsors of plans that contain 

cash or deferred arrangements or 

provide for employee or matching 

contributions, and participants in these 

plans.

DATES: Effective Date: These regulations 

are effective December 29, 2004.

FOR FURTHER INFORMATION CONTACT:

Concerning the regulations, R. Lisa 

Mojiri-Azad or John T. Ricotta at (202) 

622–6060 (not a toll-free number).

SUPPLEMENTARY INFORMATION: 

Paperwork Reduction Act 

The collections of information 

contained in these final regulations have 

been reviewed and approved by the 

Office of Management and Budget in 

accordance with the Paperwork 

Reduction Act of 1995 (44 U.S.C. 

3507(d)) under control number 1545–

1669. Responses to this collection of 

information are mandatory. 

An agency may not conduct or 

sponsor, and a person is not required to 

respond to, a collection of information 

unless it displays a valid control 

number assigned by the Office of 

Management and Budget. 

The estimated annual burden per 

respondent varies from .033 hour to 2.5 

hours, depending on the individual 

circumstances, with an estimated 

average of 1 hour, 10 minutes. 

Comments concerning the accuracy of 

this burden estimate and suggestions for 

reducing this burden should be sent to 

the Internal Revenue Service, Attn: IRS 

Reports Clearance Officer, 

SE:W:CAR:MP:T:T:SP, Washington, DC 

20224, and to the Office of Management 

and Budget, Attn: Desk Officer for the 

Department of the Treasury, Office of 

Information and Regulatory Affairs, 

Washington, DC 20503. 

Books or records relating to a 

collection of information must be 

retained as long as their contents might 

become material in the administration 

of any internal revenue law. Generally, 

tax returns and tax return information 

are confidential, as required by 26 

U.S.C. 6103. 

Background 

This document contains final 

regulations setting forth the 

requirements (including the 

nondiscrimination requirements) for 

cash or deferred arrangements under 

section 401(k) and for matching 

contributions and employee 

contributions under section 401(m) of 

the Internal Revenue Code (Code). 

Comprehensive final regulations 

under sections 401(k) and 401(m) of the 

Code were last published in the Federal 

Register in TD 8357 (published August 

9, 1991) and TD 8376 (published 

December 2, 1991) and amended by TD 

8581 published on December 22, 1994 

(the pre-SBJPA regulations). Since 1994, 

many significant changes have been 

made to sections 401(k) and 401(m) by 

the Small Business Job Protection Act of 

1996, Public Law 104–188 (110 Stat. 

1755) (SBJPA), the Taxpayer Relief Act 

of 1997, Public Law 105–34 (111 Stat. 

788) (TRA ’97), and the Economic 

Growth and Tax Relief Reconciliation 

Act of 2001, Public Law 107–16 (115 

Stat. 38) (EGTRRA). 

The most substantial changes to the 

statutory provisions of section 401(k) 

and section 401(m) were made to the 

methodology for testing the amount of 

elective contributions, matching 

contributions, and employee 

contributions for nondiscrimination. 

Section 401(a)(4) prohibits 

discrimination in contributions or 

benefits in favor of highly compensated 

employees, within the meaning of 

section 414(q) (HCEs). Section 401(k) 

provides a special nondiscrimination 

test for elective contributions under a 

cash or deferred arrangement that is part 

of a profit-sharing plan, stock bonus 

plan, pre-ERISA money purchase plan, 

or rural cooperative plan, called the 

actual deferral percentage (ADP) test. 

Section 401(m) provides a parallel test 

for matching contributions and 

employee contributions under a defined 

contribution plan, called the actual 

contribution percentage (ACP) test. 

These special nondiscrimination 

standards are provided in recognition of 

the fact that the amount of elective 

contributions and employee 

contributions (and corresponding 

matching contributions) is determined 

by the employee’s utilization of the 

contribution opportunity offered under 

the plan. This is in contrast to the 

situation in other defined contribution 

plans where the amount of 

contributions is determined by the 

amount the employer decides to 

contribute.

Sections 401(k) and 401(m) provide 

alternative methods for satisfying the 

applicable nondiscrimination rules: a 

mathematical comparison and a number 

of design-based methods. The inherent 

variation in the amount of contributions 

among employees, and the fact that the 

economic situation of HCEs may make 

them more likely to make elective or 

employee contributions, means that the 

usual nondiscrimination test under 

section 401(a)(4)—under which, for 

each HCE with a contribution level, 

there must be a specified number of 

nonhighly compensated employees 

(NHCEs) with equal or greater 

contributions—is not appropriate. 

Instead, average rates of contributions 

are used in the ADP and ACP tests (with 

a built-in differential permitted for 

HCEs) and minimum standards for 

nonelective or matching contributions 

are provided in the design-based 

alternatives. 

Prior to the enactment of SBJPA, 

sections 401(k) and 401(m) provided 

only for mathematical comparison. 

Specifically, the ADP and ACP tests 

compare the average of the rates of 

contributions of the HCEs to the average 

of the rates of contributions of the 

NHCEs. For this purpose, the rate of 

contributions for an employee is the 

amount of contributions for an 

employee divided by the employee’s 

compensation for the plan year. These 

tests are satisfied if the average rate of 

HCE contributions does not exceed 1.25 

times the average rate of contributions 

of the NHCEs. Alternatively, these tests 

are satisfied if the average rate of HCE 

contributions does not exceed the 

average rate of contributions of the 

NHCEs by more than 2 percentage 

points and is no more than 2 times the 

average rate of contributions of the 

NHCEs. To the extent that these tests are 

not satisfied, the statute provides for 

correction through distribution to HCEs 

(or forfeiture of nonvested matching 

contributions) or, to the extent provided 

in regulations, recharacterization of 

elective contributions as after-tax 

contributions. In addition, to the extent 

provided in regulations, nonelective 

contributions can be made to NHCEs 

and elective contributions and certain 

matching contributions can be moved 

between the ADP and ACP tests, in 

order the reduce the discrepancy 

between the average rates of 

Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 78145

1A designated Roth contribution is an elective 

contribution that is included in income. The 

Treasury and the IRS expect to issue guidance on 

designated Roth contributions in the near future.

contribution for the HCEs and the 

NHCEs. 

SBJPA added design-based alternative 

methods of satisfying the ADP and ACP 

tests. Under these methods, if a plan 

meets certain contribution and notice 

requirements, the plan is deemed to 

satisfy the nondiscrimination rules 

without regard to actual utilization of 

the contribution opportunity offered 

under the plan. These regulations reflect 

this change and the other changes that 

were made to sections 401(k) and 

401(m) under SBJPA, TRA ’97 and 

EGTRRA since the issuance of the preSBJPA regulations. 

SBJPA made the following significant 

changes affecting section 401(k) and 

section 401(m) plans: 

• The ADP test and ACP test were 

amended to allow the use of prior year 

data for NHCEs. 

• The method of distributing to 

correct failures of the ADP test or ACP 

test was changed to require distribution 

to the HCEs with the highest 

contributions. 

• Tax-exempt organizations and 

Indian tribal governments are permitted 

to maintain section 401(k) plans. 

• Safe harbor alternatives to the ADP 

test and ACP test were introduced in 

order to provide design-based methods 

to satisfy the nondiscrimination tests. 

• The SIMPLE 401(k) plan (an 

alternative design-based method to 

satisfy the nondiscrimination tests for 

small employers that corresponds to the 

provisions of section 408(p) for SIMPLE 

IRA plans by providing for smaller 

contributions) was added. 

• A special testing option was 

provided for plans that permit 

participation before employees meet the 

minimum age and service requirements, 

in order to encourage employers to 

permit employees to start participating 

sooner. 

TRA ’97 made the following 

significant changes affecting section 

401(k) and section 401(m) plans: 

• Grandfathered state and local 

governmental plans are treated as 

automatically satisfying the ADP and 

ACP tests. 

• Matching contributions for selfemployed individuals are no longer 

treated as elective contributions. 

EGTRRA made the following 

significant changes affecting section 

401(k) and section 401(m) plans: 

• Catch-up contributions were added 

to provide for additional elective 

contributions for participants age 50 or 

older. 

• The Secretary is directed to change 

the section 401(k) regulations to shorten 

the period of time that an employee is 

stopped from making elective 

contributions under the safe harbor 

rules for hardship distributions. 

• Beginning in 2006, section 401(k) 

plans will be permitted to allow 

employees to designate their elective 

contributions as ‘‘Roth contributions’’

that will generally be subject to taxation 

under the rules applicable to Roth IRAs 

under section 408A. 

• Section 401(k) plans using the 

design-based safe harbor and providing 

no additional contributions in a year are 

exempted from the top-heavy rules of 

section 416. 

• Distributions from section 401(k) 

plans are permitted upon ‘‘severance 

from employment’’ rather than 

‘‘separation from service.’’

• The multiple use test formerly 

specified in section 401(m)(9) is 

repealed. 

• Faster vesting is required for 

matching contributions. 

• Matching contributions are taken 

into account in satisfying the top-heavy 

requirements of section 416. 

In addition, since publication of the 

pre-SBJPA regulations, a number of 

items of guidance affecting section 

401(k) and section 401(m) plans 

addressing these statutory changes and 

other issues have been released by the 

IRS, including: 

• Notice 97–2 (1997–1 C.B. 348) 

provides initial guidance on prior year 

ADP and ACP testing and guidance on 

correction of excess contributions and 

excess aggregate contributions, 

including distribution to the HCEs with 

the highest contributions. 

• Rev. Proc. 97–9 (1997–1 C.B. 624) 

provides model amendments for 

SIMPLE 401(k) plans. 

• Notice 98–1 (1998–1 C.B. 327) 

provides additional guidance on prior 

year testing issues.

• Notice 98–52 (1998–2 C.B. 632) and 

Notice 2000–3 (2000–1 C.B. 413) 

provides guidance on safe harbor 

section 401(k) plans. 

• Rev. Rul. 2000–8 (2000–1 C.B. 617) 

addresses the use of automatic 

enrollment features in section 401(k) 

plans. 

• Notice 2001–56 (2001–2 C.B. 277) 

and Notice 2002–4 (2002–1 C.B. 298) 

provided initial guidance related to the 

changes made by EGTRRA. 

These items of guidance, with some 

modification, were incorporated into the 

proposed regulations under section 

401(k) and section 401(m) which were 

published in the Federal Register on 

July 17, 2003. 68 FR 42476. 

On November 12, 2003, a public 

hearing was held on the proposed 

regulations. After consideration of the 

comments, these final regulations adopt 

the provisions of the proposed 

regulations with certain modifications, 

the most significant of which are 

highlighted below. 

Explanation of Provisions 

1. Rules Applicable to All Cash or 

Deferred Arrangements 

Section 401(k)(1) provides that a 

profit-sharing, stock bonus, pre-ERISA 

money purchase or rural cooperative 

plan will not fail to qualify under 

section 401(a) merely because it 

contains a qualified cash or deferred 

arrangement. As under the proposed 

regulations, § 1.401(k)–1 sets forth the 

general definition of a cash or deferred 

arrangement (CODA), the additional 

requirements that a CODA must satisfy 

in order to be a qualified CODA, and the 

treatment of contributions made under a 

qualified or nonqualified CODA. 

As under the proposed regulations, 

the final regulations define a CODA as 

an arrangement under which employees 

can make a cash or deferred election 

with respect to contributions to, or 

accruals or benefits under, a plan 

intended to satisfy the requirements of 

section 401(a). A cash or deferred 

election is any direct or indirect election 

by an employee (or modification of an 

earlier election) to have the employer 

either: (1) Provide an amount to the 

employee in the form of cash or some 

other taxable benefit that is not 

currently available; or (2) contribute an 

amount to a trust, or provide an accrual 

or other benefit, under a plan deferring 

the receipt of compensation. These final 

regulations retain the definition of a 

CODA from the proposed regulations, 

with some minor modifications. First, 

the exclusion of an arrangement under 

which employees make after-tax 

contributions from the definition of a 

CODA does not encompass an 

arrangement under which employees 

make designated Roth contributions.1

Second, the final regulations clarify that 

the regulatory provision specifying that 

compliance with section 401(k) and 

section 402(e)(3) is the only means of 

providing a cash or deferred election to 

an employee without violating the 

constructive receipt rules is limited to 

cash or deferred elections under which 

the contribution or accrual is made 

under a qualified plan or trust.

As under the proposed regulations, 

these final regulations incorporate prior 

guidance on automatic enrollment and 

thus reflect the fact that a CODA can 

specify that the default that applies in 

the absence of an affirmative election by 

78146 Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 

2The Department of Labor has advised Treasury 

and the IRS that, under Title I of the Employee 

Retirement Income Security Act of 1974 (‘‘ERISA’’) 

(88 Stat. 829), Public Law 93–406, fiduciaries of a 

plan must ensure that the plan is administered 

prudently and solely in the interest of plan 

participants and beneficiaries. While ERISA section 

404(c) may serve to relieve certain fiduciaries from 

liability when participants or beneficiaries exercise 

control over the assets in their individual accounts, 

the Department of Labor has taken the position that 

a participant or beneficiary will not be considered 

to have exercised control when the participant or 

beneficiary is merely apprised of investments that 

will be made on his or her behalf in the absence 

of instructions to the contrary. See 29 CFR 

2550.404c–1 and 57 FR 46924.

3The Department of Labor has advised Treasury 

and the IRS that its view is that amounts a 

participant pays to or has withheld by an employer, 

whether pursuant to a cash or deferred election or 

otherwise, for contribution to an employee benefit 

plan constitute participant contributions for 

purposes of Subtitle A and Part 4 of Subtitle B of 

Title I of ERISA.

an employee can be a contribution to a 

trust, as described in Rev. Rul. 2000–8. 

Although the facts of Rev. Rul. 2000–8 

specified a certain percentage of 

compensation that would apply as a 

default, the percentage chosen was 

merely illustrative. Thus, the final 

regulations do not constrain the choice 

of default provisions.2 However, in 

order to be a qualified CODA, as 

indicated in Rev. Rul. 2000–8, it is cash 

in lieu of the default employer 

contribution.

These final regulations also clarify the 

rules relating to one-time irrevocable 

elections that are not treated as cash or 

deferred elections. First, the final 

regulations replace the requirement that 

the election be made upon 

commencement of employment or first 

becoming eligible under the plan or any 

plan of the employer with the 

requirement that the election be made 

no later than first becoming eligible 

under the plan or any other plan of the 

employer. Second, the final regulations 

define any other plan of the employer 

for this purpose to mean any plan or 

arrangement that is described in section 

219(g)(5)(D), which includes a section 

457(b) governmental plan and a section 

403(b) plan, as well as a qualified plan. 

The final regulations retain the rule 

that a contribution is made pursuant to 

a cash or deferred election only if the 

contribution is made after the relevant 

election. Thus, a contribution made in 

anticipation of an employee’s election is 

not treated as an elective contribution. 

A number of commentators indicated 

that the rule in the proposed regulation 

requiring that elective contributions not 

precede the services to which they 

relate (or the date when the 

compensation would otherwise be paid, 

if earlier than the date when the services 

are performed) was too broad. Some of 

these commentators suggested the 

addition of an exception to cover 

instances where the employer has 

administrative reasons for depositing 

the contributions before the employee’s 

services or pay day (for example, the 

temporary absence of the bookkeeper 

responsible for transmitting funds to the 

plan), while others suggested loosening 

the rule where the early contribution 

does not result in an accelerated 

deduction. 

After considering these comments, the 

IRS and Treasury have concluded that 

the prefunding of elective contributions 

and matching contributions is 

inconsistent with sections 401(k) and 

401(m) and that the restrictions on the 

timing of contributions are consistent 

with the fundamental premise of 

elective contributions (i.e., these are 

contributions that are paid to the plan 

as a result of an employee election not 

to receive those amounts in cash). 

Accordingly, the final regulations 

generally provide that contributions are 

made pursuant to a cash or deferred 

election only if the contributions are 

made after the employee’s performance 

of services which relate to the 

compensation that, but for the election, 

would have been paid to the employee. 

Amounts contributed in anticipation of 

future performance of services generally 

are not treated as elective contributions 

under these final regulations. Thus, an 

employer is not able to prefund elective 

contributions in order to accelerate the 

deductions for elective contributions; 

and employer contributions made under 

the facts in Notice 2002–48 (2002–2 

C.B.139) are no longer permitted to be 

taken into account under the ADP test 

or the ACP test and would not satisfy 

any plan requirement to provide 

elective contributions or matching 

contributions.

The proposed regulations contained 

an exception to the rule precluding the 

funding of elective contributions before 

the performance of services in the 

situation where the compensation 

would also have been paid, but for the 

election, before the performance of 

services and that exception has been 

retained in the final regulations. After 

consideration of the administrative 

concerns raised by the comments, these 

final regulations also include an 

exception for occasional bona fide 

administrative considerations. Under 

this exception, employer contributions 

will not fail to satisfy the regulatory 

requirements relating to the timing of 

elective contributions merely because 

contributions for an occasional pay 

period are made before the services with 

respect to that pay period are 

performed, provided that the early 

contributions are made for bona fide 

administrative considerations and are 

not made early with a principal purpose 

of accelerating deductions. In addition, 

the final regulations include changes to 

the rules precluding the prefunding of 

matching contributions discussed 

below. 

One commentator asked for 

clarification of the interaction between 

these timing rules and the rule under 

the regulations that treats a selfemployed individual’s earned income as 

being currently available on the last day 

of the individual’s taxable year and 

whether this last day rule precludes a 

partner from making elective 

contributions during the year through a 

reduction in the partner’s draw. The 

restriction on the timing of 

contributions is not intended to prevent 

a partner from deferring amounts that 

are paid to the partner throughout the 

year on account of services performed 

by the partner during the year, and the 

final regulations have been modified to 

clarify this point. However, selfemployed individuals who take 

advantage of this opportunity to defer 

amounts during the year must make 

sure that the amount contributed during 

the year will not exceed the limits (such 

as the limits of section 415) that will 

apply to the individual, based on the 

individual’s actual earned income for 

the relevant period. 

2. Qualified CODAs 

A. General Rules Relating to Qualified 

CODAs 

Elective contributions under a 

qualified CODA are treated as employer 

contributions for purposes of the 

Internal Revenue Code.3 Elective 

contributions under a qualified CODA 

generally are not included in the 

employee’s gross income at the time the 

cash would have been received (but for 

the cash or deferred election) or at the 

time contributed to the plan. Elective 

contributions under a qualified CODA 

are included in the employee’s gross 

income, however, if the contributions 

are in excess of the section 402(g) limit 

for a year, are designated Roth 

contributions (under section 402A, 

effective for tax years beginning after 

December 31, 2005), or are 

recharacterized as after-tax 

contributions as part of a correction of 

an ADP test failure.

A CODA is not qualified unless it is 

part of a profit sharing plan, stock bonus 

plan, pre-ERISA money purchase plan, 

or rural cooperative plan and provides 

for an election between contributions to 

the plan or payments directly in cash. 

Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 78147

In addition, a CODA is not qualified 

unless it meets the following 

requirements: (1) The elective 

contributions under the CODA satisfy 

either the ADP test set forth in section 

401(k)(3) or one of the design-based 

alternatives in section 401(k)(11) or (12); 

(2) elective contributions under the 

CODA are nonforfeitable at all times; (3) 

elective contributions are distributable 

only on the occurrence of certain events, 

including attainment of age 591⁄2, 

hardship, death, disability, severance 

from employment, or termination of the 

plan; (4) the group of employees eligible 

to participate in the CODA satisfies the 

coverage requirements of section 

410(b)(1); (5) no other benefit (other 

than matching contributions and certain 

other specified benefits) is conditioned, 

directly or indirectly, upon the 

employee’s making or not making 

elective contributions under the CODA; 

and (6) no more than 1 year of service 

is required for eligibility to elect to 

make a cash or deferred election. 

Subject to certain exceptions, State 

and local governmental plans are not 

allowed to include a qualified CODA. 

Plans sponsored by Indian tribal 

governments and rural cooperatives are 

allowed to include a qualified CODA. 

B. Nondiscrimination Rules Applicable 

to Qualified CODAs 

As under the proposed regulations, 

these final regulations provide that the 

special nondiscrimination standards set 

forth in section 401(k) (the ADP test, the 

ADP safe harbor and the SIMPLE 401(k) 

plan) are the exclusive means by which 

a qualified CODA can satisfy the 

nondiscriminatory amount of 

contribution requirement of section 

401(a)(4). Pursuant to section 

401(k)(3)(G), a State or local 

governmental plan is deemed to satisfy 

the ADP test. 

These final regulations retain the rule 

that the plan must satisfy the 

requirements of § 1.401(a)(4)–4 with 

respect to benefits, rights and features in 

addition to the requirements that 

contributions satisfy the 

nondiscrimination requirements of 

section 401(k). In addition to stating that 

the availability of each level of elective 

contribution is a right or feature subject 

to the requirements of section 401(a)(4), 

the final regulations point out that the 

right to make a designated Roth 

contribution is a right or feature. 

The proposed regulations included an 

anti-abuse rule which provided that a 

plan will not be treated as satisfying the 

requirements of section 401(k) if there 

are repeated changes to plan testing 

procedures or plan provisions that have 

the effect of distorting the ADP so as to 

increase significantly the permitted 

deferrals for HCEs, or otherwise 

manipulate the nondiscrimination rules 

of section 401(k), if a principal purpose 

of the changes was to achieve such a 

result. 

Several commentators suggested 

eliminating the anti-abuse rule in the 

proposed regulations. One of these 

commentators suggested that the 

proposed regulation’s restrictions on 

ADP testing (including the restriction on 

the use of targeted QNECs and changes 

in testing method discussed below) 

made the anti-abuse rule unnecessary 

and noted that there may be legitimate 

reasons (for example, change in 

participant demographics or merger of 

plans for administrative reasons) for 

changes to a section 401(k) plan’s 

testing procedures. Another 

commentator suggested that the antiabuse rule be replaced with guidance 

addressing various specific abusive 

transactions. 

After considering these comments, 

IRS and Treasury have determined that 

the need for rules to prevent abuse 

associated with changes in plan testing 

procedures or other plan provisions to 

inflate inappropriately the ADP for 

NHCEs or to otherwise manipulate the 

nondiscrimination provisions of section 

401(k) outweighs the concerns raised by 

these commentators. In addition, IRS 

and Treasury do not believe that the 

anti-abuse provisions of the proposed 

regulations constrain legitimate testing 

procedure changes. Therefore, these 

final regulations retain the anti-abuse 

provisions of the proposed regulations.

C. Aggregation and Disaggregation of 

Plans 

As under the proposed regulations, 

these final regulations consolidate the 

rules regarding identification of CODAs 

and plans for purposes of demonstrating 

compliance with the requirements of 

section 401(k) and retain the rule that 

all CODAs included in a plan are treated 

as a single CODA for purposes of 

applying the nondiscrimination tests. 

For this purpose, a plan is generally 

defined by reference to § 1.410(b)–7(a) 

and (b) after application of the 

mandatory disaggregation rules of 

§ 1.410(b)–7(c) (other than the 

mandatory disaggregation of section 

401(k) and section 401(m) plans) and 

permissive aggregation rules of 

§ 1.410(b)–7(d), as modified under these 

regulations. For example, if a plan 

covers collectively bargained employees 

and noncollectively bargained 

employees, the elective contributions 

for the separate groups of employees 

must be treated separately for 

nondiscrimination under section 401(k). 

As under the proposed regulations, the 

final regulations retain the special rules 

in the pre-SBJPA regulations that permit 

the aggregation of certain employees in 

different collective bargaining units and 

the prohibition on restructuring under 

§ 1.401(a)(4)–9(c). 

The proposed regulations included a 

change to the treatment of a CODA 

under a plan that includes an ESOP. 

Under the pre-SBJPA regulations, such 

a plan must be disaggregated into the 

ESOP and non-ESOP portions and apply 

two separate ADP and ACP tests: one for 

elective contributions going into the 

ESOP portion (and invested in employer 

stock) and one for elective contributions 

going in the non-ESOP portion of the 

plan. The proposed regulations 

eliminated the disaggregation of the 

ESOP and non-ESOP portions of a single 

section 414(l) plan for purposes of ADP 

and ACP testing and allowed an 

employer to permissively aggregate two 

section 414(l) plans, one that is an ESOP 

and one that is not. 

Commentators responded favorably to 

this change. Therefore, the final 

regulations retain the rule of the 

proposed regulations that eliminates the 

disaggregation of the ESOP and nonESOP portions for the ADP and ACP 

tests. Several of these commentators 

suggested that plans be permitted to 

implement this change before the 

effective date of the regulations. After 

considering these comments, the IRS 

and Treasury have determined that it 

would not be in the best interest of plan 

administration to allow this change to 

be made before the effective date of the 

entire regulations. However, as 

discussed below, a plan is permitted to 

implement this change for plan years 

that end after December 29, 2004, 

provided the plan applies all the rules 

of these final regulations, to the extent 

applicable, for that plan year and all 

subsequent plan years 

These final regulations retain the 

proposed regulations’ requirement that a 

single testing method must apply to all 

CODAs under a plan (after application 

of the aggregation and disaggregation 

rules as modified). This has the effect of 

restricting an employer’s ability to 

aggregate section 414(l) plans for 

purposes of section 410(b) if those plans 

apply inconsistent testing methods. For 

example, a plan that applies the ADP 

test of section 401(k)(3) may not be 

aggregated with a plan that uses the 

ADP safe harbor of section 401(k)(12) for 

purposes of section 410(b). However, 

the final regulations make clear that if 

a plan is disaggregated into separate 

plans under the rules of section 410(b), 

each separate plan can apply a different 

testing method. Thus, for example, if an 

78148 Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 

4Under section 402(c), as amended by the IRS 

Restructuring and Reform Act of 1998, Public Law 

105–206 (112 Stat. 685), and EGTRRA, a hardship 

distribution is not an eligible rollover distribution. 

While the change affects distributions from a 

section 401(k) plan, there is no specific reference to 

the change in these regulations because these 

regulations are under sections 401(k) and (m).

employer maintaining a plan that covers 

otherwise excludible employees is using 

the optional rule of section 410(b)(4)(B) 

to determine whether the plan satisfies 

the requirements of section 410(b), then 

the plan is treated as comprising two 

separate plans for purposes of section 

410(b) and the plan covering the 

employees who have satisfied the 

minimum age and service requirements 

of section 410(a)(1)(A) can use the ADP 

safe harbor of section 401(k)(12), while 

the plan covering the remaining 

employees uses the ADP test of section 

401(k)(3). 

D. Requirement That the Elective 

Contributions Be Immediately 

Nonforfeitable 

The final regulations reflect the 

statutory requirement that elective 

contributions to a qualified CODA be 

immediately nonforfeitable. However, 

the final regulations clarify that the 

reference to these contributions being 

‘‘disregarded for purposes of applying 

section 411(a) to other contributions’’ is 

limited to being disregarded for 

purposes of section 411(a)(2). Thus, for 

example, elective contributions under a 

qualified CODA are taken into account 

for purposes of determining whether a 

participant is a nonvested participant 

for purposes of section 411(a)(6)(D)(iii). 

E. Restrictions on Withdrawals 

As discussed above, a qualified CODA 

must provide that elective contributions 

may only be distributed after certain 

events, including hardship and 

severance from employment. EGTRRA 

amended section 401(k)(2)(B)(i)(I) by 

replacing ‘‘separation from service’’

with ‘‘severance from employment.’’

This change eliminated the ‘‘same desk 

rule’’ as a standard for distributions 

under section 401(k) plans. 

In addition, EGTRRA amended 

section 401(k)(10) by deleting 

disposition by a corporation of 

substantially all of the assets of a trade 

or business and disposition of a 

corporation’s interest in a subsidiary, 

leaving termination of the plan as the 

only distributable event described in 

section 401(k)(10). Further, EGTRRA 

directs the Secretary of the Treasury to 

revise the regulations relating to 

distributions under section 

401(k)(2)(B)(i)(IV) to provide that the 

period during which an employee is 

prohibited from making elective and 

employee contributions following a 

hardship distribution is 6 months 

(instead of 12 months as required under 

§ 1.401(k)–1(d)(2)(iv)(B)(4) of the preSBJPA regulations).4 Finally, section 

662 of EGTRRA amended section 

404(k)(2) to allow a deduction for 

dividends paid on employer securities 

held by an ESOP if those dividends are 

reinvested in employer securities 

pursuant to an election by the 

participant or beneficiary to reinvest the 

dividends or have them paid in cash. 

Section 662 of EGTRRA is effective for 

taxable years of a corporation beginning 

on or after January 1, 2002.

Notice 2001–56, Notice 2002–2 

(2002–1 C.B. 285), and Notice 2002–4 

provided guidance on these EGTRRA 

changes to the distribution rules for 

elective contributions. That guidance 

was generally incorporated in the 

proposed regulations. These final 

regulations adopt the rules in the 

proposed regulations but clarify that the 

requirement that a participant must 

have obtained all distributions currently 

available under all qualified plans of the 

employer in order to qualify for a 

hardship distribution applies equally to 

a distribution of an ESOP dividend. 

This implements the rule set forth in 

Notice 2002–2.

Comments were requested on whether 

a change in status from a common law 

employee to a leased employee 

described in section 414(n) should be 

treated as a severance from employment 

that would permit a distribution to be 

made. After reviewing the comments, 

these final regulations do not add the 

change to leased employee to the list of 

distributable events and retain the use 

of the section 410(b) definition of 

employee for purposes of section 401(k). 

Because an individual who is a leased 

employee (as defined in section 414(n)) 

is treated as an employee of the 

recipient of the individual’s services for 

purposes of section 410(b) (unless the 

safe harbor plan requirements described 

in section 414(n)(5) are met), the 

individual does not incur a severance 

from employment as a result of 

becoming a leased employee. 

In addition to the statutory changes, 

the rules relating to hardship 

distributions were reorganized in the 

proposed regulations in order to clarify 

certain ambiguities, including the 

relationship between the generally 

applicable rules, employee 

representations, and the safe harbors 

provided under the pre-SBJPA 

regulations. The final regulations adopt 

the rules in the proposed regulations 

with some minor modifications. In 

response to comments, the final 

regulations add funeral expenses and 

certain expenses relating to the repair of 

damage to the employee’s principal 

residence to the list of events that are 

deemed to be immediate and heavy 

financial needs. 

The pre-SBJPA regulations and the 

proposed regulations treated medical 

expenses for an employee’s spouse or 

dependent described in section 152 as a 

deemed heavy and financial need. The 

Working Families Tax Relief Act of 2004 

(118 Stat. 1166), Public Law 108–311, 

modified section 152’s definition of 

dependent, effective for tax years 

beginning in 2005. These final 

regulations revise the proposed 

regulations to disregard certain 

provisions in section 152’s definition of 

dependent in the case of post-secondary 

educational expenses. These final 

regulations also revise the proposed 

regulations to treat expenses for (or 

necessary to obtain) medical care that 

would be deductible under section 

213(d) (determined without regard to 

whether the expenses exceed 7.5% of 

adjusted gross income) as a deemed 

heavy and financial need. These 

changes have the effect of allowing 

medical expenses and post-secondary 

educational expenses for an employee, 

spouse, or dependent (without regard to 

the change in the definition of 

dependent under the Working Families 

Tax Relief Act of 2004) to be treated as 

a deemed heavy and financial need. The 

modifications in these final regulations 

also effectively expand the definition of 

dependent for medical expenses to 

include a non-custodial child who is 

subject to the special rule of section 

152(e), but would exclude 

nonprescription drugs or medicine 

(other than insulin). Prior to the 

effective date of these regulations with 

respect to a plan, a sponsor can 

continue to interpret the plan terms and 

the pre-SBJPA regulations without 

regard to the statutory change in the 

definition of dependent. 

Some commentators asked for specific 

guidance on the documentation and 

verification requirements for a hardship 

distribution. The final regulations do 

not address this issue. However, 

taxpayers are reminded that section 

6001 requires that they keep the records 

necessary to demonstrate compliance 

with the qualification requirements of 

section 401 and the rules of section 

401(k) and 401(m). 

F. Other Rules for Qualified CODAs

The final regulations retain the 

additional requirements set forth in the 

Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 78149

pre-SBJPA regulations that a CODA 

must satisfy in order to be qualified, 

with some minor modifications. First, in 

order to be a qualified CODA, the 

arrangement must provide an employee 

with an effective opportunity to elect to 

receive the amount in cash no less than 

once during the plan year. Whether an 

employee has an effective opportunity is 

determined based on all the relevant 

facts and circumstances, including 

adequacy of notice of the availability of 

the election, the period of time before 

the cash is currently available during 

which an election may be made, and 

any other conditions on elections. 

The final regulations also require a 

plan to provide for satisfaction of one of 

the specific nondiscrimination 

alternatives described in section 401(k). 

As with the pre-SBJPA regulations, the 

plan may accomplish this by 

incorporating by reference the ADP test 

of section 401(k)(3) and the regulations 

under proposed § 1.401(k)–2(a) and (b), 

if that is the nondiscrimination 

alternative being used. If, with respect 

to the nondiscrimination alternative 

being used, there are optional choices 

available, the plan must provide which 

of the optional choices will apply. For 

example, a plan that uses the ADP test 

of section 401(k)(3) must specify 

whether it is using the current year 

testing method or prior year testing 

method. Additionally, a plan that uses 

the prior year testing method must 

specify whether the ADP for eligible 

NHCEs for the first plan year is 3% or 

the actual ADP for the eligible NHCEs 

for the first plan year. The final 

regulations also provide that the 

Commissioner may, in guidance of 

general applicability, specify the default 

options that will apply under the plan 

if the nondiscrimination test is 

incorporated by reference in accordance 

with the final regulations. 

Additionally, a plan that uses the safe 

harbor method must specify whether the 

safe harbor contribution will be the 

nonelective safe harbor contribution or 

the matching safe harbor contribution 

and is not permitted to provide that 

ADP testing will be used if the 

requirements for the safe harbor are not 

satisfied. The safe harbors are intended 

to provide employees with a minimum 

threshold in benefits in exchange for 

easier compliance for the plan sponsor. 

It would be inconsistent with this 

approach to providing benefits to allow 

an employer to deliver smaller benefits 

to NHCEs and revert to testing. 

Accordingly, if, at the beginning of the 

plan year, a plan contains an allocation 

formula that includes safe harbor 

matching or nonelective contributions, 

these regulations clarify that, except to 

the extent permitted under § 1.401(k)–3 

and § 1.401(m)–3, the plan may not be 

amended to revert to testing for the plan 

year. 

The final regulations retain the 

existing rules relating to the section 

401(k)(4)(A) prohibition on having 

benefits (other than a match) contingent 

on making or not making an elective 

contribution. These final regulations 

also reflect the amendment to section 

416(c)(2)(A) (under which matching 

contributions can be taken into account 

for purposes of satisfying the top-heavy 

minimum contribution requirement 

without violating the prohibition on 

making benefits contingent on making 

or not making elective contributions), 

the amendment of section 401(k)(4)(B) 

by SBJPA (allowing tax exempt 

organizations to maintain section 401(k) 

plans), and the enactment of section 

402(g)(8) (providing that matching 

contributions with respect to partners 

and sole proprietors are no longer 

treated as elective contributions). 

3. The Actual Deferral Percentage (ADP) 

Test 

A. General Rules Relating to the ADP 

Test 

Section 1.401(k)–2 sets forth the rules 

for a CODA that is applying the ADP 

test contained in section 401(k)(3). 

Under the ADP test, the percentage of 

compensation deferred for the eligible 

HCEs is compared annually to the 

percentage of compensation deferred for 

eligible NHCEs, and if certain limits are 

exceeded by the HCEs, corrective action 

must be taken by the plan. Correction 

can be made through the distribution of 

excess contributions, the 

recharacterization of excess 

contributions, or additional employer 

contributions. 

Section 401(k)(3)(A), as amended by 

SBJPA, generally provides for the use of 

prior year data in determining the ADP 

of NHCEs, while current year data is 

used for HCEs. This testing option is 

referred to as the prior year testing 

method. Alternatively, a plan may 

provide for the use of current year data 

for determining the ADPs for both 

NHCEs and HCEs, which is known as 

the current year testing method. The 

regulations use the term applicable year 

to describe the year for which the ADP 

is determined for the NHCEs. 

Section 401(k)(3)(F), as added by 

SBJPA, provides that a plan benefiting 

otherwise excludable employees and 

that, pursuant to section 410(b)(4)(B), is 

being treated as two separate plans for 

purposes of section 410(b), is permitted 

to disregard NHCEs who have not met 

the minimum age and service 

requirements of section 410(a)(1)(A). 

Thus, the regulations permit such a plan 

to perform the ADP test by comparing 

the ADP for all eligible HCEs for the 

plan year and the ADP of eligible 

NHCEs for the applicable year, 

disregarding all NHCEs who have not 

met the minimum age and service 

requirements of section 410(a)(1)(A). 

Because section 401(k)(3)(F) is 

permissive, the final regulations follow 

the proposed regulations and do not 

eliminate the existing testing option 

under which a plan benefiting otherwise 

excludable employees is disaggregated 

into separate plans where the ADP test 

is performed separately for all eligible 

employees who have completed the 

minimum age and service requirements 

of section 410(a)(1)(A) and for all 

eligible employees who have not 

completed the minimum age and service 

requirements. 

B. Elective Contributions Used in the 

ADP Test 

The regulations generally follow the 

proposed regulations in defining which 

elective contributions are reflected in 

the ADP test and which ones are not. 

Thus, these regulations reflect the rule 

contained in the regulations under 

section 414(v), under which catch-up 

contributions that are in excess of a 

statutory limit or an employer-provided 

limit are not taken into account under 

the ADP test. See § 1.414(v)–1. The final 

regulations add a comparable rule for 

additional elective contributions that 

are made by reason of an eligible 

employee’s qualified military service 

pursuant to section 414(u). The final 

regulations retain the rule that elective 

contributions must be paid to the trust 

within 12 months after the end of the 

plan year. However, for plans subject to 

Title I of ERISA, contributions must be 

paid to the trust much sooner in order 

to satisfy the Department of Labor’s 

regulations relating to when elective 

contributions become plan assets. 

Section 401(k)(3) provides that the 

actual deferral ratio (ADR) of an HCE 

who is eligible to participate in 2 or 

more CODAs of the same employer is 

calculated by treating all CODAs in 

which the employee is eligible to 

participate as one CODA. These final 

regulations adopt the provision in the 

proposed regulations that provides that 

the ADR for each HCE participating in 

more than one CODA is determined by 

aggregating the HCE’s elective 

contributions that are within the plan 

year of the CODA being tested.

78150 Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 

5With respect to this timing requirement, it 

should be noted that in order to be taken into 

account for purposes of section 415(c) for a 

limitation year, the contributions will need to be 

made within the time frame set forth in the 

regulations under section 415 (generally, no later 

than 30 days after the end of the section 404(a)(6) 

period applicable to the taxable year with or within 

which the limitation year ends).

C. Additional Employer Contributions 

Used in the ADP Test 

The final regulations generally retain 

the rules in the proposed regulations 

permitting a plan to take qualified 

nonelective contributions or qualified 

matching contributions (i.e., nonelective 

or matching contributions that satisfy 

the vesting and distribution limitations 

of section 401(k)(2)(B) and (C)) into 

account under the ADP test, except as 

described below. Thus, an employer 

whose CODA has failed the ADP test 

can correct this failure by making 

additional qualified nonelective 

contributions (QNECs) or qualified 

matching contributions (QMACs) for its 

NHCEs. 

As under the pre-SBJPA regulations, 

these final regulations provide that 

QNECs must satisfy four requirements 

in addition to the vesting and 

distribution rules described above 

before they can be taken into account 

under the ADP test: (1) The amount of 

nonelective contributions, including the 

QNECs that are used under the ADP test 

or the ACP test, must satisfy section 

401(a)(4); (2) the amount of nonelective 

contributions, excluding the QNECs that 

are used under the ADP test or the ACP 

test, must satisfy section 401(a)(4); (3) 

the plan to which the QNEC or QMAC 

is made must be a plan that can be 

aggregated with the plan maintaining 

the CODA; and (4) the QNECs or 

QMACs must not be contingent on the 

performance of services after the 

allocation date and must be contributed 

within 12 months after the end of the 

plan year within which the contribution 

is to be allocated.5 Thus, in the case of 

a plan using prior year ADP testing, any 

QNECs that are to be allocated to the 

NHCEs for the prior plan year must be 

contributed before the last day of the 

current plan year in order to be taken 

into account.

Some plans provide a correction 

mechanism for a failed ADP test that 

targets QNECs to certain NHCEs in order 

to reduce the total contributions to 

NHCEs under the correction. Under the 

method that minimizes the total QNECs 

allocated to NHCEs under the 

correction, the employer makes a QNEC 

to the extent permitted by the section 

415 limits to the NHCE with the lowest 

compensation during the year in order 

to raise that NHCE’s ADR. If the plan 

still fails to pass the ADP test, the 

employer continues expanding the 

group of NHCEs who receive QNECs to 

the next lowest-paid NHCE until the 

ADP test is satisfied. By using this 

bottom-up leveling technique, the 

employer can pass the ADP test by 

contributing small amounts of money to 

NHCEs who have very low 

compensation for the plan year (for 

example, an employee who terminated 

employment in early January with $300 

of compensation). This is because of the 

fact that the ADP test is based on an 

unweighted average of ADRs and a 

small dollar (but high percentage of 

compensation) contribution to a 

terminated or other partial-year 

employee has a larger impact on the 

ADP test than the same contribution to 

a full-year employee. 

The IRS and Treasury have been 

concerned that, by using this type of 

technique, employers may pass the ADP 

test by making high percentage QNECs 

to a small number of employees with 

low compensation rather than providing 

contributions to a broader group of 

NHCEs. In addition, the legislative 

history to EGTRRA expresses 

Congressional intent that the Secretary 

of the Treasury will use his existing 

authority to address situations where 

qualified nonelective contributions are 

targeted to certain participants with 

lower compensation in order to increase 

the ADP of the NHCEs. (See EGTRRA 

Conference Report, H.R. Conf. Rep. 107–

84, 240). 

Accordingly, the proposed regulations 

added a new requirement that a QNEC 

must satisfy in order to be taken into 

account under the ADP test. This 

requirement, designed to limit the use of 

targeted QNECs, generally prohibited a 

plan from counting QNECs for purposes 

of the ADP test to the extent that QNECs 

are more than double the QNECs at least 

half of the other NHCEs are receiving, 

when expressed as a percentage of 

compensation. 

The restriction on targeting QNECs is 

implemented by providing that a QNEC 

for an NHCE that exceeds 5% of 

compensation could be taken into 

account for the ADP test only to the 

extent the contribution, when expressed 

as a percentage of compensation, does 

not exceed two times the plan’s 

representative contribution rate. The 

plan’s representative contribution rate is 

defined as the lowest contribution rate 

(i.e., the sum of QNECs made and 

QMACs taken into account for an 

employee divided by the employee’s 

compensation) among a group of NHCEs 

that is half of all the eligible NHCEs 

under the arrangement (or the lowest 

contribution rate among all eligible 

NHCEs under the arrangement who are 

employed on the last day of the year, if 

greater). 

While some commentators applauded 

the restriction on targeted QNECs, a 

number of commentators suggested that 

certain types of contributions be 

exempted from the definition of targeted 

QNECs. In particular, commentators 

suggested that QNECs equal to a flat 

dollar amount that are made to all 

NHCEs and QNECs that are made in 

connection with an employer’s 

obligation to pay a prevailing wage 

under the Davis-Bacon Act (46 Stat. 

1494), Public Law 71–798, Service 

Contract Act of 1965 (79 Stat. 1965), 

Public Law 89–386, or similar 

legislation should be able to be taken 

into account under the ADP test (even 

though such contributions create widely 

different contribution percentages 

among the NHCE population) because 

they are not ‘‘targeted’’. 

After reviewing the comments, the 

IRS and Treasury believe that the 

restrictions on targeting QNECs should 

apply essentially as they were proposed. 

While flat dollar QNEC contributions 

may not have the appearance of 

targeting, allowing those contributions 

to skew the results of the ADP test 

undermines the integrity of the ADP 

test. However, the final regulations 

provide more flexibility for QNECs that 

are made in connection with an 

employer’s obligation to pay a 

prevailing wage under the Davis-Bacon 

Act (46 Stat. 1494), Public Law 71–798, 

Service Contract Act of 1965 (79 Stat. 

1965), Public Law 89–286, or similar 

legislation by allowing a QNEC of up to 

10% of compensation to be taken into 

account under the ADP test in such a 

case. 

The final regulations under section 

401(m) provide parallel restrictions on 

QNECs taken into account in ACP 

testing, and a QNEC cannot be taken 

into account under both the ADP and 

ACP test (including for purposes of 

determining the representative 

contribution rate). As discussed more 

fully below, the final regulations 

generally retain the proposed 

regulations limitation on targeting 

matching contributions, which limits 

the extent to which QMACs can be 

targeted as a means of avoiding the 

restrictions on targeted QNECs. 

D. Correction

Section 401(k)(8)(C), as amended by 

SBJPA, provides that, for purposes of 

correcting a plan’s failure to meet the 

nondiscrimination requirements of 

section 401(k)(3), the distribution of 

excess contributions is made on the 

basis of the amount of the contributions 

Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 78151

by, or on behalf of, each HCE. The final 

regulations implement this correction 

procedure in the same manner as set 

forth in Notice 97–2. Thus, the total 

amount of excess contributions is 

determined using the rules under the 

pre-SBJPA regulations (i.e., based on 

high percentages). Then, that total 

amount is apportioned among the HCEs 

by assigning the excess to be distributed 

first to those HCEs who have the 

greatest dollar amount of contributions 

taken into account under the ADP test 

(as opposed to the highest deferral 

percentage). If these amounts are 

distributed or recharacterized in 

accordance with these regulations, the 

plan complies with the ADP test for the 

plan year with no obligation to 

recalculate the ADP test. 

The final regulations generally follow 

the rules in the proposed regulations on 

the determination of net income 

attributable to excess contributions. 

However, the regulatory language 

regarding the calculation of gap period 

income (i.e., income for the period after 

the plan year) has been clarified to 

specify that gap period income needs to 

be included only to the extent the 

employee is or would be credited with 

allocable gain or loss on those excess 

contributions for that period, if the total 

account were to be distributed. In 

addition, in response to administrative 

concerns raised by comments, the final 

regulations provide that a distribution of 

excess contributions is not required to 

include the income allocable to the 

excess contributions for a period that is 

no more than 7 days before the 

distribution. As under the pre-SBJPA 

regulations, the determination of the 

income for the gap period could be 

based on the income determined using 

the alternative method for the aggregate 

of the plan year and the gap period or 

using 10% of the income for the plan 

year (determined under the alternative 

method) for each month in the gap 

period. 

The final regulations retain the rules 

in the proposed regulations regarding 

the timing and tax treatment of 

distributions of excess contributions, 

coordination with the distribution of 

excess deferrals and the treatment of 

matches attributable to excess 

contributions. However, the final 

regulations clarify that if excess 

contributions are distributed, they are 

includible in income on the dates the 

elective contributions would have been 

received by the employee had the 

employee originally elected to receive 

the amounts in cash, treating the excess 

contributions that are being distributed 

as the first elective contributions for the 

plan year. 

4. Safe Harbor Section 401(k) Plans 

Section 401(k)(12) provides a designbased safe harbor method under which 

a CODA is treated as satisfying the ADP 

test if the arrangement meets certain 

contribution and notice requirements. 

Section 1.401(k)–3 of these final 

regulations, which sets forth the 

requirements for these arrangements, 

generally follows the rules set forth in 

Notice 98–52 and Notice 2000–3. Thus, 

a plan satisfies the section 401(k) safe 

harbor if it makes specified QMACs for 

all eligible NHCEs. The matching 

contributions can be under a basic 

matching formula that provides for 

QMACs equal to 100% of the first 3% 

of elective contributions and 50% of the 

next 2% or an enhanced matching 

formula that is at least as generous in 

the aggregate, provided the rate of 

matching contributions under the 

enhanced matching formula does not 

increase as the employee’s rate of 

elective contributions increases. In lieu 

of QMACs, the plan is permitted to 

provide QNECs equal to 3% of 

compensation for all eligible NHCEs. In 

addition, notice must be provided to 

each eligible employee, within a 

reasonable time before the beginning of 

the year, of the employee’s right to defer 

under the plan. 

The proposed regulations did not 

include any exception to the 

requirements for safe harbor matching 

contributions with respect to catch-up 

contributions. As part of the proposed 

regulations the IRS and Treasury 

solicited comments on the specific 

circumstances under which elective 

contributions by an NHCE to a safe 

harbor plan would be less than the 

amount required to be matched, e.g., 

less than 5% of safe harbor 

compensation, but would be treated by 

the plan as catch-up contributions, and 

on the extent to which a safe harbor 

plan should be required to match catchup contributions under such 

circumstances. After reviewing the 

comments and the applicable statutory 

provisions (including the amendments 

to section 414(v)(3)(B) made by the Job 

Creation and Worker Assistance Act of 

2002, (JCWAA) (Public Law 107–147)), 

the IRS and Treasury have determined 

that no such exception is appropriate. 

Section 401(k)(12)(D) contains a 

requirement that each eligible employee 

be provided with a written notice of the 

employee’s rights and obligations under 

the plan. These final regulations provide 

that the notice can be provided in 

writing or through another medium that 

is prescribed by the Commissioner as 

satisfying the requirement for a written 

notice. As reflected in the priority 

guidance plan, the IRS and Treasury are 

currently developing guidance setting 

forth the extent to which the notice 

described in section 401(k)(12)(D), as 

well as other notices under the various 

requirements relating to qualified 

retirement plans, can be provided 

electronically, taking into account the 

effect of the Electronic Signatures in 

Global and National Commerce Act (E–

SIGN) (114 Stat. 464), Public Law 106–

229. Until that guidance is issued, plan 

administrators and employers may 

continue to rely on the interim guidance 

in Q&A–7 of Notice 2000–3 on the use 

of electronic media to satisfy the notice 

requirement in section 401(k)(12)(D). 

These final regulations specify that a 

section 401(k) safe harbor plan must 

generally be adopted before the 

beginning of the plan year and be 

maintained throughout a full 12-month 

plan year. This requirement is 

consistent with the notion that the 

statute specifies a certain contribution 

level for NHCEs in order to be deemed 

to pass the nondiscrimination 

requirements. If the contribution level is 

not maintained for a full 12-month year, 

the employer contributions made on 

behalf of NHCEs should not support 

what could be a full year’s contribution 

by the HCEs. 

The final regulations adopt the 

exceptions to this 12-month rule that 

were set forth in the proposed 

regulations. Thus, a section 401(k) safe 

harbor plan could have a short plan year 

in the year the plan terminates, 

provided the plan termination is in 

connection with a merger or acquisition 

involving the employer, or the employer 

incurs a substantial business hardship 

comparable to a substantial business 

hardship described in section 412(d). A 

section 401(k) safe harbor plan could 

also have a short plan year in the year 

the plan terminates (without regard to 

the reason for the termination or the 

financial condition of the employer) if 

the employer makes the safe harbor 

contributions for the short year, 

employees are provided notice of the 

change, and the plan passes the ADP 

test. In either case, the employer must 

make the safe harbor contributions 

through the date of plan termination.

In addition, a safe harbor plan could 

have a short plan year if it is preceded 

and followed by plan years as a section 

401(k) safe harbor plan. Under these 

final regulations, the following plan 

year is permitted to be shorter than 12 

months if the short plan year is as a 

result of a plan termination (whether or 

not the plan termination is in 

connection with a merger or acquisition 

involving the employer). These final 

regulations clarify that this treatment is 

78152 Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 

unavailable if in the following plan year 

safe harbor matching contributions are 

reduced or suspended. In the event that 

the short plan year is followed by 

another short plan year, this treatment 

is available if the plan satisfies the 

401(k) safe harbor requirements for the 

12 month period immediately following 

the first short plan year. 

5. SIMPLE 401(k) Plans 

Pursuant to section 401(k)(11), a 

SIMPLE 401(k) plan is treated as 

satisfying the requirements of section 

401(k)(3)(A)(ii) if the contribution, 

vesting, notice and exclusive plan 

requirements of section 401(k)(11) are 

satisfied. Section 1.401(k)–4 of these 

regulations reflects the provisions of 

section 401(k)(11) in a manner that 

follows the positions reflected in the 

model amendments set forth in Rev. 

Proc. 97–9. 

6. Matching Contributions and 

Employee Contributions. 

Section 401(m)(2) sets forth a 

nondiscrimination test, the ACP test, 

with respect to matching contributions 

and employee contributions that is 

parallel to the nondiscrimination test for 

elective contributions set forth in 

section 401(k). Section 1.401(m)–1 of 

the regulations sets forth this test in a 

manner that is consistent with the 

nondiscrimination test set forth in 

§ 1.401(k)–1(b). Thus, satisfaction of the 

ACP test, the ACP safe harbor or the 

SIMPLE 401(k) provisions is the 

exclusive means that can be used to 

satisfy the nondiscrimination in amount 

of contribution requirements of section 

401(a)(4) with respect to employee 

contributions and matching 

contributions. An anti-abuse provision 

comparable to that provided in 

connection with the regulations under 

section 401(k) limits the ability of an 

employer to make repeated changes in 

plan provisions or testing procedures 

that have the effect of distorting the ACP 

so as to increase significantly the 

permitted ACP for HCEs, or otherwise 

manipulate the nondiscrimination rules 

of section 401(m), if a principal purpose 

of the changes was to achieve such a 

result. 

The final regulations also include 

provisions regarding plan aggregation 

and disaggregation that are similar to 

those that apply for CODAs under 

section 401(k). For example, matching 

contributions made under the portion of 

a plan that is an ESOP and the portion 

of the same plan that is not an ESOP are 

not disaggregated under these final 

regulations. 

The definitions of matching 

contribution and employee contribution 

under § 1.401(m)–1 of the regulations 

generally follow the definitions in the 

pre-SBJPA regulations. Thus, whether 

an employer contribution is on account 

of an elective deferral or employee 

contribution—and thus is a matching 

contribution—is determined based on 

all the relevant facts and circumstances. 

The final regulations generally follow 

the proposed regulations in providing 

that a contribution is not treated as a 

matching contribution on account of an 

elective deferral if it is contributed 

before the employee’s performance of 

services with respect to which the 

elective deferral is made (or when the 

cash that is subject to the cash or 

deferred election would be currently 

available, if earlier) and an employer 

contribution is not a matching 

contribution made on account of an 

employee contribution if it is 

contributed before the employee 

contribution. Thus, under these 

regulations, an employer would not be 

able to prefund matching contributions 

to accelerate the deduction for those 

contributions; and, as noted above with 

respect to the timing of elective 

contributions, employer contributions 

made under the facts in Notice 2002–48 

would not be taken into account under 

the ACP test and would not satisfy any 

plan requirement to provide matching 

contributions. 

However, in response to comments, 

the final regulations make an exception 

to this prefunding restriction for 

forfeitures and for contributions that 

result in a matching allocation of 

employer securities released from 

encumbrance under a securities 

acquisition loan in a leveraged ESOP, 

provided that the contributions are for 

a required payment that is due under 

the loan terms and are not made early 

with a principal purpose of accelerating 

deductions. 

7. ACP Test for Matching Contributions 

and Employee Contributions 

Section 1.401(m)–2 of the final 

regulations provides rules for the ACP 

test that generally parallel the rules 

applicable to the ADP test in § 1.401(k)–

2. Thus, for example, the ACP test may 

be run by comparing the ACP for 

eligible HCEs for the current year with 

the ACP for eligible NHCEs for either 

the current plan year or the prior plan 

year. The determination of the actual 

contribution ratio (ACR) for an eligible 

employee, and the contributions that are 

taken into account in determining that 

ACR, under the final regulations are 

comparable to the rules under the 

section 401(k) regulations. Thus, for 

example, the ACR for an HCE who has 

matching contributions or employee 

contributions under two or more plans 

is determined by adding together 

matching contributions and employee 

contributions under all plans of the 

employer during the plan year of the 

plan being tested, in a manner 

comparable to that for determining the 

ADR of an HCE who participates in two 

or more CODAs.

The final regulations allow QNECs to 

be taken into account for ACP testing, 

but would provide essentially the same 

restrictions on targeting QNECs to a 

small number of NHCEs as is provided 

in § 1.401(k)–2. The only difference in 

the rules is that the contribution 

percentages used to determine the 

lowest contribution percentage is based 

on the sum of the QNECs and those 

matching contributions taken into 

account in the ACP test, rather than the 

sum of the QNECs and the QMACs 

taken into account under the ADP test. 

Because QNECs that do not exceed 5% 

are not subject to the limits on targeted 

QNECs under either the ADP test or the 

ACP test, an employer is permitted to 

take into account up to 10% in QNECs 

for an eligible NHCE, 5% in ADP testing 

and 5% in ACP testing, without regard 

to how many NHCEs receive QNECs 

(with each of those numbers doubled for 

QNECs that are made in connection 

with an employer’s obligation to 

provide a prevailing wage under the 

Davis-Bacon Act (46 Stat. 1494), Public 

Law 71–798, Service Contract Act of 

1965 (79 Stat. 1965), Public Law 89–

286, or similar legislation). 

In addition, to prevent an employer 

from using targeted matching 

contributions to circumvent the 

limitation on targeted QNECs, the 

proposed regulations provided a parallel 

rule to limit targeted matching 

contributions for NHCEs from being 

taken into account in the ACP test to the 

extent the matching rate for the 

contribution exceeds the greater of 

100% and 2 times the representative 

matching rate. These final regulations 

retain this basic rule with modifications 

to make it more consistent with the rule 

for QNECs. First, similar to the rule for 

QNECs, under these final regulations, a 

contribution that matches an elective 

contribution may be taken into account 

to the extent it does not exceed the 

greater of 5% of compensation. Only 

then does the rate of matching 

contribution rate become relevant. 

Further, in determining the 

representative matching rate these final 

regulations provide a new rule if the 

matching rate is not the same for all 

levels of elective contributions for an 

employee. In that case, the employee’s 

matching rate is determined assuming 

that an employee’s elective deferrals are 

Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 78153

equal to 6 percent of compensation. 

There is also a parallel rule for matching 

contributions for employee 

contributions. 

8. Changes to Other Regulations 

These regulations include a number of 

cross-reference changes to other 

regulations to reflect the structure of 

these final regulations. However, no 

changes were made to the regulations 

under section 401(a)(26) and the rule 

relating to treating matching 

contributions as employer contributions 

for purposes of section 416 (see § 1.416–

1, Q&A M–19) because these regulations 

have not been updated to reflect recent 

statutory changes. 

Effective Date 

These final regulations apply for plan 

years beginning on or after January 1, 

2006. However, plan sponsors are 

permitted to apply these final 

regulations to any plan year that ends 

after December 29, 2004, provided the 

plan applies all the rules of these final 

regulations, to the extent applicable, for 

that plan year and all subsequent plan 

years. Taxpayers are cautioned, 

however, that a decision to apply these 

regulations in the middle of a plan year 

could only be successfully implemented 

if the plan has been operated in 

accordance with these regulations for 

that year. 

For plan years beginning before the 

effective date of these regulations with 

respect to a plan, the plan must apply 

the rules of the prior regulations (as they 

appeared in the April 1, 2004 edition of 

26 CFR part 1), the statutory provisions 

of section 401(k) and (m), and 

applicable IRS notices. 

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 

has also been determined that section 

553(b) of the Administrative Procedure 

Act (5 U.S.C. chapter 5) does not apply 

to these regulations. It is hereby 

certified that the collection of 

information in these regulations will not 

have a significant economic impact on 

a substantial number of small entities. 

This certification is based upon the 

conclusion that few plans containing 

qualified cash or deferred arrangements 

will correct excess contributions 

through the recharacterization of these 

amounts as employee contributions 

under § 1.401(k)–2(b)(3) of these 

regulations. The collection of 

information contained in § 1.401(k)–

3(d), (f), and § 1.401(m)–3(e) are 

required by statutory provisions. 

However, the IRS has considered 

alternatives that would lessen the 

impact of these statutory requirements 

on small entities. Thus, the collection of 

information in these regulations will 

only have a minimal economic impact 

on most small entities. Therefore, an 

analysis under the Regulatory 

Flexibility Act (5 U.S.C. chapter 6) is 

not required. Pursuant to section 7805(f) 

of the Code, the proposed regulations 

preceding these regulations were 

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 R. Lisa Mojiri-Azad and 

John T. Ricotta 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.

Amendments to the Regulations

■ Accordingly, 26 CFR parts 1 and 601 

are 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 * * *

Section 1.401(k)–1 also issued under 26 

U.S.C. 401(m)(9). 

Section 1.401(k)–2 also issued under 26 

U.S.C. 401(m)(9). 

Section 1.401(k)–3 also issued under 26 

U.S.C. 401(m)(9). 

Section 1.401(k)–4 also issued under 26 

U.S.C. 401(m)(9). 

Section 1.401(k)–5 also issued under 26 

U.S.C. 401(m)(9). 

Section 1.401(k)–6 also issued under 26 

U.S.C. 401(m)(9).

* * * * *

Section 1.401(m)–1 also issued under 26 

U.S.C. 401(m)(9). 

Section 1.401(m)–2 also issued under 26 

U.S.C. 401(m)(9). 

Section 1.401(m)–3 also issued under 26 

U.S.C. 401(m)(9). 

Section 1.401(m)–4 also issued under 26 

U.S.C. 401(m)(9). 

Section 1.401(m)–5 also issued under 26 

U.S.C. 401(m)(9).

* * * * *

■ Par. 2. For each section set forth below, 

remove the text that appears in the 

column labeled ‘‘Remove’’ and replace 

with the text that appears in the column 

labeled ‘‘Insert’’:

Regulation cite Remove Insert 

§ 1.72(p)–1, Q&A–12 .......................................... ‘‘1.401(k)–1(d)(6)(ii)’’ ........................................ ‘‘1.401(k)–1(d)(5)(iii)’’ 

§ 1.401(a)(4)–1(b)(2)(ii)(B) .................................. ‘‘1.401(k)–1(b)(4)’’ ............................................ ‘‘1.401(k)–2(a)(5)(i)’’ 

§ 1.401(a)(4)–1(b)(2)(ii)(B) .................................. ‘‘1.401(k)–1(b)(4)(i)’’ ......................................... ‘‘1.401(k)–2(a)(4)(i)’’ 

§ 1.401(a)(4)–1(b)(2)(ii)(B) .................................. ‘‘1.401(m)–1(b)(4)(ii)(A)’’ .................................. ‘‘1.401(m)–2(a)(4)(iii)’’ 

§ 1.401(a)(4)–1(b)(2)(ii)(B) .................................. ‘‘1.401(k)–1(b)(5)’’ ............................................ ‘‘1.401(k)–2(a)(6’’ 

§ 1.401(a)(4)–1(b)(2)(ii)(B) .................................. ‘‘1.401(m)–1(b)(5)’’ ........................................... ‘‘1.401(m)–2(a)(6)’’ 

§ 1.401(a)(4)–4(e)(3)(iii)(D) ................................. ‘‘1.401(k)–1(g)(3)’’ ............................................ ‘‘1.401(k)–6’’ 

§ 1.401(a)(4)–4(e)(3)(iii)(F) ................................. ‘‘1.401(m)–1(f)(6)’’ ............................................ ‘‘1.401(m)–1(a)(3)’’ 

§ 1.401(a)(4)–4(e)(3)(iii)(G) ................................. ‘‘1.401(m)–1(f)(12)’’ .......................................... ‘‘1.401(m)–1(a)(2)’’ 

§ 1.401(a)(4)–4(e)(3)(iii)(G) ................................. ‘‘1.401(k)–1(f)(1)(i)’’ .......................................... ‘‘1.401(k)–2(b)(1)(i)’’ 

§ 1.401(a)(4)–4(e)(3)(iii)(G) ................................. ‘‘1.401(m)–1(e)(1)(i), and 1.401(m)–2(c)’’ ........ ‘‘1.401(m)–2(b)(1)(i)’’ 

§ 1.401(a)(4)–9(c)(3)(ii) ....................................... ‘‘1.401(k)–1(b)(3)(ii) and 1.401(m)–1(b)(3)(ii)’’ ‘‘1.401(k)–1(b)(4)(iv)(B) and 1.401(m)–

1(b)(4)(iv)(B)’’ 

§ 1.401(a)(4)–11(g)(3)(vii)(A) .............................. ‘‘1.401(k)–1(g)(13)(ii)’’ ...................................... ‘‘1.401(k)–6’’ 

§ 1.401(a)(4)–11(g)(3)(vii)(A) .............................. ‘‘1.401(k)–1(g)(4)’’ ............................................ ‘‘1.401(k)–6’’ 

§ 1.401(a)(4)–11(g)(3)(vii)(A) .............................. ‘‘1.401(m)–1(f)(4)’’ ............................................ ‘‘1.401(m)–5’’ 

§ 1.401(a)(4)–11(g)(6), Example 7 ..................... ‘‘1.401(k)–1(f)’’ ................................................. ‘‘1.401(k)–2(b)’’ 

§ 1.401(a)(17)–1(b)(3)(iii)(B) ............................... ‘‘1.401(k)–1(g)(3)’’ ............................................ ‘‘1.401(k)–6’’ 

§ 1.401(a)(17)–1(b)(3)(iii)(B) ............................... ‘‘1.401(m)–1(f)(12)’’ .......................................... ‘‘1.401(m)–5’’ 

§ 1.401(a)(17)–1(b)(3)(iii)(B) ............................... ‘‘1.401(m)–1(f)(6)’’ ............................................ ‘‘1.401(m)–5’’ 

78154 Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 

Regulation cite Remove Insert 

§ 1.401(a)(17)–1(d)(5)(ii) .................................... ‘‘1.401(m)–(f)(6)’’ .............................................. ‘‘1.401(m)–1(a)(3)’’

§ 1.401(l)–1(a)(4)(iii) ........................................... ‘‘1.401(k)–1(g)(3)’’ ............................................ ‘‘1.401(k)–6’’

§ 1.401(l)–1(a)(4)(iii) ........................................... ‘‘1.401(m)–1(f)(6) or (f)(12)’’ ............................ ‘‘1.401(m)–1(a)(3) or (a)(2)’’

§ 1.402(a)–1(d)(1) ............................................... ‘‘1.401(k)–1(a)(3)(iii) and (2)(i)’’ ....................... ‘‘1.401(k)–1(a)(3)(iv) and (2)(iv)’’

§ 1.402(a)–1(d)(2)(i) ............................................ ‘‘1.401(k)–1(g)(3)’’ ............................................ ‘‘1.401(k)–6’’

§ 1.402(a)–1(d)(2)(i) ............................................ ‘‘1.401(k)–1(a)(4)(i)’’ ......................................... ‘‘1.401(k)–1(a)(4)(i)’’

§ 1.402(a)–1(d)(2)(i) ............................................ ‘‘1.401(k)–1(a)(7)’’ ............................................ ‘‘1.401(k)–1(a)(5)(iv)(B)’’

§ 1.402(a)–1(d)(2)(ii) ........................................... ‘‘1.401(m)–1(f)(12)’’ .......................................... ‘‘1.401(m)–1(a)(2)’’

§ 1.402(a)–1(d)(2)(iii) .......................................... ‘‘1.401(k)–1(a)(4)(iv)’’ ....................................... ‘‘1.401(k)–1(a)(3)(v)’’

§ 1.402(a)–1(d)(2)(iii) .......................................... ‘‘1.401(k)–1(a)(6)(ii)(C)’’ ................................... ‘‘1.401(k)–1(a)(3)(v)(B)’’

§ 1.402(a)–1(d)(3)(ii)(A) ...................................... ‘‘1.401(k)–(g)(12)’’ ............................................ ‘‘1.401(k)–6’’

§ 1.402(a)–1(d)(3)(iv) .......................................... ‘‘1.401(k)–1(a)(7)’’ ............................................ ‘‘1.401–1(a)(5)(iv)(B)’’

§ 1.402(c)–2, Q&A–4(c) ...................................... ‘‘1.401(k)–1(f)’’ ................................................. ‘‘1.401(k)–2(b)(2)’’

§ 1.402(c)–2, Q&A–4(c) ...................................... ‘‘1.401(m)–1(e)(3)’’ ........................................... ‘‘1.401(m)–2(b)(2)’’

§ 1.402(g)–1(c)(2) ............................................... ‘‘1.401(k)–1(a)(3)(iv)’’ ....................................... ‘‘1.401(k)–1(a)(3)(v)’’

§ 1.402(g)–1(e)(6) ............................................... ‘‘1.401(k)–1(f)(5)(i)’’ .......................................... ‘‘1.401(k)–2(b)(4)(i)’’

§ 1.410(b)–3(a)(3), Example 2 ........................... ‘‘1.401(k)–1(g)(4)’’ ............................................ ‘‘1.401(k)–6’’

§ 1.410(b)–3(a)(3), Example 3 ........................... ‘‘1.401(m)–1(f)(4)’’ ............................................ ‘‘1.401(m)–5’’

§ 1.410(b)–7(c)(1) ............................................... ‘‘1.401(k)–1(b)(4)(iv)’’ ....................................... ‘‘1.401(k)–2(a)(5)’’

§ 1.410(b)–9 ........................................................ ‘‘1.401(k)–1(g)(3)’’ ............................................ ‘‘1.401(k)–6’’

§ 1.410(b)–9 ........................................................ ‘‘1.401(k)–1(a)(4)(i)’’ ......................................... ‘‘1.401(k)–1(a)(4)(i)’’

§ 1.410(b)–9 ........................................................ ‘‘1.401(k)–1(b)(5)’’ ............................................ ‘‘1.401(k)–1(a)(6)’’

§ 1.410(b)–9 ........................................................ ‘‘1.401(m)–1(f)(12)’’ .......................................... ‘‘1.401(m)–1(a)(2)’’

§ 1.410(b)–9 ........................................................ ‘‘1.401(m)–1(e)(1)’’ ........................................... ‘‘1.401(m)–2(b)(1)’’

§ 1.410(b)–9 ........................................................ ‘‘1.401(f)–1(f)(2)’’ .............................................. ‘‘1.401(k)–6’’

§ 1.410(b)–9 ........................................................ ‘‘1.401(m)–1(f)(8)’’ ............................................ ‘‘1.401(m)–5’’

§ 1.411(a)–4(b)(7) ............................................... ‘‘1.401(m)–1(f)(12)’’ .......................................... ‘‘1.401(m)–1(a)(2)’’

§ 1.411(a)–4(b)(7) ............................................... ‘‘1.401(m)–1(e)(1)’’ ........................................... ‘‘1.401(m)–2(b)(1)’’

§ 1.411(a)–4(b)(7) ............................................... ‘‘1.401(k)–1(f)(2) and (g)(7)’’ ............................ ‘‘1.401(k)–2(b)(2)(ii) and 1.401(k)–6’’

§ 1.411(a)–4(b)(7) ............................................... ‘‘1.401(m)–1(f)(8)’’ ............................................ ‘‘1.401(m)–5’’

§ 1.411(d)–4(d), Q&A–2(b)(2)(x) ......................... ‘‘1.401(k)–1(d)(2)’’ ............................................ ‘‘1.401(k)–1(d)(3)’’

§ 1.411(d)–4(d), Q&A–2(b)(2)(x) ......................... ‘‘1.401(k)–1(d)(2)’’ ............................................ ‘‘1.401(k)–1(d)(3)’’

§ 1.414(r)–5(g)(2)(iv)(A) ...................................... ‘‘1.401(m)–1(f)(12)’’ .......................................... ‘‘1.401(m)–1(a)(2)’’

§ 1.414(r)–5(g)(2)(iv)(A) ...................................... ‘‘1.401(k)–1(g)(3)’’ ............................................ ‘‘1.401(k)–6’’

§ 1.414(r)–5(g)(2)(iv)(B) ...................................... ‘‘1.401(m)–1(f)(12)’’ .......................................... ‘‘1.401(m)–1(a)(2)’’

§ 1.414(r)–5(g)(3)(iv) ........................................... ‘‘1.401(k)–1(g)(3)’’ ............................................ ‘‘1.401(k)–6’’

§ 54.4979–1(b)(1) ............................................... ‘‘1.401(m)–1(f)(8)’’ ............................................ ‘‘1.401(m)–5’’

§ 54.4979–1(b)(2) ............................................... ‘‘1.401(k)–1(g)(7)’’ ............................................ ‘‘1.401(k)–6’’

§ 54.4979–1(c)(1) ............................................... ‘‘1.401(k)–1(b)(5)’’ ............................................ ‘‘1.401(k)–2(a)(6)’’

§ 54.4979–1(c)(1) ............................................... ‘‘1.401(m)–1(b)(5)’’ ........................................... ‘‘1.401(m)–2(a)(6)’’

§ 54.4979–1(c)(1) ............................................... ‘‘1.401(k)–1(f)(1)(i) and (6)(i)’’ .......................... ‘‘1.401(m)–2(b)(1)(i) and (5)(i)’’

§ 54.4979–1(c)(1) ............................................... ‘‘1.401(m)–1(e)(1)(i)’’ ........................................ ‘‘1.401(m)–2(b)(1)(i)’’

§ 54.4979–1(c)(2) ............................................... ‘‘1.401(k)–1(f)(1)(i) and (6)(i)’’ .......................... ‘‘1.401(k)–2(b)(1)(i) and (6)(i)’’

§ 54.4979–1(c)(2) ............................................... ‘‘1.401(k)–1(f)(3)(ii) and (4)(v)’’ ........................ ‘‘1.401(k)–2(b)(3)(ii) and (2)(vi)’’

§ 54.4979–1(c)(2) ............................................... ‘‘1.401(m)–1(e)(3)(v)’’ ....................................... ‘‘1.401(m)–2(b)(2)(vi)’’

§ 54.4979–1(c)(3) ............................................... ‘‘1.401(k)–1(f)(4)(ii)’’ ......................................... ‘‘1.401(k)–2(b)(2)(iv)’’

§ 54.4979–1(c)(3) ............................................... ‘‘1.401(m)–1(e)(3)(ii)’’ ....................................... ‘‘1.401(m)–2(b)(2)(iv)’’

■ Par. 3. In § 1.410(b)–3, paragraph 

(a)(2)(i) is revised to read a follows:

§ 1.410(b)–3 Employees and former 

employees who benefit under a plan. 

(a) * * *

(2) Exceptions to allocation or accrual 

requirement—(i) Section 401(k) and 

401(m) plans. Notwithstanding 

paragraph (a)(1) of this section, an 

employee is treated as benefiting under 

a section 401(k) plan for a plan year if 

and only if the employee is an eligible 

employee as defined in § 1.401(k)–6 

under the plan. Similarly, an employee 

is treated as benefiting under a section 

401(m) plan for a plan year if and only 

if the employee is an eligible employee 

as defined in § 1.401(m)–5 under the 

plan for the plan year.

* * * * *

■ Par. 4. Sections 1.401(k)–0 and 

1.401(k)–1 are revised and §§ 1.401(k)–2 

through 1.401(k)–6 are added to read as 

follows:

§ 1.401(k)–0 Table of contents. 

This section contains first a list of 

section headings and then a list of the 

paragraphs in each section in 

§§ 1.401(k)–1 through 1.401(k)–6.

List of Sections 

§ 1.401(k)–1 Certain cash or deferred 

arrangements. 

§ 1.401(k)–2 ADP test. 

§ 1.401(k)–3 Safe harbor requirements. 

§ 1.401(k)–4 SIMPLE 401(k) plan 

requirements. 

§ 1.401(k)–5 Special rules for mergers, 

acquisitions and similar events. [Reserved] 

§ 1.401(k)–6 Definitions.

List of Paragraphs

§ 1.401(k)–1 Certain cash or deferred 

arrangements.

(a) General rules. 

(1) Certain plans permitted to include cash 

or deferred arrangements. 

(2) Rules applicable to cash or deferred 

arrangements generally. 

(i) Definition of cash or deferred 

arrangement. 

(ii) Treatment of after-tax employee 

contributions. 

(iii) Treatment of ESOP dividend election. 

(iv) Treatment of elective contributions as 

plan assets. 

(3) Rules applicable to cash or deferred 

elections generally. 

(i) Definition of cash or deferred election. 

(ii) Automatic enrollment. 

(iii) Rules related to timing. 

(A) Requirement that amounts not be 

currently available. 

(B) Contribution may not precede election. 

Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 78155

(C) Contribution may not precede services. 

(iv) Current availability defined. 

(v) Certain one-time elections not treated as 

cash or deferred elections. 

(vi) Tax treatment of employees. 

(vii) Examples. 

(4) Rules applicable to qualified cash or 

deferred arrangements. 

(i) Definition of qualified cash or deferred 

arrangement. 

(ii) Treatment of elective contributions as 

employer contributions. 

(iii) Tax treatment of employees. 

(iv) Application of nondiscrimination 

requirements to plan that includes a qualified 

cash or deferred arrangement. 

(A) Exclusive means of amounts testing. 

(B) Testing benefits, rights and features. 

(C) Minimum coverage requirement. 

(5) Rules applicable to nonqualified cash or 

deferred arrangements. 

(i) Definition of nonqualified cash or 

deferred arrangement. 

(ii) Treatment of elective contributions as 

nonelective contributions. 

(iii) Tax treatment of employees. 

(iv) Qualification of plan that includes a 

nonqualified cash or deferred arrangement. 

(A) In general. 

(B) Application of section 401(a)(4) to 

certain plans. 

(v) Example. 

(6) Rules applicable to cash or deferred 

arrangements of self-employed individuals. 

(i) Application of general rules. 

(ii) Treatment of matching contributions 

made on behalf of self-employed individuals. 

(iii) Timing of self-employed individual’s 

cash or deferred election. 

(iv) Special rule for certain payments to 

self-employed individuals. 

(b) Coverage and nondiscrimination 

requirements. 

(1) In general. 

(2) Automatic satisfaction by certain plans. 

(3) Anti-abuse provisions. 

(4) Aggregation and restructuring. 

(i) In general. 

(ii) Aggregation of cash or deferred 

arrangements within a plan. 

(iii) Aggregation of plans. 

(A) In general. 

(B) Plans with inconsistent ADP testing 

methods. 

(iv) Disaggregation of plans and separate 

testing.

(A) In general. 

(B) Restructuring prohibited. 

(v) Modifications to section 410(b) rules. 

(A) Certain disaggregation rules not 

applicable. 

(B) Permissive aggregation of collective 

bargaining units. 

(C) Multiemployer plans. 

(vi) Examples. 

(c) Nonforfeitability requirements. 

(1) General rule. 

(2) Definition of immediately 

nonforfeitable. 

(3) Example. 

(d) Distribution limitation. 

(1) General rule. 

(2) Rules applicable to distributions upon 

severance from employment. 

(3) Rules applicable to hardship 

distributions. 

(i) Distribution must be on account of 

hardship. 

(ii) Limit on maximum distributable 

amount. 

(A) General rule. 

(B) Grandfathered amounts. 

(iii) Immediate and heavy financial need. 

(A) In general. 

(B) Deemed immediate and heavy financial 

need. 

(iv) Distribution necessary to satisfy 

financial need. 

(A) Distribution may not exceed amount of 

need. 

(B) No alternative means available. 

(C) Employer reliance on employee 

representation. 

(D) Employee need not take 

counterproductive actions. 

(E) Distribution deemed necessary to 

satisfy immediate and heavy financial need. 

(F) Definition of other plans. 

(v) Commissioner may expand standards. 

(4) Rules applicable to distributions upon 

plan termination. 

(i) No alternative defined contribution 

plan. 

(ii) Lump sum requirement for certain 

distributions. 

(5) Rules applicable to all distributions. 

(i) Exclusive distribution rules. 

(ii) Deemed distributions. 

(iii) ESOP dividend distributions. 

(iv) Limitations apply after transfer. 

(6) Examples. 

(e) Additional requirements for qualified 

cash or deferred arrangements. 

(1) Qualified plan requirement. 

(2) Election requirements. 

(i) Cash must be available. 

(ii) Frequency of elections. 

(3) Separate accounting requirement. 

(i) General rule. 

(ii) Satisfaction of separate accounting 

requirement. 

(4) Limitations on cash or deferred 

arrangements of state and local governments. 

(i) General rule. 

(ii) Rural cooperative plans and Indian 

tribal governments. 

(iii) Adoption after May 6, 1986. 

(iv) Adoption before May 7, 1986. 

(5) One-year eligibility requirement. 

(6) Other benefits not contingent upon 

elective contributions. 

(i) General rule. 

(ii) Definition of other benefits. 

(iii) Effect of certain statutory limits. 

(iv) Nonqualified deferred compensation. 

(v) Plan loans and distributions. 

(vi) Examples. 

(7) Plan provision requirement. 

(f) Special rules for designated Roth 

contributions. [Reserved] 

(g) Effective dates. 

(1) General rule. 

(2) Early implementation permitted. 

(3) Collectively bargained plans. 

(4) Applicability of prior regulations. 

§ 1.401(k)–2 ADP Test 

(a) Actual deferral percentage (ADP) Test. 

(1) In general. 

(i) ADP test formula. 

(ii) HCEs as sole eligible employees. 

(iii) Special rule for early participation. 

(2) Determination of ADP. 

(i) General rule. 

(ii) Determination of applicable year under 

current year and prior year testing method. 

(3) Determination of ADR. 

(i) General rule. 

(ii) ADR of HCEs eligible under more than 

one arrangement. 

(A) General rule. 

(B) Plans not permitted to be aggregated. 

(iii) Examples. 

(4) Elective contributions taken into 

account under the ADP test. 

(i) General rule. 

(ii) Elective contributions for partners and 

self-employed individuals. 

(iii) Elective contributions for HCEs. 

(5) Elective contributions not taken into 

account under the ADP test. 

(i) General rule.

(ii) Elective contributions for NHCEs. 

(iii) Elective contributions treated as catchup contributions. 

(v) Additional elective contributions 

pursuant to section 414(u). 

(iv) Elective contributions used to satisfy 

the ACP test. 

(6) Qualified nonelective contributions and 

qualified matching contributions that may be 

taken into account under the ADP test. 

(i) Timing of allocation. 

(ii) Requirement that amount satisfy 

section 401(a)(4). 

(iii) Aggregation must be permitted. 

(iv) Disporportionate contributions not 

taken into account. 

(A) General rule. 

(B) Definition of representative 

contribution rate. 

(C) Definition of applicable contribution 

rate. 

(D) Special rule for prevailing wage 

contributions. 

(v) Qualified matching contributions. 

(vi) Contributions only used once. 

(7) Examples. 

(b) Correction of excess contributions. 

(1) Permissible correction methods. 

(i) In general. 

(A) Qualified nonelective contributions or 

qualified matching contributions. 

(B) Excess contributions distributed. 

(C) Excess contributions recharacterized. 

(ii) Combination of correction methods. 

(iii) Exclusive means of correction. 

(2) Corrections through distribution. 

(i) General rule. 

(ii) Calculation of total amount to be 

distributed. 

(A) Calculate the dollar amount of excess 

contributions for each HCE. 

(B) Determination of the total amount of 

excess contributions. 

(C) Satisfaction of ADP. 

(iii) Apportionment of total amount of 

excess contributions among the HCEs. 

(A) Calculate the dollar amount of excess 

contributions for each HCE. 

(B) Limit on amount apportioned to any 

individual. 

(C) Apportionment to additional HCEs. 

(iv) Income allocable to excess 

contributions. 

(A) General rule. 

(B) Method of allocating income. 

(C) Alternative method of allocating plan 

year income. 

78156 Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 

(D) Safe harbor method of allocating gap 

period income. 

(E) Alternative method for allocating plan 

year and gap period income. 

(v) Distribution. 

(vi) Tax treatment of corrective 

distributions. 

(A) General rule. 

(B) Rule for de minimis distributions. 

(vii) Other rules. 

(A) No employee or spousal consent 

required. 

(B) Treatment of corrective distributions as 

elective contributions. 

(C) No reduction of required minimum 

distribution. 

(D) Partial distributions. 

(viii) Examples. 

(3) Recharacterization of excess 

contributions. 

(i) General rule. 

(ii) Treatment of recharacterized excess 

contributions. 

(iii) Additional rules. 

(A) Time of recharacterization. 

(B) Employee contributions must be 

permitted under plan. 

(C) Treatment of recharacterized excess 

contributions. 

(4) Rules applicable to all corrections. 

(i) Coordination with distribution of excess 

deferrals. 

(A) Treatment of excess deferrals that 

reduce excess contributions. 

(B) Treatment of excess contributions that 

reduce excess deferrals. 

(ii) Forfeiture of match on distributed 

excess contributions. 

(iii) Permitted forfeiture of QMAC. 

(iv) No requirement for recalculation. 

(v) Treatment of excess contributions that 

are catch-up contributions. 

(5) Failure to timely correct. 

(i) Failure to correct within 21⁄2 months 

after end of plan year. 

(ii) Failure to correct within 12 months 

after end of plan year. 

(c) Additional rules for prior year testing 

method. 

(1) Rules for change in testing method. 

(i) General rule. 

(ii) Situations permitting a change to the 

prior year testing method. 

(2) Calculation of ADP under the prior year 

testing method for the first plan year. 

(i) Plans that are not successor plans. 

(ii) First plan year defined. 

(iii) Successor plans. 

(3) Plans using different testing methods 

for the ADP and ACP test. 

(4) Rules for plan coverage changes. 

(i) In general. 

(ii) Optional rule for minor plan coverage 

changes. 

(iii) Definitions. 

(A) Plan coverage change. 

(B) Prior year subgroup. 

(C) Weighted average of the ADPs for the 

prior year subgroups. 

(iv) Examples.

§ 1.401(k)–3 Safe harbor requirements

(a) ADP test safe harbor.

(b) Safe harbor nonelective contribution 

requirement. 

(1) General rule. 

(2) Safe harbor compensation defined. 

(c) Safe harbor matching contribution 

requirement. 

(1) In general. 

(2) Basic matching formula. 

(3) Enhanced matching formula. 

(4) Limitation on HCE matching 

contributions. 

(5) Use of safe harbor match not precluded 

by certain plan provisions. 

(i) Safe harbor matching contributions on 

employee contributions. 

(ii) Periodic matching contributions. 

(6) Permissible restrictions on elective 

contributions by NHCEs. 

(i) General rule. 

(ii) Restrictions on election periods. 

(iii) Restrictions on amount of elective 

contributions. 

(iv) Restrictions on types of compensation 

that may be deferred. 

(v) Restrictions due to limitations under 

the Internal Revenue Code. 

(7) Examples. 

(d) Notice requirement. 

(1) General rule. 

(2) Content requirement. 

(i) General rule. 

(ii) Minimum content requirement. 

(iii) References to SPD. 

(3) Timing requirement. 

(i) General rule. 

(ii) Deemed satisfaction of timing 

requirement. 

(e) Plan year requirement. 

(1) General rule. 

(2) Initial plan year. 

(3) Change of plan year. 

(4) Final plan year. 

(f) Plan amendments adopting safe harbor 

nonelective contributions. 

(1) General rule. 

(2) Contingent notice provided. 

(3) Follow-up notice requirement. 

(g) Permissible reduction or suspension of 

safe harbor matching contributions. 

(1) General rule. 

(2) Notice of suspension requirement. 

(h) Additional rules. 

(1) Contributions taken into account. 

(2) Use of safe harbor nonelective 

contributions to satisfy other 

nondiscrimination tests. 

(3) Early participation rules. 

(4) Satisfying safe harbor contribution 

requirement under another defined 

contribution plan. 

(5) Contributions used only once. 

§ 1.401(k)–4 SIMPLE 401(k) Plan 

Requirements 

(a) General rule. 

(b) Eligible employer. 

(1) General rule. 

(2) Special rule. 

(c) Exclusive plan. 

(1) General rule. 

(2) Special rule. 

(d) Election and notice. 

(1) General rule. 

(2) Employee elections. 

(i) Initial plan year of participation. 

(ii) Subsequent plan years. 

(iii) Election to terminate. 

(3) Employee notices. 

(e) Contributions. 

(1) General rule. 

(2) Elective contributions. 

(3) Matching contributions. 

(4) Nonelective contributions. 

(5) SIMPLE compensation. 

(f) Vesting. 

(g) Plan year. 

(h) Other rules. 

§ 1.401(k)–5 Special Rules for Mergers, 

Acquisitions and Similar Events. [Reserved] 

§ 1.401(k)–6 Definitions.

§ 1.401(k)–1 Certain cash or deferred 

arrangements. 

(a) General rules—(1) Certain plans 

permitted to include cash or deferred 

arrangements. A plan, other than a 

profit-sharing, stock bonus, pre-ERISA 

money purchase pension, or rural 

cooperative plan, does not satisfy the 

requirements of section 401(a) if the 

plan includes a cash or deferred 

arrangement. A profit-sharing, stock 

bonus, pre-ERISA money purchase 

pension, or rural cooperative plan does 

not fail to satisfy the requirements of 

section 401(a) merely because the plan 

includes a cash or deferred arrangement. 

A cash or deferred arrangement is part 

of a plan for purposes of this section if 

any contributions to the plan, or 

accruals or other benefits under the 

plan, are made or provided pursuant to 

the cash or deferred arrangement. 

(2) Rules applicable to cash or 

deferred arrangements generally—(i) 

Definition of cash or deferred 

arrangement. Except as provided in 

paragraphs (a)(2)(ii) and (iii) of this 

section, a cash or deferred arrangement 

is an arrangement under which an 

eligible employee may make a cash or 

deferred election with respect to 

contributions to, or accruals or other 

benefits under, a plan that is intended 

to satisfy the requirements of section 

401(a) (including a contract that is 

intended to satisfy the requirements of 

section 403(a)). 

(ii) Treatment of after-tax employee 

contributions. A cash or deferred 

arrangement does not include an 

arrangement under which amounts 

contributed under a plan at an 

employee’s election are designated or 

treated at the time of contribution as 

after-tax employee contributions (e.g., 

by treating the contributions as taxable 

income subject to applicable 

withholding requirements). See also

section 414(h)(1). A designated Roth 

contribution, however, is not treated as 

an after-tax contribution for purposes of 

this section, § 1.401(k)–2 through 

§ 1.401(k)–6 and § 1.401(m)–1 through 

§ 1.401(m)–5. A contribution can be an 

after-tax employee contribution under 

the rule of this paragraph (a)(2)(ii) even 

if the employee’s election to make afterVerDate jul<14>2003 18:47 Dec 28, 2004 Jkt 205001 PO 00000 Frm 00014 Fmt 4701 Sfmt 4700 E:\FR\FM\29DER2.SGM 29DER2
Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 78157

tax employee contributions is made 

before the amounts subject to the 

election are currently available to the 

employee. 

(iii) Treatment of ESOP dividend 

election. A cash or deferred arrangement 

does not include an arrangement under 

an ESOP under which dividends are 

either distributed or invested pursuant 

to an election made by participants or 

their beneficiaries in accordance with 

section 404(k)(2)(A)(iii). 

(iv) Treatment of elective 

contributions as plan assets. The extent 

to which elective contributions 

constitute plan assets for purposes of 

the prohibited transaction provisions of 

section 4975 and Title I of the Employee 

Retirement Income Security Act of 1974 

(88 Stat. 829), Public Law 93–406, is 

determined in accordance with 

regulations and rulings issued by the 

Department of Labor. See 29 CFR 

2510.3–102. 

(3) Rules applicable to cash or 

deferred elections generally—(i) 

Definition of cash or deferred election.

A cash or deferred election is any direct 

or indirect election (or modification of 

an earlier election) by an employee to 

have the employer either—

(A) Provide an amount to the 

employee in the form of cash (or some 

other taxable benefit) that is not 

currently available; or 

(B) Contribute an amount to a trust, or 

provide an accrual or other benefit, 

under a plan deferring the receipt of 

compensation. 

(ii) Automatic enrollment. For 

purposes of determining whether an 

election is a cash or deferred election, 

it is irrelevant whether the default that 

applies in the absence of an affirmative 

election is described in paragraph 

(a)(3)(i)(A) of this section (i.e., the 

employee receives an amount in cash or 

some other taxable benefit) or in 

paragraph (a)(3)(i)(B) of this section (i.e., 

the employer contributes an amount to 

a trust or provides an accrual or other 

benefit under a plan deferring the 

receipt of compensation). 

(iii) Rules related to timing—(A) 

Requirement that amounts not be 

currently available. A cash or deferred 

election can only be made with respect 

to an amount that is not currently 

available to the employee on the date of 

the election. Further, a cash or deferred 

election can only be made with respect 

to amounts that would (but for the cash 

or deferred election) become currently 

available after the later of the date on 

which the employer adopts the cash or 

deferred arrangement or the date on 

which the arrangement first becomes 

effective. 

(B) Contribution may not precede 

election. A contribution is made 

pursuant to a cash or deferred election 

only if the contribution is made after the 

election is made. 

(C) Contribution may not precede 

services—(1) General rule. Contributions 

are made pursuant to a cash or deferred 

election only if the contributions are 

made after the employee’s performance 

of service with respect to which the 

contributions are made (or when the 

cash or other taxable benefit would be 

currently available, if earlier). 

(2) Exception for bona fide 

administrative considerations. The 

timing of contributions will not be 

treated as failing to satisfy the 

requirements of this paragraph 

(a)(3)(iii)(C) merely because 

contributions for a pay period are 

occasionally made before the services 

with respect to that pay period are 

performed, provided the contributions 

are made early in order to accommodate 

bona fide administrative considerations 

(for example, the temporary absence of 

the bookkeeper with responsibility to 

transmit contributions to the plan) and 

are not paid early with a principal 

purpose of accelerating deductions.

(iv) Current availability defined. Cash 

or another taxable benefit is currently 

available to the employee if it has been 

paid to the employee or if the employee 

is able currently to receive the cash or 

other taxable benefit at the employee’s 

discretion. An amount is not currently 

available to an employee if there is a 

significant limitation or restriction on 

the employee’s right to receive the 

amount currently. Similarly, an amount 

is not currently available as of a date if 

the employee may under no 

circumstances receive the amount 

before a particular time in the future. 

The determination of whether an 

amount is currently available to an 

employee does not depend on whether 

it has been constructively received by 

the employee for purposes of section 

451. 

(v) Certain one-time elections not 

treated as cash or deferred elections. A 

cash or deferred election does not 

include a one-time irrevocable election 

made no later than the employee’s first 

becoming eligible under the plan or any 

other plan or arrangement of the 

employer that is described in section 

219(g)(5)(A) (whether or not such other 

plan or arrangement has terminated), to 

have contributions equal to a specified 

amount or percentage of the employee’s 

compensation (including no amount of 

compensation) made by the employer 

on the employee’s behalf to the plan and 

a specified amount or percentage of the 

employee’s compensation (including no 

amount of compensation) divided 

among all other plans or arrangements 

of the employer (including plans or 

arrangements not yet established) for the 

duration of the employee’s employment 

with the employer, or in the case of a 

defined benefit plan to receive accruals 

or other benefits (including no benefits) 

under such plans. Thus, for example, 

employer contributions made pursuant 

to a one-time irrevocable election 

described in this paragraph are not 

treated as having been made pursuant to 

a cash or deferred election and are not 

includible in an employee’s gross 

income by reason of § 1.402(a)–1(d). In 

the case of an irrevocable election made 

on or before December 23, 1994—

(A) The election does not fail to be 

treated as a one-time irrevocable 

election under this paragraph (a)(3)(v) 

merely because an employee was 

previously eligible under another plan 

of the employer (whether or not such 

other plan has terminated); and 

(B) In the case of a plan in which 

partners may participate, the election 

does not fail to be treated as a one-time 

irrevocable election under this 

paragraph (a)(3)(v) merely because the 

election was made after commencement 

of employment or after the employee’s 

first becoming eligible under any plan of 

the employer, provided that the election 

was made before the first day of the first 

plan year beginning after December 31, 

1988, or, if later, March 31,1989. 

(vi) Tax treatment of employees. An 

amount generally is includible in an 

employee’s gross income for the taxable 

year in which the employee actually or 

constructively receives the amount. But 

for section 402(e)(3), an employee is 

treated as having received an amount 

that is contributed to an exempt trust or 

plan described in section 401(a) or 

403(a) pursuant to the employee’s cash 

or deferred election. This is the case 

even if the election to defer is made 

before the year in which the amount is 

earned, or before the amount is 

currently available. See § 1.402(a)–1(d). 

(vii) Examples. The following 

examples illustrate the application of 

this paragraph (a)(3):

Example 1. (i) An employer maintains a 

profit-sharing plan under which each eligible 

employee has an election to defer an annual 

bonus payable on January 30 each year. The 

bonus equals 10% of compensation during 

the previous calendar year. Deferred amounts 

are not treated as after-tax employee 

contributions. The bonus is currently 

available on January 30. 

(ii) An election made prior to January 30 

to defer all or part of the bonus is a cash or 

deferred election, and the bonus deferral 

arrangement is a cash or deferred 

arrangement.

78158 Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 

Example 2. (i) An employer maintains a 

profit-sharing plan which provides for 

discretionary profit sharing contributions and 

under which each eligible employee may 

elect to reduce his compensation by up to 

10% and to have the employer contribute 

such amount to the plan. The employer pays 

each employee every two weeks for services 

during the immediately preceding two 

weeks. The employee’s election to defer 

compensation for a payroll period must be 

made prior to the date the amount would 

otherwise be paid. The employer contributes 

to the plan the amount of compensation that 

each employee elected to defer, at the time 

it would otherwise be paid to the employee, 

and does not treat the contribution as an 

after-tax employee contribution. 

(ii) The election is a cash or deferred 

election and the contributions are elective 

contributions.

Example 3. (i) The facts are the same as in 

Example 2, except that the employer makes 

a $10,000 contribution on January 31 of the 

plan year that is in addition to the 

contributions that satisfy the employer’s 

obligation to make contributions with respect 

to cash or deferred elections for prior payroll 

periods. Employee A makes an election on 

February 15 to defer $2,000 from 

compensation that is not currently available 

and the employer reduces the employee’s 

compensation to reflect the election. 

(ii) None of the additional $10,000 

contributed January 31 is a contribution 

made pursuant to Employee A’s cash or 

deferred election, because the contribution 

was made before the election was made. 

Accordingly, the employer must make an 

additional contribution of $2,000 in order to 

satisfy its obligation to contribute an amount 

to the plan pursuant to Employee A’s 

election. The $10,000 contribution may be 

allocated under the plan terms providing for 

discretionary profit sharing contributions.

Example 4. (i) The facts are the same as in 

Example 3, except that Employee A had an 

outstanding election to defer $500 from each 

payroll period’s compensation. The $10,000 

additional payment that is contributed early 

is not made early in order to accommodate 

bona fide administrative considerations.

(ii) None of the additional $10,000 

contributed January 31 is a contribution 

made pursuant to Employee A’s cash or 

deferred election for future payroll periods, 

because the contribution was made before the 

earlier of Employee A’s performance of 

services to which the contribution is 

attributable or when the compensation would 

be currently available. Furthermore, the 

exception for early contributions in 

paragraph (a)(3)(iii)(C)(2) of this section does 

not apply. Accordingly, the employer must 

make an additional contribution of $500 per 

payroll period in order to satisfy its 

obligation to contribute an amount to the 

plan pursuant to Employee A’s election. The 

$10,000 contribution may be allocated under 

the plan terms providing for discretionary 

profit sharing contributions.

Example 5. (i) Employer B establishes a 

money purchase pension plan in 1986. This 

is the first qualified plan established by 

Employer B. All salaried employees are 

eligible to participate under the plan. Hourlypaid employees are not eligible to participate 

under the plan. In 2000, Employer B 

establishes a profit-sharing plan under which 

all employees (both salaried and hourly) are 

eligible. Employer B permits all employees 

on the effective date of the profit-sharing 

plan to make a one-time irrevocable election 

to have Employer B contribute 5% of 

compensation on their behalf to the plan and 

make no other contribution to any other plan 

of Employer B (including plans not yet 

established) for the duration of the 

employee’s employment with Employer B, 

and have their salaries reduced by 5%. 

(ii) The election provided under the profitsharing plan is not a one-time irrevocable 

election within the meaning of paragraph 

(a)(3)(v) of this section with respect to the 

salaried employees of Employer B who, 

before becoming eligible to participate under 

the profit-sharing plan, became eligible to 

participate under the money purchase 

pension plan. The election under the profitsharing plan is a one-time irrevocable 

election within the meaning of paragraph 

(a)(3)(v) of this section with respect to the 

hourly employees, because they were not 

previously eligible to participate under 

another plan of the employer.

(4) Rules applicable to qualified cash 

or deferred arrangements—(i) Definition 

of qualified cash or deferred 

arrangement. A qualified cash or 

deferred arrangement is a cash or 

deferred arrangement that satisfies the 

requirements of paragraphs (b), (c), (d), 

and (e) of this section. 

(ii) Treatment of elective 

contributions as employer contributions.

Except as otherwise provided in 

§ 1.401(k)–2(b)(3), elective contributions 

under a qualified cash or deferred 

arrangement (including designated Roth 

contributions) are treated as employer 

contributions. Thus, for example, 

elective contributions under such an 

arrangement are treated as employer 

contributions for purposes of sections 

401(a), 401(k), 402, 404, 409, 411, 412, 

415, 416, and 417. 

(iii) Tax treatment of employees.

Except as provided in section 402(g), 

402A (effective for taxable years 

beginning after December 31, 2005), or 

§ 1.401(k)–2(b)(3), elective contributions 

under a qualified cash or deferred 

arrangement are neither includible in an 

employee’s gross income at the time the 

cash would have been includible in the 

employee’s gross income (but for the 

cash or deferred election), nor at the 

time the elective contributions are 

contributed to the plan. See § 1.402(a)–

1(d)(2)(i). 

(iv) Application of nondiscrimination 

requirements to plan that includes a 

qualified cash or deferred 

arrangement—(A) Exclusive means of 

amounts testing. Elective contributions 

(including elective contributions that 

are designated Roth contributions) 

under a qualified cash or deferred 

arrangement satisfy the requirements of 

section 401(a)(4) with respect to 

amounts if and only if the amount of 

elective contributions satisfies the 

nondiscrimination test of section 401(k) 

under paragraph (b)(1) of this section. 

See § 1.401(a)(4)–1(b)(2)(ii)(B). 

(B) Testing benefits, rights and 

features. A plan that includes a 

qualified cash or deferred arrangement 

must satisfy the requirements of section 

401(a)(4) with respect to benefits, rights 

and features in addition to the 

requirements regarding amounts 

described in paragraph (a)(4)(iv)(A) of 

this section. For example, the right to 

make each level of elective 

contributions under a cash or deferred 

arrangement and the right to make 

designated Roth contributions are rights 

or features subject to the requirements 

of section 401(a)(4). See § 1.401(a)(4)–

4(e)(3)(i) and (iii)(D). Thus, for example, 

if all employees are eligible to make a 

stated level of elective contributions 

under a cash or deferred arrangement, 

but that level of contributions can only 

be made from compensation in excess of 

a stated amount, such as the Social 

Security taxable wage base, the 

arrangement will generally favor HCEs 

with respect to the availability of 

elective contributions and thus will 

generally not satisfy the requirements of 

section 401(a)(4). 

(C) Minimum coverage requirement. A 

qualified cash or deferred arrangement 

is treated as a separate plan that must 

satisfy the requirements of section 

410(b). See § 1.410(b)–7(c)(1) for special 

rules. The determination of whether a 

cash or deferred arrangement satisfies 

the requirements of section 410(b) must 

be made without regard to the 

modifications to the disaggregation rules 

set forth in paragraph (b)(4)(v) of this 

section. See also § 1.401(a)(4)–

11(g)(3)(vii)(A), relating to corrective 

amendments that may be made to satisfy 

the minimum coverage requirements of 

section 410(b). 

(5) Rules applicable to nonqualified 

cash or deferred arrangements—(i) 

Definition of nonqualified cash or 

deferred arrangement. A nonqualified 

cash or deferred arrangement is a cash 

or deferred arrangement that fails to 

satisfy one or more of the requirements 

in paragraph (b), (c), (d) or (e) of this 

section. 

(ii) Treatment of elective 

contributions as nonelective 

contributions. Except as specifically 

provided otherwise, elective 

contributions under a nonqualified cash 

or deferred arrangement are treated as 

nonelective employer contributions. 

Thus, for example, the elective 

Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 78159

contributions under such an 

arrangement are treated as nonelective 

employer contributions for purposes of 

sections 401(a) (including section 

401(a)(4)) and 401(k), 404, 409, 411, 

412, 415, 416, and 417 and are not 

subject to the requirements of section 

401(m). 

(iii) Tax treatment of employees.

Elective contributions under a 

nonqualified cash or deferred 

arrangement are includible in an 

employee’s gross income at the time the 

cash or other taxable amount that the 

employee would have received (but for 

the cash or deferred election) would 

have been includible in the employee’s 

gross income. See § 1.402(a)–1(d)(1). 

(iv) Qualification of plan that 

includes a nonqualified cash or deferred 

arrangement— (A) In general. A profitsharing, stock bonus, pre-ERISA money 

purchase pension, or rural cooperative 

plan does not fail to satisfy the 

requirements of section 401(a) merely 

because the plan includes a 

nonqualified cash or deferred 

arrangement. In determining whether 

the plan satisfies the requirements of 

section 401(a)(4), the nondiscrimination 

tests of sections 401(k), paragraph (b)(1) 

of this section, section 401(m)(2) and 

§ 1.401(m)–1(b) may not be used. See

§§ 1.401(a)(4)–1(b)(2)(ii)(B) and 

1.410(b)–9 (definition of section 401(k) 

plan). 

(B) Application of section 401(a)(4) to 

certain plans. The amount of employer 

contributions under a nonqualified cash 

or deferred arrangement is treated as 

satisfying section 401(a)(4) if the 

arrangement is part of a collectively 

bargained plan that automatically 

satisfies the requirements of section 

410(b). See §§ 1.401(a)(4)–(c)(5) and 

1.410(b)–2(b)(7). Additionally, the 

requirements of sections 401(a)(4) and 

410(b) do not apply to a governmental 

plan (within the meaning of section 

414(d)) maintained by a State or local 

government or political subdivision 

thereof (or agency or instrumentality 

thereof). See sections 401(a)(5) and 

410(c)(1)(A). 

(v) Example. The following example 

illustrates the application of this 

paragraph (a)(5):

Example. (i) For the 2006 plan year, 

Employer A maintains a collectively 

bargained plan that includes a cash or 

deferred arrangement. Employer 

contributions under the cash or deferred 

arrangement do not satisfy the 

nondiscrimination test of section 401(k) and 

paragraph (b) of this section. 

(ii) The arrangement is a nonqualified cash 

or deferred arrangement. The employer 

contributions under the cash or deferred 

arrangement are considered to be 

nondiscriminatory under section 401(a)(4), 

and the elective contributions are generally 

treated as employer contributions under 

paragraph (a)(5)(ii) of this section. Under 

paragraph (a)(5)(iii) of this section and under 

§ 1.402(a)–1(d)(1), however, the elective 

contributions are includible in each 

employee’s gross income.

(6) Rules applicable to cash or 

deferred arrangements of self-employed 

individuals—(i) Application of general 

rules. Generally, a partnership or sole 

proprietorship is permitted to maintain 

a cash or deferred arrangement, and 

individual partners or owners are 

permitted to make cash or deferred 

elections with respect to compensation 

attributable to services rendered to the 

entity, under the same rules that apply 

to other cash or deferred arrangements. 

For example, any contributions made on 

behalf of an individual partner or owner 

pursuant to a cash or deferred 

arrangement of a partnership or sole 

proprietorship are elective contributions 

unless they are designated or treated as 

after-tax employee contributions. In the 

case of a partnership, a cash or deferred 

arrangement includes any arrangement 

that directly or indirectly permits 

individual partners to vary the amount 

of contributions made on their behalf. 

Consistent with § 1.402(a)–1(d), the 

elective contributions under such an 

arrangement are includible in income 

and are not deductible under section 

404(a) unless the arrangement is a 

qualified cash or deferred arrangement 

(i.e., the requirements of section 401(k) 

and this section are satisfied). Also, 

even if the arrangement is a qualified 

cash or deferred arrangement, the 

elective contributions are includible in 

gross income and are not deductible 

under section 404(a) to the extent they 

exceed the applicable limit under 

section 402(g). See also § 1.401(a)–30. 

(ii) Treatment of matching 

contributions made on behalf of selfemployed individuals. Under section 

402(g)(8), matching contributions made 

on behalf of a self-employed individual 

are not treated as elective contributions 

made pursuant to a cash or deferred 

election, without regard to whether such 

matching contributions indirectly 

permit individual partners to vary the 

amount of contributions made on their 

behalf. 

(iii) Timing of self-employed 

individual’s cash or deferred election.

For purposes of paragraph (a)(3)(iv) of 

this section, a partner’s compensation is 

deemed currently available on the last 

day of the partnership taxable year and 

a sole proprietor’s compensation is 

deemed currently available on the last 

day of the individual’s taxable year. 

Accordingly, a self-employed individual 

may not make a cash or deferred 

election with respect to compensation 

for a partnership or sole proprietorship 

taxable year after the last day of that 

year. See § 1.401(k)–2(a)(4)(ii) for the 

rules regarding when these 

contributions are treated as allocated. 

(iv) Special rule for certain payments 

to self-employed individuals. For 

purposes of sections 401(k) and 401(m), 

the earned income of a self-employed 

individual for a taxable year constitutes 

payment for services during that year. 

Thus, for example, if a partnership 

provides for cash advance payments 

during the taxable year to be made to a 

partner based on the value of the 

partner’s services prior to the date of 

payment (and which do not exceed a 

reasonable estimate of the partner’s 

earned income for the taxable year), a 

contribution of a portion of these 

payments to a profit sharing plan in 

accordance with an election to defer the 

portion of the advance payments does 

not fail to be made pursuant to a cash 

or deferred election within the meaning 

of paragraph (a)(3)(iii) of this section 

merely because the contribution is made 

before the amount of the partner’s 

earned income is finally determined and 

reported. However, see § 1.401(k)–

2(a)(4)(ii) for rules on when earned 

income is treated as received. 

(b) Coverage and nondiscrimination 

requirements—(1) In general. A cash or 

deferred arrangement satisfies this 

paragraph (b) for a plan year only if—

(i) The group of eligible employees 

under the cash or deferred arrangement 

(including any employees taken into 

account for purposes of section 410(b) 

pursuant to § 1.401(a)(4)–

11(g)(3)(vii)(A)) satisfies the 

requirements of section 410(b) 

(including the average benefit 

percentage test, if applicable); and 

(ii) The cash or deferred arrangement 

satisfies—

(A) The ADP test of section 401(k)(3) 

described in § 1.401(k)–2; 

(B) The ADP safe harbor provisions of 

section 401(k)(12) described in 

§ 1.401(k)–3; or 

(C) The SIMPLE 401(k) provisions of 

section 401(k)(11) described in 

§ 1.401(k)–4. 

(2) Automatic satisfaction by certain 

plans. Notwithstanding paragraph (b)(1) 

of this section, a governmental plan 

(within the meaning of section 414(d)) 

maintained by a State or local 

government or political subdivision 

thereof (or agency or instrumentality 

thereof) shall be treated as meeting the 

requirements of this paragraph (b). 

(3) Anti-abuse provisions. This 

section and §§ 1.401(k)–2 through 

1.401(k)–6 are designed to provide 

simple, practical rules that 

78160 Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 

accommodate legitimate plan changes. 

At the same time, the rules are intended 

to be applied by employers in a manner 

that does not make use of changes in 

plan testing procedures or other plan 

provisions to inflate inappropriately the 

ADP for NHCEs (which is used as a 

benchmark for testing the ADP for 

HCEs) or to otherwise manipulate the 

nondiscrimination testing requirements 

of this paragraph (b). Further, this 

paragraph (b) is part of the overall 

requirement that benefits or 

contributions not discriminate in favor 

of HCEs. Therefore, a plan will not be 

treated as satisfying the requirements of 

this paragraph (b) if there are repeated 

changes to plan testing procedures or 

plan provisions that have the effect of 

distorting the ADP so as to increase 

significantly the permitted ADP for 

HCEs, or otherwise manipulate the 

nondiscrimination rules of this 

paragraph, if a principal purpose of the 

changes was to achieve such a result. 

(4) Aggregation and restructuring—(i) 

In general. This paragraph (b)(4) 

contains the exclusive rules for 

aggregating and disaggregating plans 

and cash or deferred arrangements for 

purposes of this section, and 

§§ 1.401(k)–2 through 1.401(k)–6. 

(ii) Aggregation of cash or deferred 

arrangements within a plan. Except as 

otherwise specifically provided in this 

paragraph (b)(4), all cash or deferred 

arrangements included in a plan are 

treated as a single cash or deferred 

arrangement and a plan must apply a 

single test under paragraph (b)(1)(ii) of 

this section with respect to all such 

arrangements within the plan. Thus, for 

example, if two groups of employees are 

eligible for separate cash or deferred 

arrangements under the same plan, all 

contributions under both cash or 

deferred arrangements must be treated 

as made under a single cash or deferred 

arrangement subject to a single test, 

even if they have significantly different 

features, such as different limits on 

elective contributions.

(iii) Aggregation of plans—(A) In 

general. For purposes of this section and 

§§ 1.401(k)–2 through 1.401(k)–6, the 

term plan means a plan within the 

meaning of § 1.410(b)–7(a) and (b), after 

application of the mandatory 

disaggregation rules of § 1.410(b)–7(c), 

and the permissive aggregation rules of 

§ 1.410(b)–7(d), as modified by 

paragraph (b)(4)(v) of this section. Thus, 

for example, two plans (within the 

meaning of § 1.410(b)–7(b)) that are 

treated as a single plan pursuant to the 

permissive aggregation rules of 

§ 1.410(b)–7(d) are treated as a single 

plan for purposes of sections 401(k) and 

(m). 

(B) Plans with inconsistent ADP 

testing methods. Pursuant to paragraph 

(b)(4)(ii) of this section, a single testing 

method must apply with respect to all 

cash or deferred arrangements under a 

plan. Thus, in applying the permissive 

aggregation rules of § 1.410(b)–7(d), an 

employer may not aggregate plans 

(within the meaning of § 1.410(b)–7(b)) 

that apply inconsistent testing methods. 

For example, a plan (within the 

meaning of § 1.410(b)–7(b)) that applies 

the current year testing method may not 

be aggregated with another plan that 

applies the prior year testing method. 

Similarly, an employer may not 

aggregate a plan (within the meaning of 

§ 1.410(b)–7(b)) using the ADP safe 

harbor provisions of section 401(k)(12) 

and another plan that is using the ADP 

test of section 401(k)(3). 

(iv) Disaggregation of plans and 

separate testing—(A) In general. If a 

cash or deferred arrangement is 

included in a plan (within the meaning 

of § 1.410(b)–7(b)) that is mandatorily 

disaggregated under the rules of section 

410(b) (as modified by this paragraph 

(b)(4)), the cash or deferred arrangement 

must be disaggregated in a consistent 

manner. For example, in the case of an 

employer that is treated as operating 

qualified separate lines of business 

under section 414(r), if the eligible 

employees under a cash or deferred 

arrangement are in more than one 

qualified separate line of business, only 

those employees within each qualified 

separate line of business may be taken 

into account in determining whether 

each disaggregated portion of the plan 

complies with the requirements of 

section 401(k), unless the employer is 

applying the special rule for employerwide plans in § 1.414(r)–1(c)(2)(ii) with 

respect to the plan. Similarly, if a cash 

or deferred arrangement under which 

employees are permitted to participate 

before they have completed the 

minimum age and service requirements 

of section 410(a)(1) applies section 

410(b)(4)(B) for determining whether the 

plan complies with section 410(b)(1), 

then the arrangement must be treated as 

two separate arrangements, one 

comprising all eligible employees who 

have met the age and service 

requirements of section 410(a)(1) and 

one comprising all eligible employees 

who have not met the age and service 

requirements under section 410(a)(1), 

unless the plan is using the rule in 

§ 1.401(k)–2(a)(1)(iii)(A). 

(B) Restructuring prohibited.

Restructuring under § 1.401(a)(4)–9(c) 

may not be used to demonstrate 

compliance with the requirements of 

section 401(k). See § 1.401(a)(4)–

9(c)(3)(ii). 

(v) Modifications to section 410(b) 

rules—(A) Certain disaggregation rules 

not applicable. The mandatory 

disaggregation rules relating to section 

401(k) plans and section 401(m) plans 

set forth in § 1.410(b)–7(c)(1) and ESOP 

and non-ESOP portions of a plan set 

forth in § 1.410(b)–7(c)(2) shall not 

apply for purposes of this section and 

§§ 1.401(k)–2 through 1.401(k)–6. 

Accordingly, notwithstanding 

§ 1.410(b)–7(d)(2), an ESOP and a nonESOP which are different plans (within 

the meaning of section 414(l), as 

described in § 1.410(b)–7(b)) are 

permitted to be aggregated for these 

purposes. 

(B) Permissive aggregation of 

collective bargaining units.

Notwithstanding the general rule under 

section 410(b) and § 1.410(b)–7(c) that a 

plan that benefits employees who are 

included in a unit of employees covered 

by a collective bargaining agreement 

and employees who are not included in 

the collective bargaining unit is treated 

as comprising separate plans, an 

employer can treat two or more separate 

collective bargaining units as a single 

collective bargaining unit for purposes 

of this section and §§ 1.401(k)–2 

through 1.401(k)–6, provided that the 

combinations of units are determined on 

a basis that is reasonable and reasonably 

consistent from year to year. Thus, for 

example, if a plan benefits employees in 

three categories (e.g., employees 

included in collective bargaining unit A, 

employees included in collective 

bargaining unit B, and employees who 

are not included in any collective 

bargaining unit), the plan can be treated 

as comprising three separate plans, each 

of which benefits only one category of 

employees. However, if collective 

bargaining units A and B are treated as 

a single collective bargaining unit, the 

plan will be treated as comprising only 

two separate plans, one benefiting all 

employees who are included in a 

collective bargaining unit and another 

benefiting all other employees. 

Similarly, if a plan benefits only 

employees who are included in 

collective bargaining unit A and 

employees who are included in 

collective bargaining unit B, the plan 

can be treated as comprising two 

separate plans. However, if collective 

bargaining units A and B are treated as 

a single collective bargaining unit, the 

plan will be treated as a single plan. An 

employee is treated as included in a 

unit of employees covered by a 

collective bargaining agreement if and 

only if the employee is a collectively 

bargained employee within the meaning 

of § 1.410(b)–6(d)(2). 

Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 78161

(C) Multiemployer plans.

Notwithstanding § 1.410(b)–

7(c)(4)(ii)(C), the portion of the plan that 

is maintained pursuant to a collective 

bargaining agreement (within the 

meaning of § 1.413–1(a)(2)) is treated as 

a single plan maintained by a single 

employer that employs all the 

employees benefiting under the same 

benefit computation formula and 

covered pursuant to that collective 

bargaining agreement. The rules of 

paragraph (b)(4)(v)(B) of this section 

(including the permissive aggregation of 

collective bargaining units) apply to the 

resulting deemed single plan in the 

same manner as they would to a single 

employer plan, except that the plan 

administrator is substituted for the 

employer where appropriate and that 

appropriate fiduciary obligations are 

taken into account. The noncollectively 

bargained portion of the plan is treated 

as maintained by one or more 

employers, depending on whether the 

noncollectively bargaining unit 

employees who benefit under the plan 

are employed by one or more 

employers. 

(vi) Examples. The following 

examples illustrate the application of 

this paragraph (b)(4):

Example 1. (i) Employer A maintains Plan 

V, a profit-sharing plan that includes a cash 

or deferred arrangement in which all of the 

employees of Employer A are eligible to 

participate. For purposes of applying section 

410(b), Employer A is treated as operating 

qualified separate lines of business under 

section 414(r) in accordance with § 1.414(r)–

1(b). However, Employer A applies the 

special rule for employer-wide plans in 

§ 1.414(r)–1(c)(2)(ii) to the portion of its 

profit-sharing plan that consists of elective 

contributions under the cash or deferred 

arrangement (and to no other plans or 

portions of plans). 

(ii) Under these facts, the requirements of 

this section and §§ 1.401(k)–2 through 

1.401(k)–6 must be applied on an employerwide rather than a qualified separate line of 

business basis.

Example 2. (i) Employer B maintains Plan 

W, a profit-sharing plan that includes a cash 

or deferred arrangement in which all of the 

employees of Employer B are eligible to 

participate. For purposes of applying section 

410(b), the plan treats the cash or deferred 

arrangement as two separate plans, one for 

the employees who have completed the 

minimum age and service eligibility 

conditions under section 410(a)(1) and the 

other for employees who have not completed 

the conditions. The plan provides that it will 

satisfy the section 401(k) safe harbor 

requirement of § 1.401(k)–3 with respect to 

the employees who have met the minimum 

age and service conditions and that it will 

meet the ADP test requirements of § 1.401(k)–

2 with respect to the employees who have 

not met the minimum age and service 

conditions. 

(ii) Under these facts, the cash or deferred 

arrangement must be disaggregated on a 

consistent basis with the disaggregation of 

Plan W. Thus, the requirements of § 1.401(k)–

2 must be applied by comparing the ADP for 

eligible HCEs who have not completed the 

minimum age and service conditions with 

the ADP for eligible NHCEs for the applicable 

year who have not completed the minimum 

age and service conditions.

Example 3. (i) Employer C maintains Plan 

X, a stock-bonus plan including an ESOP. 

The plan also includes a cash or deferred 

arrangement for participants in the ESOP and 

non-ESOP portions of the plan. 

(ii) Pursuant to paragraph (b)(4)(v)(A) of 

this section the ESOP and non-ESOP portions 

of the stock-bonus plan are a single cash or 

deferred arrangement for purposes of this 

section and §§ 1.401(k)–2 through 1.401(k)–6. 

However, as provided in paragraph 

(a)(4)(iv)(C) of this section, the ESOP and 

non-ESOP portions of the plan are still 

treated as separate plans for purposes of 

satisfying the requirements of section 410(b).

(c) Nonforfeitability requirements—(1) 

General rule. A cash or deferred 

arrangement satisfies this paragraph (c) 

only if the amount attributable to an 

employee’s elective contributions are 

immediately nonforfeitable, within the 

meaning of paragraph (c)(2) of this 

section, are disregarded for purposes of 

applying section 411(a)(2) to other 

contributions or benefits, and the 

contributions remain nonforfeitable 

even if the employee makes no 

additional elective contributions under 

a cash or deferred arrangement. 

(2) Definition of immediately 

nonforfeitable. An amount is 

immediately nonforfeitable if it is 

immediately nonforfeitable within the 

meaning of section 411, and would be 

nonforfeitable under the plan regardless 

of the age and service of the employee 

or whether the employee is employed 

on a specific date. An amount that is 

subject to forfeitures or suspensions 

permitted by section 411(a)(3) does not 

satisfy the requirements of this 

paragraph (c). 

(3) Example. The following example 

illustrates the application of this 

paragraph (c):

Example. (i) Employees B and C are 

covered by Employer Y’s stock bonus plan, 

which includes a cash or deferred 

arrangement. All employees participating in 

the plan have a nonforfeitable right to a 

percentage of their account balance derived 

from all contributions (including elective 

contributions) as shown in the following 

table:

Years of service Nonforfeitable

percentage 

Less than 1 ..................... 0 

1 ...................................... 20 

2 ...................................... 40 

3 ...................................... 60 

Years of service Nonforfeitable

percentage 

4 ...................................... 80 

5 or more ........................ 100 

(ii) The cash or deferred arrangement does 

not satisfy paragraph (c) of this section 

because elective contributions are not 

immediately nonforfeitable. Thus, the cash or 

deferred arrangement is a nonqualified cash 

or deferred arrangement.

(d) Distribution limitation—(1) 

General rule. A cash or deferred 

arrangement satisfies this paragraph (d) 

only if amounts attributable to elective 

contributions may not be distributed 

before one of the following events, and 

any distributions so permitted also 

satisfy the additional requirements of 

paragraphs (d)(2) through (5) of this 

section (to the extent applicable)—

(i) The employee’s death, disability, 

or severance from employment; 

(ii) In the case of a profit-sharing, 

stock bonus or rural cooperative plan, 

the employee’s attainment of age 591⁄2, 

or the employee’s hardship; or 

(iii) The termination of the plan. 

(2) Rules applicable to distributions 

upon severance from employment. An 

employee has a severance from 

employment when the employee ceases 

to be an employee of the employer 

maintaining the plan. An employee does 

not have a severance from employment 

if, in connection with a change of 

employment, the employee’s new 

employer maintains such plan with 

respect to the employee. For example, a 

new employer maintains a plan with 

respect to an employee by continuing or 

assuming sponsorship of the plan or by 

accepting a transfer of plan assets and 

liabilities (within the meaning of section 

414(l)) with respect to the employee. 

(3) Rules applicable to hardship 

distributions—(i) Distribution must be 

on account of hardship. A distribution 

is treated as made after an employee’s 

hardship for purposes of paragraph 

(d)(1)(ii) of this section if and only if it 

is made on account of the hardship. For 

purposes of this rule, a distribution is 

made on account of hardship only if the 

distribution both is made on account of 

an immediate and heavy financial need 

of the employee and is necessary to 

satisfy the financial need. The 

determination of the existence of an 

immediate and heavy financial need 

and of the amount necessary to meet the 

need must be made in accordance with 

nondiscriminatory and objective 

standards set forth in the plan.

(ii) Limit on maximum distributable 

amount—(A) General rule. A 

distribution on account of hardship 

must be limited to the maximum 

78162 Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 

distributable amount. The maximum 

distributable amount is equal to the 

employee’s total elective contributions 

as of the date of distribution, reduced by 

the amount of previous distributions of 

elective contributions. Thus, the 

maximum distributable amount does 

not include earnings, QNECs or QMACs, 

unless grandfathered under paragraph 

(d)(3)(ii)(B) of this section. 

(B) Grandfathered amounts. If the 

plan so provides, the maximum 

distributable amount may be increased 

for amounts credited to the employee’s 

account as of a date specified in the 

plan that is no later than December 31, 

1988, or if later, the end of the last plan 

year ending before July 1, 1989 (or in 

the case of a collectively bargained plan, 

the earlier of—

(1) The later of January 1, 1989, or the 

date on which the last of the collective 

bargaining agreements in effect on 

March 1, 1986 terminates (determined 

without regard to any extension thereof 

after February 28, 1986); or 

(2) January 1, 1991 and consisting 

of—

(i) Income allocable to elective 

contributions; 

(ii) Qualified nonelective 

contributions and allocable income; and 

(iii) Qualified matching contributions 

and allocable income. 

(iii) Immediate and heavy financial 

need—(A) In general. Whether an 

employee has an immediate and heavy 

financial need is to be determined based 

on all the relevant facts and 

circumstances. Generally, for example, 

the need to pay the funeral expenses of 

a family member would constitute an 

immediate and heavy financial need. A 

distribution made to an employee for 

the purchase of a boat or television 

would generally not constitute a 

distribution made on account of an 

immediate and heavy financial need. A 

financial need may be immediate and 

heavy even if it was reasonably 

foreseeable or voluntarily incurred by 

the employee. 

(B) Deemed immediate and heavy 

financial need. A distribution is deemed 

to be on account of an immediate and 

heavy financial need of the employee if 

the distribution is for—

(1) Expenses for (or necessary to 

obtain) medical care that would be 

deductible under section 213(d) 

(determined without regard to whether 

the expenses exceed 7.5% of adjusted 

gross income); 

(2) Costs directly related to the 

purchase of a principal residence for the 

employee (excluding mortgage 

payments); 

(3) Payment of tuition, related 

educational fees, and room and board 

expenses, for up to the next 12 months 

of post-secondary education for the 

employee, or the employee’s spouse, 

children, or dependents (as defined in 

section 152, and, for taxable years 

beginning on or after January 1, 2005, 

without regard to section 152(b)(1), 

(b)(2) and (d)(1)(B)); 

(4) Payments necessary to prevent the 

eviction of the employee from the 

employee’s principal residence or 

foreclosure on the mortgage on that 

residence; 

(5) Payments for burial or funeral 

expenses for the employee’s deceased 

parent, spouse, children or dependents 

(as defined in section 152, and, for 

taxable years beginning on or after 

January 1, 2005, without regard to 

section 152(d)(1)(B)); or 

(6) Expenses for the repair of damage 

to the employee’s principal residence 

that would qualify for the casualty 

deduction under section 165 

(determined without regard to whether 

the loss exceeds 10% of adjusted gross 

income). 

(iv) Distribution necessary to satisfy 

financial need—(A) Distribution may 

not exceed amount of need. A 

distribution is treated as necessary to 

satisfy an immediate and heavy 

financial need of an employee only to 

the extent the amount of the distribution 

is not in excess of the amount required 

to satisfy the financial need. For this 

purpose, the amount required to satisfy 

the financial need may include any 

amounts necessary to pay any federal, 

state, or local income taxes or penalties 

reasonably anticipated to result from the 

distribution. 

(B) No alternative means available. A 

distribution is not treated as necessary 

to satisfy an immediate and heavy 

financial need of an employee to the 

extent the need may be relieved from 

other resources that are reasonably 

available to the employee. This 

determination generally is to be made 

on the basis of all the relevant facts and 

circumstances. For purposes of this 

paragraph (d)(3)(iv), the employee’s 

resources are deemed to include those 

assets of the employee’s spouse and 

minor children that are reasonably 

available to the employee. Thus, for 

example, a vacation home owned by the 

employee and the employee’s spouse, 

whether as community property, joint 

tenants, tenants by the entirety, or 

tenants in common, generally will be 

deemed a resource of the employee. 

However, property held for the 

employee’s child under an irrevocable 

trust or under the Uniform Gifts to 

Minors Act (or comparable State law) is 

not treated as a resource of the 

employee. 

(C) Employer reliance on employee 

representation. For purposes of 

paragraph (d)(3)(iv)(B) of this section, an 

immediate and heavy financial need 

generally may be treated as not capable 

of being relieved from other resources 

that are reasonably available to the 

employee, if the employer relies upon 

the employee’s representation (made in 

writing or such other form as may be 

prescribed by the Commissioner), unless 

the employer has actual knowledge to 

the contrary, that the need cannot 

reasonably be relieved—

(1) Through reimbursement or 

compensation by insurance or 

otherwise; 

(2) By liquidation of the employee’s 

assets; 

(3) By cessation of elective 

contributions or employee contributions 

under the plan; 

(4) By other currently available 

distributions (including distribution of 

ESOP dividends under section 404(k)) 

and nontaxable (at the time of the loan) 

loans, under plans maintained by the 

employer or by any other employer; or 

(5) By borrowing from commercial 

sources on reasonable commercial terms 

in an amount sufficient to satisfy the 

need. 

(D) Employee need not take 

counterproductive actions. For purposes 

of this paragraph (d)(3)(iv), a need 

cannot reasonably be relieved by one of 

the actions described in paragraph 

(d)(3)(iv)(C) of this section if the effect 

would be to increase the amount of the 

need. For example, the need for funds 

to purchase a principal residence cannot 

reasonably be relieved by a plan loan if 

the loan would disqualify the employee 

from obtaining other necessary 

financing. 

(E) Distribution deemed necessary to 

satisfy immediate and heavy financial 

need. A distribution is deemed 

necessary to satisfy an immediate and 

heavy financial need of an employee if 

each of the following requirements are 

satisfied—

(1) The employee has obtained all 

other currently available distributions 

(including distribution of ESOP 

dividends under section 404(k), but not 

hardship distributions) and nontaxable 

(at the time of the loan) loans, under the 

plan and all other plans maintained by 

the employer; and 

(2) The employee is prohibited, under 

the terms of the plan or an otherwise 

legally enforceable agreement, from 

making elective contributions and 

employee contributions to the plan and 

all other plans maintained by the 

employer for at least 6 months after 

receipt of the hardship distribution. 

Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 78163

(F) Definition of other plans. For 

purposes of paragraph (d)(3)(iv)(C)(4) 

and (E)(1) of this section, the phrase 

plans maintained by the employer

means all qualified and nonqualified 

plans of deferred compensation 

maintained by the employer, including 

a cash or deferred arrangement that is 

part of a cafeteria plan within the 

meaning of section 125. However, it 

does not include the mandatory 

employee contribution portion of a 

defined benefit plan or a health or 

welfare benefit plan (including one that 

is part of a cafeteria plan). In addition, 

for purposes of paragraph (d)(3)(iv)(E)(2) 

of this section, the phrase plans 

maintained by the employer also 

includes a stock option, stock purchase, 

or similar plan maintained by the 

employer. See § 1.401(k)–6 for the 

continued treatment of suspended 

employees as eligible employees.

(v) Commissioner may expand 

standards. The Commissioner may 

prescribe additional guidance of general 

applicability, published in the Internal 

Revenue Bulletin (see § 601.601(d)(2) of 

this chapter), expanding the list of 

deemed immediate and heavy financial 

needs and prescribing additional 

methods for distributions to be deemed 

necessary to satisfy an immediate and 

heavy financial need. 

(4) Rules applicable to distributions 

upon plan termination—(i) No 

alternative defined contribution plan. A 

distribution may not be made under 

paragraph (d)(1)(iii) of this section if the 

employer establishes or maintains an 

alternative defined contribution plan. 

For purposes of the preceding sentence, 

the definition of the term ‘‘employer’’

contained in § 1.401(k)–6 is applied as 

of the date of plan termination, and a 

plan is an alternative defined 

contribution plan only if it is a defined 

contribution plan that exists at any time 

during the period beginning on the date 

of plan termination and ending 12 

months after distribution of all assets 

from the terminated plan. However, if at 

all times during the 24-month period 

beginning 12 months before the date of 

plan termination, fewer than 2% of the 

employees who were eligible under the 

defined contribution plan that includes 

the cash or deferred arrangement as of 

the date of plan termination are eligible 

under the other defined contribution 

plan, the other plan is not an alternative 

defined contribution plan. In addition, a 

defined contribution plan is not treated 

as an alternative defined contribution 

plan if it is an employee stock 

ownership plan as defined in section 

4975(e)(7) or 409(a), a simplified 

employee pension as defined in section 

408(k), a SIMPLE IRA plan as defined in 

section 408(p), a plan or contract that 

satisfies the requirements of section 

403(b), or a plan that is described in 

section 457(b) or (f). 

(ii) Lump sum requirement for certain 

distributions. A distribution may be 

made under paragraph (d)(1)(iii) of this 

section only if it is a lump sum 

distribution. The term lump sum 

distribution has the meaning provided 

in section 402(e)(4)(D) (without regard 

to section 402(e)(4)(D)(i)(I), (II), (III) and 

(IV)). In addition, a lump sum 

distribution includes a distribution of 

an annuity contract from a trust that is 

part of a plan described in section 

401(a) and which is exempt from tax 

under section 501(a) or an annuity plan 

described in 403(a). 

(5) Rules applicable to all 

distributions—(i) Exclusive distribution 

rules. Amounts attributable to elective 

contributions may not be distributed on 

account of any event not described in 

this paragraph (d), such as completion 

of a stated period of plan participation 

or the lapse of a fixed number of years. 

For example, if excess deferrals (and 

income) for an employee’s taxable year 

are not distributed within the time 

prescribed in § 1.402(g)–1(e)(2) or (3), 

the amounts may be distributed only on 

account of an event described in this 

paragraph (d). Pursuant to section 

401(k)(8), the prohibition on 

distributions set forth in this section 

does not apply to a distribution of 

excess contributions under § 1.401(k)–

2(b). 

(ii) Deemed distributions. The cost of 

life insurance (determined under 

section 72) is not treated as a 

distribution for purposes of section 

401(k)(2) and this paragraph (d). The 

making of a loan is not treated as a 

distribution, even if the loan is secured 

by the employee’s accrued benefit 

attributable to elective contributions or 

is includible in the employee’s income 

under section 72(p). However, the 

reduction, by reason of default on a 

loan, of an employee’s accrued benefit 

derived from elective contributions is 

treated as a distribution. 

(iii) ESOP dividend distributions. A 

plan does not fail to satisfy the 

requirements of this paragraph (d) 

merely by reason of a dividend 

distribution described in section 

404(k)(2). 

(iv) Limitations apply after transfer.

The limitations of this paragraph (d) 

generally continue to apply to amounts 

attributable to elective contributions 

(including QNECs and qualified 

matching contributions taken into 

account for the ADP test under 

§ 1.401(k)–2(a)(6)) that are transferred to 

another qualified plan of the same or 

another employer. Thus, the transferee 

plan will generally fail to satisfy the 

requirements of section 401(a) and this 

section if transferred amounts may be 

distributed before the times specified in 

this paragraph (d). In addition, a cash or 

deferred arrangement fails to satisfy the 

limitations of this paragraph (d) if it 

transfers amounts to a plan that does not 

provide that the transferred amounts 

may not be distributed before the times 

specified in this paragraph (d). The 

transferor plan does not fail to comply 

with the preceding sentence if it 

reasonably concludes that the transferee 

plan provides that the transferred 

amounts may not be distributed before 

the times specified in this paragraph (d). 

What constitutes a basis for a reasonable 

conclusion is determined under 

standards comparable to those under the 

rules related to acceptance of rollover 

distributions. See § 1.401(a)(31)–1, A–

14. The limitations of this paragraph (d) 

cease to apply after the transfer, 

however, if the amounts could have 

been distributed at the time of the 

transfer (other than on account of 

hardship), and the transfer is an elective 

transfer described in § 1.411(d)–4, Q&A–

3(b)(1). The limitations of this paragraph 

(d) also do not apply to amounts that 

have been paid in a direct rollover to the 

plan after being distributed by another 

plan. 

(6) Examples. The following examples 

illustrate the application of this 

paragraph (d):

Example 1. Employer M maintains Plan V, 

a profit-sharing plan that includes a cash or 

deferred arrangement. Elective contributions 

under the arrangement may be withdrawn for 

any reason after two years following the end 

of the plan year in which the contributions 

were made. Because the plan permits 

distributions of elective contributions before 

the occurrence of one of the events specified 

in section 401(k)(2)(B) and this paragraph (d), 

the cash or deferred arrangement is a 

nonqualified cash or deferred arrangement 

and the elective contributions are currently 

includible in income under section 402.

Example 2. (i) Employer N maintains Plan 

W, a profit-sharing plan that includes a cash 

or deferred arrangement. Plan W provides for 

distributions upon a participant’s severance 

from employment, death or disability. All 

employees of Employer N and its wholly 

owned subsidiary, Employer O, are eligible to 

participate in Plan W. Employer N agrees to 

sell all issued and outstanding shares of 

Employer O to an unrelated entity, Employer 

T, effective on December 31, 2006. Following 

the transaction, Employer O will be a wholly 

owned subsidiary of Employer T. 

Additionally, individuals who are employed 

by Employer O on the effective date of the 

sale continue to be employed by Employer O 

following the sale. Following the transaction, 

all employees of Employer O will cease to 

participate in Plan W and will become 

eligible to participate in the cash or deferred 

78164 Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 

arrangement maintained by Employer T, Plan 

X. No assets will be transferred from Plan W 

to Plan X, except in the case of a direct 

rollover within the meaning of section 

401(a)(31). 

(ii) Employer O ceases to be a member of 

Employer N’s controlled group as a result of 

the sale. Therefore, employees of Employer O 

who participated in Plan W will have a 

severance from employment and are eligible 

to receive a distribution from Plan W.

Example 3. (i) Employer Q maintains Plan 

Y, a profit-sharing plan that includes a cash 

or deferred arrangement. Plan Y, the only 

plan maintained by Employer Q, does not 

provide for loans. However, Plan Y provides 

that elective contributions under the 

arrangement may be distributed to an eligible 

employee on account of hardship using the 

deemed immediate and heavy financial need 

provisions of paragraph (d)(3)(iii)(B) of this 

section and provisions regarding 

distributions necessary to satisfy financial 

need of paragraphs (d)(3)(iv)(A) through (D) 

of this section. Employee A is an eligible 

employee in Plan Y with an account balance 

of $50,000 attributable to elective 

contributions made by Employee A. The total 

amount of elective contributions made by 

Employee A, who has not previously 

received a distribution from Plan Y, is 

$20,000. Employee A requests a $15,000 

hardship distribution of his elective 

contributions to pay 6 months of college 

tuition and room and board expenses for his 

dependent. At the time of the distribution 

request, the sole asset of Employee A (that is 

reasonably available to Employee A within 

the meaning of paragraph (d)(3)(iv)(B) of this 

section) is a savings account with an 

available balance of $10,000. 

(ii) A distribution is made on account of 

hardship only if the distribution both is made 

on account of an immediate and heavy 

financial need of the employee and is 

necessary to satisfy the financial need. Under 

paragraph (d)(3)(iii)(B) of this section, a 

distribution for payment of up to the next 12 

months of post-secondary education and 

room and board expenses for Employee A’s 

dependent is deemed to be on account of an 

immediate and heavy financial need of 

Employee A. 

(iii) A distribution is treated as necessary 

to satisfy Employee A’s immediate and heavy 

financial need to the extent the need may not 

be relieved from other resources reasonably 

available to Employee A. Under paragraph 

(d)(3)(iv)(B) of this section, Employee A’s 

$10,000 savings account is a resource that is 

reasonably available to the employee and 

must be taken into account in determining 

the amount necessary to satisfy Employee A’s 

immediate and heavy financial need. Thus, 

Employee A may receive a distribution of 

only $5,000 of his elective contributions on 

account of this hardship, plus an amount 

necessary to pay any federal, state, or local 

income taxes or penalties reasonably 

anticipated to result from the distribution.

Example 4. (i) The facts are the same as in 

Example 3. Employee B, another employee of 

Employer Q has an account balance of 

$25,000, attributable to Employee B’s elective 

contributions. The total amount of elective 

contributions made by Employee B, who has 

not previously received a distribution from 

Plan Y, is $15,000. Employee B requests a 

$10,000 distribution of his elective 

contributions to pay 6 months of college 

tuition and room and board expenses for his 

child. Employee B makes a written 

representation (with respect to which 

Employer Q has no actual knowledge to the 

contrary) that the need cannot reasonably be 

relieved: 

(A) Through reimbursement or 

compensation by insurance or otherwise; 

(B) By liquidation of the employee’s assets; 

(C) By cessation of elective contributions or 

employee contributions under the plan; 

(D) By other distributions or nontaxable (at 

the time of the loan) loans from plans 

maintained by the employer or by any other 

employer; or 

(E) By borrowing from commercial sources 

on reasonable commercial terms in an 

amount sufficient to satisfy the need. 

(ii) Under paragraph (d)(3)(iii)(B) of this 

section, a distribution for payment of up to 

the next 12 months of post-secondary 

education and room and board expenses for 

Employee B’s child is deemed to be on 

account of an Employee B’s immediate and 

heavy financial need. In addition, because 

Employer Q can rely on Employee B’s written 

representation, the distribution is considered 

necessary to satisfy Employee B’s immediate 

and heavy financial need. Therefore, 

Employee B may receive a $10,000 

distribution of his elective contributions on 

account of hardship plus an amount 

necessary to pay any federal, state, or local 

income taxes or penalties reasonably 

anticipated to result from the distribution.

Example 5. (i) The facts are the same as in 

Example 3, except Plan Y provides for 

hardship distributions using the safe harbor 

rule of paragraph (d)(3)(iv)(E) of this section. 

Accordingly, Plan Y provides for a 6 month 

suspension of an eligible employee’s elective 

contributions and employee contributions to 

the plan after the receipt of a hardship 

distribution by such eligible employee.

(ii) Under paragraph (d)(3)(iii)(B) of this 

section, a distribution for payment of up to 

the next 12 months of post-secondary 

education and room and board expenses for 

Employee A’s dependent is deemed to be on 

account of an Employee A’s immediate and 

heavy financial need. In addition, because 

Employee A is not eligible for any other 

distribution or loan from Plan Y and Plan Y 

suspends Employee A’s elective 

contributions and employee contributions 

following receipt of the hardship 

distribution, the distribution will be deemed 

necessary to satisfy Employee A’s immediate 

and heavy financial need (and Employee A 

is not required to first liquidate his savings 

account). Therefore, Employee A may receive 

a $15,000 distribution of his elective 

contributions on account of hardship plus an 

amount necessary to pay any federal, state, or 

local income taxes or penalties reasonably 

anticipated to result from the distribution.

Example 6. Employer R maintains a preERISA money purchase pension plan that 

includes a cash or deferred arrangement that 

is not a rural cooperative plan. Elective 

contributions under the arrangement may be 

distributed to an employee on account of 

hardship. Under paragraph (d)(1) of this 

section, hardship is a permissible 

distribution event only in a profit-sharing, 

stock bonus or rural cooperative plan. Since 

elective contributions under the arrangement 

may be distributed before a permissible 

distribution event occurs, the cash or 

deferred arrangement does not satisfy this 

paragraph (d), and is not a qualified cash or 

deferred arrangement. Moreover, the plan is 

not a qualified plan because a money 

purchase pension plan may not provide for 

payment of benefits upon hardship. See

§ 1.401–1(b)(1)(i).

(e) Additional requirements for 

qualified cash or deferred 

arrangements—(1) Qualified plan 

requirement. A cash or deferred 

arrangement satisfies this paragraph (e) 

only if the plan of which it is a part is 

a profit-sharing, stock bonus, pre-ERISA 

money purchase or rural cooperative 

plan that otherwise satisfies the 

requirements of section 401(a) (taking 

into account the cash or deferred 

arrangement). A plan that includes a 

cash or deferred arrangement may 

provide for other contributions, 

including employer contributions (other 

than elective contributions), employee 

contributions, or both. However, except 

as expressly permitted under section 

401(m), 410(b)(2)(A)(ii) or 416(c)(2)(A), 

elective contributions and matching 

contributions taken into account under 

§ 1.401(k)–2(a) may not be taken into 

account for purposes of determining 

whether any other contributions under 

any plan (including the plan to which 

the contributions are made) satisfy the 

requirements of section 401(a). 

(2) Election requirements—(i) Cash 

must be available. A cash or deferred 

arrangement satisfies this paragraph (e) 

only if the arrangement provides that 

the amount that each eligible employee 

may defer as an elective contribution is 

available to the employee in cash. Thus, 

for example, if an eligible employee is 

provided the option to receive a taxable 

benefit (other than cash) or to have the 

employer contribute on the employee’s 

behalf to a profit-sharing plan an 

amount equal to the value of the taxable 

benefit, the arrangement is not a 

qualified cash or deferred arrangement. 

Similarly, if an employee has the option 

to receive a specified amount in cash or 

to have the employer contribute an 

amount in excess of the specified cash 

amount to a profit-sharing plan on the 

employee’s behalf, any contribution 

made by the employer on the 

employee’s behalf in excess of the 

specified cash amount is not treated as 

made pursuant to a qualified cash or 

deferred arrangement, but would be 

treated as a matching contribution. This 

cash availability requirement applies 

even if the cash or deferred arrangement 

Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 78165

is part of a cafeteria plan within the 

meaning of section 125. 

(ii) Frequency of elections. A cash or 

deferred arrangement satisfies this 

paragraph (e) only if the arrangement 

provides an employee with an effective 

opportunity to make (or change) a cash 

or deferred election at least once during 

each plan year. Whether an employee 

has an effective opportunity is 

determined based on all the relevant 

facts and circumstances, including the 

adequacy of notice of the availability of 

the election, the period of time during 

which an election may be made, and 

any other conditions on elections. 

(3) Separate accounting 

requirement—(i) General rule. A cash or 

deferred arrangement satisfies this 

paragraph (e) only if the portion of an 

employee’s benefit subject to the 

requirements of paragraphs (c) and (d) 

of this section is determined by an 

acceptable separate accounting between 

that portion and any other benefits. 

Separate accounting is not acceptable 

unless contributions and withdrawals 

are attributed to the separate accounts 

and gains, losses, and other credits or 

charges are separately allocated on a 

reasonable and consistent basis to the 

accounts subject to the requirements of 

paragraphs (c) and (d) of this section 

and to other accounts. Subject to section 

401(a)(4), forfeitures are not required to 

be allocated to the accounts in which 

benefits are subject to paragraphs (c) 

and (d) of this section. The separate 

accounting requirement of this 

paragraph (e)(3)(i) applies at the time 

the elective contribution is contributed 

to the plan and continues to apply until 

the contribution is distributed under the 

plan. 

(ii) Satisfaction of separate 

accounting requirement. The 

requirements of paragraph (e)(3)(i) of 

this section are treated as satisfied if all 

amounts held under a plan that includes 

a qualified cash or deferred arrangement 

(and, if applicable, under another plan 

to which QNECs and QMACs are made) 

are subject to the requirements of 

paragraphs (c) and (d) of this section. 

(4) Limitations on cash or deferred 

arrangements of state and local 

governments—(i) General rule. A cash 

or deferred arrangement does not satisfy 

the requirements of this paragraph (e) if 

the arrangement is adopted after May 6, 

1986, by a State or local government or 

political subdivision thereof, or any 

agency or instrumentality thereof (a 

governmental unit). For purposes of this 

paragraph (e)(4), an employer that has 

made a legally binding commitment to 

adopt a cash or deferred arrangement is 

treated as having adopted the 

arrangement on that date. 

(ii) Rural cooperative plans and 

Indian tribal governments. This 

paragraph (e)(4) does not apply to a 

rural cooperative plan or to a plan of an 

employer which is an Indian tribal 

government (as defined in section 

7701(a)(40)), a subdivision of an Indian 

tribal government (determined in 

accordance with section 7871(d)), an 

agency or instrumentality of an Indian 

tribal government or subdivision 

thereof, or a corporation chartered 

under Federal, State or tribal law which 

is owned in whole or in part by any of 

the entities in this paragraph (e)(4)(ii). 

(iii) Adoption after May 6, 1986. A 

cash or deferred arrangement is treated 

as adopted after May 6, 1986, with 

respect to all employees of any 

employer that adopts the arrangement 

after such date. 

(iv) Adoption before May 7, 1986. If a 

governmental unit adopted a cash or 

deferred arrangement before May 7, 

1986, then any cash or deferred 

arrangement adopted by the unit at any 

time is treated as adopted before that 

date. If an employer adopted an 

arrangement prior to such date, all 

employees of the employer may 

participate in the arrangement. 

(5) One-year eligibility requirement. A 

cash or deferred arrangement satisfies 

this paragraph (e) only if no employee 

is required to complete a period of 

service with the employer maintaining 

the plan extending beyond the period 

permitted under section 410(a)(1) 

(determined without regard to section 

410(a)(1)(B)(i)) to be eligible to make a 

cash or deferred election under the 

arrangement. 

(6) Other benefits not contingent upon 

elective contributions—(i) General rule.

A cash or deferred arrangement satisfies 

this paragraph (e) only if no other 

benefit is conditioned (directly or 

indirectly) upon the employee’s electing 

to make or not to make elective 

contributions under the arrangement. 

The preceding sentence does not apply 

to—

(A) Any matching contribution (as 

defined in § 1.401(m)–1(a)(2)) made by 

reason of such an election; 

(B) Any benefit, right or feature (such 

as a plan loan) that requires, or results 

in, an amount to be withheld from an 

employee’s pay (e.g. to pay for the 

benefit or to repay the loan), to the 

extent the cash or deferred arrangement 

restricts elective contributions to 

amounts available after such 

withholding from the employee’s pay 

(after deduction of all applicable income 

and employment taxes); 

(C) Any reduction in the employer’s 

top-heavy contributions under section 

416(c)(2) because of matching 

contributions that resulted from the 

elective contributions; or 

(D) Any benefit that is provided at the 

employee’s election under a plan 

described in section 125(d) in lieu of an 

elective contribution under a qualified 

cash or deferred arrangement. 

(ii) Definition of other benefits. For 

purposes of this paragraph (e)(6), other 

benefits include, but are not limited to, 

benefits under a defined benefit plan; 

nonelective contributions under a 

defined contribution plan; the 

availability, cost, or amount of health 

benefits; vacations or vacation pay; life 

insurance; dental plans; legal services 

plans; loans (including plan loans); 

financial planning services; subsidized 

retirement benefits; stock options; 

property subject to section 83; and 

dependent care assistance. Also, 

increases in salary, bonuses or other 

cash remuneration (other than the 

amount that would be contributed 

under the cash or deferred election) are 

benefits for purposes of this paragraph 

(e)(6). The ability to make after-tax 

employee contributions is a benefit, but 

that benefit is not contingent upon an 

employee’s electing to make or not make 

elective contributions under the 

arrangement merely because the amount 

of elective contributions reduces dollarfor-dollar the amount of after-tax 

employee contributions that may be 

made. Additionally, benefits under any 

other plan or arrangement (whether or 

not qualified) are not contingent upon 

an employee’s electing to make or not to 

make elective contributions under a 

cash or deferred arrangement merely 

because the elective contributions are or 

are not taken into account as 

compensation under the other plan or 

arrangement for purposes of 

determining benefits.

(iii) Effect of certain statutory limits.

Any benefit under an excess benefit 

plan described in section 3(36) of the 

Employee Retirement Income Security 

Act of 1974 (88 Stat. 829), Public Law 

93–406, that is dependent on the 

employee’s electing to make or not to 

make elective contributions is not 

treated as contingent. Deferred 

compensation under a nonqualified 

plan of deferred compensation that is 

dependent on an employee’s having 

made the maximum elective deferrals 

under section 402(g) or the maximum 

elective contributions permitted under 

the terms of the plan also is not treated 

as contingent. 

(iv) Nonqualified deferred 

compensation. Except as otherwise 

provided in paragraph (e)(6)(iii) of this 

section, participation in a nonqualified 

deferred compensation plan is treated as 

contingent for purposes of this 

78166 Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 

paragraph (e)(6) to the extent that an 

employee may receive additional 

deferred compensation under the 

nonqualified plan to the extent the 

employee makes or does not make 

elective contributions. 

(v) Plan loans and distributions. A 

loan or distribution of elective 

contributions is not a benefit 

conditioned on an employee’s electing 

to make or not make elective 

contributions under the arrangement 

merely because the amount of the loan 

or distribution is based on the amount 

of the employee’s account balance. 

(vi) Examples. The following 

examples illustrate the application of 

this paragraph (e)(6):

Example 1. Employer T maintains a cash 

or deferred arrangement for all of its 

employees. Employer T also maintains a 

nonqualified deferred compensation plan for 

two highly paid executives, Employees R and 

C. Under the terms of the nonqualified 

deferred compensation plan, R and C are 

eligible to participate only if they do not 

make elective contributions under the cash or 

deferred arrangement. Participation in the 

nonqualified plan is a contingent benefit for 

purposes of this paragraph (e)(6), because R’s 

and C’s participation is conditioned on their 

electing not to make elective contributions 

under the cash or deferred arrangement.

Example 2. Employer T maintains a cash 

or deferred arrangement for all its employees. 

Employer T also maintains a nonqualified 

deferred compensation plan for two highly 

paid executives, Employees R and C. Under 

the terms of the arrangements, Employees R 

and C may defer a maximum of 10% of their 

compensation, and may allocate their 

deferral between the cash or deferred 

arrangement and the nonqualified deferred 

compensation plan in any way they choose 

(subject to the overall 10% maximum). 

Because the maximum deferral available 

under the nonqualified deferred 

compensation plan depends on the elective 

deferrals made under the cash or deferred 

arrangement, the right to participate in the 

nonqualified plan is a contingent benefit for 

purposes of this paragraph (e)(6).

(7) Plan provision requirement. A 

plan that includes a cash or deferred 

arrangement satisfies this paragraph (e) 

only if it provides that the 

nondiscrimination requirements of 

section 401(k) will be met. Thus, the 

plan must provide for satisfaction of one 

of the specific alternatives described in 

paragraph (b)(1)(ii) of this section and, 

if with respect to that alternative there 

are optional choices, which of the 

optional choices will apply. For 

example, a plan that uses the ADP test 

of section 401(k)(3), as described in 

paragraph (b)(1)(ii)(A) of this section, 

must specify whether it is using the 

current year testing method or prior year 

testing method. Additionally, a plan 

that uses the prior year testing method 

must specify whether the ADP for 

eligible NHCEs for the first plan year is 

3% or the ADP for the eligible NHCEs 

for the first plan year. Similarly, a plan 

that uses the safe harbor method of 

section 401(k)(12), as described in 

paragraph (b)(1)(ii)(B) of this section, 

must specify whether the safe harbor 

contribution will be the nonelective safe 

harbor contribution or the matching safe 

harbor contribution and is not permitted 

to provide that ADP testing will be used 

if the requirements for the safe harbor 

are not satisfied. For purposes of this 

paragraph (e)(7), a plan may incorporate 

by reference the provisions of section 

401(k)(3) and § 1.401(k)–2 if that is the 

nondiscrimination test being applied. 

The Commissioner may, in guidance of 

general applicability, published in the 

Internal Revenue Bulletin (see 

§ 601.601(d)(2) of this chapter), specify 

the options that will apply under the 

plan if the nondiscrimination test is 

incorporated by reference in accordance 

with the preceding sentence. 

(f) Special rules for designated Roth 

contributions. [Reserved]. 

(g) Effective dates—(1) General rule.

Except as otherwise provided in this 

paragraph (g), this section and 

§§ 1.401(k)–2 through 1.401(k)–6 apply 

to plan years that begin on or after 

January 1, 2006. 

(2) Early implementation permitted. A 

plan is permitted to apply the rules of 

this section and §§ 1.401(k)–2 through 

1.401(k)–6 to any plan year that ends 

after December 29, 2004, provided the 

plan applies all the rules of this section 

and §§ 1.401(k)–2 through 1.401(k)–6 

and all the rules of §§ 1.401(m)–1 

through 1.401(m)–5, to the extent 

applicable, for that plan year and all 

subsequent plan years. 

(3) Collectively bargained plans. In 

the case of a plan maintained pursuant 

to one or more collective bargaining 

agreements between employee 

representatives and one or more 

employers in effect on the date 

described in paragraph (g)(1) of this 

section, the provisions of this section 

and §§ 1.401(k)–2 through 1.401(k)–6 

apply to the later of the first plan year 

beginning after the termination of the 

last such agreement or the first plan year 

described in paragraph (g)(1) of this 

section. 

(4) Applicability of prior regulations.

For any plan year before a plan applies 

this section and §§ 1.401(k)–2 through 

1.401(k)–6 (either the first plan year 

beginning on or after January 1, 2006, or 

such earlier year, as provided in 

paragraph (g)(2) of this section), 

§ 1.401(k)–1 (as it appeared in the April 

1, 2004 edition of 26 CFR part 1) applies 

to the plan to the extent that section, as 

it so appears, reflects the statutory 

provisions of section 401(k) as in effect 

for the relevant year.

§ 1.401(k)–2 ADP test. 

(a) Actual deferral percentage (ADP) 

test—(1) In general—(i) ADP test 

formula. A cash or deferred arrangement 

satisfies the ADP test for a plan year 

only if—

(A) The ADP for the eligible HCEs for 

the plan year is not more than the ADP 

for the eligible NHCEs for the applicable 

year multiplied by 1.25; or 

(B) The excess of the ADP for the 

eligible HCEs for the plan year over the 

ADP for the eligible NHCEs for the 

applicable year is not more than 2 

percentage points, and the ADP for the 

eligible HCEs for the plan year is not 

more than the ADP for the eligible 

NHCEs for the applicable year 

multiplied by 2. 

(ii) HCEs as sole eligible employees. If, 

for the applicable year for determining 

the ADP of the NHCEs for a plan year, 

there are no eligible NHCEs (i.e., all of 

the eligible employees under the cash or 

deferred arrangement for the applicable 

year are HCEs), the arrangement is 

deemed to satisfy the ADP test for the 

plan year. 

(iii) Special rule for early 

participation. If a cash or deferred 

arrangement provides that employees 

are eligible to participate before they 

have completed the minimum age and 

service requirements of section 

410(a)(1)(A), and if the plan applies 

section 410(b)(4)(B) in determining 

whether the cash or deferred 

arrangement meets the requirements of 

section 410(b)(1), then in determining 

whether the arrangement meets the 

requirements under paragraph (a)(1) of 

this section, either—

(A) Pursuant to section 401(k)(3)(F), 

the ADP test is performed under the 

plan (determined without regard to 

disaggregation under § 1.410(b)–7(c)(3)), 

using the ADP for all eligible HCEs for 

the plan year and the ADP of eligible 

NHCEs for the applicable year, 

disregarding all NHCEs who have not 

met the minimum age and service 

requirements of section 410(a)(1)(A); or 

(B) Pursuant to § 1.401(k)–1(b)(4), the 

plan is disaggregated into separate plans 

and the ADP test is performed 

separately for all eligible employees 

who have completed the minimum age 

and service requirements of section 

410(a)(1)(A) and for all eligible 

employees who have not completed the 

minimum age and service requirements 

of section 410(a)(1)(A). 

(2) Determination of ADP—(i) General 

rule. The ADP for a group of eligible 

employees (either eligible HCEs or 

Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 78167

eligible NHCEs) for a plan year or 

applicable year is the average of the 

ADRs of the eligible employees in that 

group for that year. The ADP for a group 

of eligible employees is calculated to the 

nearest hundredth of a percentage point. 

(ii) Determination of applicable year 

under current year and prior year 

testing method. The ADP test is applied 

using the prior year testing method or 

the current year testing method. Under 

the prior year testing method, the 

applicable year for determining the ADP 

for the eligible NHCEs is the plan year 

immediately preceding the plan year for 

which the ADP test is being performed. 

Under the prior year testing method, the 

ADP for the eligible NHCEs is 

determined using the ADRs for the 

eligible employees who were NHCEs in 

that preceding plan year, regardless of 

whether those NHCEs are eligible 

employees or NHCEs in the plan year 

for which the ADP test is being 

calculated. Under the current year 

testing method, the applicable year for 

determining the ADP for the eligible 

NHCEs is the same plan year as the plan 

year for which the ADP test is being 

performed. Under either method, the 

ADP for eligible HCEs is the average of 

the ADRs of the eligible HCEs for the 

plan year for which the ADP test is 

being performed. See paragraph (c) of 

this section for additional rules for the 

prior year testing method. 

(3) Determination of ADR—(i) General 

rule. The ADR of an eligible employee 

for a plan year or applicable year is the 

sum of the employee’s elective 

contributions taken into account with 

respect to such employee for the year, 

determined under the rules of 

paragraphs (a)(4) and (5) of this section, 

and the qualified nonelective 

contributions and qualified matching 

contributions taken into account with 

respect to such employee under 

paragraph (a)(6) of this section for the 

year, divided by the employee’s 

compensation taken into account for the 

year. The ADR is calculated to the 

nearest hundredth of a percentage point. 

If no elective contributions, qualified 

nonelective contributions, or qualified 

matching contributions are taken into 

account under this section with respect 

to an eligible employee for the year, the 

ADR of the employee is zero. 

(ii) ADR of HCEs eligible under more 

than one arrangement—(A) General 

rule. Pursuant to section 401(k)(3)(A), 

the ADR of an HCE who is an eligible 

employee in more than one cash or 

deferred arrangement of the same 

employer is calculated by treating all 

contributions with respect to such HCE 

under any such arrangement as being 

made under the cash or deferred 

arrangement being tested. Thus, the 

ADR for such an HCE is calculated by 

accumulating all contributions under 

any cash or deferred arrangement (other 

than a cash or deferred arrangement 

described in paragraph (a)(3)(ii)(B) of 

this section) that would be taken into 

account under this section for the plan 

year, if the cash or deferred arrangement 

under which the contribution was made 

applied this section and had the same 

plan year. For example, in the case of 

a plan with a 12-month plan year, the 

ADR for the plan year of that plan for 

an HCE who participates in multiple 

cash or deferred arrangements of the 

same employer is the sum of all 

contributions during such 12-month 

period that would be taken into account 

with respect to the HCE under all such 

arrangements in which the HCE is an 

eligible employee, divided by the HCE’s 

compensation for that 12-month period 

(determined using the compensation 

definition for the plan being tested), 

without regard to the plan year of the 

other plans and whether those plans are 

satisfying this section or § 1.401(k)–3. 

(B) Plans not permitted to be 

aggregated. Cash or deferred 

arrangements under plans that are not 

permitted to be aggregated under 

§ 1.401(k)–1(b)(4) (determined without 

regard to the prohibition on aggregating 

plans with inconsistent testing methods 

set forth in § 1.401(k)–1(b)(4)(iii)(B) and 

the prohibition on aggregating plans 

with different plan years set forth in 

§ 1.410(b)–7(d)(5)) are not aggregated 

under this paragraph (a)(3)(ii). 

(iii) Examples. The following 

examples illustrate the application of 

this paragraph (a)(3):

Example 1. (i) Employee A, an HCE with 

compensation of $120,000, is eligible to make 

elective contributions under Plan S and Plan 

T, two profit-sharing plans maintained by 

Employer H with calendar year plan years, 

each of which includes a cash or deferred 

arrangement. During the current plan year, 

Employee A makes elective contributions of 

$6,000 to Plan S and $4,000 to Plan T. 

(ii) Under each plan, the ADR for 

Employee A is determined by dividing 

Employee A’s total elective contributions 

under both arrangements by Employee A’s 

compensation taken into account under the 

plan for the year. Therefore, Employee A’s 

ADR under each plan is 8.33% ($10,000/

$120,000).

Example 2. (i) The facts are the same as in 

Example 1, except that Plan T defines 

compensation (for deferral and testing 

purposes) to exclude all bonuses paid to an 

employee. Plan S defines compensation (for 

deferral and testing purposes) to include 

bonuses paid to an employee. During the 

current year, Employee A’s compensation 

included a $10,000 bonus. Therefore, 

Employee A’s compensation under Plan T is 

$110,000 and Employee A’s compensation 

under Plan S is $120,000. 

(ii) Employee A’s ADR under Plan T is 

9.09% ($10,000/$110,000) and under Plan S, 

Employee A’s ADR is 8.33% ($10,000/

$120,000).

Example 3. (i) Employer J sponsors two 

profit-sharing plans, Plan U and Plan V, each 

of which includes a cash or deferred 

arrangement. Plan U’s plan year begins on 

July 1 and ends on June 30. Plan V has a 

calendar year plan year. Compensation under 

both plans is limited to the participant’s 

compensation during the period of 

participation. Employee B is an HCE who 

participates in both plans. Employee B’s 

monthly compensation and elective 

contributions to each plan for the 2005 and 

2006 calendar years are as follows:

Calendar 

year 

Monthly 

compensation 

Monthly 

elective 

contribution to 

Plan U 

Monthly 

elective 

contribution to 

Plan V 

2005 ...... $10,000 $500 $400 

2006 ...... 11,500 700 550 

(ii) Under Plan U, Employee B’s ADR for 

the plan year ended June 30, 2006, is equal 

to Employee B’s total elective contributions 

under Plan U and Plan V for the plan year 

ending June 30, 2006, divided by Employee 

B’s compensation for that period. Therefore, 

Employee B’s ADR under Plan U for the plan 

year ending June 30, 2006, is (($900 × 6) + 

($1,250 × 6)) / (($10,000 × 6) + ($11,500 × 6)), 

or 10%. 

(iii) Under Plan V, Employee B’s ADR for 

the plan year ended December 31, 2005, is 

equal to total elective contributions under 

Plan U and V for the plan year ending 

December 31, 2005, divided by Employee B’s 

compensation for that period. Therefore, 

Employee B’s ADR under Plan V for the plan 

year ending December 31, 2005, is ($10,800/

$120,000), or 9%.

Example 4. (i) The facts are the same as 

Example 3, except that Employee B first 

becomes eligible to participate in Plan U on 

January 1, 2006. 

(ii) Under Plan U, Employee B’s ADR for 

the plan year ended June 30, 2006, is equal 

to Employee B’s total elective contributions 

under Plan U and V for the plan year ending 

June 30, 2006, divided by Employee B’s 

compensation for that period. Therefore, 

Employee B’s ADR under Plan U for the plan 

year ending June 30, 2006, is (($400 × 6) + 

($1,250 × 6)) / (($10,000 × 6) + ($11,500 × 6)), 

or 7.67%.

(4) Elective contributions taken into 

account under the ADP test—(i) General 

rule. An elective contribution is taken 

into account in determining the ADR for 

an eligible employee for a plan year or 

applicable year only if each of the 

following requirements is satisfied—

(A) The elective contribution is 

allocated to the eligible employee’s 

account under the plan as of a date 

within that year. For purposes of this 

rule, an elective contribution is 

78168 Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 

considered allocated as of a date within 

a year only if—

(1) The allocation is not contingent on 

the employee’s participation in the plan 

or performance of services on any date 

subsequent to that date; and 

(2) The elective contribution is 

actually paid to the trust no later than 

the end of the 12-month period 

immediately following the year to 

which the contribution relates. 

(B) The elective contribution relates to 

compensation that either—

(1) Would have been received by the 

employee in the year but for the 

employee’s election to defer under the 

arrangement; or 

(2) Is attributable to services 

performed by the employee in the year 

and, but for the employee’s election to 

defer, would have been received by the 

employee within 21⁄2 months after the 

close of the year, but only if the plan 

provides for elective contributions that 

relate to compensation that would have 

been received after the close of a year 

to be allocated to such prior year rather 

than the year in which the 

compensation would have been 

received. 

(ii) Elective contributions for partners 

and self-employed individuals. For 

purposes of this paragraph (a)(4), a 

partner’s distributive share of 

partnership income is treated as 

received on the last day of the 

partnership taxable year and a sole 

proprietor’s compensation is treated as 

received on the last day of the 

individual’s taxable year. Thus, an 

elective contribution made on behalf of 

a partner or sole proprietor is treated as 

allocated to the partner’s account for the 

plan year that includes the last day of 

the partnership taxable year, provided 

the requirements of paragraph (a)(4)(i) of 

this section are met. 

(iii) Elective contributions for HCEs.

Elective contributions of an HCE must 

include any excess deferrals, as 

described in § 1.402(g)–1(a), even if 

those excess deferrals are distributed, 

pursuant to § 1.402(g)–1(e). 

(5) Elective contributions not taken 

into account under the ADP test—(i) 

General rule. Elective contributions that 

do not satisfy the requirements of 

paragraph (a)(4)(i) of this section may 

not be taken into account in 

determining the ADR of an eligible 

employee for the plan year or applicable 

year with respect to which the 

contributions were made, or for any 

other plan year. Instead, the amount of 

the elective contributions must satisfy 

the requirements of section 401(a)(4) 

(without regard to the ADP test) for the 

plan year for which they are allocated 

under the plan as if they were 

nonelective contributions and were the 

only nonelective contributions for that 

year. See §§ 1.401(a)(4)–1(b)(2)(ii)(B) 

and 1.410(b)–7(c)(1). 

(ii) Elective contributions for NHCEs.

Elective contributions of an NHCE shall 

not include any excess deferrals, as 

described in § 1.402(g)–1(a), to the 

extent the excess deferrals are 

prohibited under section 401(a)(30). 

However, to the extent that the excess 

deferrals are not prohibited under 

section 401(a)(30), they are included in 

elective contributions even if 

distributed pursuant to § 1.402(g)–1(e). 

(iii) Elective contributions treated as 

catch-up contributions. Elective 

contributions that are treated as catchup contributions under section 414(v) 

because they exceed a statutory limit or 

employer-provided limit (within the 

meaning of § 1.414(v)–1(b)(1)) are not 

taken into account under paragraph 

(a)(4) of this section for the plan year for 

which the contributions were made, or 

for any other plan year. 

(iv) Elective contributions used to 

satisfy the ACP test. Except to the extent 

necessary to demonstrate satisfaction of 

the requirement of § 1.401(m)–2(a)(6)(ii), 

elective contributions taken into 

account for the ACP test under 

§ 1.401(m)–2(a)(6) are not taken into 

account under paragraph (a)(4) of this 

section. 

(v) Additional elective contributions 

pursuant to section 414(u). Additional 

elective contributions made pursuant to 

section 414(u) by reason of an eligible 

employee’s qualified military service are 

not taken into account under paragraph 

(a)(4) of this section for the plan year for 

which the contributions are made, or for 

any other plan year. 

(6) Qualified nonelective 

contributions and qualified matching 

contributions that may be taken into 

account under the ADP test. Qualified 

nonelective contributions and qualified 

matching contributions may be taken 

into account in determining the ADR for 

an eligible employee for a plan year or 

applicable year but only to the extent 

the contributions satisfy the following 

requirements—

(i) Timing of allocation. The qualified 

nonelective contribution or qualified 

matching contribution is allocated to the 

employee’s account as of a date within 

that year within the meaning of 

paragraph (a)(4)(i)(A) of this section. 

Consequently, under the prior year 

testing method, in order to be taken into 

account in calculating the ADP for the 

eligible NHCEs for the applicable year, 

a qualified nonelective contribution or 

qualified matching contribution must be 

contributed no later than the end of the 

12-month period immediately following 

the applicable year even though the 

applicable year is different than the plan 

year being tested. 

(ii) Requirement that amount satisfy 

section 401(a)(4). The amount of 

nonelective contributions, including 

those qualified nonelective 

contributions taken into account under 

this paragraph (a)(6) and those qualified 

nonelective contributions taken into 

account for the ACP test of section 

401(m)(2) under § 1.401(m)–2(a)(6), 

satisfies the requirements of section 

401(a)(4). See § 1.401(a)(4)–1(b)(2). The 

amount of nonelective contributions, 

excluding those qualified nonelective 

contributions taken into account under 

this paragraph (a)(6) and those qualified 

nonelective contributions taken into 

account for the ACP test of section 

401(m)(2) under § 1.401(m)–2(a)(6), 

satisfies the requirements of section 

401(a)(4). See § 1.401(a)(4)–1(b)(2). In 

the case of an employer that is applying 

the special rule for employer-wide plans 

in § 1.414(r)–1(c)(2)(ii) with respect to 

the cash or deferred arrangement, the 

determination of whether the qualified 

nonelective contributions satisfy the 

requirements of this paragraph (a)(6)(ii) 

must be made on an employer-wide 

basis regardless of whether the plans to 

which the qualified nonelective 

contributions are made are satisfying the 

requirements of section 410(b) on an 

employer-wide basis. Conversely, in the 

case of an employer that is treated as 

operating qualified separate lines of 

business, and does not apply the special 

rule for employer-wide plans in 

§ 1.414(r)–1(c)(2)(ii) with respect to the 

cash or deferred arrangement, then the 

determination of whether the qualified 

nonelective contributions satisfy the 

requirements of this paragraph (a)(6)(ii) 

is not permitted to be made on an 

employer-wide basis regardless of 

whether the plans to which the 

qualified nonelective contributions are 

made are satisfying the requirements of 

section 410(b) on that basis. 

(iii) Aggregation must be permitted.

The plan that contains the cash or 

deferred arrangement and the plan or 

plans to which the qualified nonelective 

contributions or qualified matching 

contributions are made, are plans that 

would be permitted to be aggregated 

under § 1.401(k)–1(b)(4). If the plan year 

of the plan that contains the cash or 

deferred arrangement is changed to 

satisfy the requirement under 

§ 1.410(b)–7(d)(5) that aggregated plans 

have the same plan year, qualified 

nonelective contributions and qualified 

matching contributions may be taken 

into account in the resulting short plan 

year only if such qualified nonelective 

contributions and qualified matching 

Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 78169

contributions could have been taken 

into account under an ADP test for a 

plan with the same short plan year. 

(iv) Disproportionate contributions 

not taken into account—(A) General 

rule. Qualified nonelective 

contributions cannot be taken into 

account for a plan year for an NHCE to 

the extent such contributions exceed the 

product of that NHCE’s compensation 

and the greater of 5% or two times the 

plan’s representative contribution rate. 

Any qualified nonelective contribution 

taken into account under an ACP test 

under § 1.401(m)–2(a)(6) (including the 

determination of the representative 

contribution rate for purposes of 

§ 1.401(m)–2(a)(6)(v)(B)), is not 

permitted to be taken into account for 

purposes of this paragraph (a)(6) 

(including the determination of the 

representative contribution rate under 

paragraph (a)(6)(iv)(B) of this section). 

(B) Definition of representative 

contribution rate. For purposes of this 

paragraph (a)(6)(iv), the plan’s 

representative contribution rate is the 

lowest applicable contribution rate of 

any eligible NHCE among a group of 

eligible NHCEs that consists of half of 

all eligible NHCEs for the plan year (or, 

if greater, the lowest applicable 

contribution rate of any eligible NHCE 

in the group of all eligible NHCEs for 

the plan year and who is employed by 

the employer on the last day of the plan 

year).

(C) Definition of applicable 

contribution rate. For purposes of this 

paragraph (a)(6)(iv), the applicable 

contribution rate for an eligible NHCE is 

the sum of the qualified matching 

contributions taken into account under 

this paragraph (a)(6) for the eligible 

NHCE for the plan year and the 

qualified nonelective contributions 

made for the eligible NHCE for the plan 

year, divided by the eligible NHCE’s 

compensation for the same period. 

(D) Special rule for prevailing wage 

contributions. Notwithstanding 

paragraph (a)(6)(iv)(A) of this section, 

qualified nonelective contributions that 

are made in connection with an 

employer’s obligation to pay prevailing 

wages under the Davis-Bacon Act (46 

Stat. 1494), Public Law 71–798, Service 

Contract Act of 1965 (79 Stat. 1965), 

Public Law 89–286, or similar 

legislation can be taken into account for 

a plan year for an NHCE to the extent 

such contributions do not exceed 10 

percent of that NHCE’s compensation. 

(v) Qualified matching contributions.

Qualified matching contributions satisfy 

this paragraph (a)(6) only to the extent 

that such qualified matching 

contributions are matching 

contributions that are not precluded 

from being taken into account under the 

ACP test for the plan year under the 

rules of § 1.401(m)–2(a)(5)(ii). 

(vi) Contributions only used once.

Qualified nonelective contributions and 

qualified matching contributions cannot 

be taken into account under this 

paragraph (a)(6) to the extent such 

contributions are taken into account for 

purposes of satisfying any other ADP 

test, any ACP test, or the requirements 

of § 1.401(k)–3, 1.401(m)–3 or 1.401(k)–

4. Thus, for example, matching 

contributions that are made pursuant to 

§ 1.401(k)–3(c) cannot be taken into 

account under the ADP test. Similarly, 

if a plan switches from the current year 

testing method to the prior year testing 

method pursuant to § 1.401(k)–2(c), 

qualified nonelective contributions that 

are taken into account under the current 

year testing method for a year may not 

be taken into account under the prior 

year testing method for the next year. 

(7) Examples. The following examples 

illustrate the application of this 

paragraph (a):

Example 1. (i) Employer X has three 

employees, A, B, and C. Employer X sponsors 

a profit-sharing plan (Plan Z) that includes a 

cash or deferred arrangement. Each year, 

Employer X determines a bonus attributable 

to the prior year. Under the cash or deferred 

arrangement, each eligible employee may 

elect to receive none, all or any part of the 

bonus in cash. X contributes the remainder 

to Plan Z. The portion of the bonus paid in 

cash, if any, is paid 2 months after the end 

of the plan year and thus is included in 

compensation for the following plan year. 

Employee A is an HCE, while Employees B 

and C are NHCEs. The plan uses the current 

year testing method and defines 

compensation to include elective 

contributions and bonuses paid during each 

plan year. In February of 2005, Employer X 

determined that no bonuses will be paid for 

2004. In February of 2006, Employer X 

provided a bonus for each employee equal to 

10% of regular compensation for 2005. For 

the 2005 plan year, A, B, and C have the 

following compensation and make the 

following elections:

Employee Compensation Elective

contribution 

A ............... $100,000 $4,340 

B ............... 60,000 2,860 

C ............... 45,000 1,250 

(ii) For each employee, the ratio of elective 

contributions to the employee’s 

compensation for the plan year is:

Employee 

Ratio of elective 

contribution to 

compensation 

ADR

(percent) 

A ............. $4,340/$100,000 4.34 

B ............. 2,860/60,000 4.77 

C ............. 1,250/45,000 2.78 

(iii) The ADP for the HCEs (Employee A) 

is 4.34%. The ADP for the NHCEs is 3.78% 

((4.77% + 2.78%)/2). Because 4.34% is less 

than 4.73% (3.78% multiplied by 1.25), the 

plan satisfies the ADP test under paragraph 

(a)(1)(i) of this section.

Example 2. (i) The facts are the same as in 

Example 1, except that elective contributions 

are made pursuant to a salary reduction 

agreement throughout the plan year, and no 

bonuses are paid. As provided by section 

414(s)(2), Employer X includes elective 

contributions in compensation. During the 

year, B and C defer the same amount as in 

Example 1, but A defers $5,770. Thus, the 

compensation and elective contributions for 

A, B, and C are:

Employee Compensation Elective

contributions 

ADR

(percent) 

A ....................................................................................................................................................... $100,000 $5,770 5.77 

B ....................................................................................................................................................... 60,000 2,860 4.77 

C ...................................................................................................................................................... 45,000 1,250 2.78 

(ii) The ADP for the HCEs (Employee A) is 

5.77%. The ADP for the NHCEs is 3.78% 

((4.77% + 2.78%)/2). Because 5.77% exceeds 

4.73% (3.78% × 1.25), the plan does not 

satisfy the ADP test under paragraph (a)(1)(i) 

of this section. However, because the ADP for 

the HCEs does not exceed the ADP for the 

NHCEs by more than 2 percentage points and 

the ADP for the HCEs does not exceed the 

ADP for the NHCEs multiplied by 2 (3.78% 

× 2 = 7.56%), the plan satisfies the ADP test 

under paragraph (a)(1)(ii) of this section.

Example 3. (i) Employees D through L are 

eligible employees in Plan T, a profit-sharing 

plan that contains a cash or deferred 

arrangement. The plan is a calendar year plan 

that uses the prior year testing method. Plan 

T provides that elective contributions are 

included in compensation (as provided 

under section 414(s)(2)). Each eligible 

employee may elect to defer up to 6% of 

compensation under the cash or deferred 

arrangement. Employees D and E are HCEs. 

The compensation, elective contributions, 

and ADRs of Employees D and E for the 2006 

plan year are shown below:

78170 Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 

Employee 

Compensation 

for 2006 plan 

year 

Elective contributions for 

2006 plan year 

ADR for 2006 

plan year

(percent) 

D .................................................................................................................................................. $100,000 $10,000 10 

E ................................................................................................................................................... 95,000 4,750 5 

(ii) During the 2005 plan year, Employees 

F through L were eligible NHCEs. The 

compensation, elective contributions and 

ADRs of Employees F through L for the 2005 

plan year are shown in the following table:

Employee 

Compensation 

for 2005 plan 

year 

Elective contributions for 

2005 plan year 

ADR for 2005 

plan year

(percent) 

F ................................................................................................................................................... $60,000 $3,600 6 

G .................................................................................................................................................. 40,000 1,600 4 

H .................................................................................................................................................. 30,000 1,200 4 

I .................................................................................................................................................... 20,000 600 3 

J ................................................................................................................................................... 20,000 600 3 

K ................................................................................................................................................... 10,000 300 3 

L ................................................................................................................................................... 5,000 150 3 

(iii) The ADP for 2006 for the HCEs is 

7.5%. Because Plan T is using the prior year 

testing method, the applicable year for 

determining the NHCE ADP is the prior plan 

year (i.e., 2005). The NHCE ADP is 

determined using the ADRs for NHCEs 

eligible during the prior plan year (without 

regard to whether they are eligible under the 

plan during the plan year). The ADP for the 

NHCEs is 3.71% (the sum of the individual 

ADRs, 26%, divided by 7 employees). 

Because 7.5% exceeds 4.64% (3.71% × 1.25), 

Plan T does not satisfy the ADP test under 

paragraph (a)(1)(i) of this section. In addition, 

because the ADP for the HCEs exceeds the 

ADP for the NHCEs by more than 2 

percentage points, Plan T does not satisfy the 

ADP test under paragraph (a)(1)(ii) of this 

section. Therefore, the cash or deferred 

arrangement fails to be a qualified cash or 

deferred arrangement unless the ADP failure 

is corrected under paragraph (b) of this 

section.

Example 4. (i) Plan U is a calendar year 

profit-sharing plan that contains a cash or 

deferred arrangement and uses the current 

year testing method. Plan U provides that 

elective contributions are included in 

compensation (as provided under section 

414(s)(2)). The following amounts are 

contributed under Plan U for the 2006 plan 

year: QNECs equal to 2% of each employee’s 

compensation; Contributions equal to 6% of 

each employee’s compensation that are not 

immediately vested under the terms of the 

plan; 3% of each employee’s compensation 

that the employee may elect to receive as 

cash or to defer under the plan. Both types 

of nonelective contributions are made for the 

HCEs (employees M and N) and the NHCEs 

(employees O through S) for the plan year 

and are contributed after the end of the plan 

year and before the end of the following plan 

year. In addition, neither type of nonelective 

contributions is used for any other ADP or 

ACP test. 

(ii) For the 2006 plan year, the 

compensation, elective contributions, and 

actual deferral ratios of employees M through 

S are shown in the following table:

Employee Compensation Elective

contributions 

Actual deferral 

ratio

(percent) 

M .................................................................................................................................................. $100,000 $3,000 3 

N .................................................................................................................................................. 100,000 2,000 2 

O .................................................................................................................................................. 60,000 1,800 3 

P ................................................................................................................................................... 40,000 0 0 

Q .................................................................................................................................................. 30,000 0 0 

R .................................................................................................................................................. 5,000 0 0 

S ................................................................................................................................................... 20,000 0 0 

(iii) The elective contributions alone do not 

satisfy the ADP test of section 401(k)(3) and 

paragraph (a)(1) of this section because the 

ADP for the HCEs, consisting of employees 

M and N, is 2.5% and the ADP for the NHCEs 

is 0.6%. 

(iv) The 2% QNECs satisfies the timing 

requirement of paragraph (a)(6)(i) of this 

section because it is paid within 12-month 

after the plan year for which allocated. All 

nonelective contributions also satisfy the 

requirements relating to section 401(a)(4) set 

forth in paragraph (a)(6)(ii) of this section 

(because all employees receive an 8% 

nonelective contribution and the nonelective 

contributions excluding the QNECs is 6% for 

all employees). In addition, the QNECs are 

not disproportionate under paragraph 

(a)(6)(iv) of this section because no QNEC for 

an NHCE exceeds the product of the plan’s 

applicable contribution rate (2%) and that 

NHCE’s compensation. 

(v) Because the rules of paragraph (a)(6) of 

this section are satisfied, the 2% QNECs may 

be taken into account in applying the ADP 

test of section 401(k)(3) and paragraph (a)(1) 

of this section. The 6% nonelective 

contributions, however, may not be taken 

into account because they are not QNECs. 

(vi) If the 2% QNECs are taken into 

account, the ADP for the HCEs is 4.5%, and 

the actual deferral percentage for the NHCEs 

is 2.6%. Because 4.5% is not more than two 

percentage points greater than 2.6 percent, 

and not more than two times 2.6, the cash or 

deferred arrangement satisfies the ADP test of 

section 401(k)(3) under paragraph (a)(1)(ii) of 

this section.

Example 5. (i) The facts are the same as 

Example 4, except the plan uses the prior 

year testing method. In addition, the NHCE 

ADP for the 2005 plan year (the prior plan 

year) is 0.8% and no QNECs are contributed 

for the 2005 plan year during 2005 or 2006. 

(ii) In 2007, it is determined that the 

elective contributions alone do not satisfy the 

ADP test of section 401(k)(3) and paragraph 

(a)(1) of this section for 2006 because the 

2006 ADP for the eligible HCEs, consisting of 

employees M and N, is 2.5% and the 2005 

ADP for the eligible NHCEs is 0.8%. An 

additional QNEC of 2% of compensation is 

made for each eligible NHCE in 2007 and 

allocated for 2005. 

(iii) The 2% QNECs that are made in 2007 

and allocated for the 2005 plan year do not 

satisfy the timing requirement of paragraph 

Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 78171

(a)(6)(i) of this section for the applicable year 

for the 2005 plan year because they were not 

contributed before the last day of the 2006 

plan year. Accordingly, the 2% QNECs do 

not satisfy the rules of paragraph (a)(6) of this 

section and may not be taken into account in 

applying the ADP test of section 401(k)(3) 

and paragraph (a)(1) of this section for the 

2006 plan year. The cash or deferred 

arrangement fails to be a qualified cash or 

deferred arrangement unless the ADP failure 

is corrected under paragraph (b) of this 

section.

Example 6. (i) The facts are the same as 

Example 4, except that the ADP for the HCEs 

is 4.6% and there is no 6% nonelective 

contribution under the plan. The employer 

would like to take into account the 2% QNEC 

in determining the ADP for the NHCEs but 

not in determining the ADP for the HCEs. 

(ii) The elective contributions alone fail the 

requirements of section 401(k) and paragraph 

(a)(1) of this section because the HCE ADP for 

the plan year (4.6%) exceeds 0.75% (0.6% ×

1.25) and 1.2% (0.6% × 2). 

(iii) The 2% QNECs may not be taken into 

account in determining the ADP of the 

NHCEs because they fail to satisfy the 

requirements relating to section 401(a)(4) set 

forth in paragraph (a)(6)(ii) of this section. 

This is because the amount of nonelective 

contributions, excluding those QNECs that 

would be taken into account under the ADP 

test, would be 2% of compensation for the 

HCEs and 0% for the NHCEs. Therefore, the 

cash or deferred arrangement fails to be a 

qualified cash or deferred arrangement unless 

the ADP failure is corrected under paragraph 

(b) of this section.

Example 7. (i) The facts are the same as 

Example 6, except that Employee R receives 

a QNEC in an amount of $500 and no QNECs 

are made on behalf of the other employees. 

(ii) If the QNEC could be taken into 

account under paragraph (a)(6) of this 

section, the ADP for the NHCEs would be 

2.6% and the plan would satisfy the ADP 

test. The QNEC is disproportionate under 

paragraph (a)(6)(iv) of this section, and 

cannot be taken into account under 

paragraph (a)(6) of this section, to the extent 

it exceeds the greater of 5% and two times 

the plan’s representative contribution rate 

(0%), multiplied by Employee R’s 

compensation. The plan’s representative 

contribution rate is 0% because it is the 

lowest applicable contribution rate among a 

group of NHCEs that is at least half of all 

NHCEs, or all the NHCEs who are employed 

on the last day of the plan year. Therefore, 

the QNEC may be taken into account under 

the ADP test only to the extent it does not 

exceed 5% times Employee R’s compensation 

(or $250) and the cash or deferred 

arrangement fails to satisfy the ADP test and 

must correct under paragraph (b) of this 

section.

Example 8. (i) The facts are the same as in 

Example 4 except that the plan changes from 

the current year testing method to the prior 

year testing method for the following plan 

year (2007 plan year). The ADP for the HCEs 

for the 2007 plan year is 3.5%. 

(ii) The 2% QNECs may not be taken into 

account in determining the ADP for the 

NHCEs for the applicable year (2006 plan 

year) in satisfying the ADP test for the 2007 

plan year because they were taken into 

account in satisfying the ADP test for the 

2006 plan year. Accordingly, the NHCE ADP 

for the applicable year is 0.6%. The elective 

contributions for the plan year fail the 

requirements of section 401(k) and paragraph 

(a)(1) of this section because the HCE ADP for 

the plan year (3.5%) exceeds the ADP limit 

of 1.2% (the greater of 0.75% (0.6% × 1.25) 

and 1.2% (0.6% × 2)), determined using the 

applicable year ADP for the NHCEs. 

Therefore, the cash or deferred arrangement 

fails to be a qualified cash or deferred 

arrangement unless the ADP failure is 

corrected under paragraph (b) of this section.

Example 9. (i)(A) Employer N maintains 

Plan X, a profit sharing plan that contains a 

cash or deferred arrangement and that uses 

the current year testing method. Plan X 

provides for employee contributions, elective 

contributions, and matching contributions. 

Matching contributions on behalf of NHCEs 

are qualified matching contributions 

(QMACs) and are contributed during the 

2005 plan year. Matching contributions on 

behalf of HCEs are not QMACs, because they 

fail to satisfy the nonforfeitability 

requirement of § 1.401(k)–1(c). The elective 

contributions and matching contributions 

with respect to HCEs for the 2005 plan year 

are shown in the following table:

Elective

contributions 

Total matching 

contributions 

Matching contributions that 

are not 

QMACs 

QMACs 

Highly compensated employees ................................................................................. 15% 5% 5% 0% 

(B) The elective contributions and 

matching contributions with respect to the 

NHCEs for the 2005 plan year are shown in 

the following table:

Elective

contributions 

Total matching 

contributions 

Matching contributions that 

are not 

QMACs 

QMACs 

Nonhighly compensated employees ........................................................................... 11% 4% 0% 4% 

(ii) The plan fails to satisfy the ADP test 

of section 401(k)(3)(A) and paragraph (a)(1) of 

this section because the ADP for HCEs (15%) 

is more than 125% of the ADP for NHCEs 

(11%), and more than 2 percentage points 

greater than 11%. However, the plan 

provides that QMACs may be used to meet 

the requirements of section 401(k)(3)(A)(ii) 

provided that they are not used for any other 

ADP or ACP test. QMACs equal to 1% of 

compensation are taken into account for each 

NHCE in applying the ADP test. After this 

adjustment, the applicable ADP and ACP 

(taking into account the provisions of 

§ 1.401(m)-2(a)(5)(ii)) for the plan year are as 

follows:

Actual

deferral

percentage 

Actual

contribution

percentage 

HCEs ........ 15 5 

Nonhighly 

compensated 

employees ........ 12 3 

(iii) The elective contributions and QMACs 

taken into account for purposes of the ADP 

test of section 401(k)(3) satisfy the 

requirements of section 401(k)(3)(A)(ii) under 

paragraph (a)(1)(ii) of this section because the 

ADP for HCEs (15%) is not more than the 

ADP for NHCEs multiplied by 1.25 (12% ×

1.25 = 15%).

(b) Correction of excess 

contributions—(1) Permissible 

correction methods—(i) In general. A 

cash or deferred arrangement does not 

fail to satisfy the requirements of section 

401(k)(3) and paragraph (a)(1) of this 

section if the employer, in accordance 

with the terms of the plan that includes 

the cash or deferred arrangement, uses 

any of the following correction 

methods—

(A) Qualified nonelective 

contributions or qualified matching 

contributions. The employer makes 

qualified nonelective contributions or 

qualified matching contributions that 

are taken into account under this 

78172 Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 

section and, in combination with other 

amounts taken into account under 

paragraph (a) of this section, allow the 

cash or deferred arrangement to satisfy 

the requirements of paragraph (a)(1) of 

this section. 

(B) Excess contributions distributed.

Excess contributions are distributed in 

accordance with paragraph (b)(2) of this 

section. 

(C) Excess contributions 

recharacterized. Excess contributions 

are recharacterized in accordance with 

paragraph (b)(3) of this section. 

(ii) Combination of correction 

methods. A plan may provide for the 

use of any of the correction methods 

described in paragraph (b)(1)(i) of this 

section, may limit elective contributions 

in a manner designed to prevent excess 

contributions from being made, or may 

use a combination of these methods, to 

avoid or correct excess contributions. A 

plan may permit an HCE to elect 

whether any excess contributions are to 

be recharacterized or distributed. If the 

plan uses a combination of correction 

methods, any contribution made under 

paragraph (b)(1)(i)(A) of this section 

must be taken into account before 

application of the correction methods in 

paragraph (b)(1)(i)(B) or (C) of this 

section. 

(iii) Exclusive means of correction. A 

failure to satisfy the requirements of 

paragraph (a)(1) of this section may not 

be corrected using any method other 

than the ones described in paragraphs 

(b)(1)(i) and (ii) of this section. Thus, 

excess contributions for a plan year may 

not remain unallocated or be allocated 

to a suspense account for allocation to 

one or more employees in any future 

year. In addition, excess contributions 

may not be corrected using the 

retroactive correction rules of 

§ 1.401(a)(4)–11(g). See § 1.401(a)(4)–

11(g)(3)(vii) and (5). 

(2) Corrections through distribution—

(i) General rule. This paragraph (b)(2) 

contains the rules for correction of 

excess contributions through a 

distribution from the plan. Correction 

through a distribution generally 

involves a 4-step process. First, the plan 

must determine, in accordance with 

paragraph (b)(2)(ii) of this section, the 

total amount of excess contributions 

that must be distributed under the plan. 

Second, the plan must apportion the 

total amount of excess contributions 

among HCEs in accordance with 

paragraph (b)(2)(iii) of this section. 

Third, the plan must determine the 

income allocable to excess contributions 

in accordance with paragraph (b)(2)(iv) 

of this section. Finally, the plan must 

distribute the apportioned excess 

contributions and allocable income in 

accordance with paragraph (b)(2)(v) of 

this section. Paragraph (b)(2)(vi) of this 

section provides rules relating to the tax 

treatment of these distributions. 

Paragraph (b)(2)(vii) provides other 

rules relating to these distributions. 

(ii) Calculation of total amount to be 

distributed. The following procedures 

must be used to determine the total 

amount of the excess contributions to be 

distributed—

(A) Calculate the dollar amount of 

excess contributions for each HCE. The 

amount of excess contributions 

attributable to a given HCE for a plan 

year is the amount (if any) by which the 

HCE’s contributions taken into account 

under this section must be reduced for 

the HCE’s ADR to equal the highest 

permitted ADR under the plan. To 

calculate the highest permitted ADR 

under a plan, the ADR of the HCE with 

the highest ADR is reduced by the 

amount required to cause that HCE’s 

ADR to equal the ADR of the HCE with 

the next highest ADR. If a lesser 

reduction would enable the arrangement 

to satisfy the requirements of paragraph 

(b)(2)(ii)(C) of this section, only this 

lesser reduction is used in determining 

the highest permitted ADR. 

(B) Determination of the total amount 

of excess contributions. The process 

described in paragraph (b)(2)(ii)(A) of 

this section must be repeated until the 

arrangement would satisfy the 

requirements of paragraph (b)(2)(ii)(C) of 

this section. The sum of all reductions 

for all HCEs determined under 

paragraph (b)(2)(ii)(A) of this section is 

the total amount of excess contributions 

for the plan year. 

(C) Satisfaction of ADP. A cash or 

deferred arrangement satisfies this 

paragraph (b)(2)(ii)(C) if the arrangement 

would satisfy the requirements of 

paragraph (a)(1)(ii) of this section if the 

ADR for each HCE were determined 

after the reductions described in 

paragraph (b)(2)(ii)(A) of this section. 

(iii) Apportionment of total amount of 

excess contributions among the HCEs.

The following procedures must be used 

in apportioning the total amount of 

excess contributions determined under 

paragraph (b)(2)(ii) of this section 

among the HCEs: 

(A) Calculate the dollar amount of 

excess contributions for each HCE. The 

contributions of the HCE with the 

highest dollar amount of contributions 

taken into account under this section 

are reduced by the amount required to 

cause that HCE’s contributions to equal 

the dollar amount of the contributions 

taken into account under this section for 

the HCE with the next highest dollar 

amount of contributions taken into 

account under this section. If a lesser 

apportionment to the HCE would enable 

the plan to apportion the total amount 

of excess contributions, only the lesser 

apportionment would apply. 

(B) Limit on amount apportioned to 

any individual. For purposes of this 

paragraph (b)(2)(iii), the amount of 

contributions taken into account under 

this section with respect to an HCE who 

is an eligible employee in more than one 

plan of an employer is determined by 

taking into account all contributions 

otherwise taken into account with 

respect to such HCE under any plan of 

the employer during the plan year of the 

plan being tested as being made under 

the plan being tested. However, the 

amount of excess contributions 

apportioned for a plan year with respect 

to any HCE must not exceed the amount 

of contributions actually contributed to 

the plan for the HCE for the plan year. 

Thus, in the case of an HCE who is an 

eligible employee in more than one plan 

of the same employer to which elective 

contributions are made and whose ADR 

is calculated in accordance with 

paragraph (a)(3)(ii) of this section, the 

amount required to be distributed under 

this paragraph (b)(2)(iii) shall not 

exceed the contributions actually 

contributed to the plan and taken into 

account under this section for the plan 

year. 

(C) Apportionment to additional 

HCEs. The procedure in paragraph 

(b)(2)(iii)(A) of this section must be 

repeated until the total amount of excess 

contributions determined under 

paragraph (b)(2)(ii) of this section has 

been apportioned. 

(iv) Income allocable to excess 

contributions—(A) General rule. The 

income allocable to excess contributions 

is equal to the sum of the allocable gain 

or loss for the plan year and, to the 

extent the excess contributions are or 

will be credited with gain or loss for the 

gap period (i.e., the period after the 

close of the plan year and prior to the 

distribution) if the total account were to 

be distributed, the allocable gain or loss 

during that period. 

(B) Method of allocating income. A 

plan may use any reasonable method for 

computing the income allocable to 

excess contributions, provided that the 

method does not violate section 

401(a)(4), is used consistently for all 

participants and for all corrective 

distributions under the plan for the plan 

year, and is used by the plan for 

allocating income to participant’s 

accounts. See § 1.401(a)(4)–1(c)(8). A 

plan will not fail to use a reasonable 

method for computing the income 

allocable to excess contributions merely 

because the income allocable to excess 

contributions is determined on a date 

Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 78173

that is no more than 7 days before the 

distribution. 

(C) Alternative method of allocating 

plan year income. A plan may allocate 

income to excess contributions for the 

plan year by multiplying the income for 

the plan year allocable to the elective 

contributions and other amounts taken 

into account under this section 

(including contributions made for the 

plan year), by a fraction, the numerator 

of which is the excess contributions for 

the employee for the plan year, and the 

denominator of which is the sum of 

the—

(1) Account balance attributable to 

elective contributions and other 

contributions taken into account under 

this section as of the beginning of the 

plan year, and 

(2) Any additional amount of such 

contributions made for the plan year. 

(D) Safe harbor method of allocating 

gap period income. A plan may use the 

safe harbor method in this paragraph 

(b)(2)(iv)(D) to determine income on 

excess contributions for the gap period. 

Under this safe harbor method, income 

on excess contributions for the gap 

period is equal to 10% of the income 

allocable to excess contributions for the 

plan year that would be determined 

under paragraph (b)(2)(iv)(C) of this 

section, multiplied by the number of 

calendar months that have elapsed since 

the end of the plan year. For purposes 

of calculating the number of calendar 

months that have elapsed under the safe 

harbor method, a corrective distribution 

that is made on or before the fifteenth 

day of a month is treated as made on the 

last day of the preceding month and a 

distribution made after the fifteenth day 

of a month is treated as made on the last 

day of the month.

(E) Alternative method for allocating 

plan year and gap period income. A 

plan may determine the allocable gain 

or loss for the aggregate of the plan year 

and the gap period by applying the 

alternative method provided by 

paragraph (b)(2)(iv)(C) of this section to 

this aggregate period. This is 

accomplished by substituting the 

income for the plan year and the gap 

period for the income for the plan year 

and by substituting the contributions 

taken into account under this section for 

the plan year and the gap period for the 

contributions taken into account under 

this section for the plan year in 

determining the fraction that is 

multiplied by that income. 

(v) Distribution. Within 12 months 

after the close of the plan year in which 

the excess contribution arose, the plan 

must distribute to each HCE the excess 

contributions apportioned to such HCE 

under paragraph (b)(2)(iii) of this 

section and the allocable income. 

Except as otherwise provided in this 

paragraph (b)(2)(v) and paragraph 

(b)(4)(i) of this section, a distribution of 

excess contributions must be in addition 

to any other distributions made during 

the year and must be designated as a 

corrective distribution by the employer. 

In the event of a complete termination 

of the plan during the plan year in 

which an excess contribution arose, the 

corrective distribution must be made as 

soon as administratively feasible after 

the date of termination of the plan, but 

in no event later than 12 months after 

the date of termination. If the entire 

account balance of an HCE is distributed 

prior to when the plan makes a 

distribution of excess contributions in 

accordance with this paragraph (b)(2), 

the distribution is deemed to have been 

a corrective distribution of excess 

contributions (and income) to the extent 

that a corrective distribution would 

otherwise have been required. 

(vi) Tax treatment of corrective 

distributions—(A) General rule. Except 

as provided in this paragraph (b)(2)(vi), 

a corrective distribution of excess 

contributions (and income) that is made 

within 21⁄2 months after the end of the 

plan year for which the excess 

contributions were made is includible 

in the employee’s gross income on the 

dates the elective contributions would 

have been received by the employee had 

the employee originally elected to 

receive the amounts in cash, treating the 

excess contributions that are being 

distributed as the first elective 

contributions for the plan year. A 

corrective distribution of excess 

contributions (and income) that is made 

more than 21⁄2 months after the end of 

the plan year for which the 

contributions were made is includible 

in the employee’s gross income in the 

employee’s taxable year in which 

distributed. Regardless of when the 

corrective distribution is made, it is not 

subject to the early distribution tax of 

section 72(t). See also paragraph (b)(4) 

of this section for additional rules 

relating to the employer excise tax on 

amounts distributed more than 21⁄2

months after the end of the plan year. 

See also § 1.402(c)–2, A–4 for 

restrictions on rolling over distributions 

that are excess contributions. 

(B) Rule for de minimis distributions.

If the total amount of excess 

contributions, determined under this 

paragraph (b)(2), and excess aggregate 

contributions determined under 

§ 1.401(m)–2(b)(2) distributed to a 

recipient under a plan for any plan year 

is less than $100 (excluding income), a 

corrective distribution of excess 

contributions (and income) is includible 

in the gross income of the recipient in 

the taxable year of the recipient in 

which the corrective distribution is 

made. 

(vii) Other rules—(A) No employee or 

spousal consent required. A corrective 

distribution of excess contributions (and 

income) may be made under the terms 

of the plan without regard to any notice 

or consent otherwise required under 

sections 411(a)(11) and 417. 

(B) Treatment of corrective 

distributions as elective contributions.

Excess contributions are treated as 

employer contributions for purposes of 

sections 404 and 415 even if distributed 

from the plan. 

(C) No reduction of required 

minimum distribution. A distribution of 

excess contributions (and income) is not 

treated as a distribution for purposes of 

determining whether the plan satisfies 

the minimum distribution requirements 

of section 401(a)(9). See § 1.401(a)(9)–5, 

A–9(b). 

(D) Partial distributions. Any 

distribution of less than the entire 

amount of excess contributions (and 

allocable income) with respect to any 

HCE is treated as a pro rata distribution 

of excess contributions and allocable 

income. 

(viii) Examples. The following 

examples illustrate the application of 

this paragraph (b)(2). For purposes of 

these examples, none of the plans 

provide for catch-up contributions 

under section 414(v). The examples are 

as follows:

Example 1. (i) Plan P, a calendar year 

profit-sharing plan that includes a cash or 

deferred arrangement, provides for 

distribution of excess contributions to HCEs 

to the extent necessary to satisfy the ADP 

test. For the 2006 plan year, Employee A, an 

HCE, has elective contributions of $12,000 

and $200,000 in compensation, for an ADR 

of 6%, and Employee B, a second HCE, has 

elective contributions of $8,960 and 

compensation of $128,000, for an ADR of 7%. 

The ADP for the NHCEs is 3% for the 2006 

plan year. Under the ADP test, the ADP of 

the two HCEs under the plan may not exceed 

5% (i.e., 2 percentage points more than the 

ADP of the NHCEs under the plan). The ADP 

for the 2 HCEs under the plan is 6.5%. 

Therefore, there must be a correction of 

excess contributions for the 2006 plan year. 

(ii) The total amount of excess 

contributions for the HCEs is determined 

under paragraph (b)(2)(ii) of this section as 

follows: the elective contributions of 

Employee B (the HCE with the highest ADR) 

are reduced by $1,280 in order to reduce his 

ADR to 6% ($7,680/$128,000), which is the 

ADR of Employee A. 

(iii) Because the ADP of the HCEs 

determined after the $1,280 reduction to 

Employee B still exceeds 5%, further 

reductions in elective contributions are 

necessary in order to reduce the ADP of the 

78174 Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 

HCEs to 5%. The elective contributions of 

Employee A and Employee B are each 

reduced by 1% of compensation ($2,000 and 

$1,280 respectively). Because the ADP of the 

HCEs determined after the reductions equals 

5%, the plan would satisfy the requirements 

of (a)(1)(ii) of this section. 

(iv) The total amount of excess 

contributions ($4,560 = 

$1,280+$2,000+$1,280) is apportioned among 

the HCEs under paragraph (b)(2)(iii) of this 

section first to the HCE with the highest 

amount of elective contributions. Therefore, 

Employee A is apportioned $3,040 (the 

amount required to cause Employee A’s 

elective contributions to equal the next 

highest dollar amount of elective 

contributions). 

(v) Because the total amount of excess 

contributions has not been apportioned, 

further apportionment is necessary. The 

balance ($1,520) of the total amount of excess 

contributions is apportioned equally among 

Employee A and Employee B ($760 to each). 

(vi) Therefore, the cash or deferred 

arrangement will satisfy the requirements of 

paragraph (a)(1) of this section if, by the end 

of the 12 month period following the end of 

the 2006 plan year, Employee A receives a 

corrective distribution of excess 

contributions equal to $3,800 ($3,040 + $760) 

and allocable income and Employee B 

receives a corrective distribution of $760 and 

allocable income. 

Example 2. (i) The facts are the same as in 

Example 1, except Employee A’s ADR is 

based on $3,000 of elective contributions to 

this plan and $9,000 of elective contributions 

to another plan of the employer. 

(ii) The total amount of excess 

contributions ($4,560 = 

$1,280+$2,000+$1,280) is apportioned among 

the HCEs under paragraph (b)(2)(iii) of this 

section first to the HCE with the highest 

amount of elective contributions. The 

amount of elective contributions for 

Employee A is $12,000. Therefore, Employee 

A is apportioned $3,040 (the amount 

required to cause Employee A’s elective 

contributions to equal the next highest dollar 

amount of elective contributions). However, 

pursuant to paragraph (b)(2)(iii)(B) of this 

section, no more than the amount actually 

contributed to the plan may be apportioned 

to an HCE. Accordingly, no more than $3,000 

may be apportioned to Employee A. 

Therefore, the remaining $1,560 must be 

apportioned to Employee B. 

(iii) The cash or deferred arrangement will 

satisfy the requirements of paragraph (a)(1) of 

this section if, by the end of the 12 month 

period following the end of the 2006 plan 

year, Employee A receives a corrective 

distribution of excess contributions equal to 

$3,000 (total amount of elective contributions 

actually contributed to the plan for Employee 

A) and allocable income and Employee B 

receives a corrective distribution of $1,560 

and allocable income. 

Example 3. (i) The facts are the same as in 

Example 1. The plan allocates income on a 

daily basis. The corrective distributions are 

made in February 2007. The excess 

contribution that must be distributed to 

Employee A as a corrective distribution is 

$3,800. This amount must be increased (or 

decreased) to reflect gains (or losses) 

allocable to that amount during the 2006 plan 

year. The plan uses a reasonable method that 

satisfies paragraph (b)(2)(iv)(B) of this section 

to determine the gain during the 2006 plan 

year allocable to the $3,800 as $145. 

Therefore, as of the end of the 2006 plan 

year, the amount of corrective distribution 

that is required would be $3,945. 

(ii) Because the plan allocates income on 

a daily basis, excess contributions are 

credited with gain or loss during the gap 

period. Therefore, the corrective distribution 

must include income allocable to $3,945 

through the date of distribution. For the 

period from January 1 through the date of 

distribution (or if the plan provides 7 days 

before the date of distribution), the income 

allocable to $3,945 is $105. Therefore, the 

plan will satisfy the requirements of 

paragraph (a)(1) of this section if Employee 

A receives a corrective distribution of $4,050. 

Example 4. (i) The facts are the same as in 

Example 1. The plan determines plan year 

income using the alternative method for 

calculating income provided in paragraph 

(b)(2)(iv)(C) of this section and using the 

portion of the participant’s account 

attributable to elective contributions, 

including elective contributions made for the 

plan year. The plan uses the safe harbor 

method provided in paragraph (b)(2)(iv)(D) of 

this section for allocating gap period income. 

The corrective distribution is made during 

the last week of February 2007. At the 

beginning of the 2006 plan year, $100,000 of 

Employee A’s plan account represents 

elective contributions plus attributable 

earnings. During the 2006 plan year, $10,000 

in elective contributions were contributed to 

the plan for Employee A. The income 

allocable to Employee A’s account 

attributable to elective contributions for the 

2006 plan year is $8,000. 

(ii) Therefore, the plan year income 

allocable to the $3,800 corrective distribution 

for Employee A is $266.65 ($8,000 multiplied 

by $3,800 divided by $110,000). Therefore, as 

of the end of the 2006 plan year, the amount 

of corrective distribution that is required is 

$4,066.65. This amount must be increased by 

the gap period income of $53.32 (10% 

multiplied by $266.65 (2006 plan year 

income attributable to the excess 

contribution) multiplied by 2 (number of 

calendar months since end of 2006 plan 

year). Therefore, the plan will satisfy the 

requirements of paragraph (a)(1) of this 

section if Employee A receives a corrective 

distribution of $4,119.97.

Example 5. (i) The facts are the same as in 

Example 4, except that the plan provides for 

quarterly valuations based on the account 

balance at the end of the quarter. 

(ii) Because the plan’s method for 

allocating income does not allocate any 

income to amounts distributed during the 

quarter, Employee A will not be credited 

with an allocation of income with respect to 

the amount distributed. Accordingly, Plan P 

need not plan adjust the distribution of 

excess contribution for income during the 

gap period and thus satisfies paragraph (a)(1) 

of this section if Employee A receives a 

corrective distribution of $4,066.65.

(3) Recharacterization of excess 

contributions—(i) General rule. Excess 

contributions are recharacterized in 

accordance with this paragraph (b)(3) 

only if the excess contributions that 

would have to be distributed under 

(b)(2) of this section if the plan was 

correcting through distribution of excess 

contributions are recharacterized as 

described in paragraph (b)(3)(ii) of this 

section, and all of the conditions set 

forth in paragraph (b)(3)(iii) of this 

section are satisfied. 

(ii) Treatment of recharacterized 

excess contributions. Recharacterized 

excess contributions are includible in 

the employee’s gross income as if such 

amounts were distributed under 

paragraph (b)(2) of this section. The 

recharacterized excess contributions are 

treated as employee contributions for 

purposes of section 72, sections 

401(a)(4), 401(m), § 1.401(k)–1(d) and 

§ 1.401(k)–2. This requirement is not 

treated as satisfied unless the payor or 

plan administrator reports the 

recharacterized excess contributions as 

employee contributions to the Internal 

Revenue Service and the employee by 

timely providing such Federal tax forms 

and accompanying instructions and 

timely taking such other action as is 

prescribed by the Commissioner in 

revenue rulings, notices and other 

guidance published in the Internal 

Revenue Bulletin (see § 601.601(d)(2) of 

this chapter) as well as the applicable 

Federal tax forms and accompanying 

instructions. 

(iii) Additional rules—(A) Time of 

recharacterization. Excess contributions 

may not be recharacterized under this 

paragraph (b)(3) after 21⁄2 months after 

the close of the plan year to which the 

recharacterization relates. 

Recharacterization is deemed to have 

occurred on the date on which the last 

of those HCEs with excess contributions 

to be recharacterized is notified in 

accordance with paragraph (b)(3)(ii) of 

this section. 

(B) Employee contributions must be 

permitted under plan. The amount of 

recharacterized excess contributions, in 

combination with the employee 

contributions actually made by the HCE, 

may not exceed the maximum amount 

of employee contributions (determined 

without regard to the ACP test of section 

401(m)(2)) permitted under the 

provisions of the plan as in effect on the 

first day of the plan year. 

(C) Treatment of recharacterized 

excess contributions. Recharacterized 

excess contributions continue to be 

treated as employer contributions for all 

purposes under the Internal Revenue 

Code (other than those specified in 

paragraph (b)(3)(ii) of this section), 

Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 78175

including section 401(a) and sections 

404, 409, 411, 412, 415, 416, and 417. 

Thus, for example, recharacterized 

excess contributions remain subject to 

the requirements of § 1.401(k)–1(c); 

must be deducted under section 404; 

and are treated as employer 

contributions described in section 

415(c)(2)(A). 

(4) Rules applicable to all 

corrections—(i) Coordination with 

distribution of excess deferrals—(A) 

Treatment of excess deferrals that 

reduce excess contributions. The 

amount of excess contributions (and 

allocable income) to be distributed 

under paragraph (b)(2) of this section or 

the amount of excess contributions 

recharacterized under paragraph (b)(3) 

of this section with respect to an 

employee for a plan year, is reduced by 

any amounts previously distributed to 

the employee from the plan to correct 

excess deferrals for the employee’s 

taxable year ending with or within the 

plan year in accordance with section 

402(g)(2). 

(B) Treatment of excess contributions 

that reduce excess deferrals. Under 

§ 1.402(g)–1(e), the amount required to 

be distributed to correct an excess 

deferral to an employee for a taxable 

year is reduced by any excess 

contributions (and allocable income) 

previously distributed or excess 

contributions recharacterized with 

respect to the employee for the plan 

year beginning with or within the 

taxable year. The amount of excess 

contributions includible in the gross 

income of the employee, and the 

amount of excess contributions reported 

by the payer or plan administrator as 

includible in the gross income of the 

employee, does not include the amount 

of any reduction under § 1.402(g)–

1(e)(6). 

(ii) Forfeiture of match on distributed 

excess contributions. A matching 

contribution is taken into account under 

section 401(a)(4) even if the match is 

with respect to an elective contribution 

that is distributed or recharacterized 

under this paragraph (b). This requires 

that, after correction of excess 

contributions, each level of matching 

contributions be currently and 

effectively available to a group of 

employees that satisfies section 410(b). 

See § 1.401(a)(4)–4(e)(3)(iii)(G). Thus, a 

plan that provides the same rate of 

matching contributions to all employees 

will not meet the requirements of 

section 401(a)(4) if elective 

contributions are distributed under this 

paragraph (b) to HCEs to the extent 

needed to meet the requirements of 

section 401(k)(3), while matching 

contributions attributable to those 

elective contributions remain allocated 

to the HCEs’ accounts. Under section 

411(a)(3)(G) and § 1.411(a)–4(b)(7), a 

plan may forfeit matching contributions 

attributable to excess contributions, 

excess aggregate contributions or excess 

deferrals to avoid a violation of section 

401(a)(4). See also § 1.401(a)(4)–

11(g)(3)(vii)(B) regarding the use of 

additional allocations to the accounts of 

NHCEs for the purpose of correcting a 

discriminatory rate of matching 

contributions. 

(iii) Permitted forfeiture of QMAC.

Pursuant to section 401(k)(8)(E), a 

qualified matching contribution is not 

treated as forfeitable under § 1.401(k)–

1(c) merely because under the plan it is 

forfeited in accordance with paragraph 

(b)(4)(ii) of this section. 

(iv) No requirement for recalculation.

If excess contributions are distributed or 

recharacterized in accordance with 

paragraphs (b)(2) and (3) of this section, 

the cash or deferred arrangement is 

treated as meeting the 

nondiscrimination test of section 

401(k)(3) regardless of whether the ADP 

for the HCEs, if recalculated after the 

distributions or recharacterizations, 

would satisfy section 401(k)(3). 

(v) Treatment of excess contributions 

that are catch-up contributions. A cash 

or deferred arrangement does not fail to 

meet the requirements of section 

401(k)(3) and paragraph (a)(1) of this 

section merely because excess 

contributions that are catch-up 

contributions because they exceed the 

ADP limit, as described in § 1.414(v)–

1(b)(1)(iii), are not corrected in 

accordance with this paragraph (b). 

(5) Failure to timely correct—(i) 

Failure to correct within 21⁄2 months 

after end of plan year. If a plan does not 

correct excess contributions within 21⁄2

months after the close of the plan year 

for which the excess contributions are 

made, the employer will be liable for a 

10% excise tax on the amount of the 

excess contributions. See section 4979 

and § 54.4979–1 of this chapter. 

Qualified nonelective contributions and 

qualified matching contributions 

properly taken into account under 

paragraph (a)(6) of this section for a plan 

year may enable a plan to avoid having 

excess contributions, even if the 

contributions are made after the close of 

the 21⁄2 month period. 

(ii) Failure to correct within 12 

months after end of plan year. If excess 

contributions are not corrected within 

12 months after the close of the plan 

year for which they were made, the cash 

or deferred arrangement will fail to 

satisfy the requirements of section 

401(k)(3) for the plan year for which the 

excess contributions are made and all 

subsequent plan years during which the 

excess contributions remain in the trust. 

(c) Additional rules for prior year 

testing method—(1) Rules for change in 

testing method—(i) General rule. A plan 

is permitted to change from the prior 

year testing method to the current year 

testing method for any plan year. A plan 

is permitted to change from the current 

year testing method to the prior year 

testing method only in situations 

described in paragraph (c)(1)(ii) of this 

section. For purposes of this paragraph 

(c)(1), a plan that uses the safe harbor 

method described in § 1.401(k)–3 or a 

SIMPLE 401(k) plan is treated as using 

the current year testing method for that 

plan year. 

(ii) Situations permitting a change to 

the prior year testing method. The 

situations described in this paragraph 

(c)(1)(ii) are: 

(A) The plan is not the result of the 

aggregation of two or more plans, and 

the current year testing method was 

used under the plan for each of the 5 

plan years preceding the plan year of 

the change (or if lesser, the number of 

plan years the plan has been in 

existence, including years in which the 

plan was a portion of another plan).

(B) The plan is the result of the 

aggregation of two or more plans, and 

for each of the plans that are being 

aggregated (the aggregating plans), the 

current year testing method was used 

for each of the 5 plan years preceding 

the plan year of the change (or if lesser, 

the number of plan years since that 

aggregating plan has been in existence, 

including years in which the aggregating 

plan was a portion of another plan). 

(C) A transaction described in section 

410(b)(6)(C)(i) and § 1.410(b)–2(f) occurs 

and—

(1) As a result of the transaction, the 

employer maintains both a plan using 

the prior year testing method and a plan 

using the current year testing method; 

and 

(2) The change from the current year 

testing method to the prior year testing 

method occurs within the transition 

period described in section 

410(b)(6)(C)(ii). 

(2) Calculation of ADP under the prior 

year testing method for the first plan 

year—(i) Plans that are not successor 

plans. If, for the first plan year of any 

plan (other than a successor plan), the 

plan uses the prior year testing method, 

the plan is permitted to use either that 

first plan year as the applicable year for 

determining the ADP for eligible 

NHCEs, or use 3% as the ADP for 

eligible NHCEs, for applying the ADP 

test for that first plan year. A plan (other 

than a successor plan) that uses the 

prior year testing method but has 

78176 Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 

elected for its first plan year to use that 

year as the applicable year is not treated 

as changing its testing method in the 

second plan year and is not subject to 

the limitations on double counting on 

QNECs under paragraph (a)(6)(vi) of this 

section for the second plan year. 

(ii) First plan year defined. For 

purposes of this paragraph (c)(2), the 

first plan year of any plan is the first 

year in which the plan provides for 

elective contributions. Thus, the rules of 

this paragraph (c)(2) do not apply to a 

plan (within the meaning of § 1.410(b)–

7(b)) for a plan year if for such plan year 

the plan is aggregated under § 1.401(k)–

1(b)(4) with any other plan that 

provided for elective contributions in 

the prior year. 

(iii) Successor plans. A plan is a 

successor plan if 50% or more of the 

eligible employees for the first plan year 

were eligible employees under a 

qualified cash or deferred arrangement 

maintained by the employer in the prior 

year. If a plan that is a successor plan 

uses the prior year testing method for its 

first plan year, the ADP for the group of 

NHCEs for the applicable year must be 

determined under paragraph (c)(4) of 

this section. 

(3) Plans using different testing 

methods for the ADP and ACP test.

Except as otherwise provided in this 

paragraph (c)(3), a plan may use the 

current year testing method or prior year 

testing method for the ADP test for a 

plan year without regard to whether the 

current year testing method or prior year 

testing method is used for the ACP test 

for that year. For example, a plan may 

use the prior year testing method for the 

ADP test and the current year testing 

method for its ACP test for the plan 

year. However, plans that use different 

testing methods under this paragraph 

(c)(3) cannot use—

(i) The recharacterization method of 

paragraph (b)(3) of this section to correct 

excess contributions for a plan year; 

(ii) The rules of § 1.401(m)–2(a)(6)(ii) 

to take elective contributions into 

account under the ACP test (rather than 

the ADP test); or 

(iii) The rules of paragraph (a)(6)(v) of 

this section to take qualified matching 

contributions into account under the 

ADP test (rather than the ACP test). 

(4) Rules for plan coverage changes—

(i) In general. A plan that uses the prior 

year testing method and experiences a 

plan coverage change during a plan year 

satisfies the requirements of this section 

for that year only if the plan provides 

that the ADP for the NHCEs for the plan 

year is the weighted average of the ADPs 

for the prior year subgroups. 

(ii) Optional rule for minor plan 

coverage changes. If a plan coverage 

change occurs and 90% or more of the 

total number of the NHCEs from all 

prior year subgroups are from a single 

prior year subgroup, then, in lieu of 

using the weighted averages described 

in paragraph (c)(4)(i) of this section, the 

plan may provide that the ADP for the 

group of eligible NHCEs for the prior 

year under the plan is the ADP of the 

NHCEs for the prior year of the plan 

under which that single prior year 

subgroup was eligible. 

(iii) Definitions. The following 

definitions apply for purposes of this 

paragraph (c)(4): 

(A) Plan coverage change. The term 

plan coverage change means a change in 

the group or groups of eligible 

employees under a plan on account of—

(1) The establishment or amendment 

of a plan; 

(2) A plan merger or spinoff under 

section 414(l); 

(3) A change in the way plans (within 

the meaning of § 1.410(b)–7(b)) are 

combined or separated for purposes of 

§ 1.401(k)–1(b)(4) (e.g., permissively 

aggregating plans not previously 

aggregated under § 1.410(b)–7(d), or 

ceasing to permissively aggregate plans 

under § 1.410(b)–7(d)); 

(4) A reclassification of a substantial 

group of employees that has the same 

effect as amending the plan (e.g., a 

transfer of a substantial group of 

employees from one division to another 

division); or 

(5) A combination of any of 

paragraphs (c)(4)(iii)(A)(1) through (4) of 

this section. 

(B) Prior year subgroup. The term 

prior year subgroup means all NHCEs 

for the prior plan year who, in the prior 

year, were eligible employees under a 

specific plan maintained by the 

employer that included a qualified cash 

or deferred arrangement and who would 

have been eligible employees in the 

prior year under the plan being tested if 

the plan coverage change had first been 

effective as of the first day of the prior 

plan year instead of first being effective 

during the plan year. The determination 

of whether an NHCE is a member of a 

prior year subgroup is made without 

regard to whether the NHCE terminated 

employment during the prior year. 

(C) Weighted average of the ADPs for 

the prior year subgroups. The term 

weighted average of the ADPs for the 

prior year subgroups means the sum, for 

all prior year subgroups, of the adjusted 

ADPs for the plan year. The term 

adjusted ADP with respect to a prior 

year subgroup means the ADP for the 

prior plan year of the specific plan 

under which the members of the prior 

year subgroup were eligible employees 

on the first day of the prior plan year, 

multiplied by a fraction, the numerator 

of which is the number of NHCEs in the 

prior year subgroup and denominator of 

which is the total number of NHCEs in 

all prior year subgroups. 

(iv) Examples. The following 

examples illustrate the application of 

this paragraph (c)(4):

Example 1. (i) Employer B maintains two 

calendar year plans, Plan O and Plan P, each 

of which includes a cash or deferred 

arrangement. The plans were not 

permissively aggregated under § 1.410(b)–

7(d) for the 2005 plan year. Both plans use 

the prior year testing method. Plan O had 300 

eligible employees who were NHCEs for the 

2005 plan year, and their ADP for that year 

was 6%. Sixty of the eligible employees who 

were NHCEs for the 2005 plan year under 

Plan O, terminated their employment during 

that year. Plan P had 100 eligible employees 

who were NHCEs for 2005, and the ADP for 

those NHCEs for that plan was 4%. Plan O 

and Plan P are permissively aggregated under 

§ 1.410(b)–7(d) for the 2006 plan year. 

(ii) The permissive aggregation of Plan O 

and Plan P for the 2006 plan year under 

§ 1.410(b)–7(d) is a plan coverage change that 

results in treating the plans as one plan (Plan 

OP) for purposes of § 1.401(k)–1(b)(4). 

Therefore, the prior year ADP for the NHCEs 

under Plan OP for the 2006 plan year is the 

weighted average of the ADPs for the prior 

year subgroups: the Plan O prior year 

subgroup and the Plan P prior year subgroup. 

(iii) The Plan O prior year subgroup 

consists of the 300 employees who, in the 

2005 plan year, were eligible NHCEs under 

Plan O and who would have been eligible 

under Plan OP for the 2005 plan year if Plan 

O and Plan P had been permissively 

aggregated for that plan year. The Plan P 

prior year subgroup consists of the 100 

employees who, in the 2005 plan year, were 

eligible NHCEs under Plan P and would have 

been eligible under Plan OP for the 2005 plan 

year if Plan O and Plan P had been 

permissively aggregated for that plan year. 

(iv) The weighted average of the ADPs for 

the prior year subgroups is the sum of the 

adjusted ADP for the Plan O prior year 

subgroup and the adjusted ADP for the Plan 

P prior year subgroup. The adjusted ADP for 

the Plan O prior year subgroup is 4.5%, 

calculated as follows: 6% (the ADP for the 

NHCEs under Plan O for the 2005 plan year) 

× 300/400 (the number of NHCEs in the Plan 

O prior year subgroup divided by the total 

number of NHCEs in all prior year 

subgroups). The adjusted ADP for the Plan P 

prior year subgroup is 1%, calculated as 

follows: 4% (the ADP for the NHCEs under 

Plan P for the 2005 plan year) × 100/400 (the 

number of NHCEs in the Plan P prior year 

subgroup divided by the total number of 

NHCEs in all prior year subgroups). Thus, the 

prior year ADP for NHCEs under Plan OP for 

the 2006 plan year is 5.5% (the sum of 

adjusted ADPs for the prior year subgroups, 

4.5% plus 1%). 

(v) As provided in paragraph (c)(4)(iii)(B) 

of this section, the determination of whether 

an NHCE is a member of a prior year 

subgroup is made without regard to whether 

that NHCE terminated employment during 

Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 78177

the prior year. Thus, the prior ADP for the 

NHCEs under Plan OP for the 2006 plan year 

is unaffected by the termination of the 60 

NHCEs covered by Plan O during the 2005 

plan year.

Example 2. (i) The facts are the same as 

Example 1, except that the 60 employees 

who terminated employment during the 2005 

plan are instead spun-off to another plan. 

(ii) The permissive aggregation of Plan O 

and Plan P for the 2006 plan year under 

§ 1.410(b)–7(d) is a plan coverage change that 

results in treating the plans as one plan (Plan 

OP) for purposes of § 1.401(k)–1(b)(4) and the 

spin-off of the 60 employees is a plan 

coverage change. Therefore, the prior year 

ADP for the NHCEs under Plan OP for the 

2006 plan year is the weighted average of the 

ADPs for the prior year subgroups: the Plan 

O prior year subgroup and the Plan P prior 

year subgroup. 

(iii) For purposes of determining the prior 

year subgroups, the employees who would 

have been eligible employees in the prior 

year under the plan being tested are 

determined as if both plan coverage changes 

had first been effective as of the first day of 

the prior plan year. The Plan O prior year 

subgroup consists of the 240 employees who, 

in the 2005 plan year, were eligible NHCEs 

under Plan O and would have been eligible 

under Plan OP for the 2005 plan year if the 

spin-off had occurred at the beginning of the 

2005 plan year and Plan O and Plan P had 

been permissively aggregated under 

§ 1.410(b)–7(d) for that plan year. The Plan P 

prior year subgroup consists of the 100 

employees who, in the 2005 plan year, were 

eligible NHCEs under Plan P and would have 

been eligible under Plan OP for the 2005 plan 

year if Plan O and Plan P had been 

permissively aggregated under § 1.410(b)–

7(d) for that plan year. 

(iv) The weighted average of the ADPs for 

the prior year subgroups is the sum of the 

adjusted ADP with respect to the prior year 

subgroup consisting of eligible NHCEs from 

Plan O and the adjusted ADP with respect to 

the prior year subgroup consisting of eligible 

NHCEs from Plan P. The adjusted ADP for 

the prior year subgroup consisting of eligible 

NHCEs under Plan O is 4.23%, calculated as 

follows: 6% (the ADP for the NHCEs under 

Plan O for the 2005 plan year) × 240/340 (the 

number of NHCEs in that prior year subgroup 

divided by the total number of NHCEs in all 

prior year subgroups). The adjusted ADP for 

the prior year subgroup consisting of the 

eligible NHCEs from Plan P is 1.18%, 

calculated as follows: 4% (the ADP for the 

NHCEs under Plan P for the 2005 plan year) 

× 100/340 (the number of NHCEs in that prior 

year subgroup divided by the total number of 

NHCEs in all prior year subgroups). Thus, the 

prior year ADP for NHCEs under Plan OP for 

the 2006 plan year is 5.41% (the sum of 

adjusted ADPs for the prior year subgroups, 

4.23% plus 1.18%).

Example 3. (i) The facts are the same as in 

Example 1, except that instead of Plan O and 

Plan P being permissively aggregated for the 

2006 plan year, 200 of the employees eligible 

under Plan O were spun-off from Plan O and 

merged into Plan P. 

(ii) The spin-off from Plan O and merger 

to Plan P for the 2006 plan year are plan 

coverage changes for Plan P. Therefore, the 

prior year ADP for the NHCEs under Plan P 

for the 2006 plan year is the weighted 

average of the ADPs for the prior year 

subgroups under Plan P. There are 2 

subgroups under Plan P for the 2006 plan 

year. The Plan O prior year subgroup consists 

of the 200 employees who, in the 2005 plan 

year, were eligible NHCEs under Plan O and 

who would have been eligible under Plan P 

for the 2005 plan year if the spin-off and 

merger had occurred on the first day of the 

2005 plan year. The Plan P prior year 

subgroup consists of the 100 employees who, 

in the 2005 plan year, were eligible NHCEs 

under Plan P for the 2005 plan year. 

(iii) The weighted average of the ADPs for 

the prior year subgroups is the sum of the 

adjusted ADP for the Plan O prior year 

subgroup and the adjusted ADP for the Plan 

P prior year subgroup. The adjusted ADP for 

the Plan O prior year subgroup is 4.0%, 

calculated as follows: 6% (the ADP for the 

NHCEs under Plan O for the 2005 plan year) 

× 200/300 (the number of NHCEs in the Plan 

O prior year subgroup divided by the total 

number of NHCEs in all prior year 

subgroups). The adjusted ADP for the Plan P 

prior year subgroup is 1.33%, calculated as 

follows: 4% (the ADP for the NHCEs under 

Plan P for the 2005 plan year) × 100/300 (the 

number of NHCEs in the Plan P prior year 

subgroup divided by the total number of 

NHCEs in all prior year subgroups). Thus, the 

prior year ADP for NHCEs under Plan P for 

the 2006 plan year is 5.33% (the sum of 

adjusted ADPs for the 2 prior year subgroups, 

4.0% plus 1.33%). 

(iv) The spin-off from Plan O for the 2006 

plan year is a plan coverage change for Plan 

O. Therefore, the prior year ADP for the 

NHCEs under Plan O for the 2006 plan year 

is the weighted average of the ADPs for the 

prior year subgroups under Plan O. In this 

case, there is only one prior year subgroup 

under Plan O, the employees who were 

NHCEs of Employer B for the 2005 plan year 

and who were eligible for the 2005 plan year 

under Plan O. Because there is only one prior 

year subgroup under Plan O, the weighted 

average of the ADPs for the prior year 

subgroup under Plan O is equal to the NHCE 

ADP for the prior year (2005 plan year) under 

Plan O, or 6%.

Example 4. (i) Employer C maintains a 

calendar year plan, Plan Q, which includes 

a cash or deferred arrangement that uses the 

prior year testing method. Plan Q covers 

employees of Division A and Division B. In 

2005, Plan Q had 500 eligible employees who 

were NHCEs, and the ADP for those NHCEs 

for 2005 was 2%. Effective January 1, 2006, 

Employer C amends the eligibility provisions 

under Plan Q to exclude employees of 

Division B effective January 1, 2006. In 

addition, effective on that same date, 

Employer C establishes a new calendar year 

plan, Plan R, which includes a cash or 

deferred arrangement that uses the prior year 

testing method. The only eligible employees 

under Plan R are the 100 employees of 

Division B who were eligible employees 

under Plan Q. 

(ii) Plan R is a successor plan, within the 

meaning of paragraph (c)(2)(iii) of this 

section (because all of the employees were 

eligible employees under Plan Q in the prior 

year). Therefore, Plan R cannot use the first 

plan year rule set forth in paragraph (c)(2)(i) 

of this section. 

(iii) The amendment to the eligibility 

provisions of Plan Q and the establishment 

of Plan R are plan coverage changes within 

the meaning of paragraph (c)(4)(iii)(A) of this 

section for Plan Q and Plan R. Accordingly, 

each plan must determine the NHCE ADP for 

the 2006 plan year under the rules set forth 

in paragraph (c)(4) of this section. 

(iv) The prior year ADP for NHCEs under 

Plan Q is the weighted average of the ADPs 

for the prior year subgroups. Plan Q has only 

one prior year subgroup (because the only 

NHCEs who would have been eligible 

employees under Plan Q for the 2005 plan 

year if the amendment to the Plan Q 

eligibility provisions had occurred as of the 

first day of that plan year were eligible 

employees under Plan Q). Therefore, for 

purposes of the 2006 plan year under Plan Q, 

the ADP for NHCEs for the prior year is the 

weighted average of the ADPs for the prior 

year subgroups, or 2%, the same as if the 

plan amendment had not occurred. 

(v) Similarly, Plan R has only one prior 

year subgroup (because the only NHCEs who 

would have been eligible employees under 

Plan R for the 2005 plan year if the plan were 

established as of the first day of that plan 

year were eligible employees under Plan Q). 

Therefore, for purposes of the 2006 testing 

year under Plan R, the ADP for NHCEs for 

the prior year is the weighted average of the 

ADPs for the prior year subgroups, or 2%, the 

same as that of Plan Q.

Example 5. (i) The facts are the same as in 

Example 4, except that the provisions of Plan 

R extend eligibility to 50 hourly employees 

who previously were not eligible employees 

under any qualified cash or deferred 

arrangement maintained by Employer C. 

(ii) Plan R is a successor plan (because 100 

of Plan R’s 150 eligible employees were 

eligible employees under another qualified 

cash or deferred arrangement maintained by 

Employer C in the prior year). Therefore, 

Plan R cannot use the first plan year rule set 

forth in paragraph (c)(2)(i) of this section. 

(iii) The establishment of Plan R is a plan 

coverage change that affects Plan R. Because 

the 50 hourly employees were not eligible 

employees under any qualified cash or 

deferred arrangement of Employer C for the 

prior plan year, they do not comprise a prior 

year subgroup. Accordingly, Plan R still has 

only one prior year subgroup. Therefore, for 

purposes of the 2006 testing year under Plan 

R, the ADP for NHCEs for the prior year is 

the weighted average of the ADPs for the 

prior year subgroups, or 2%, the same as that 

of Plan Q.

§ 1.401(k)–3 Safe harbor requirements. 

(a) ADP test safe harbor. A cash or 

deferred arrangement satisfies the ADP 

safe harbor provision of section 

401(k)(12) for a plan year if the 

arrangement satisfies the safe harbor 

contribution requirement of paragraph 

(b) or (c) of this section for the plan 

year, the notice requirement of 

paragraph (d) of this section, the plan 

78178 Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 

year requirements of paragraph (e) of 

this section, and the additional rules of 

paragraphs (f), (g) and (h) of this section, 

as applicable. Pursuant to section 

401(k)(12)(E)(ii), the safe harbor 

contribution requirement of paragraph 

(b) or (c) of this section must be satisfied 

without regard to section 401(l). The 

contributions made under paragraphs 

(b) and (c) of this section are referred to 

as safe harbor nonelective contributions 

and safe harbor matching contributions, 

respectively. 

(b) Safe harbor nonelective 

contribution requirement—(1) General 

rule. The safe harbor nonelective 

contribution requirement of this 

paragraph is satisfied if, under the terms 

of the plan, the employer is required to 

make a qualified nonelective 

contribution on behalf of each eligible 

NHCE equal to at least 3% of the 

employee’s safe harbor compensation. 

(2) Safe harbor compensation defined.

For purposes of this section, safe harbor 

compensation means compensation as 

defined in § 1.401(k)–6 (which 

incorporates the definition of 

compensation in § 1.414(s)–1); 

provided, however, that the rule in the 

last sentence of § 1.414(s)–1(d)(2)(iii) 

(which generally permits a definition of 

compensation to exclude all 

compensation in excess of a specified 

dollar amount) does not apply in 

determining the safe harbor 

compensation of NHCEs. Thus, for 

example, the plan may limit the period 

used to determine safe harbor 

compensation to the eligible employee’s 

period of participation. 

(c) Safe harbor matching contribution 

requirement—(1) In general. The safe 

harbor matching contribution 

requirement of this paragraph (c) is 

satisfied if, under the plan, qualified 

matching contributions are made on 

behalf of each eligible NHCE in an 

amount determined under the basic 

matching formula of section 

401(k)(12)(B)(i)(I), as described in 

paragraph (c)(2) of this section, or under 

an enhanced matching formula of 

section 401(k)(12)(B)(i)(II), as described 

in paragraph (c)(3) of this section. 

(2) Basic matching formula. Under the 

basic matching formula, each eligible 

NHCE receives qualified matching 

contributions in an amount equal to the 

sum of—

(i) 100% of the amount of the 

employee’s elective contributions that 

do not exceed 3% of the employee’s safe 

harbor compensation; and 

(ii) 50% of the amount of the 

employee’s elective contributions that 

exceed 3% of the employee’s safe harbor 

compensation but that do not exceed 

5% of the employee’s safe harbor 

compensation. 

(3) Enhanced matching formula.

Under an enhanced matching formula, 

each eligible NHCE receives a matching 

contribution under a formula that, at 

any rate of elective contributions by the 

employee, provides an aggregate amount 

of qualified matching contributions at 

least equal to the aggregate amount of 

qualified matching contributions that 

would have been provided under the 

basic matching formula of paragraph 

(c)(2) of this section. In addition, under 

an enhanced matching formula, the ratio 

of matching contributions on behalf of 

an employee under the plan for a plan 

year to the employee’s elective 

contributions may not increase as the 

amount of an employee’s elective 

contributions increases. 

(4) Limitation on HCE matching 

contributions. The safe harbor matching 

contribution requirement of this 

paragraph (c) is not satisfied if the ratio 

of matching contributions made on 

account of an HCE’s elective 

contributions under the cash or deferred 

arrangement for a plan year to those 

elective contributions is greater than the 

ratio of matching contributions to 

elective contributions that would apply 

with respect to any eligible NHCE with 

elective contributions at the same 

percentage of safe harbor compensation. 

(5) Use of safe harbor match not 

precluded by certain plan provisions—

(i) Safe harbor matching contributions 

on employee contributions. The safe 

harbor matching contribution 

requirement of this paragraph (c) will 

not fail to be satisfied merely because 

safe harbor matching contributions are 

made on both elective contributions and 

employee contributions if safe harbor 

matching contributions are made with 

respect to the sum of elective 

contributions and employee 

contributions on the same terms as safe 

harbor matching contributions are made 

with respect to elective contributions. 

Alternatively, the safe harbor matching 

contribution requirement of this 

paragraph (c) will not fail to be satisfied 

merely because safe harbor matching 

contributions are made on both elective 

contributions and employee 

contributions if safe harbor matching 

contributions on elective contributions 

are not affected by the amount of 

employee contributions. 

(ii) Periodic matching contributions.

The safe harbor matching contribution 

requirement of this paragraph (c) will 

not fail to be satisfied merely because 

the plan provides that safe harbor 

matching contributions will be made 

separately with respect to each payroll 

period (or with respect to all payroll 

periods ending with or within each 

month or quarter of a plan year) taken 

into account under the plan for the plan 

year, provided that safe harbor matching 

contributions with respect to any 

elective contributions made during a 

plan year quarter are contributed to the 

plan by the last day of the immediately 

following plan year quarter. 

(6) Permissible restrictions on elective 

contributions by NHCEs—(i) General 

rule. The safe harbor matching 

contribution requirement of this 

paragraph (c) is not satisfied if elective 

contributions by NHCEs are restricted, 

unless the restrictions are permitted by 

this paragraph (c)(6). 

(ii) Restrictions on election periods. A 

plan may limit the frequency and 

duration of periods in which eligible 

employees may make or change cash or 

deferred elections under a plan. 

However, an employee must have a 

reasonable opportunity (including a 

reasonable period after receipt of the 

notice described in paragraph (d) of this 

section) to make or change a cash or 

deferred election for the plan year. For 

purposes of this paragraph (c)(6)(ii), a 

30-day period is deemed to be a 

reasonable period to make or change a 

cash or deferred election. 

(iii) Restrictions on amount of elective 

contributions. A plan is permitted to 

limit the amount of elective 

contributions that may be made by an 

eligible employee under a plan, 

provided that each NHCE who is an 

eligible employee is permitted (unless 

the employee is restricted under 

paragraph (c)(6)(v) of this section) to 

make elective contributions in an 

amount that is at least sufficient to 

receive the maximum amount of 

matching contributions available under 

the plan for the plan year, and the 

employee is permitted to elect any 

lesser amount of elective contributions. 

However, a plan may require eligible 

employees to make cash or deferred 

elections in whole percentages of 

compensation or whole dollar amounts. 

(iv) Restrictions on types of 

compensation that may be deferred. A 

plan may limit the types of 

compensation that may be deferred by 

an eligible employee under a plan, 

provided that each eligible NHCE is 

permitted to make elective contributions 

under a definition of compensation that 

would be a reasonable definition of 

compensation within the meaning of 

§ 1.414(s)–1(d)(2). Thus, the definition 

of compensation from which elective 

contributions may be made is not 

required to satisfy the 

nondiscrimination requirement of 

§ 1.414(s)–1(d)(3). 

Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 78179

(v) Restrictions due to limitations 

under the Internal Revenue Code. A 

plan may limit the amount of elective 

contributions made by an eligible 

employee under a plan—

(A) Because of the limitations of 

section 402(g) or 415; or 

(B) Because, on account of a hardship 

distribution, an employee’s ability to 

make elective contributions has been 

suspended for 6 months in accordance 

with § 1.401(k)–1(d)(3)(iv)(E). 

(7) Examples. The following examples 

illustrate the safe harbor contribution 

requirement of this paragraph (c):

Example 1. (i) Beginning January 1, 2006, 

Employer A maintains Plan L covering 

employees in Divisions D and E, each of 

which includes HCEs and NHCEs. Plan L 

contains a cash or deferred arrangement and 

provides qualified matching contributions 

equal to 100% of each eligible employee’s 

elective contributions up to 3% of 

compensation and 50% of the next 2% of 

compensation. For purposes of the matching 

contribution formula, safe harbor 

compensation is defined as all compensation 

within the meaning of section 415(c)(3) (a 

definition that satisfies section 414(s)). Also, 

each employee is permitted to make elective 

contributions from all safe harbor 

compensation within the meaning of section 

415(c)(3) and may change a cash or deferred 

election at any time. Plan L limits the amount 

of an employee’s elective contributions for 

purposes of section 402(g) and section 415, 

and, in the case of a hardship distribution, 

suspends an employee’s ability to make 

elective contributions for 6 months in 

accordance with § 1.401(k)–1(d)(3)(iv)(E). All 

contributions under Plan L are nonforfeitable 

and are subject to the withdrawal restrictions 

of section 401(k)(2)(B). Plan L provides for no 

other contributions and Employer A 

maintains no other plans. Plan L is 

maintained on a calendar-year basis, and all 

contributions for a plan year are made within 

12 months after the end of the plan year.

(ii) Based on these facts, matching 

contributions under Plan L are safe harbor 

matching contributions because they are 

qualified matching contributions equal to the 

basic matching formula. Accordingly, Plan L 

satisfies the safe harbor contribution 

requirement of this paragraph (c).

Example 2. (i) The facts are the same as in 

Example 1, except that instead of providing 

a basic matching contribution, Plan L 

provides a qualified matching contribution 

equal to 100% of each eligible employee’s 

elective contributions up to 4% of safe harbor 

compensation. 

(ii) Plan L’s formula is an enhanced 

matching formula because each eligible 

NHCE receives safe harbor matching 

contributions at a rate that, at any rate of 

elective contributions, provides an aggregate 

amount of qualified matching contributions 

at least equal to the aggregate amount of 

qualified matching contributions that would 

have been received under the basic safe 

harbor matching formula, and the rate of 

matching contributions does not increase as 

the rate of an employee’s elective 

contributions increases. Accordingly, Plan L 

satisfies the safe harbor contribution 

requirement of this paragraph (c).

Example 3. (i) The facts are the same as in 

Example 2, except that instead of permitting 

each employee to make elective contributions 

from all compensation within the meaning of 

section 415(c)(3), each employee’s elective 

contributions under Plan L are limited to 

15% of the employee’s basic compensation. 

Basic compensation is defined under Plan L 

as compensation within the meaning of 

section 415(c)(3), but excluding overtime 

pay. 

(ii) The definition of basic compensation 

under Plan L is a reasonable definition of 

compensation within the meaning of 

§ 1.414(s)–1(d)(2). 

(iii) Plan L will not fail to satisfy the safe 

harbor contribution requirement of this 

paragraph (c) merely because Plan L limits 

the amount of elective contributions and the 

types of compensation that may be deferred 

by eligible employees, provided that each 

eligible NHCE may make elective 

contributions equal to at least 4% of the 

employee’s safe harbor compensation.

Example 4. (i) The facts are the same as in 

Example 1, except that Plan L provides that 

only employees employed on the last day of 

the plan year will receive a safe harbor 

matching contribution. 

(ii) Even if the plan that provides for 

employee contributions and matching 

contributions satisfies the minimum coverage 

requirements of section 410(b)(1) taking into 

account this last-day requirement, Plan L 

would not satisfy the safe harbor contribution 

requirement of this paragraph (c) because 

safe harbor matching contributions are not 

made on behalf of all eligible NHCEs who 

make elective contributions. 

(iii) The result would be the same if, 

instead of providing safe harbor matching 

contributions, Plan L provides for a 3% safe 

harbor nonelective contribution that is 

restricted to eligible employees under the 

cash or deferred arrangement who are 

employed on the last day of the plan year.

Example 5. (i) The facts are the same as in 

Example 1, except that instead of providing 

qualified matching contributions under the 

basic matching formula to employees in both 

Divisions D and E, employees in Division E 

are provided qualified matching 

contributions under the basic matching 

formula, while safe harbor matching 

contributions continue to be provided to 

employees in Division D under the enhanced 

matching formula described in Example 2.

(ii) Even if Plan L satisfies § 1.401(a)(4)–4 

with respect to each rate of matching 

contributions available to employees under 

the plan, the plan would fail to satisfy the 

safe harbor contribution requirement of this 

paragraph (c) because the rate of matching 

contributions with respect to HCEs in 

Division D at a rate of elective contributions 

between 3% and 5% would be greater than 

that with respect to NHCEs in Division E at 

the same rate of elective contributions. For 

example, an HCE in Division D who would 

have a 4% rate of elective contributions 

would have a rate of matching contributions 

of 100% while an NHCE in Division E who 

would have the same rate of elective 

contributions would have a lower rate of 

matching contributions.

(d) Notice requirement—(1) General 

rule. The notice requirement of this 

paragraph (d) is satisfied for a plan year 

if each eligible employee is given notice 

of the employee’s rights and obligations 

under the plan and the notice satisfies 

the content requirement of paragraph 

(d)(2) of this section and the timing 

requirement of paragraph (d)(3) of this 

section. The notice must be in writing 

or in such other form as may be 

approved by the Commissioner. 

(2) Content requirement—(i) General 

rule. The content requirement of this 

paragraph (d)(2) is satisfied if the notice 

is—

(A) Sufficiently accurate and 

comprehensive to inform the employee 

of the employee’s rights and obligations 

under the plan; and 

(B) Written in a manner calculated to 

be understood by the average employee 

eligible to participate in the plan. 

(ii) Minimum content requirement.

Subject to the requirements of paragraph 

(d)(2)(iii) of this section, a notice is not 

considered sufficiently accurate and 

comprehensive unless the notice 

accurately describes—

(A) The safe harbor matching 

contribution or safe harbor nonelective 

contribution formula used under the 

plan (including a description of the 

levels of safe harbor matching 

contributions, if any, available under 

the plan); 

(B) Any other contributions under the 

plan or matching contributions to 

another plan on account of elective 

contributions or employee contributions 

under the plan (including the potential 

for discretionary matching 

contributions) and the conditions under 

which such contributions are made; 

(C) The plan to which safe harbor 

contributions will be made (if different 

than the plan containing the cash or 

deferred arrangement); 

(D) The type and amount of 

compensation that may be deferred 

under the plan; 

(E) How to make cash or deferred 

elections, including any administrative 

requirements that apply to such 

elections; 

(F) The periods available under the 

plan for making cash or deferred 

elections; 

(G) Withdrawal and vesting 

provisions applicable to contributions 

under the plan; and 

(H) Information that makes it easy to 

obtain additional information about the 

plan (including an additional copy of 

the summary plan description) such as 

telephone numbers, addresses and, if 

applicable, electronic addresses, of 

78180 Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 

individuals or offices from whom 

employees can obtain such plan 

information. 

(iii) References to SPD. A plan will 

not fail to satisfy the content 

requirements of this paragraph (d)(2) 

merely because, in the case of 

information described in paragraph 

(d)(2)(ii)(B) of this section (relating to 

any other contributions under the plan), 

paragraph (d)(2)(ii)(C) of this section 

(relating to the plan to which safe 

harbor contributions will be made) or 

paragraph (d)(2)(ii)(D) of this section 

(relating to the type and amount of 

compensation that may be deferred 

under the plan), the notice crossreferences the relevant portions of a 

summary plan description that provides 

the same information that would be 

provided in accordance with such 

paragraphs and that has been provided 

(or is concurrently provided) to 

employees. 

(3) Timing requirement—(i) General 

rule. The timing requirement of this 

paragraph (d)(3) is satisfied if the notice 

is provided within a reasonable period 

before the beginning of the plan year (or, 

in the year an employee becomes 

eligible, within a reasonable period 

before the employee becomes eligible). 

The determination of whether a notice 

satisfies the timing requirement of this 

paragraph (d)(3) is based on all of the 

relevant facts and circumstances. 

(ii) Deemed satisfaction of timing 

requirement. The timing requirement of 

this paragraph (d)(3) is deemed to be 

satisfied if at least 30 days (and no more 

than 90 days) before the beginning of 

each plan year, the notice is given to 

each eligible employee for the plan year. 

In the case of an employee who does not 

receive the notice within the period 

described in the previous sentence 

because the employee becomes eligible 

after the 90th day before the beginning 

of the plan year, the timing requirement 

is deemed to be satisfied if the notice is 

provided no more than 90 days before 

the employee becomes eligible (and no 

later than the date the employee 

becomes eligible). Thus, for example, 

the preceding sentence would apply in 

the case of any employee eligible for the 

first plan year under a newly 

established plan that provides for 

elective contributions, or would apply 

in the case of the first plan year in 

which an employee becomes eligible 

under an existing plan that provides for 

elective contributions. 

(e) Plan year requirement—(1) 

General rule. Except as provided in this 

paragraph (e) or in paragraph (f) of this 

section, a plan will fail to satisfy the 

requirements of section 401(k)(12) and 

this section unless plan provisions that 

satisfy the rules of this section are 

adopted before the first day of the plan 

year and remain in effect for an entire 

12-month plan year. In addition, except 

as provided in paragraph (g) of this 

section, a plan which includes 

provisions that satisfy the rules of this 

section will not satisfy the requirements 

of § 1.401(k)–1(b) if it is amended to 

change such provisions for that plan 

year. Moreover, if, as described under 

paragraph (h)(4) of this section, safe 

harbor matching or nonelective 

contributions will be made to another 

plan for a plan year, provisions under 

that other plan specifying that the safe 

harbor contributions will be made and 

providing that the contributions will be 

QNECs or QMACs must also be adopted 

before the first day of that plan year. 

(2) Initial plan year. A newly 

established plan (other than a successor 

plan within the meaning of § 1.401(k)–

2(c)(2)(iii)) will not be treated as 

violating the requirements of this 

paragraph (e) merely because the plan 

year is less than 12 months, provided 

that the plan year is at least 3 months 

long (or, in the case of a newly 

established employer that establishes 

the plan as soon as administratively 

feasible after the employer comes into 

existence, a shorter period). Similarly, a 

cash or deferred arrangement will not 

fail to satisfy the requirement of this 

paragraph (e) if it is added to an existing 

profit sharing, stock bonus, or preERISA money purchase pension plan for 

the first time during that year provided 

that—

(i) The plan is not a successor plan; 

and 

(ii) The cash or deferred arrangement 

is made effective no later than 3 months 

prior to the end of the plan year. 

(3) Change of plan year. A plan that 

has a short plan year as a result of 

changing its plan year will not fail to 

satisfy the requirements of paragraph 

(e)(1) of this section merely because the 

plan year has less than 12 months, 

provided that—

(i) The plan satisfied the requirements 

of this section for the immediately 

preceding plan year; and 

(ii) The plan satisfies the 

requirements of this section (determined 

without regard to paragraph (g) of this 

section) for the immediately following 

plan year (or for the immediately 

following 12 months if the immediately 

following plan year is less than 12 

months). 

(4) Final plan year. A plan that 

terminates during a plan year will not 

fail to satisfy the requirements of 

paragraph (e)(1) of this section merely 

because the final plan year is less than 

12 months, provided that the plan 

satisfies the requirement of this section 

through the date of termination and 

either—

(i) The plan would satisfy the 

requirements of paragraph (g) of this 

section, treating the termination of the 

plan as a reduction or suspension of safe 

harbor matching contributions, other 

than the requirement that employees 

have a reasonable opportunity to change 

their cash or deferred elections and, if 

applicable, employee contribution 

elections; or 

(ii) The plan termination is in 

connection with a transaction described 

in section 410(b)(6)(C) or the employer 

incurs a substantial business hardship 

comparable to a substantial business 

hardship described in section 412(d). 

(f) Plan amendments adopting safe 

harbor nonelective contributions—(1) 

General rule. Notwithstanding 

paragraph (e)(1) of this section, a plan 

that provides for the use of the current 

year testing method may be amended 

after the first day of the plan year and 

no later than 30 days before the last day 

of the plan year to adopt the safe harbor 

method of this section, effective as of 

the first day of the plan year, using 

nonelective contributions under 

paragraph (b) of this section, but only if 

the plan provides the contingent and 

follow-up notices described in this 

section. A plan amendment made 

pursuant to this paragraph (f)(1) for a 

plan year may provide for the use of the 

safe harbor method described in this 

section solely for that plan year and a 

plan sponsor is not limited in the 

number of years for which it is 

permitted to adopt an amendment 

providing for the safe harbor method of 

this section using nonelective 

contributions under paragraph (b) of 

this section and this paragraph (f). 

(2) Contingent notice provided. A plan 

satisfies the requirement to provide the 

contingent notice under this paragraph 

(f)(2) if it provides a notice that would 

satisfy the requirements of paragraph (d) 

of this section, except that, in lieu of 

setting forth the safe harbor 

contributions used under the plan as set 

forth in paragraph (d)(2)(ii)(A) of this 

section, the notice specifies that the 

plan may be amended during the plan 

year to include the safe harbor 

nonelective contribution and that, if the 

plan is amended, a follow-up notice will 

be provided. 

(3) Follow-up notice requirement. A 

plan satisfies the requirement to provide 

a follow-up notice under this paragraph 

(f)(3) if, no later than 30 days before the 

last day of the plan year, each eligible 

employee is given a notice that states 

that the safe harbor nonelective 

contributions will be made for the plan 

Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 78181

year. The notice must be in writing or 

in such other form as may be prescribed 

by the Commissioner and is permitted 

to be combined with a contingent notice 

provided under paragraph (f)(2) of this 

section for the next plan year. 

(g) Permissible reduction or 

suspension of safe harbor matching 

contributions—(1) General rule. A plan 

that provides for safe harbor matching 

contributions will not fail to satisfy the 

requirements of section 401(k)(3) for a 

plan year merely because the plan is 

amended during a plan year to reduce 

or suspend safe harbor matching 

contributions on future elective 

contributions (and, if applicable, 

employee contributions) provided 

that—

(i) All eligible employees are provided 

the supplemental notice in accordance 

with paragraph (g)(2) of this section; 

(ii) The reduction or suspension of 

safe harbor matching contributions is 

effective no earlier than the later of 30 

days after eligible employees are 

provided the notice described in 

paragraph (g)(2) of this section and the 

date the amendment is adopted; 

(iii) Eligible employees are given a 

reasonable opportunity (including a 

reasonable period after receipt of the 

supplemental notice) prior to the 

reduction or suspension of safe harbor 

matching contributions to change their 

cash or deferred elections and, if 

applicable, their employee contribution 

elections; 

(iv) The plan is amended to provide 

that the ADP test will be satisfied for the 

entire plan year in which the reduction 

or suspension occurs using the current 

year testing method described in 

§ 1.401(k)–2(a)(2)(ii); and 

(v) The plan satisfies the requirements 

of this section (other than this paragraph 

(g)) with respect to amounts deferred 

through the effective date of the 

amendment. 

(2) Notice of suspension requirement.

The notice of suspension requirement of 

this paragraph (g)(2) is satisfied if each 

eligible employee is given a notice (in 

writing or such other form as prescribed 

by the Commissioner) that explains—

(i) The consequences of the 

amendment which reduces or suspends 

matching contributions on future 

elective contributions and, if applicable, 

employee contributions; 

(ii) The procedures for changing their 

cash or deferred election and, if 

applicable, their employee contribution 

elections; and 

(iii) The effective date of the 

amendment. 

(h) Additional rules—(1) 

Contributions taken into account. A 

contribution is taken into account for 

purposes of this section for a plan year 

if and only if the contribution would be 

taken into account for such plan year 

under the rules of § 1.401(k)–2(a) or 

1.401(m)–2(a). Thus, for example, a safe 

harbor matching contribution must be 

made within 12 months of the end of 

the plan year. Similarly, an elective 

contribution that would be taken into 

account for a plan year under 

§ 1.401(k)–2(a)(4)(i)(B)(2) must be taken 

into account for such plan year for 

purposes of this section, even if the 

compensation would have been 

received after the close of the plan year. 

(2) Use of safe harbor nonelective 

contributions to satisfy other 

nondiscrimination tests. A safe harbor 

nonelective contribution used to satisfy 

the nonelective contribution 

requirement under paragraph (b) of this 

section may also be taken into account 

for purposes of determining whether a 

plan satisfies section 401(a)(4). Thus, 

these contributions are not subject to the 

limitations on qualified nonelective 

contributions under § 1.401(k)–

2(a)(6)(ii), but are subject to the rules 

generally applicable to nonelective 

contributions under section 401(a)(4). 

See § 1.401(a)(4)–1(b)(2)(ii). However, 

pursuant to section 401(k)(12)(E)(ii), to 

the extent they are needed to satisfy the 

safe harbor contribution requirement of 

paragraph (b) of this section, safe harbor 

nonelective contributions may not be 

taken into account under any plan for 

purposes of section 401(l) (including the 

imputation of permitted disparity under 

§ 1.401(a)(4)–7). 

(3) Early participation rules. Section 

401(k)(3)(F) and § 1.401(k)–

2(a)(1)(iii)(A), which provide an 

alternative nondiscrimination rule for 

certain plans that provide for early 

participation, do not apply for purposes 

of section 401(k)(12) and this section. 

Thus, a plan is not treated as satisfying 

this section with respect to the eligible 

employees who have not completed the 

minimum age and service requirements 

of section 410(a)(1)(A) unless the plan 

satisfies the requirements of this section 

with respect to such eligible employees. 

However, a plan is permitted to apply 

the rules of section 410(b)(4)(B) to treat 

the plan as two separate plans for 

purposes of section 410(b) and apply the 

safe harbor requirements of this section 

to one plan and apply the requirements 

of § 1.401(k)–2 to the other plan. See 

§ 1.401(k)–1(b)(4)(vi), Example 2.

(4) Satisfying safe harbor contribution 

requirement under another defined 

contribution plan. Safe harbor matching 

or nonelective contributions may be 

made to the plan that contains the cash 

or deferred arrangement or to another 

defined contribution plan that satisfies 

section 401(a) or 403(a). If safe harbor 

contributions are made to another 

defined contribution plan, the safe 

harbor plan must specify the plan to 

which the safe harbor contributions are 

made and the contribution requirement 

of paragraph (b) or (c) of this section 

must be satisfied in the other defined 

contribution plan in the same manner as 

if the contributions were made to the 

plan that contains the cash or deferred 

arrangement. Consequently, the plan to 

which the contributions are made must 

have the same plan year as the plan 

containing the cash and deferred 

arrangement and each employee eligible 

under the plan containing the cash or 

deferred arrangement must be eligible 

under the same conditions under the 

other defined contribution plan. The 

plan to which the safe harbor 

contributions are made need not be a 

plan that can be aggregated with the 

plan that contains the cash or deferred 

arrangement. 

(5) Contributions used only once. Safe 

harbor matching or nonelective 

contributions cannot be used to satisfy 

the requirements of this section with 

respect to more than one plan.

§ 1.401(k)–4 SIMPLE 401(k) plan 

requirements. 

(a) General rule. A cash or deferred 

arrangement satisfies the SIMPLE 401(k) 

plan provision of section 401(k)(11) for 

a plan year if the arrangement satisfies 

the requirements of paragraphs (b) 

through (i) of this section for that year. 

A plan that contains a cash or deferred 

arrangement that satisfies this section is 

referred to as a SIMPLE 401(k) plan. 

Pursuant to section 401(k)(11), a 

SIMPLE 401(k) plan is treated as 

satisfying the ADP test of section 

401(k)(3)(A)(ii) for that year. 

(b) Eligible employer—(1) General 

rule. A SIMPLE 401(k) plan must be 

established by an eligible employer. 

Eligible employer for purposes of this 

section means, with respect to any plan 

year, an employer that had no more than 

100 employees who each received at 

least $5,000 of SIMPLE compensation, 

as defined in paragraph (e)(5) of this 

section, from the employer for the prior 

calendar year. 

(2) Special rule. An eligible employer 

that establishes a SIMPLE 401(k) plan 

for a plan year and that fails to be an 

eligible employer for any subsequent 

plan year, is treated as an eligible 

employer for the 2 plan years following 

the last plan year the employer was an 

eligible employer. If the failure is due to 

any acquisition, disposition, or similar 

transaction involving an eligible 

employer, the preceding sentence 

78182 Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 

applies only if the provisions of section 

410(b)(6)(C)(i) are satisfied. 

(c) Exclusive plan—(1) General rule.

The SIMPLE 401(k) plan must be the 

exclusive plan for each SIMPLE 401(k) 

plan participant for the plan year. This 

requirement is satisfied if there are no 

contributions made, or benefits accrued, 

for services during the plan year on 

behalf of any SIMPLE 401(k) plan 

participant under any other qualified 

plan maintained by the employer. Other 

qualified plan for purposes of this 

section means any plan, contract, 

pension, or trust described in section 

219(g)(5)(A) or (B). 

(2) Special rule. A SIMPLE 401(k) 

plan will not be treated as failing the 

requirements of this paragraph (c) 

merely because any SIMPLE 401(k) plan 

participant receives an allocation of 

forfeitures under another plan of the 

employer. 

(d) Election and notice—(1) General 

rule. An eligible employer establishing 

or maintaining a SIMPLE 401(k) plan 

must satisfy the election and notice 

requirements in paragraphs (d)(2) and 

(3) of this section. 

(2) Employee elections—(i) Initial 

plan year of participation. For the plan 

year in which an employee first 

becomes eligible under the SIMPLE 

401(k) plan, the employee must be 

permitted to make a cash or deferred 

election under the plan during a 60-day 

period that includes either the day the 

employee becomes eligible or the day 

before. 

(ii) Subsequent plan years. For each 

subsequent plan year, each eligible 

employee must be permitted to make or 

modify his cash or deferred election 

during the 60-day period immediately 

preceding such plan year. 

(iii) Election to terminate. An eligible 

employee must be permitted to 

terminate his cash or deferred election 

at any time. If an employee does 

terminate his cash or deferred election, 

the plan is permitted to provide that 

such employee cannot have elective 

contributions made under the plan for 

the remainder of the plan year. 

(3) Employee notices. The employer 

must notify each eligible employee 

within a reasonable time prior to each 

60-day election period, or on the day the 

election period starts, that he or she can 

make a cash or deferred election, or 

modify a prior election, if applicable, 

during that period. The notice must 

state whether the eligible employer will 

make the matching contributions 

described in paragraph (e)(3) of this 

section or the nonelective contributions 

described in paragraph (e)(4) of this 

section. 

(e) Contributions—(1) General rule. A 

SIMPLE 401(k) plan satisfies the 

contribution requirements of this 

paragraph (e) for a plan year only if no 

contributions may be made to the 

SIMPLE 401(k) plan during such year, 

other than contributions described in 

this paragraph (e) and rollover 

contributions described in § 1.402(c)–2, 

Q&A–1(a). 

(2) Elective contributions. Subject to 

the limitations on annual additions 

under section 415, each eligible 

employee must be permitted to make an 

election to have up to $10,000 of 

elective contributions made on the 

employee’s behalf under the SIMPLE 

401(k) plan for a plan year. The $10,000 

limit is increased beginning in 2006 in 

the same manner as the $160,000 

amount is adjusted under section 

415(d), except that pursuant to section 

408(p)(2)(E)(ii) the base period shall be 

the calendar quarter beginning July 1, 

2004 and any increase which is not a 

multiple of $500 is rounded to the next 

lower multiple of $500. 

(3) Matching contributions. Each plan 

year, the eligible employer must 

contribute a matching contribution to 

the account of each eligible employee 

on whose behalf elective contributions 

were made for the plan year. The 

amount of the matching contribution 

must equal the lesser of the eligible 

employee’s elective contributions for 

the plan year or 3% of the eligible 

employee’s SIMPLE compensation for 

the entire plan year. 

(4) Nonelective contributions. For any 

plan year, in lieu of contributing 

matching contributions described in 

paragraph (e)(3) of this section, an 

eligible employer may, in accordance 

with plan terms, contribute a 

nonelective contribution to the account 

of each eligible employee in an amount 

equal to 2% of the eligible employee’s 

SIMPLE compensation for the entire 

plan year. The eligible employer may 

limit the nonelective contributions to 

those eligible employees who received 

at least $5,000 of SIMPLE compensation 

from the employer for the entire plan 

year. 

(5) SIMPLE compensation. Except as 

otherwise provided, the term SIMPLE 

compensation for purposes of this 

section means the sum of wages, tips, 

and other compensation from the 

eligible employer subject to federal 

income tax withholding (as described in 

section 6051(a)(3)) and the employee’s 

elective contributions made under any 

other plan, and if applicable, elective 

deferrals under a section 408(p) SIMPLE 

IRA plan, a section 408(k)(6) SARSEP, 

or a plan or contract that satisfies the 

requirements of section 403(b), and 

compensation deferred under a section 

457 plan, required to be reported by the 

employer on Form W–2 (as described in 

section 6051(a)(8)). For self-employed 

individuals, SIMPLE compensation 

means net earnings from selfemployment determined under section 

1402(a) prior to subtracting any 

contributions made under the SIMPLE 

401(k) plan on behalf of the individual. 

(f) Vesting. All benefits attributable to 

contributions described in paragraph (e) 

of this section must be nonforfeitable at 

all times. 

(g) Plan year. The plan year of a 

SIMPLE 401(k) plan must be the whole 

calendar year. Thus, in general, a 

SIMPLE 401(k) plan can be established 

only on January 1 and can be terminated 

only on December 31. However, in the 

case of an employer that did not 

previously maintain a SIMPLE 401(k) 

plan, the establishment date can be as 

late as October 1 (or later in the case of 

an employer that comes into existence 

after October 1 and establishes the 

SIMPLE 401(k) plan as soon as 

administratively feasible after the 

employer comes into existence). 

(h) Other rules. A SIMPLE 401(k) plan 

is not treated as a top-heavy plan under 

section 416. See section 416(g)(4)(G).

§ 1.401(k)–5 Special rules for mergers, 

acquisitions and similar events. [Reserved]

§ 1.401(k)–6 Definitions. 

Unless otherwise provided, the 

definitions of this section govern for 

purposes of section 401(k) and the 

regulations thereunder. 

Actual contribution percentage (ACP) 

test. Actual contribution percentage test

or ACP test means the test described in 

§ 1.401(m)–2(a)(1). 

Actual deferral percentage (ADP). 

Actual deferral percentage or ADP

means the ADP of the group of eligible 

employees as defined in § 1.401(k)–

2(a)(2). 

Actual deferral percentage (ADP) test. 

Actual deferral percentage test or ADP 

test means the test described in 

§ 1.401(k)–2(a)(1). 

Actual deferral ratio (ADR). Actual 

deferral ratio or ADR means the ADR of 

an eligible employee as defined in 

§ 1.401(k)–2(a)(3). 

Cash or deferred arrangement. Cash 

or deferred arrangement is defined in 

§ 1.401(k)–1(a)(2). 

Cash or deferred election. Cash or 

deferred election is defined in 

§ 1.401(k)–1(a)(3). 

Compensation. Compensation means 

compensation as defined in section 

414(s) and § 1.414(s)–1. The period used 

to determine an employee’s 

compensation for a plan year must be 

Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 78183

either the plan year or the calendar year 

ending within the plan year. Whichever 

period is selected must be applied 

uniformly to determine the 

compensation of every eligible 

employee under the plan for that plan 

year. A plan may, however, limit the 

period taken into account under either 

method to that portion of the plan year 

or calendar year in which the employee 

was an eligible employee, provided that 

this limit is applied uniformly to all 

eligible employees under the plan for 

the plan year. In the case of an HCE 

whose ADR is determined under 

§ 1.401(k)–2(a)(3)(ii), period of 

participation includes periods under 

another plan for which elective 

contributions are aggregated under 

§ 1.401(k)–2(a)(3)(ii). See also section 

401(a)(17) and § 1.401(a)(17)–1(c)(1). 

Current year testing method. Current 

year testing method means the testing 

method described in § 1.401(k)–

2(a)(2)(ii) or 1.401(m)–2(a)(2)(ii) under 

which the applicable year is the current 

plan year. 

Elective contributions. Elective 

contributions means employer 

contributions made to a plan pursuant 

to a cash or deferred election under a 

cash or deferred arrangement (whether 

or not the arrangement is a qualified 

cash or deferred arrangement under 

§ 1.401(k)–1(a)(4)). 

Eligible employee—(1) General rule. 

Eligible employee means an employee 

who is directly or indirectly eligible to 

make a cash or deferred election under 

the plan for all or a portion of the plan 

year. For example, if an employee must 

perform purely ministerial or 

mechanical acts (e.g., formal application 

for participation or consent to payroll 

withholding) in order to be eligible to 

make a cash or deferred election for a 

plan year, the employee is an eligible 

employee for the plan year without 

regard to whether the employee 

performs the acts. 

(2) Conditions on eligibility. An 

employee who is unable to make a cash 

or deferred election because the 

employee has not contributed to another 

plan is also an eligible employee. By 

contrast, if an employee must perform 

additional service (e.g., satisfy a 

minimum period of service 

requirement) in order to be eligible to 

make a cash or deferred election for a 

plan year, the employee is not an 

eligible employee for the plan year 

unless the service is actually performed. 

See § 1.401(k)–1(e)(5), however, for 

certain limits on the use of minimum 

service requirements. An employee who 

would be eligible to make elective 

contributions but for a suspension due 

to a distribution, a loan, or an election 

not to participate in the plan, is treated 

as an eligible employee for purposes of 

section 401(k)(3) for a plan year even 

though the employee may not make a 

cash or deferred election by reason of 

the suspension. Finally, an employee 

does not fail to be treated as an eligible 

employee merely because the employee 

may receive no additional annual 

additions because of section 415(c)(1). 

(3) Certain one-time elections. An 

employee is not an eligible employee 

merely because the employee, no later 

than the employee’s first becoming 

eligible to make a cash or deferred 

election under any plan or arrangement 

of the employer (described in section 

219(g)(5)(A)), is given the one-time 

opportunity to elect, and the employee 

does in fact elect, not to be eligible to 

make a cash or deferred election under 

the plan or any other plan or 

arrangement maintained by the 

employer (including plans not yet 

established) for the duration of the 

employee’s employment with the 

employer. This rule applies in addition 

to the rules in § 1.401(k)–1(a)(3)(v) 

relating to the definition of a cash or 

deferred election. In no event is an 

election made after December 23, 1994, 

treated as a one-time irrevocable 

election under this paragraph if the 

election is made by an employee who 

previously became eligible under 

another plan or arrangement (whether or 

not terminated) of the employer. 

Eligible HCE. Eligible HCE means an 

eligible employee who is an HCE. 

Eligible NHCE. Eligible NHCE means 

an eligible employee who is not an HCE. 

Employee. Employee means an 

employee within the meaning of 

§ 1.410(b)–9. 

Employee stock ownership plan 

(ESOP). Employee stock ownership plan

or ESOP means the portion of a plan 

that is an ESOP within the meaning of 

§ 1.410(b)–7(c)(2). 

Employer. Employer means an 

employer within the meaning of 

§ 1.410(b)–9. 

Excess contributions. Excess 

contributions means, with respect to a 

plan year, the amount of total excess 

contributions apportioned to an HCE 

under § 1.401(k)–2(b)(2)(iii). 

Excess deferrals. Excess deferrals

means excess deferrals as defined in 

§ 1.402(g)–1(e)(3). 

Highly compensated employee (HCE). 

Highly compensated employee or HCE

has the meaning provided in section 

414(q). 

Matching contributions. Matching 

contributions means matching 

contributions as defined in § 1.401(m)–

1(a)(2). 

Nonelective contributions. 

Nonelective contributions means 

employer contributions (other than 

matching contributions) with respect to 

which the employee may not elect to 

have the contributions paid to the 

employee in cash or other benefits 

instead of being contributed to the plan. 

Non-employee stock ownership plan 

(non-ESOP). Non-employee stock 

ownership plan or non-ESOP means the 

portion of a plan that is not an ESOP 

within the meaning of § 1.410(b)–7(c)(2). 

Non-highly compensated employee 

(NHCE). Non-highly compensated 

employee or NHCE means an employee 

who is not an HCE. 

Plan. Plan is defined in § 1.401(k)–

1(b)(4).

Pre-ERISA money purchase pension 

plan. (1) Pre-ERISA money purchase 

pension plan is a pension plan—

(i) That is a defined contribution plan 

(as defined in section 414(i)); 

(ii) That was in existence on June 27, 

1974, and as in effect on that date, 

included a salary reduction agreement; 

and 

(iii) Under which neither the 

employee contributions nor the 

employer contributions, including 

elective contributions, may exceed the 

levels (as a percentage of compensation) 

provided for by the contribution 

formula in effect on June 27, 1974. 

(2) A plan was in existence on June 

27, 1974, if it was a written plan 

adopted on or before that date, even if 

no funds had yet been paid to the trust 

associated with the plan. 

Prior year testing method. Prior year 

testing method means the testing 

method under which the applicable year 

is the prior plan year, as described in 

§ 1.401(k)–2(a)(2)(ii) or 1.401(m)–

2(a)(2)(ii). 

Qualified matching contributions 

(QMACs). Qualified matching 

contributions or QMACs means 

matching contributions that, except as 

provided otherwise in § 1.401(k)–1(c) 

and (d), satisfy the requirements of 

§ 1.401(k)–1(c) and (d) as though the 

contributions were elective 

contributions, without regard to 

whether the contributions are actually 

taken into account under the ADP test 

under § 1.401(k)–2(a)(6) or the ACP test 

under § 1.401(m)–2(a)(6). Thus, the 

matching contributions must satisfy the 

vesting requirements of § 1.401(k)–1(c) 

and be subject to the distribution 

requirements of § 1.401(k)–1(d) when 

they are contributed to the plan. See 

also § 1.401(k)–2(b)(4)(iii) for a rule 

providing that a matching contribution 

does not fail to qualify as a QMAC 

solely because it is forfeitable under 

78184 Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 

section 411(a)(3)(G) as a result of being 

a matching contribution with respect to 

an excess deferral, excess contribution, 

or excess aggregate contribution. 

Qualified nonelective contributions 

(QNECs). Qualified nonelective 

contributions or QNECs means 

employer contributions, other than 

elective contributions or matching 

contributions, that, except as provided 

otherwise in § 1.401(k)–1(c) and (d), 

satisfy the requirements of § 1.401(k)–

1(c) and (d) as though the contributions 

were elective contributions, without 

regard to whether the contributions are 

actually taken into account under the 

ADP test under § 1.401(k)–2(a)(6) or the 

ACP test under § 1.401(m)–2(a)(6). Thus, 

the nonelective contributions must 

satisfy the vesting requirements of 

§ 1.401(k)–1(c) and be subject to the 

distribution requirements of § 1.401(k)–

1(d) when they are contributed to the 

plan. 

Rural cooperative plans. Rural 

cooperative plan means a plan 

described in section 401(k)(7).

■ Par. 5. Sections 1.401(m)–0 through 

1.401(m)–2 are revised and sections 

1.401(m)–3 through 1.401(m)–5 are 

added to read as follows:

§ 1.401(m)–0 Table of contents. 

This section contains first a list of 

section headings and then a list of the 

paragraphs in each section in 

§§ 1.401(m)–1 through 1.401(m)–5.

List of Sections 

§ 1.401(m)–1 Employee contributions and 

matching contributions. 

§ 1.401(m)–2 ACP test. 

§ 1.401(m)–3 Safe harbor requirements. 

§ 1.401(m)–4 Special rules for mergers, 

acquisitions and similar events. [Reserved]. 

§ 1.401(m)–5 Definitions.

List of Paragraphs

§ 1.401(m)–1 Employee contributions and 

matching contributions.

(a) General nondiscrimination rules. 

(1) Nondiscriminatory amount of 

contributions. 

(i) Exclusive means of amounts testing. 

(ii) Testing benefits, rights and features. 

(2) Matching contributions. 

(i) In general. 

(ii) Employer contributions made on 

account of an employee contribution or 

elective deferral. 

(iii) Employer contributions not on account 

of an employee contribution or elective 

deferral. 

(A) General rule. 

(B) Special rule for forfeitures and released 

ESOP shares. 

(C) Exception for bona fide administrative 

considerations. 

(3) Employee contributions. 

(i) In general. 

(ii) Certain contributions not treated as 

employee contributions. 

(iii) Qualified cost-of-living arrangements. 

(b) Nondiscrimination requirements for 

amount of contributions. 

(1) Matching contributions and employee 

contributions. 

(2) Automatic satisfaction by certain plans. 

(3) Anti-abuse provisions. 

(4) Aggregation and restructuring. 

(i) In general. 

(ii) Aggregation of employee contributions 

and matching contributions within a plan. 

(iii) Aggregation of plans. 

(A) In general. 

(B) Arrangements with inconsistent ACP 

testing methods. 

(iv) Disaggregation of plans and separate 

testing. 

(A) In general. 

(B) Restructuring prohibited. 

(v) Certain disaggregation rules not 

applicable. 

(c) Additional requirements. 

(1) Separate testing for employee 

contributions and matching contributions. 

(2) Plan provision requirement. 

(d) Effective date. 

(1) General rule. 

(2) Early implementation permitted. 

(3) Applicability of prior regulations.

§ 1.401(m)–2 ACP test.

(a) Actual contribution percentage (ACP) 

test. 

(1) In general. 

(i) ACP test formula. 

(ii) HCEs as sole eligible employees. 

(iii) Special rule for early participation. 

(2) Determination of ACP. 

(i) General rule. 

(ii) Determination of applicable year under 

current year and prior year testing method. 

(3) Determination of ACR. 

(i) General rule. 

(ii) ACR of HCEs eligible under more than 

one plan. 

(A) General rule. 

(B) Plans not permitted to be aggregated. 

(iii) Example. 

(4) Employee contributions and matching 

contributions taken into account under the 

ACP test. 

(i) Employee contributions. 

(ii) Recharacterized elective contributions. 

(iii) Matching contributions. 

(5) Employee contributions and matching 

contributions not taken into account under 

the ACP test. 

(i) General rule. 

(ii) Disproportionate matching 

contributions. 

(A) Matching contributions in excess of 

100%. 

(B) Representative matching rate. 

(C) Definition of matching rate. 

(iii) Qualified matching contributions used 

to satisfy the ADP test. 

(iv) Matching contributions taken into 

account under safe harbor provisions. 

(v) Treatment of forfeited matching 

contributions. 

(vi) Additional employee contributions or 

matching contributions pursuant to section 

414(u). 

(6) Qualified nonelective contributions and 

elective contributions that may be taken into 

account under the ACP test. 

(i) Timing of allocation. 

(ii) Elective contributions taken into 

account under the ACP test. 

(iii) Requirement that amount satisfy 

section 401(a)(4). 

(iv) Aggregation must be permitted. 

(v) Disproportionate contributions not 

taken into account. 

(A) General rule. 

(B) Definition of representative 

contribution rate. 

(C) Definition of applicable contribution 

rate. 

(D) Special rule for prevailing wage 

contributions. 

(vi) Contribution only used once. 

(7) Examples. 

(b) Correction of excess aggregate 

contributions. 

(1) Permissible correction methods. 

(i) In general. 

(A) Additional contributions. 

(B) Excess aggregate contributions 

distributed or forfeited. 

(ii) Combination of correction methods. 

(iii) Exclusive means of correction. 

(2) Correction through distribution. 

(i) General rule. 

(ii) Calculation of total amount to be 

distributed. 

(A) Calculate the dollar amount of excess 

aggregate contributions for each HCE. 

(B) Determination of the total amount of 

excess aggregate contributions. 

(C) Satisfaction of ACP. 

(iii) Apportionment of total amount of 

excess aggregate contributions among the 

HCEs. 

(A) Calculate the dollar amount of excess 

aggregate contributions for each HCE. 

(B) Limit on amount apportioned to any 

HCE. 

(C) Apportionment to additional HCEs. 

(iv) Income allocable to excess aggregate 

contributions. 

(A) General rule. 

(B) Method of allocating income. 

(C) Alternative method of allocating 

income for the plan year. 

(D) Safe harbor method of allocating gap 

period income. 

(E) Alternative method of allocating plan 

year and gap period income. 

(F) Allocable income for recharacterized 

elective contributions. 

(v) Distribution and forfeiture. 

(vi) Tax treatment of corrective 

distributions. 

(A) General rule. 

(B) Rule for de minimis distributions.

(3) Other rules. 

(i) No employee or spousal consent 

required. 

(ii) Treatment of corrective distributions 

and forfeited contributions as employer 

contributions. 

(iii) No reduction of required minimum 

distribution. 

(iv) Partial correction. 

(v) Matching contributions on excess 

contributions, excess deferrals and excess 

aggregate contributions. 

(A) Corrective distributions not permitted. 

(B) Coordination with section 401(a)(4). 

(vi) No requirement for recalculation. 

(4) Failure to timely correct. 

Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 78185

(i) Failure to correct within 21⁄2 months 

after end of plan year. 

(ii) Failure to correct within 12 months 

after end of plan year. 

(5) Examples. 

(c) Additional rules for prior year testing 

method. 

(1) Rules for change in testing method. 

(2) Calculation of ACP under the prior year 

testing method for the first plan year. 

(i) Plans that are not successor plans. 

(ii) First plan year defined. 

(iii) Plans that are successor plans. 

(3) Plans using different testing methods 

for the ACP and ADP test. 

(4) Rules for plan coverage change. 

(i) In general. 

(ii) Optional rule for minor plan coverage 

changes. 

(iii) Definitions. 

(A) Plan coverage change. 

(B) Prior year subgroup. 

(C) Weighted average of the ACPs for the 

prior year subgroups. 

(iv) Examples.

§ 1.401(m)–3 Safe harbor requirements.

(a) ACP test safe harbor. 

(b) Safe harbor nonelective contribution 

requirement. 

(c) Safe harbor matching contribution 

requirement. 

(d) Limitation on contributions. 

(1) General rule. 

(2) Matching rate must not increase. 

(3) Limit on matching contributions. 

(4) Limitation on rate of match. 

(5) HCEs participating in multiple plans. 

(6) Permissible restrictions on elective 

deferrals by NHCEs. 

(i) General rule. 

(ii) Restrictions on election periods. 

(iii) Restrictions on amount of 

contributions. 

(iv) Restrictions on types of compensation 

that may be deferred. 

(v) Restrictions due to limitations under 

the Internal Revenue Code. 

(e) Notice requirement. 

(f) Plan year requirement. 

(1) General rule. 

(2) Initial plan year. 

(3) Change of plan year. 

(4) Final plan year. 

(g) Plan amendments adopting nonelective 

safe harbor contributions. 

(h) Permissible reduction or suspension of 

safe harbor matching contributions. 

(1) General rule. 

(2) Notice of suspension requirement. 

(i) Reserved. 

(j) Other rules. 

(1) Contributions taken into account. 

(2) Use of safe harbor nonelective 

contributions to satisfy other 

nondiscrimination tests. 

(3) Early participation rules. 

(4) Satisfying safe harbor contribution 

requirement under another defined 

contribution plan. 

(5) Contributions used only once. 

(6) Plan must satisfy ACP with respect to 

employee contributions.

§ 1.401(m)–4 Special rules for mergers, 

acquisitions and similar events. 

[Reserved].

§ 1.401(m)–5 Definitions.

§ 1.401(m)–1 Employee contributions and 

matching contributions. 

(a) General nondiscrimination rules—

(1) Nondiscriminatory amount of 

contributions—(i) Exclusive means of 

amounts testing. A defined contribution 

plan does not satisfy section 401(a) for 

a plan year unless the amount of 

employee contributions and matching 

contributions to the plan for the plan 

year satisfies section 401(a)(4). The 

amount of employee contributions and 

matching contributions under a plan 

satisfies the requirements of section 

401(a)(4) with respect to amounts if and 

only if the amount of employee 

contributions and matching 

contributions satisfies the 

nondiscrimination test of section 401(m) 

under paragraph (b) of this section and 

the plan satisfies the additional 

requirements of paragraph (c) of this 

section. See § 1.401(a)(4)–1(b)(2)(ii)(B). 

(ii) Testing benefits, rights and 

features. A plan that provides for 

employee contributions or matching 

contributions must satisfy the 

requirements of section 401(a)(4) 

relating to benefits, rights and features 

in addition to the requirement regarding 

amounts described in paragraph (a)(1)(i) 

of this section. For example, the right to 

make each level of employee 

contributions and the right to each level 

of matching contributions under the 

plan are benefits, rights or features 

subject to the requirements of section 

401(a)(4). See § 1.401(a)(4)–4(e)(3)(i) and 

(iii)(F) through (G). 

(2) Matching contributions—(i) In 

general. For purposes of section 401(m), 

this section and §§ 1.401(m)–2 through 

1.401(m)–5, matching contributions 

are—

(A) Any employer contribution 

(including a contribution made at the 

employer’s discretion) to a defined 

contribution plan on account of an 

employee contribution to a plan 

maintained by the employer; 

(B) Any employer contribution 

(including a contribution made at the 

employer’s discretion) to a defined 

contribution plan on account of an 

elective deferral; and 

(C) Any forfeiture allocated on the 

basis of employee contributions, 

matching contributions, or elective 

deferrals. 

(ii) Employer contributions made on 

account of an employee contribution or 

elective deferral. Whether an employer 

contribution is made on account of an 

employee contribution or an elective 

deferral is determined on the basis of all 

the relevant facts and circumstances, 

including the relationship between the 

employer contribution and employee 

actions outside the plan. An employer 

contribution made to a defined 

contribution plan on account of 

contributions made by an employee 

under an employer-sponsored savings 

arrangement that are not held in a plan 

that is intended to be a qualified plan 

or other arrangement described in 

§ 1.402(g)–1(b) is not a matching 

contribution. 

(iii) Employer contributions not on 

account of an employee contribution or 

elective deferral—(A) General rule.

Employer contributions are not 

matching contributions made on 

account of elective deferrals if they are 

contributed before the cash or deferred 

election is made or before the 

employees’ performance of services 

with respect to which the elective 

deferrals are made (or when the cash 

that is subject to the cash or deferred 

elections would be currently available, 

if earlier). In addition, an employer 

contribution is not a matching 

contribution made on account of an 

employee contribution if it is 

contributed before the employee 

contribution. 

(B) Exceptions for forfeitures and 

released ESOP shares. The rule of 

paragraph (a)(3)(iii)(A) of this section 

does not apply to a forfeiture that is 

allocated as a matching contribution. In 

addition, an allocation of shares from an 

ESOP loan suspense account described 

in § 54.4975–11(c) and (d) of this 

chapter will not fail to be treated as a 

matching contribution solely because 

the employer contribution that resulted 

in the release and allocation of those 

shares from the suspense account is 

made before the employees’

performance of services with respect to 

which the elective deferrals are made 

(or when the cash that is subject to the 

cash or deferred elections would be 

currently available, if earlier) provided 

that—

(1) The contribution is for a required 

payment that is due under the loan 

terms; and 

(2) The contribution is not made early 

with a principal purpose of accelerating 

deductions. 

(C) Exception for bona fide 

administrative considerations. The 

timing of contributions will not be 

treated as failing to satisfy the 

requirements of this paragraph (a)(3)(iii) 

merely because contributions are 

occasionally made before the 

employees’ performance of services 

with respect to which the elective 

78186 Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 

deferrals are made (or when the cash 

that is subject to the cash or deferred 

elections would be currently available, 

if earlier) in order to accommodate bona 

fide administrative considerations and 

are not paid early with a principal 

purpose of accelerating deductions. 

(3) Employee contributions—(i) In 

general. For purposes of section 401(m), 

this section and §§ 1.401(m)–2 through 

1.401(m)–5, employee contributions are 

contributions to a plan that are 

designated or treated at the time of 

contribution as after-tax employee 

contributions (e.g., by treating the 

contributions as taxable income subject 

to applicable withholding requirements) 

and are allocated to an individual 

account for each eligible employee to 

which attributable earnings and losses 

are allocated. See § 1.401(k)–1(a)(2)(ii). 

The term employee contributions 

includes—

(A) Employee contributions to the 

defined contribution portion of a plan 

described in section 414(k); 

(B) Employee contributions applied to 

the purchase of whole life insurance 

protection or survivor benefit protection 

under a defined contribution plan; 

(C) Amounts attributable to excess 

contributions within the meaning of 

section 401(k)(8)(B) that are 

recharacterized as employee 

contributions under § 1.401(k)–2(b)(3); 

and 

(D) Employee contributions to a plan 

or contract that satisfies the 

requirements of section 403(b). 

(ii) Certain contributions not treated 

as employee contributions. The term 

employee contributions does not 

include designated Roth contributions, 

repayment of loans, rollover 

contributions, repayment of 

distributions described in section 

411(a)(7)(C), or employee contributions 

that are transferred to the plan from 

another plan. 

(iii) Qualified cost-of-living 

arrangements. Employee contributions 

to a qualified cost-of-living arrangement 

described in section 415(k)(2)(B) are 

treated as employee contributions to a 

defined contribution plan, without 

regard to the requirement that the 

employee contributions be allocated to 

an individual account to which 

attributable earnings and losses are 

allocated. 

(b) Nondiscrimination requirements 

for amount of contributions—(1) 

Matching contributions and employee 

contributions. The matching 

contributions and employee 

contributions under a plan satisfy this 

paragraph (b) for a plan year only if the 

plan satisfies—

(i)The ACP test of section 401(m)(2) 

described in § 1.401(m)–2; 

(ii) The ACP safe harbor provisions of 

section 401(m)(11) described in 

§ 1.401(m)–3; or 

(iii) The SIMPLE 401(k) provisions of 

sections 401(k)(11) and 401(m)(10) 

described in § 1.401(k)–4. 

(2) Automatic satisfaction by certain 

plans. Notwithstanding paragraph (b)(1) 

of this section, the requirements of this 

section are treated as satisfied with 

respect to employee contributions and 

matching contributions under a 

collectively bargained plan (or the 

portion of a plan) that automatically 

satisfies section 410(b). See 

§§ 1.401(a)(4)–1(c)(5) and 1.410(b)–

2(b)(7). Additionally, the requirements 

of sections 401(a)(4) and 410(b) do not 

apply to a governmental plan (within 

the meaning of section 414(d)) 

maintained by a State or local 

government or political subdivision 

thereof (or agency or instrumentality 

thereof) and, accordingly such plans are 

not required to comply with this 

section. See sections 401(a)(5)(G), 

403(b)(12)(C) and 410(c)(1)(A). 

(3) Anti-abuse provisions. Sections 

1.401(m)–1 through 1.401(m)–5 are 

designed to provide simple, practical 

rules that accommodate legitimate plan 

changes. At the same time, the rules are 

intended to be applied by employers in 

a manner that does not make use of 

changes in plan testing procedures or 

other plan provisions to inflate 

inappropriately the ACP for NHCEs 

(which is used as a benchmark for 

testing the ACP for HCEs) or to 

otherwise manipulate the 

nondiscrimination testing requirements 

of this paragraph (b). Further, this 

paragraph (b) is part of the overall 

requirement that benefits or 

contributions not discriminate in favor 

of HCEs. Therefore, a plan will not be 

treated as satisfying the requirements of 

this paragraph (b) if there are repeated 

changes to plan testing procedures or 

plan provisions that have the effect of 

distorting the ACP so as to increase 

significantly the permitted ACP for 

HCEs, or otherwise manipulate the 

nondiscrimination rules of this 

paragraph, if a principal purpose of the 

changes was to achieve such a result. 

(4) Aggregation and restructuring—(i) 

In general. This paragraph (b)(4) 

contains the exclusive rules for 

aggregating and disaggregating plans 

that provide for employee contributions 

and matching contributions for 

purposes of this section and 

§§ 1.401(m)–2 through 1.401(m)–5. 

(ii) Aggregation of employee 

contributions and matching 

contributions within a plan. Except as 

otherwise specifically provided in this 

paragraph (b)(4) and § 1.401(m)–3(j)(6), 

a plan must be subject to a single test 

under paragraph (b)(1) of this section 

with respect to all employee 

contributions and matching 

contributions and all eligible employees 

under the plan. Thus, for example, if 

two groups of employees are eligible for 

matching contributions under a plan, all 

employee contributions and matching 

contributions under the plan must be 

subject to a single test, even if they have 

significantly different features, such as 

different rates of match. 

(iii) Aggregation of plans—(A) In 

general. The term plan means a plan 

within the meaning of § 1.410(b)–7(a) 

and (b), after application of the 

mandatory disaggregation rules of 

§ 1.410(b)–7(c), and the permissive 

aggregation rules of § 1.410(b)–7(d), as 

modified by paragraph (b)(4)(v) of this 

section. Thus, for example, two plans 

(within the meaning of § 1.410(b)–7(b)) 

that are treated as a single plan pursuant 

to the permissive aggregation rules of 

§ 1.410(b)–7(d) are treated as a single 

plan for purposes of sections 401(k) and 

401(m). 

(B) Arrangements with inconsistent 

ACP testing methods. Pursuant to 

paragraph (b)(4)(ii) of this section, a 

single testing method must apply with 

respect to all employee contributions 

and matching contributions and all 

eligible employees under a plan. Thus, 

in applying the permissive aggregation 

rules of § 1.410(b)–7(d), an employer 

may not aggregate plans (within the 

meaning of § 1.410(b)–7(b)) that apply 

inconsistent testing methods. For 

example, a plan (within the meaning of 

§ 1.410(b)–7) that applies the current 

year testing method may not be 

aggregated with another plan that 

applies the prior year testing method. 

Similarly, an employer may not 

aggregate a plan (within the meaning of 

§ 1.410(b)–7) that is using the ACP safe 

harbor provisions of section 401(m)(11) 

and another plan that is using the ACP 

test of section 401(m)(2). 

(iv) Disaggregation of plans and 

separate testing—(A) In general. If 

employee contributions or matching 

contributions are included in a plan 

(within the meaning of § 1.410(b)–7(b)) 

that is mandatorily disaggregated under 

the rules of section 410(b) (as modified 

by this paragraph (b)(4)), the matching 

contributions and employee 

contributions under that plan must be 

disaggregated in a consistent manner. 

For example, in the case of an employer 

that is treated as operating qualified 

separate lines of business under section 

414(r), if the eligible employees under a 

plan which provides for employee 

Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 78187

contributions or matching contributions 

are in more than one qualified separate 

line of business, only those employees 

within each qualified separate line of 

business may be taken into account in 

determining whether each disaggregated 

portion of the plan complies with the 

requirements of section 401(m), unless 

the employer is applying the special 

rule for employer-wide plans in 

§ 1.414(r)–1(c)(2)(ii) with respect to the 

plan. Similarly, if a plan that provides 

for employee contributions or matching 

contributions under which employees 

are permitted to participate before they 

have completed the minimum age and 

service requirements of section 410(a)(1) 

applies section 410(b)(4)(B) for 

determining whether the plan complies 

with section 410(b)(1), then the plan 

must be treated as two separate plans, 

one comprising all eligible employees 

who have met the minimum age and 

service requirements of section 410(a)(1) 

and one comprising all eligible 

employees who have not met the 

minimum age and service requirements 

of section 410(a)(1), unless the plan is 

using the rule in § 1.401(m)–

2(a)(1)(iii)(A). 

(B) Restructuring prohibited.

Restructuring under § 1.401(a)(4)–9(c) 

may not be used to demonstrate 

compliance with the requirements of 

section 401(m). See § 1.401(a)(4)–

9(c)(3)(ii). 

(v) Certain disaggregation rules not 

applicable. The mandatory 

disaggregation rules relating to section 

401(k) plans and section 401(m) plans 

set forth in § 1.410(b)–7(c)(1) and to 

ESOP and non-ESOP portions of a plan 

set forth in § 1.410(b)–7(c)(2) shall not 

apply for purposes of this section and 

§§ 1.401(m)–2 through 1.401(m)–5. 

Accordingly, notwithstanding 

§ 1.410(b)–7(d)(2), an ESOP and a nonESOP which are different plans (within 

the meaning of section 414(l), as 

described in § 1.410(b)–7(b)) are 

permitted to be aggregated for these 

purposes.

(c) Additional requirements—(1) 

Separate testing for employee 

contributions and matching 

contributions. Under § 1.410(b)–7(c)(1), 

the group of employees who are eligible 

to make employee contributions or 

eligible to receive matching 

contributions must satisfy the 

requirements of section 410(b) as if 

those employees were covered under a 

separate plan. The determination of 

whether the separate plan satisfies the 

requirements of section 410(b) must be 

made without regard to the 

modifications to the disaggregation rules 

set forth in paragraph (b)(4)(v) of this 

section. In addition, except as expressly 

permitted under section 401(k), 

410(b)(2)(A)(ii), or 416(c)(2)(A), 

employee contributions, matching 

contributions and elective contributions 

taken into account under § 1.401(m)–

2(a)(6) may not be taken into account for 

purposes of determining whether any 

other contributions under any plan 

(including the plan to which the 

employee contributions or matching 

contributions are made) satisfy the 

requirements of section 401(a). See also 

§ 1.401(a)(4)–11(g)(3)(vii) for special 

rules relating to corrections of violations 

of the minimum coverage requirements 

or discriminatory rates of matching 

contributions. 

(2) Plan provision requirement. A 

plan that provides for employee 

contributions or matching contributions 

satisfies this section only if it provides 

that the nondiscrimination requirements 

of section 401(m) will be met. Thus, the 

plan must provide for satisfaction of one 

of the specific alternatives described in 

paragraph (b)(1) of this section and, if 

with respect to that alternative there are 

optional choices, which of the optional 

choices will apply. For example, a plan 

that uses the ACP test of section 

401(m)(2), as described in paragraph 

(b)(1)(i) of this section, must specify 

whether it is using the current year 

testing method or prior year testing 

method. Additionally, a plan that uses 

the prior year testing method must 

specify whether the ACP for eligible 

NHCEs for the first plan year is 3% or 

the ACP for the eligible NHCEs for the 

first plan year. Similarly, a plan that 

uses the safe harbor method of section 

401(m)(11), as described in paragraph 

(b)(1)(ii) of this section, must specify 

whether the safe harbor contribution 

will be the nonelective safe harbor 

contribution or the matching safe harbor 

contribution and is not permitted to 

provide that ACP testing will be used if 

the requirements for the safe harbor are 

not satisfied. For purposes of this 

paragraph (c)(2), a plan may incorporate 

by reference the provisions of section 

401(m)(2) and § 1.401(m)–2 if that is the 

nondiscrimination test being applied. 

The Commissioner may, in guidance of 

general applicability, published in the 

Internal Revenue Bulletin (see 

§ 601.601(d)(2) of this chapter), specify 

the options that will apply under the 

plan if the nondiscrimination test is 

incorporated by reference in accordance 

with the preceding sentence. 

(d) Effective date—(1) General rule.

Except as otherwise provided in this 

paragraph (d), this section and 

§§ 1.401(m)–2 through 1.401(m)–5 apply 

to plan years that begin on or after 

January 1, 2006. 

(2) Early implementation permitted. A 

plan is permitted to apply the rules of 

this section and §§ 1.401(m)–2 through 

1.401(m)–5 to any plan year that ends 

after December 29, 2004, provided the 

plan applies all the rules of this section 

and §§ 1.401(m)–2 through 1.401(m)–5 

and all the rules of §§ 1.401(k)–1 

through 1.401(k)–6, to the extent 

applicable, for that plan year and all 

subsequent plan years. 

(3) Applicability of prior regulations.

For any plan year, before a plan applies 

this section and §§ 1.401(m)–2 through 

1.401(m)–5 (either the first plan year 

beginning on or after January 1, 2006 or 

such earlier year, as provided in 

paragraph (d)(2) of this section), 

§ 1.401(m)–1 and § 1.401(m)–2 (as they 

appeared in the April 1, 2004 edition of 

26 CFR part 1) apply to the plan to the 

extent those sections, as they so appear, 

reflect the statutory provisions of 

section 401(m) as in effect for the 

relevant year.

§ 1.401(m)–2 ACP test. 

(a) Actual contribution percentage 

(ACP) test—(1) In general—(i) ACP test 

formula. A plan satisfies the ACP test 

for a plan year only if—

(A) The ACP for the eligible HCEs for 

the plan year is not more than the ACP 

for the eligible NHCEs for the applicable 

year multiplied by 1.25; or 

(B) The excess of the ACP for the 

eligible HCEs for the plan year over the 

ACP for the eligible NHCEs for the 

applicable year is not more than 2 

percentage points, and the ACP for the 

eligible HCEs for the plan year is not 

more than the ACP for the eligible 

NHCEs for the applicable year 

multiplied by 2. 

(ii) HCEs as sole eligible employees. If, 

for the applicable year there are no 

eligible NHCEs (i.e., all of the eligible 

employees under the plan for the 

applicable year are HCEs), the plan is 

deemed to satisfy the ACP test. 

(iii) Special rule for early 

participation. If a plan providing for 

employee contributions or matching 

contributions provides that employees 

are eligible to participate before they 

have completed the minimum age and 

service requirements of section 

410(a)(1)(A), and if the plan applies 

section 410(b)(4)(B) in determining 

whether the plan meets the 

requirements of section 410(b)(1), then 

in determining whether the plan meets 

the requirements under paragraph (a)(1) 

of this section either—

(A) Pursuant to section 401(m)(5)(C), 

the ACP test is performed under the 

plan (determined without regard to 

disaggregation under § 1.410(b)–7(c)(3)), 

using the ACP for all eligible HCEs for 

78188 Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 

the plan year and the ACP of eligible 

NHCEs for the applicable year, 

disregarding all NHCEs who have not 

met the minimum age and service 

requirements of section 410(a)(1)(A); or

(B) Pursuant to § 1.401(m)–1(b)(4), the 

plan is disaggregated into separate plans 

and the ACP test is performed 

separately for all eligible employees 

who have completed the minimum age 

and service requirements of section 

410(a)(1)(A) and for all eligible 

employees who have not completed the 

minimum age and service requirements 

of section 410(a)(1)(A). 

(2) Determination of ACP—(i) General 

rule. The ACP for a group of eligible 

employees (either eligible HCEs or 

eligible NHCEs) for a plan year or 

applicable year is the average of the 

ACRs of eligible employees in the group 

for that year. The ACP for a group of 

eligible employees is calculated to the 

nearest hundredth of a percentage point. 

(ii) Determination of applicable year 

under current year and prior year 

testing method. The ACP test is applied 

using the prior year testing method or 

the current year testing method. Under 

the prior year testing method, the 

applicable year for determining the ACP 

for the eligible NHCEs is the plan year 

immediately preceding the plan year for 

which the ACP test is being calculated. 

Under the prior year testing method, the 

ACP for the eligible NHCEs is 

determined using the ACRs for the 

eligible employees who were NHCEs in 

that preceding plan year, regardless of 

whether those NHCEs are eligible 

employees or NHCEs in the plan year 

for which the ACP test is being 

performed. Under the current year 

testing method, the applicable year for 

determining the ACP for eligible NHCEs 

is the same plan year as the plan year 

for which the ACP test is being 

calculated. Under either method, the 

ACP for the eligible HCEs is determined 

using the ACRs of eligible employees 

who are HCEs for the plan year for 

which the ACP test is being performed. 

See paragraph (c) of this section for 

additional rules for the prior year testing 

method. 

(3) Determination of ACR—(i) General 

rule. The ACR of an eligible employee 

for the plan year or applicable year is 

the sum of the employee contributions 

and matching contributions taken into 

account with respect to such employee 

(determined under the rules of 

paragraphs (a)(4) and (5) of this section), 

and the qualified nonelective and 

elective contributions taken into 

account under paragraph (a)(6) of this 

section for the year, divided by the 

employee’s compensation taken into 

account for the year. The ACR is 

calculated to the nearest hundredth of a 

percentage point. If no employee 

contributions, matching contributions, 

elective contributions, or qualified 

nonelective contributions are taken into 

account under this section with respect 

to an eligible employee for the year, the 

ACR of the employee is zero. 

(ii) ACR of HCEs eligible under more 

than one plan—(A) General rule.

Pursuant to section 401(m)(2)(B), the 

ACR of an HCE who is an eligible 

employee in more than one plan of an 

employer to which matching 

contributions or employee contributions 

are made is calculated by treating all 

contributions with respect to such HCE 

under any such plan as being made 

under the plan being tested. Thus, the 

ACR for such an HCE is calculated by 

accumulating all matching contributions 

and employee contributions under any 

plan (other than a plan described in 

paragraph (a)(3)(ii)(B) of this section) 

that would be taken into account under 

this section for the plan year, if the plan 

under which the contribution was made 

applied this section and had the same 

plan year. For example, in the case of 

a plan with a 12-month plan year, the 

ACR for the plan year of that plan for 

an HCE who participates in multiple 

plans of the same employer that provide 

for matching contributions or employee 

contributions is the sum of all such 

contributions during such 12-month 

period that would be taken into account 

with respect to the HCE under all plans 

in which the HCE is an eligible 

employee, divided by the HCE’s 

compensation for that 12-month period 

(determined using the compensation 

definition for the plan being tested), 

without regard to the plan year of the 

other plans and whether those plans are 

satisfying this section or § 1.401(m)–3. 

(B) Plans not permitted to be 

aggregated. Contributions under plans 

that are not permitted to be aggregated 

under § 1.401(m)–1(b)(4) (determined 

without regard to the prohibition on 

aggregating plans with inconsistent 

testing methods set forth in § 1.401(m)–

1(b)(4)(iii)(B) and the prohibition on 

aggregating plans with different plan 

years set forth in § 1.410(b)–7(d)(5)) are 

not aggregated under this paragraph 

(a)(3)(ii). 

(iii) Example. The following example 

illustrates the application of paragraph 

(a)(3)(ii) of this section. See also 

§ 1.401(k)–2(a)(3)(iii) for additional 

examples of the application of the 

parallel rule under section 401(k)(3)(A). 

The example is as follows:

Example. Employee A, an HCE with 

compensation of $120,000, is eligible to make 

employee contributions under Plan S and 

Plan T, two calendar-year profit-sharing 

plans of Employer H. Plan S and Plan T use 

the same definition of compensation. Plan S 

provides a match equal to 50% of each 

employee’s contributions and Plan T has no 

match. During the current plan year, 

Employee A elects to contribute $4,000 in 

employee contributions to Plan T and $4,000 

in employee contributions to Plan S. There 

are no other contributions made on behalf of 

Employee A. Each plan must calculate 

Employee A’s ACR by dividing the total 

employee contributions by Employee A and 

matching contributions under both plans by 

$120,000. Therefore, Employee A’s ACR 

under each plan is 8.33% ($4,000 + $4,000 

+ $2,000/$120,000).

(4) Employee contributions and 

matching contributions taken into 

account under the ACP test—(i) 

Employee contributions. An employee 

contribution is taken into account in 

determining the ACR for an eligible 

employee for the plan year or applicable 

year in which the contribution is made. 

For purposes of the preceding sentence, 

an amount withheld from an employee’s 

pay (or a payment by the employee to 

an agent of the plan) is treated as 

contributed at the time of such 

withholding (or payment) if the funds 

paid are transmitted to the trust within 

a reasonable period after the 

withholding (or payment). 

(ii) Recharacterized elective 

contributions. Excess contributions 

recharacterized in accordance with 

§ 1.401(k)–2(b)(3) are taken into account 

as employee contributions for the plan 

year that includes the time at which the 

excess contribution is includible in the 

gross income of the employee under 

§ 1.401(k)–2(b)(3)(ii). 

(iii) Matching contributions. A 

matching contribution is taken into 

account in determining the ACR for an 

eligible employee for a plan year or 

applicable year only if each of the 

following requirements is satisfied—

(A) The matching contribution is 

allocated to the employee’s account 

under the terms of the plan as of a date 

within that year; 

(B) The matching contribution is 

made on account of (or the matching 

contribution is allocated on the basis of) 

the employee’s elective deferrals or 

employee contributions for that year; 

and 

(C) The matching contribution is 

actually paid to the trust no later than 

the end of the 12-month period 

immediately following the year that 

contains that date. 

(5) Employee contributions and 

matching contributions not taken into 

account under the ACP test—(i) General 

rule. Matching contributions that do not 

satisfy the requirements of paragraph 

(a)(4)(iii) of this section may not be 

taken into account in the ACP test for 

Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 78189

the plan year with respect to which the 

contributions were made, or for any 

other plan year. Instead, the amount of 

the matching contributions must satisfy 

the requirements of section 401(a)(4) 

(without regard to the ACP test) for the 

plan year for which they are allocated 

under the plan as if they were 

nonelective contributions and were the 

only nonelective contributions for that 

year. See §§ 1.401(a)(4)–1(b)(2)(ii)(B) 

and 1.410(b)–7(c)(1). 

(ii) Disproportionate matching 

contributions—(A) Matching 

contributions in excess of 100%. A 

matching contribution with respect to 

an elective deferral for an NHCE is not 

taken into account under the ACP test 

to the extent it exceeds the greatest of: 

(1) 5% of compensation; 

(2) the employee’s elective deferrals 

for a year; and 

(3) the product of 2 times the plan’s 

representative matching rate and the 

employee’s elective deferrals for a year. 

(B) Representative matching rate. For 

purposes of this paragraph (a)(5)(ii), the 

plan’s representative matching rate is 

the lowest matching rate for any eligible 

NHCE among a group of NHCEs that 

consists of half of all eligible NHCEs in 

the plan for the plan year who make 

elective deferrals for the plan year (or, 

if greater, the lowest matching rate for 

all eligible NHCEs in the plan who are 

employed by the employer on the last 

day of the plan year and who make 

elective deferrals for the plan year). 

(C) Definition of matching rate. For 

purposes of this paragraph (a)(5)(ii), the 

matching rate for an employee generally 

is the matching contributions made for 

such employee divided by the 

employee’s elective deferrals for the 

year. If the matching rate is not the same 

for all levels of elective deferrals for an 

employee, the employee’s matching rate 

is determined assuming that an 

employee’s elective deferrals are equal 

to 6 percent of compensation.

(D) Application to matching 

contributions that match employee 

contributions. If a plan provides a match 

with respect to the sum of the 

employee’s employee contributions and 

elective deferrals, that sum is 

substituted for the amount of the 

employee’s elective deferrals in 

paragraphs (a)(5)(ii) (A) and (C) of this 

section and employees who make either 

employee contributions or elective 

deferrals are taken into account under 

paragraph (a)(5)(ii)(B) of this section. 

Similarly, if a plan provides a match 

with respect to the employee’s 

employee contributions, but not elective 

deferrals, the employee’s employee 

contributions are substituted for the 

amount of the employee’s elective 

deferrals in paragraphs (a)(5)(ii) (A) and 

(C) of this section and employees who 

make employee contributions are taken 

into account under paragraph 

(a)(5)(ii)(B) of this section. 

(iii) Qualified matching contributions 

used to satisfy the ADP test. Qualified 

matching contributions that are taken 

into account for the ADP test of section 

401(k)(3) under § 1.401(k)–2(a)(6) are 

not taken into account in determining 

an eligible employee’s ACR. 

(iv) Matching contributions taken into 

account under safe harbor provisions. A 

plan that satisfies the ACP safe harbor 

requirements of section 401(m)(11) for a 

plan year but nonetheless must satisfy 

the requirements of this section because 

it provides for employee contributions 

for such plan year is permitted to apply 

this section disregarding all matching 

contributions with respect to all eligible 

employees. In addition, a plan that 

satisfies the ADP safe harbor 

requirements of § 1.401(k)–3 for a plan 

year using qualified matching 

contributions but does not satisfy the 

ACP safe harbor requirements of section 

401(m)(11) for such plan year is 

permitted to apply this section by 

excluding matching contributions with 

respect to all eligible employees that do 

not exceed 4% of each employee’s 

compensation. If a plan disregards 

matching contributions pursuant to this 

paragraph (a)(5)(iv), the disregard must 

apply with respect to all eligible 

employees. 

(v) Treatment of forfeited matching 

contributions. A matching contribution 

that is forfeited because the contribution 

to which it relates is treated as an excess 

contribution, excess deferral, or excess 

aggregate contribution is not taken into 

account for purposes of this section. 

(vi) Additional employee 

contributions or matching contributions 

pursuant to section 414(u). Additional 

employee contributions and matching 

contributions made by reason of an 

eligible employee’s qualified military 

service under section 414(u) are not 

taken into account under paragraph 

(a)(4) of this section for the plan year for 

which the contributions are made, or for 

any other plan year. 

(6) Qualified nonelective 

contributions and elective contributions 

that may be taken into account under 

the ACP test. Qualified nonelective 

contributions and elective contributions 

may be taken into account in 

determining the ACR for an eligible 

employee for a plan year or applicable 

year, but only to the extent the 

contributions satisfy the following 

requirements—

(i) Timing of allocation. The qualified 

nonelective contribution is allocated to 

the employee’s account as of a date 

within that year (within the meaning of 

§ 1.401(k)–2(a)(4)(i)(A)) and the elective 

contribution satisfies § 1.401(k)–

2(a)(4)(i). Consequently, under the prior 

year testing method, in order to be taken 

into account in calculating the ACP for 

the group of eligible NHCEs for the 

applicable year, a qualified nonelective 

contribution must be contributed no 

later than the end of the 12-month 

period following the applicable year 

even though the applicable year is 

different than the plan year being tested. 

(ii) Elective contributions taken into 

account under the ACP test. Elective 

contributions may be taken into account 

for the ACP test only if the cash or 

deferred arrangement under which the 

elective contributions are made is 

required to satisfy the ADP test in 

§ 1.401(k)–2(a)(1) and, then only to the 

extent that the cash or deferred 

arrangement would satisfy that test, 

including such elective contributions in 

the ADP for the plan year or applicable 

year. Thus, for example, elective 

deferrals made pursuant to a salary 

reduction agreement under an annuity 

described in section 403(b) are not 

permitted to be taken into account in an 

ACP test. Similarly, elective 

contributions under a cash or deferred 

arrangement that is using the section 

401(k) safe harbor described in 

§ 1.401(k)–3 cannot be taken into 

account in an ACP test. 

(iii) Requirement that amount satisfy 

section 401(a)(4). The amount of 

nonelective contributions, including 

those qualified nonelective 

contributions taken into account under 

this paragraph (a)(6) and those qualified 

nonelective contributions taken into 

account for the ADP test under 

paragraph § 1.401(k)–2(a)(6), and the 

amount of nonelective contributions, 

excluding those qualified nonelective 

contributions taken into account under 

this paragraph (a)(6) for the ACP test 

and those qualified nonelective 

contributions taken into account for the 

ADP test under paragraph § 1.401(k)–

2(a)(6), satisfies the requirements of 

section 401(a)(4). See § 1.401(a)(4)–

1(b)(2). In the case of an employer that 

is applying the special rule for 

employer-wide plans in § 1.414(r)–

1(c)(2)(ii) with respect to the plan, the 

determination of whether the qualified 

nonelective contributions satisfy the 

requirements of this paragraph (a)(6)(iii) 

must be made on an employer-wide 

basis regardless of whether the plans to 

which the qualified nonelective 

contributions are made are satisfying the 

requirements of section 410(b) on an 

employer-wide basis. Conversely, in the 

case of an employer that is treated as 

78190 Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 

operating qualified separate lines of 

business, and does not apply the special 

rule for employer-wide plans in 

§ 1.414(r)–1(c)(2)(ii) with respect to the 

plan, then the determination of whether 

the qualifiednonelective contributions 

satisfy the requirements of this 

paragraph (a)(6)(iii) is not permitted to 

be made on an employer-wide basis 

regardless of whether the plans to which 

the qualified nonelective contributions 

are made are satisfying the requirements 

of section 410(b) on that basis. 

(iv) Aggregation must be permitted.

The plan that provides for employee or 

matching contributions and the plan or 

plans to which the qualified nonelective 

contributions or elective contributions 

are made are plans that would be 

permitted to be aggregated under 

§ 1.401(m)–1(b)(4). If the plan year of 

the plan that provides for employee or 

matching contributions is changed to 

satisfy the requirement under 

§ 1.410(b)–7(d)(5) that aggregated plans 

have the same plan year, qualified 

nonelective contributions and elective 

contributions may be taken into account 

in the resulting short plan year only if 

such qualified nonelective and elective 

contributions could have been taken 

into account under an ADP test for a 

plan with that same short plan year. 

(v) Disproportionate contributions not 

taken into account—(A) General rule.

Qualified nonelective contributions 

cannot be taken into account for an 

applicable year for an NHCE to the 

extent such contributions exceed the 

product of that NHCE’s compensation 

and the greater of 5% and 2 times the 

plan’s representative contribution rate. 

Any qualified nonelective contribution 

taken into account in an ADP test under 

§ 1.401(k)–2(a)(6) (including the 

determination of the representative 

contribution rate for purposes of 

§ 1.401(k)–2(a)(6)(iv)(B)) is not 

permitted to be taken into account for 

purposes of this paragraph (a)(6) 

(including the determination of the 

representative contribution rate for 

purposes of paragraph (a)(6)(v)(B) of this 

section). 

(B) Definition of representative 

contribution rate. For purposes of this 

paragraph (a)(6)(v), the plan’s 

representative contribution rate is the 

lowest applicable contribution rate of 

any eligible NHCE among a group of 

eligible NHCEs that consists of half of 

all eligible NHCEs for the plan year (or, 

if greater, the lowest applicable 

contribution rate of any eligible NHCE 

in the group of all eligible NHCEs for 

the applicable year and who is 

employed by the employer on the last 

day of the applicable year). 

(C) Definition of applicable 

contribution rate. For purposes of this 

paragraph (a)(6)(v), the applicable 

contribution rate for an eligible NHCE is 

the sum of the matching contributions 

taken into account under this section for 

the employee for the plan year and the 

qualified nonelective contributions 

made for that employee for the plan 

year, divided by that employee’s 

compensation for the same period. 

(D) Special rule for prevailing wage 

contributions. Notwithstanding 

paragraph (a)(6)(v)(A) of this section, 

qualified nonelective contributions that 

are made in connection with an 

employer’s obligation to pay prevailing 

wages under the Davis-Bacon Act (46 

Stat. 1494), Pub. L. 71–798, Service 

Contract Act of 1965 (79 Stat. 1965), 

Pub. L. 89–286, or similar legislation 

can be taken into account for a plan year 

for an NHCE to the extent such 

contributions do not exceed 10 percent 

of that NHCE’s compensation.

(vi) Contribution only used once.

Qualified nonelective contributions 

cannot be taken into account under this 

paragraph (a)(6) to the extent such 

contributions are taken into account for 

purposes of satisfying any other ACP 

test, any ADP test, or the requirements 

of § 1.401(k)–3, 1.401(m)–3 or 1.401(k)–

4. Thus, for example, qualified 

nonelective contributions that are made 

pursuant to § 1.401(k)–3(b) cannot be 

taken into account under the ACP test. 

Similarly, if a plan switches from the 

current year testing method to the prior 

year testing method pursuant to 

§ 1.401(m)–2(c)(1), qualified nonelective 

contributions that are taken into account 

under the current year testing method 

for a plan year may not be taken into 

account under the prior year testing 

method for the next plan year. 

(7) Examples. The following examples 

illustrate the application of this 

paragraph (a). See § 1.401(k)–2(a)(6) for 

additional examples of the parallel rules 

under section 401(k)(3)(A). The 

examples are as follows:

Example 1. (i) Employer L maintains Plan 

U, a profit-sharing plan under which $.50 

matching contributions are made for each 

dollar of employee contributions. Plan U uses 

the current year testing method. The chart 

below shows the average employee 

contributions (as a percentage of 

compensation) and matching contributions 

(as a percentage of compensation) for Plan 

U’s HCEs and NHCEs for the 2006 plan year:

Employee contributions

(percentage) 

Matching contributions

(percentage) 

Actual contribution

(percentage) 

Highly compensated employees ...................................................................... 4 2 6 

Nonhighly compensated employees ................................................................ 3 1.5 4.5 

(ii) The matching rate for all NHCEs is 50% 

and thus the matching contributions are not 

disproportionate under paragraph (a)(5)(ii) of 

this section. Accordingly, they are taken into 

account in determining the ACR of eligible 

employees. 

(iii) Because the ACP for the HCEs (6.0%) 

exceeds 5.63% (4.5% x 1.25), Plan U does 

not satisfy the ACP test under paragraph 

(a)(1)(i)(A) of this section. However, because 

the ACP for the HCEs does not exceed the 

ACP for the NHCEs by more than 2 

percentage points and the ACP for the HCEs 

does not exceed the ACP for the NHCEs 

multiplied by 2 (4.5% x 2 = 9%), the plan 

satisfies the ACP test under paragraph 

(a)(1)(i)(B) of this section.

Example 2. (i) Employees A through F are 

eligible employees in Plan V, a profit-sharing 

plan of Employer M that includes a cash or 

deferred arrangement and permits employee 

contributions. Under Plan V, a $.50 matching 

contribution is made for each dollar of 

elective contributions and employee 

contributions. Plan V uses the current year 

testing method and does not provide for 

elective contributions to be taken into 

account in determining an eligible 

employee’s ACR. For the 2006 plan year, 

Employees A and B are HCEs and the 

remaining employees are NHCEs. The 

compensation, elective contributions, 

employee contributions, and matching 

contributions for the 2006 plan year are 

shown in the following table:

Employee Compensation Elective contributions 

Employee contributions Matching contributions 

A ....................................................................................................... $190,000 $15,000 $3,500 $9,250 

B ....................................................................................................... 100,000 5,000 10,000 7,500 

Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 78191

Employee Compensation Elective contributions 

Employee contributions Matching contributions 

C ...................................................................................................... 85,000 12,000 0 6,000 

D ...................................................................................................... 70,000 9,500 0 4,750 

E ....................................................................................................... 40,000 10,000 0 5,000 

F ....................................................................................................... 10,000 0 0 0 

(ii) The matching rate for all NHCEs is 50% 

and thus the matching contributions are not 

disproportionate under paragraph (a)(5)(ii) of 

this section. Accordingly, they are taken into 

account in determining the ACR of eligible 

employees, as shown in the following table:

Employee Compensation Employee contributions 

Matching contributions ACR

(percent) 

A ................................................................................................. $190,000 $3,500 $9,250 6.71 

B ................................................................................................. 100,000 10,000 7,500 17.50 

C ................................................................................................ 85,000 0 6,000 7.06 

D ................................................................................................ 70,000 0 4,750 6.79 

E ................................................................................................. 40,000 0 5,000 12.50 

F ................................................................................................. 10,000 0 0 0 

(iii) The ACP for the HCEs is 12.11% 

((6.71% + 17.50%)/2). The ACP for the 

NHCEs is 6.59% ((7.06% + 6.79% + 12.50% 

+ 0.%)/4). Plan V fails to satisfy the ACP test 

under paragraph (a)(1)(i)(A) of this section 

because the ACP of HCEs is more than 125% 

of the ACP of the NHCEs (6.59% x 1.25 = 

8.24%). In addition, Plan V fails to satisfy the 

ACP test under paragraph (a)(1)(i)(B) of this 

section because the ACP for the HCEs 

exceeds the ACP of the other employees by 

more than 2 percentage points (6.59% + 2% 

= 8.59%). Therefore, the plan fails to satisfy 

the requirements of section 401(m)(2) and 

paragraph (a)(1) of this section unless the 

ACP failure is corrected under paragraph (b) 

of this section.

Example 3. (i) The facts are the same as 

Example 2, except that the plan provides that 

the NHCEs’ elective contributions may be 

used to meet the requirements of section 

401(m) to the extent needed under that 

section. 

(ii) Pursuant to paragraph (a)(6)(ii) of this 

section, the $10,000 of elective contributions 

for Employee E may be taken into account in 

determining the ACP rather than the ADP to 

the extent that the plan satisfies the 

requirements of § 1.401(k)–2(a)(1) excluding 

from the ADP this $10,000. In this case, if the 

$10,000 were excluded from the ADP for the 

NHCEs, the ADP for the HCEs is 6.45% 

(7.89% + 5.00%) /2 and the ADP for the 

NHCEs would be 6.92% (14.12% + 13.57% 

+ 0% +0%)/4) and the plan would satisfy the 

requirements of § 1.401(k)–2(a)(1) excluding 

from the ADP the elective contributions for 

NHCEs that are taken into account under 

section 401(m). 

(iii) After taking into account the $10,000 

of elective contributions for Employee E in 

the ACP test, the ACP for the NHCEs is 

12.84% (7.06% + 6.79% + 37.50 % + 0%) /4. 

Therefore the plan satisfies the ACP test 

because the ACP for the HCEs (12.11%) is 

less than 1.25 times the ACP for the NHCEs.

Example 4. (i) The facts are the same as 

Example 2, except that Plan V provides for 

a higher than 50% match rate on the elective 

contributions and employee contributions for 

all NHCEs. The match rate is defined as the 

rate, rounded up to the next whole percent, 

necessary to allow the plan to satisfy the ACP 

test, but not in excess of 100%. In this case, 

an increase in the match rate from 50% to 

74% will be sufficient to allow the plan to 

satisfy the ACP test. Thus, for the 2006 plan 

year, the compensation, elective 

contributions, employee contributions, 

matching contributions at a 74% match rate 

of the eligible NHCEs (employees C through 

F) are shown in the following table:

Employee Compensation Elective contributions 

Employee contributions Matching contributions 

C ...................................................................................................... $85,000 $12,000 $0 $8,880 

D ...................................................................................................... 70,000 9,500 0 7,030 

E ....................................................................................................... 40,000 10,000 0 7,400 

F ....................................................................................................... 10,000 0 0 0 

(ii) The matching rate for all NHCEs is 74% 

and thus the matching contributions are not 

disproportionate under paragraph (a)(5)(ii) of 

this section. Therefore, the matching 

contributions may be taken into account in 

determining the ACP for the NHCEs. 

(iii) The ACP for the NHCEs is 9.75% 

(10.45% + 10.04% + 18.50% + 0%)/4. 

Because the ACP for the HCEs (12.11%) is 

less than 1.25 times the ACP for the NHCEs, 

the plan satisfies the requirements of section 

401(m).

Example 5. (i) The facts are the same as 

Example 4, except that: Employee E’s 

elective contributions are $2,000 (rather than 

$10,000) and pursuant to paragraph (a)(6)(ii) 

of this section, the $2,000 of elective 

contributions for Employee E are taken into 

account in determining the ACP rather than 

the ADP. In addition, Plan V provides that 

the higher match rate is not limited to 100% 

and applies only for a specified group of 

NHCEs. The only member of that group is 

Employee E. Under the plan provision, the 

higher match rate is a 400% match. Thus, for 

the 2006 plan year, the compensation, 

elective contributions, employee 

contributions, matching contributions of the 

eligible NHCEs (employees C through F) are 

shown in the following table:

Employee Compensation Elective contributions 

Employee contributions Matching contributions 

C ...................................................................................................... $85,000 $12,000 $0 $6,000 

D ...................................................................................................... 70,000 9,500 0 4,750 

E ....................................................................................................... 40,000 2,000 0 8,000 

F ....................................................................................................... 10,000 0 0 0 

78192 Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 

(ii) If the entire matching contribution 

made on behalf of Employee E were taken 

into account under the ACP test, Plan V 

would satisfy the test, because the ACP for 

the NHCEs would be 9.71% (7.06% + 6.79% 

+ 25.00% + 0%)/4. Because the ACP for the 

HCEs (12.11%) is less than 1.25 times what 

the ACP for the NHCEs would be, the plan 

would satisfy the requirements of section 

401(m). 

(iii) Pursuant to paragraph (a)(5)(ii) of this 

section, however, matching contributions for 

an eligible NHCE that exceed the greatest of 

5% of compensation, the employee’s elective 

deferrals and 2 times the product of the 

plan’s representative matching rate and the 

employee’s elective deferrals cannot be taken 

into account in applying the ACP test. The 

plan’s representative matching rate is the 

lowest matching rate for any eligible 

employee in a group of NHCEs that is at least 

half of all eligible employees who are NHCEs 

in the plan for the plan year who make 

elective contributions for the plan year. For 

Plan V, the group of NHCEs who make such 

contributions consists of Employees C, D and 

E. The matching rates for these three 

employees are 50%, 50% and 400% 

respectively. The lowest matching rate for a 

group of NHCEs that is at least half of all the 

NHCEs who make elective contributions (or 

2 NHCEs) is 50%. Because 400% is more 

than twice the plan’s representative matching 

rate and the matching contributions exceed 

5% of compensation, the full amount of 

matching contributions is not taken into 

account. Only $2,000 of the matching 

contributions made on behalf of Employee E 

(matching contributions that do not exceed 

the greatest of 5% of compensation, the 

employee’s elective deferrals, or the product 

of 100% (2 times the representative matching 

rate) and the employee’s elective deferrals) 

satisfy the requirements of paragraph 

(a)(5)(ii) of this section and may be taken into 

account under the ACP test. Accordingly, the 

ACP for the NHCEs is 5.96% (7.06% + 6.79% 

+ 10% + 0%)/4 and the plan fails to satisfy 

the requirements of section 401(m)(2) and 

paragraph (a)(1) of this section unless the 

ACP failure is corrected under paragraph (b) 

of this section.

Example 6. (i) The facts are the same as 

Example 2, except that Plan V provides a 

QNEC equal to 13% of pay for Employee F 

that will be taken into account under the 

ACP test to the extent the contributions 

satisfy the requirements of paragraph (a)(6) of 

this section. 

(ii) Pursuant to paragraph (a)(6)(v) of this 

section, a QNEC cannot be taken into account 

in determining an NHCE’s ACR to the extent 

it exceeds the greater of 5% and the product 

of the employee’s compensation and the 

plan’s representative contribution rate. The 

plan’s representative contribution rate is two 

times the lowest applicable contribution rate 

for any eligible employee in a group of 

NHCEs that is at least half of all eligible 

employees who are NHCEs in the plan for the 

plan year. For Plan V, the applicable 

contribution rates for Employees C, D, E and 

F are 7.06%, 6.79%, 12.5% and 13% 

respectively. The lowest applicable 

contribution rate for a group of NHCEs that 

is at least half of all the NHCEs is 12.50% 

(the lowest applicable contribution rate for 

the group of NHCEs that consists of 

Employees E and F). 

(iii) Under paragraph (a)(6)(v)(B) of this 

section, the plan’s representative 

contribution rate is 2 times 12.50% or 

25.00%. Accordingly, the QNECs for 

Employee F can be taken into account under 

the ACP test only to the extent they do not 

exceed 25.00% of compensation. In this case, 

all of the QNECs for Employee F may be 

taken into account under the ACP test.

(iv) After taking into account the QNECs 

for Employee F, the ACP for the NHCEs is 

9.84% (7.06% + 6.79% + 12.50% + 13%)/4. 

Because the ACP for the HCEs (12.11%) is 

less than 1.25 times the ACP for the NHCEs, 

the plan satisfies the requirements of section 

401(m)(2) and paragraph (a)(1) of this section.

(b) Correction of excess aggregate 

contributions—(1) Permissible 

correction methods—(i) In general. A 

plan that provides for employee 

contributions or matching contributions 

does not fail to satisfy the requirements 

of section 401(m)(2) and paragraph 

(a)(1) of this section if the employer, in 

accordance with the terms of the plan, 

uses either of the following correction 

methods—

(A) Additional contributions. The 

employer makes additional 

contributions that are taken into account 

for the ACP test under this section that, 

in combination with the other 

contributions taken into account under 

this section, allow the plan to satisfy the 

requirements of paragraph (a)(1) of this 

section. 

(B) Excess aggregate contributions 

distributed or forfeited. Excess aggregate 

contributions are distributed or forfeited 

in accordance with paragraph (b)(2) of 

this section. 

(ii) Combination of correction 

methods. A plan may provide for the 

use of either of the correction methods 

described in paragraph (b)(1)(i) of this 

section, may limit employee 

contributions or matching contributions 

in a manner that prevents excess 

aggregate contributions from being 

made, or may use a combination of 

these methods, to avoid or correct 

excess aggregate contributions. If a plan 

uses a combination of correction 

methods, any contributions made under 

paragraph (b)(1)(i)(A) of this section 

must be taken into account before 

application of the correction method in 

paragraph (b)(1)(i)(B) of this section. 

(iii) Exclusive means of correction. A 

failure to satisfy the requirements of 

paragraph (a)(1) of this section may not 

be corrected using any method other 

than one described in paragraph (b)(1)(i) 

or (ii) of this section. Thus, excess 

aggregate contributions for a plan year 

may not be corrected by forfeiting 

vested matching contributions, 

distributing nonvested matching 

contributions, recharacterizing matching 

contributions, or not making matching 

contributions required under the terms 

of the plan. Similarly, excess aggregate 

contributions for a plan year may not 

remain unallocated or be allocated to a 

suspense account for allocation to one 

or more employees in any future year. 

In addition, excess aggregate 

contributions may not be corrected 

using the retroactive correction rules of 

§ 1.401(a)(4)–11(g). See § 1.401(a)(4)–

11(g)(3)(vii) and (5). 

(2) Correction through distribution—

(i) General rule. This paragraph (b)(2) 

contains the rules for correction of 

excess aggregate contributions through a 

distribution from the plan. Correction 

through a distribution generally 

involves a 4-step process. First, the plan 

must determine, in accordance with 

paragraph (b)(2)(ii) of this section, the 

total amount of excess aggregate 

contributions that must be distributed 

under the plan. Second, the plan must 

apportion the total amount of excess 

aggregate contributions among the HCEs 

in accordance with paragraph (b)(2)(iii) 

of this section. Third, the plan must 

determine the income allocable to 

excess aggregate contributions in 

accordance with paragraph (b)(2)(iv) of 

this section. Finally, the plan must 

distribute the apportioned 

contributions, together with allocable 

income (or forfeit the apportioned 

matching contributions, if forfeitable) in 

accordance with paragraph (b)(2)(v) of 

this section. Paragraph (b)(2)(vi) of this 

section provides rules relating to the tax 

treatment of these distributions. 

(ii) Calculation of total amount to be 

distributed. The following procedures 

must be used to determine the total 

amount of the excess aggregate 

contributions to be distributed—

(A) Calculate the dollar amount of 

excess aggregate contributions for each 

HCE. The amount of excess aggregate 

contributions attributable to an HCE for 

a plan year is the amount (if any) by 

which the HCE’s contributions taken 

into account under this section must be 

reduced for the HCE’s ACR to equal the 

highest permitted ACR under the plan. 

To calculate the highest permitted ACR 

under a plan, the ACR of the HCE with 

the highest ACR is reduced by the 

amount required to cause that HCE’s 

ACR to equal the ACR of the HCE with 

the next highest ACR. If a lesser 

reduction would enable the plan to 

satisfy the requirements of paragraph 

(b)(2)(ii)(C) of this section, only this 

lesser reduction applies. 

(B) Determination of the total amount 

of excess aggregate contributions. The 

process described in paragraph 

Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 78193

(b)(2)(ii)(A) of this section must be 

repeated until the plan would satisfy the 

requirements of paragraph (b)(2)(ii)(C) of 

this section. The sum of all reductions 

for all HCEs determined under 

paragraph (b)(2)(ii)(A) of this section is 

the total amount of excess aggregate 

contributions for the plan year. 

(C) Satisfaction of ACP. A plan 

satisfies this paragraph (b)(2)(ii)(C) if the 

plan would satisfy the requirements of 

paragraph (a)(1)(i) of this section if the 

ACR for each HCE were determined 

after the reductions described in 

paragraph (b)(2)(ii)(A) of this section. 

(iii) Apportionment of total amount of 

excess aggregate contributions among 

the HCEs. The following procedures 

must be used in apportioning the total 

amount of excess aggregate 

contributions determined under 

paragraph (b)(2)(ii) of this section 

among the HCEs—

(A) Calculate the dollar amount of 

excess aggregate contributions for each 

HCE. The contributions with respect to 

the HCE with the highest dollar amount 

of contributions taken account under 

this section are reduced by the amount 

required to cause that HCE’s 

contributions to equal the dollar amount 

of contributions taken into account 

under this section for the HCE with the 

next highest dollar amount of such 

contributions. If a lesser apportionment 

to the HCE would enable the plan to 

apportion the total amount of excess 

aggregate contributions, only the lesser 

apportionment would apply. 

(B) Limit on amount apportioned to 

any HCE. For purposes of this paragraph 

(b)(2)(iii), the contributions for an HCE 

who is an eligible employee in more 

than one plan of an employer to which 

matching contributions and employee 

contributions are made is determined by 

adding together all contributions 

otherwise taken into account in 

determining the ACR of the HCE under 

the rules of paragraph (a)(3)(ii) of this 

section. However, the amount of 

contributions apportioned with respect 

to an HCE must not exceed the amount 

of contributions taken into account 

under this section that were actually 

made on behalf of the HCE to the plan 

for the plan year. Thus, in the case of 

an HCE who is an eligible employee in 

more than one plan of the same 

employer to which employee 

contributions or matching contributions 

are made and whose ACR is calculated 

in accordance with paragraph (a)(3)(ii) 

of this section, the amount distributed 

under this paragraph (b)(2)(iii) will not 

exceed such contributions actually 

contributed to the plan for the plan year 

that are taken into account under this 

section for the plan year. 

(C) Apportionment to additional 

HCEs. The procedure in paragraph 

(b)(2)(iii)(A) of this section must be 

repeated until the total amount of excess 

aggregate contributions have been 

apportioned. 

(iv) Income allocable to excess 

aggregate contributions—(A) General 

rule. The income allocable to excess 

aggregate contributions is equal to the 

sum of the allocable gain or loss for the 

plan year and, to the extent the excess 

aggregate contributions are or will be 

credited with gain or loss for the gap 

period (i.e., the period after the close of 

the plan year and prior to the 

distribution) if there was a total 

distribution of the account, the allocable 

gain or loss during that period. 

(B) Method of allocating income. A 

plan may use any reasonable method for 

computing the income allocable to 

excess aggregate contributions, provided 

that the method does not violate section 

401(a)(4), is used consistently for all 

participants and for all corrective 

distributions under the plan for the plan 

year, and is used by the plan for 

allocating income to participants’

accounts. See § 1.401(a)(4)–1(c)(8). A 

plan will not fail to use a reasonable 

method for computing the income 

allocable to excess contributions merely 

because the income allocable to excess 

aggregate contributions is determined 

on a date that is no more than 7 days 

before the distribution. 

(C) Alternative method of allocating 

income for the plan year. A plan may 

allocate income to excess aggregate 

contributions for the plan year by 

multiplying the income for the plan year 

allocable to employee contributions, 

matching contributions and other 

amounts taken into account under this 

section (including the contributions for 

the year), by a fraction, the numerator of 

which is the excess aggregate 

contributions for the employee for the 

plan year, and the denominator of 

which is the sum of the—

(1) Account balance attributable to 

employee contributions and matching 

contributions and other amounts taken 

into account under this section as of the 

beginning of the plan year; and 

(2) Any additional such contributions 

for the plan year. 

(D) Safe harbor method of allocating 

gap period income. A plan may use the 

safe harbor method in this paragraph 

(b)(2)(iv)(D) to determine income on 

excess aggregate contributions for the 

gap period. Under this safe harbor 

method, income on excess aggregate 

contributions for the gap period is equal 

to 10% of the income allocable to excess 

aggregate contributions for the plan year 

that would be determined under 

paragraph (b)(2)(iv)(C) of this section, 

multiplied by the number of calendar 

months that have elapsed since the end 

of the plan year. For purposes of 

calculating the number of calendar 

months that have elapsed under the safe 

harbor method, a corrective distribution 

that is made on or before the fifteenth 

day of a month is treated as made on the 

last day of the preceding month and a 

distribution made after the fifteenth day 

of a month is treated as made on the last 

day of the month. 

(E) Alternative method of allocating 

plan year and gap period income. A 

plan may determine the allocable gain 

or loss for the aggregate of the plan year 

and the gap period by applying the 

alternative method provided by 

paragraph (b)(2)(iv)(C) of this section to 

that aggregate period. This is 

accomplished by substituting the 

income for the plan year and the gap 

period for the income for the plan year 

and by substituting the contributions 

taken into account under this section for 

the plan year and the gap period for the 

contributions taken into account for the 

plan year in determining the fraction 

that is multiplied by that income. 

(F) Allocable income for 

recharacterized elective contributions. If 

recharacterized elective contributions 

are distributed as excess aggregate 

contributions, the income allocable to 

the excess aggregate contributions is 

determined as if recharacterized elective 

contributions had been distributed as 

excess contributions. Thus, income 

must be allocated to the recharacterized 

amounts distributed using the methods 

in § 1.401(k)–2(b)(2)(iv). 

(v) Distribution and forfeiture. Within 

12 months after the close of the plan 

year in which the excess aggregate 

contribution arose, the plan must 

distribute to each HCE the contributions 

apportioned to such HCE under 

paragraph (b)(2)(iii) of this section (and 

the allocable income) to the extent they 

are vested or forfeit such amounts, if 

forfeitable. Except as otherwise 

provided in this paragraph (b)(2)(v), a 

distribution of excess aggregate 

contributions must be in addition to any 

other distributions made during the year 

and must be designated as a corrective 

distribution by the employer. In the 

event of a complete termination of the 

plan during the plan year in which an 

excess aggregate contribution arose, the 

corrective distribution must be made as 

soon as administratively feasible after 

the date of termination of the plan, but 

in no event later than 12 months after 

the date of termination. If the entire 

account balance of an HCE is distributed 

prior to when the plan makes a 

distribution of excess aggregate 

78194 Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 

contributions in accordance with this 

paragraph (b)(2), the distribution is 

deemed to have been a corrective 

distribution of excess aggregate 

contributions (and income) to the extent 

that a corrective distribution would 

otherwise have been required. 

(vi) Tax treatment of corrective 

distributions—(A) General rule. Except 

as otherwise provided in this paragraph 

(b)(2)(vi), a corrective distribution of 

excess aggregate contributions (and 

income) that is made within 21⁄2 months 

after the end of the plan year for which 

the excess aggregate contributions were 

made is includible in the employee’s 

gross income for the taxable year of the 

employee ending with or within the 

plan year for which the excess aggregate 

contributions were made. A corrective 

distribution of excess aggregate 

contributions (and income) that is made 

more than 21⁄2 months after the plan 

year for which the excess aggregate 

contributions were made is includible 

in the employee’s gross income in the 

taxable year of the employee in which 

distributed. The portion of the 

distribution that is treated as an 

investment in the contract (and is 

therefore not subject to tax under 

section 72) is determined without regard 

to any plan contributions other than 

those distributed as excess aggregate 

contributions. Regardless of when the 

corrective distribution is made, it is not 

subject to the early distribution tax of 

section 72(t). See paragraph (b)(4) of this 

section for additional rules relating to 

the employer excise tax on amounts 

distributed more than 21⁄2 months after 

the end of the plan year. See also 

§ 1.402(c)–2, A–4 prohibiting rollover of 

distributions that are excess aggregate 

contributions. 

(B) Rule for de minimis distributions.

If the total amount of excess aggregate 

contributions determined under this 

paragraph (b)(2), and excess 

contributions determined under 

§ 1.401(k)–2(b)(2) distributed to a 

recipient under a plan for any plan year 

is less than $100 (excluding income), a 

corrective distribution of excess 

aggregate contributions (and income) is 

includible in gross income in the 

recipient’s taxable year in which the 

corrective distribution is made, except 

to the extent the corrective distribution 

is a return of employee contributions. 

(3) Other rules—(i) No employee or 

spousal consent required. A distribution 

of excess aggregate contributions (and 

income) may be made under the terms 

of the plan without regard to any notice 

or consent otherwise required under 

sections 411(a)(11) and 417. 

(ii) Treatment of corrective 

distributions and forfeited contributions 

as employer contributions. Excess 

aggregate contributions (other than 

amounts attributable to employee 

contributions), including forfeited 

matching contributions, are treated as 

employer contributions for purposes of 

sections 404 and 415 even if distributed 

from the plan. Forfeited matching 

contributions that are reallocated to the 

accounts of other participants for the 

plan year in which the forfeiture occurs 

are treated under section 415 as annual 

additions for the participants to whose 

accounts they are reallocated and for the 

participants from whose accounts they 

are forfeited. 

(iii) No reduction of required 

minimum distribution. A distribution of 

excess aggregate contributions (and 

income) is not treated as a distribution 

for purposes of determining whether the 

plan satisfies the minimum distribution 

requirements of section 401(a)(9). See 

§ 1.401(a)(9)–5, A–9(b). 

(iv) Partial correction. Any 

distribution of less than the entire 

amount of excess aggregate 

contributions (and allocable income) is 

treated as a pro rata distribution of 

excess aggregate contributions and 

allocable income. 

(v) Matching contributions on excess 

contributions, excess deferrals and 

excess aggregate contributions—(A) 

Corrective distributions not permitted. A 

matching contribution may not be 

distributed merely because the 

contribution to which it relates is 

treated as an excess contribution, excess 

deferral, or excess aggregate 

contribution. 

(B) Coordination with section 

401(a)(4). A matching contribution is 

taken into account under section 

401(a)(4) even if the match is 

distributed, unless the distributed 

contribution is an excess aggregate 

contribution. This requires that, after 

correction of excess aggregate 

contributions, each level of matching 

contributions be currently and 

effectively available to a group of 

employees that satisfies section 410(b). 

See § 1.401(a)(4)–4(e)(3)(iii)(G). Thus, a 

plan that provides the same rate of 

matching contributions to all employees 

will not meet the requirements of 

section 401(a)(4) if employee 

contributions are distributed under this 

paragraph (b) to HCEs to the extent 

needed to meet the requirements of 

section 401(m)(2), while matching 

contributions attributable to employee 

contributions remain allocated to the 

HCEs’ accounts. This is because the 

level of matching contributions will be 

higher for a group of employees that 

consists entirely of HCEs. Under section 

411(a)(3)(G) and § 1.411(a)–4(b)(7), a 

plan may forfeit matching contributions 

attributable to excess contributions, 

excess aggregate contributions and 

excess deferrals to avoid a violation of 

section 401(a)(4). See also § 1.401(a)(4)–

11(g)(3)(vii)(B) regarding the use of 

additional allocations to the accounts of 

NHCEs for the purpose of correcting a 

discriminatory rate of matching 

contributions. A plan is permitted to 

provide for which contributions are to 

be distributed to satisfy the ACP test so 

as to avoid discriminatory matching 

rates that would otherwise violate 

section 401(a)(4). For example, the plan 

may provide that unmatched employee 

contributions will be distributed before 

matched employee contributions. 

(vi) No requirement for recalculation.

If the distributions and forfeitures 

described in paragraph (b)(2) of this 

section are made, the employee 

contributions and matching 

contributions are treated as meeting the 

nondiscrimination test of section 

401(m)(2) regardless of whether the ACP 

for the HCEs, if recalculated after the 

distributions and forfeitures, would 

satisfy section 401(m)(2).

(4) Failure to timely correct—(i) 

Failure to correct within 21⁄2 months 

after end of plan year. If a plan does not 

correct excess aggregate contributions 

within 21⁄2 months after the close of the 

plan year for which the excess aggregate 

contributions are made, the employer 

will be liable for a 10% excise tax on the 

amount of the excess aggregate 

contributions. See section 4979 and 

§ 54.4979–1 of this chapter. Qualified 

nonelective contributions properly 

taken into account under paragraph 

(a)(6) of this section for a plan year may 

enable a plan to avoid having excess 

aggregate contributions, even if the 

contributions are made after the close of 

the 21⁄2 month period. 

(ii) Failure to correct within 12 

months after end of plan year. If excess 

aggregate contributions are not corrected 

within 12 months after the close of the 

plan year for which they were made, the 

plan will fail to meet the requirements 

of section 401(a)(4) for the plan year for 

which the excess aggregate 

contributions were made and all 

subsequent plan years in which the 

excess aggregate contributions remain in 

the trust. 

(5) Examples. The following examples 

illustrate the application of this 

paragraph. See also § 1.401(k)–2(b) for 

additional examples of the parallel 

correction rules applicable to cash or 

deferred arrangements. For purposes of 

these examples, none of the plans 

provide for catch-up contributions 

under section 414(v). The examples are 

as follows:

Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 78195

Example 1. (i) Employer L maintains a plan 

that provides for employee contributions and 

fully vested matching contributions. The 

plan provides that failures of the ACP test are 

corrected by distribution. In 2006, the ACP 

for the eligible NHCEs is 6%. Thus, the ACP 

for the eligible HCEs may not exceed 8%. 

The three HCEs who participate have the 

following compensation, contributions, and 

ACRs:

Employee Compensation Employee contributions and 

matching contributions 

Actual contribution ratio

(percent) 

A ...................................................................................... 200,000 14,000 7 

B ...................................................................................... 150,000 13,500 9 

C ...................................................................................... 100,000 12,000 12 

.............................................. .............................................. Average 9.33 

(ii) The total amount of excess aggregate 

contributions for the HCEs is determined 

under paragraph (b)(2)(ii) of this section as 

follows: the matching and employee 

contributions of Employee C (the HCE with 

the highest ACR) is reduced by 3% of 

compensation (or $3,000) in order to reduce 

the ACR of that HCE to 9%, which is the ACR 

of Employee B. 

(iii) Because the ACP of the HCEs 

determined after the $3,000 reduction still 

exceeds 8%, further reductions in matching 

contributions and employee contributions are 

necessary in order to reduce the ACP of the 

HCEs to 8%. The employee contributions and 

matching contributions for Employees B and 

C are reduced by an additional .5% of 

compensation or $1,250 ($750 and $500 

respectively). Because the ACP of the HCEs 

determined after the reductions now equals 

8%, the plan would satisfy the requirements 

of (a)(1)(ii) of this section. 

(iv) The total amount of excess aggregate 

contributions ($4,250) is apportioned among 

the HCEs under paragraph (b)(2)(iii) of this 

section first to the HCE with the highest 

amount of matching contributions and 

employee contributions. Therefore, Employee 

A is apportioned $500 (the amount required 

to cause A’s matching contributions and 

employee contributions to equal the next 

highest dollar amount of matching 

contributions and employee contributions). 

(v) Because the total amount of excess 

aggregate contributions has not been 

apportioned, further apportionment is 

necessary. The balance ($3,750) of the total 

amount of excess aggregate contributions is 

apportioned equally among Employees A and 

B ($1,500 to each, the amount required to 

cause their contributions to equal the next 

highest dollar amount of matching 

contributions and employee contributions). 

(vi) Because the total amount of excess 

aggregate contributions has not been 

apportioned, further apportionment is 

necessary. The balance ($750) of the total 

amount of excess aggregate contributions is 

apportioned equally among Employees A, B 

and C ($250 to each, the amount required to 

allocate the total amount of excess aggregate 

contributions for the plan). 

(vii) Therefore, the plan will satisfy the 

requirements of paragraph (a)(1) of this 

section if, by the end of the 12 month period 

following the end of the 2006 plan year, 

Employee A receives a corrective distribution 

of excess aggregate contributions equal to 

$2,250 ($500 + $1,500 + $250) and allocable 

income, Employee B receives a corrective 

distribution of $250 and allocable income 

and Employee C receives a corrective 

distribution of $1,750 ($1,500 + $250) and 

allocable income.

Example 2. (i) Employee D is the sole HCE 

who is eligible to participate in a cash or 

deferred arrangement maintained by 

Employer M. The plan that includes the 

arrangement, Plan X, permits employee 

contributions and provides a fully vested 

matching contribution equal to 50% of 

elective contributions. Plan X is a calendar 

year plan. Plan X corrects excess 

contributions by recharacterization and 

provides that failures of the ACP test are 

corrected by distribution. For the 2006 plan 

year, D’s compensation is $200,000, and D’s 

elective contributions are $15,000. The actual 

deferral percentages and actual contribution 

percentages for Employee D and the other 

eligible employees under Plan X are shown 

in the following table:

Actual deferral 

percentage 

Actual contribution 

percentage 

Employee D ................................................................................................................................................... 7.5 3.75 

NHCEs ........................................................................................................................................................... 4 2 

(ii) In February 2007, Employer M 

determines that D’s actual deferral ratio must 

be reduced to 6%, or $12,000, which requires 

a recharacterization of $3,000 as an employee 

contribution. This increases D’s actual 

contribution ratio to 5.25% ($7,500 in 

matching contributions plus $3,000 

recharacterized as employee contributions, 

divided by $200,000 in compensation). Since 

D’s actual contribution ratio must be limited 

to 4% for Plan X to satisfy the actual 

contribution percentage test, Plan X must 

distribute 1.25% or $2,500 of D’s employee 

contributions and matching contributions 

together with allocable income. If $2,500 in 

matching contributions and allocable income 

is distributed, this will correct the excess 

aggregate contributions and will not result in 

a discriminatory rate of matching 

contributions. See Example 8.

Example 3. (i) The facts are the same as in 

Example 2, except that Employee D also had 

elective contributions under Plan Y, 

maintained by an employer unrelated to M. 

In January 2007, D requests and receives a 

distribution of $1,200 in excess deferrals 

from Plan X. Pursuant to the terms of Plan 

X, D forfeits the $600 match on the excess 

deferrals to correct a discriminatory rate of 

match. 

(ii) The $3,000 that would otherwise have 

been recharacterized for Plan X to satisfy the 

actual deferral percentage test is reduced by 

the $1,200 already distributed as an excess 

deferral, leaving $1,800 to be recharacterized. 

See § 1.401(k)–2(b)(4)(i)(A). D’s actual 

contribution ratio is now 4.35% ($7,500 in 

matching contributions plus $1,800 in 

recharacterized contributions less $600 

forfeited matching contributions attributable 

to the excess deferrals, divided by $200,000 

in compensation). 

(iii) The matching and employee 

contributions for Employee D must be 

reduced by .35% of compensation in order to 

reduce the ACP of the HCEs to 4%. The plan 

must provide for forfeiture of additional 

matching contributions to prevent a 

discriminatory rate of matching 

contributions. See Example 8.

Example 4. (i) The facts are the same as in 

Example 3, except that D does not request a 

distribution of excess deferrals until March 

2007. Employer X has already 

recharacterized $3,000 as employee 

contributions. 

(ii) Under § 1.402(g)–1(e)(6), the amount of 

excess deferrals is reduced by the amount of 

excess contributions that are recharacterized. 

Because the amount recharacterized is greater 

than the excess deferrals, Plan X is neither 

required nor permitted to make a distribution 

of excess deferrals, and the recharacterization 

has corrected the excess deferrals.

Example 5. (i) For the 2006 plan year, 

Employee F defers $10,000 under Plan M and 

$6,000 under Plan N. Plans M and N, which 

have calendar plan years are maintained by 

unrelated employers. Plan M provides a fully 

vested, 100% matching contribution, does 

not take elective contributions into account 

under section 401(m) or take matching 

contributions into account under section 

401(k) and provides that excess contributions 

and excess aggregate contributions are 

78196 Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 

corrected by distribution. Under Plan M, 

Employee F is allocated excess contributions 

of $600 and excess aggregate contributions of 

$1,600. Employee F timely requests and 

receives a distribution of the $1,000 excess 

deferral from Plan M and, pursuant to the 

terms of Plan M, forfeits the corresponding 

$1,000 matching contribution. 

(ii) No distribution is required or permitted 

to correct the excess contributions because 

$1,000 has been distributed by Plan M as 

excess deferrals. The distribution required to 

correct the excess aggregate contributions 

(after forfeiting the matching contribution) is 

$600 ($1,600 in excess aggregate 

contributions minus $1,000 in forfeited 

matching contributions). If Employee F had 

corrected the excess deferrals of $1,000 by 

withdrawing $1,000 from Plan N, Plan M 

would have had to correct the $600 excess 

contributions in Plan M by distributing $600. 

Since Employee F then would have forfeited 

$600 (instead of $1,000) in matching 

contributions, Employee F would have had 

$1,000 ($1,600 in excess aggregate 

contributions minus $600 in forfeited 

matching contributions) remaining of excess 

aggregate contributions in Plan M. These 

would have been corrected by distributing an 

additional $1,000 from Plan M.

Example 6. (i) Employee G is the sole HCE 

in a profit sharing plan under which the 

employer matches 100% of employee 

contributions up to 2% of compensation, and 

50% of employee contributions up to the 

next 4% of compensation. For the 2008 plan 

year, Employee G has compensation of 

$100,000 and makes a 7% employee 

contribution of $7,000. Employee G receives 

a 4% matching contribution or $4,000. Thus, 

Employee G’s actual contribution ratio (ACR) 

is 11%. The actual contribution percentage 

for the NHCEs is 5%, and the employer 

determines that Employee G’s ACR must be 

reduced to 7% to comply with the rules of 

section 401(m). 

(ii) In this case, the plan satisfies the 

requirements of section if it distributes the 

unmatched employee contributions of 

$1,000, and $2,000 of matched employee 

contributions with their related matches of 

$1,000. This would leave Employee G with 

4% employee contributions, and 3% 

matching contributions, for an ACR of 7%. 

Alternatively, the plan could distribute all 

matching contributions and satisfy this 

section. However, the plan could not 

distribute $4,000 of Employee G’s employee 

contributions without forfeiting the related 

matching contributions because this would 

result in a discriminatory rate of matching 

contributions. See also Example 7.

Example 7. (i) Employee H is an HCE in 

Employer X’s profit sharing plan, which 

matches 100% of employee contributions up 

to 5% of compensation. The matching 

contribution is vested at the rate of 20% per 

year. In 2006, Employee H makes $5,000 in 

employee contributions and receives $5,000 

of matching contributions. Employee H is 

60% vested in the matching contributions at 

the end of the 2006 plan year. In February 

2007, Employer X determines that Employee 

H has excess aggregate contributions of 

$1,000. The plan provides that only matching 

contributions will be distributed as excess 

aggregate contributions. 

(ii) Employer X has two options available 

in distributing Employee H’s excess aggregate 

contributions. The first option is to distribute 

$600 of vested matching contributions and 

forfeit $400 of nonvested matching 

contributions. These amounts are in 

proportion to Employee H’s vested and 

nonvested interests in all matching 

contributions. The second option is to 

distribute $1,000 of vested matching 

contributions, leaving the nonvested 

matching contributions in the plan. 

(iii) If the second option is chosen, the plan 

must also provide a separate vesting schedule 

for vesting these nonvested matching 

contributions. This is necessary because the 

nonvested matching contributions must vest 

as rapidly as they would have had no 

distribution been made. Thus, 50% must vest 

in each of the next 2 years. 

(iv) The plan will not satisfy the 

nondiscriminatory availability requirement 

of section 401(a)(4) if only nonvested 

matching contributions are forfeited because 

the effect is that matching contributions for 

HCEs vest more rapidly than those for 

NHCEs. See § 1.401(m)–2(b)(3)(v)(B).

Example 8. (i) Employer Y maintains a 

calendar year profit sharing plan that 

includes a cash or deferred arrangement. 

Elective contributions are matched at the rate 

of 100%. After-tax employee contributions 

are permitted under the plan only for NHCEs 

and are matched at the same rate. No 

employees make excess deferrals. Employee 

J, an HCE, makes an $8,000 elective 

contribution and receives an $8,000 matching 

contribution. 

(ii) Employer Y performs the actual 

deferral percentage (ADP) and the actual 

contribution percentage (ACP). To correct 

failures of the ADP and ACP tests, the plan 

distributes to A $1,000 of excess 

contributions and $500 of excess aggregate 

contributions. After the distributions, 

Employee J’s contributions for the year are 

$7,000 of elective contributions and $7,500 of 

matching contributions. As a result, 

Employee J has received a higher effective 

rate of matching contributions than NHCEs 

($7,000 of elective contributions matched by 

$7,500 is an effective matching rate of 107 

percent). If this amount remains in Employee 

J’s account without correction, it will cause 

the plan to fail to satisfy section 401(a)(4), 

because only an HCE receives the higher 

matching contribution rate. The remaining 

$500 matching contribution may be forfeited 

(but not distributed) under section 

411(a)(3)(G), if the plan so provides. The plan 

could instead correct the discriminatory rate 

of matching contributions by making 

additional allocations to the accounts of 

NHCEs. See § 1.401(a)(4)–11(g)(3)(vii)(B) and 

(6), Example 7.

(c) Additional rules for prior year 

testing method—(1) Rules for change in 

testing method. A plan is permitted to 

change from the prior year testing 

method to the current year testing 

method for any plan year. A plan is 

permitted to change from the current 

year testing method to the prior year 

testing method only in situations 

described in § 1.401(k)–2(c)(1)(ii). For 

purposes of this paragraph (c)(1), a plan 

that uses the safe harbor method 

described in § 1.401(m)–3 or a SIMPLE 

401(k) plan is treated as using the 

current year testing method for that plan 

year 

(2) Calculation of ACP under the prior 

year testing method for the first plan 

year—(i) Plans that are not successor 

plans. If, for the first plan year of any 

plan (other than a successor plan), a 

plan uses the prior year testing method, 

the plan is permitted to use either that 

first plan year as the applicable year for 

determining the ACP for the eligible 

NHCEs, or 3% as the ACP for eligible 

NHCEs, for applying the ACP test for 

that first plan year. A plan (other than 

a successor plan) that uses the prior year 

testing method but has elected for its 

first plan year to use that year as the 

applicable year for determining the ACP 

for the eligible NHCEs is not treated as 

changing its testing method in the 

second plan year and is not subject to 

the limitations on double counting 

under paragraph (a)(6)(vi) of this section 

for the second plan year. 

(ii) First plan year defined. For 

purposes of this paragraph (c)(2), the 

first plan year of any plan is the first 

year in which the plan provides for 

employee contributions or matching 

contributions. Thus, the rules of this 

paragraph (c)(2) do not apply to a plan 

(within the meaning of § 1.410(b)–7) for 

a plan year if for such plan year the plan 

is aggregated under § 1.401(m)–1(b)(4) 

with any other plan that provides for 

employee or matching contributions in 

the prior year. 

(iii) Plans that are successor plans. A 

plan is a successor plan if 50% or more 

of the eligible employees for the first 

plan year were eligible employees under 

another plan maintained by the 

employer in the prior year that provides 

for employee contributions or matching 

contributions. If a plan that is a 

successor plan uses the prior year 

testing method for its first plan year, the 

ACP for the group of NHCEs for the 

applicable year must be determined 

under paragraph (c)(4) of this section. 

(3) Plans using different testing 

methods for the ACP and ADP test.

Except as otherwise provided in this 

paragraph (c)(3), a plan may use the 

current year testing method or prior year 

testing method for the ACP test for a 

plan year without regard to whether the 

current year testing method or prior year 

testing method is used for the ADP test 

for that year. For example, a plan may 

use the prior year testing method for the 

ACP test and the current year testing 

method for its ADP test for the plan 

year. However, plans that use different 

Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 78197

testing methods under this paragraph 

(c)(3) cannot use—

(i) The recharacterization method of 

§ 1.401(k)–2(b)(3) to correct excess 

contributions for a plan year; 

(ii) The rules of paragraph (a)(6)(ii) of 

this section to take elective 

contributions into account under the 

ACP test (rather than the ADP test); or 

(iii) The rules of paragraph § 1.401(k)–

2(a)(6) to take qualified matching 

contributions into account under the 

ADP test (rather than the ACP test). 

(4) Rules for plan coverage change—

(i) In general. A plan that uses the prior 

year testing method that experiences a 

plan coverage change during a plan year 

satisfies the requirements of this section 

for that year only if the plan provides 

that the ACP for the NHCEs for the plan 

year is the weighted average of the ACPs 

for the prior year subgroups. 

(ii) Optional rule for minor plan 

coverage changes. If a plan coverage 

change occurs and 90% or more of the 

total number of the NHCEs from all 

prior year subgroups are from a single 

prior year subgroup, then, in lieu of 

using the weighted averages described 

in paragraph (c)(4)(i) of this section, the 

plan may provide that the ACP for the 

group of eligible NHCEs for the prior 

year under the plan is the ACP of the 

NHCEs for the prior year of the plan 

under which that single prior year 

subgroup was eligible. 

(iii) Definitions. The following 

definitions apply for purposes of this 

paragraph (c)(4)—

(A) Plan coverage change. The term 

plan coverage change means a change in 

the group or groups of eligible 

employees under a plan on account of—

(1) The establishment or amendment 

of a plan; 

(2) A plan merger or spinoff under 

section 414(l); 

(3) A change in the way plans (within 

the meaning of § 1.410(b)–7) are 

combined or separated for purposes of 

§ 1.401(m)–1(b)(4) (e.g., permissively 

aggregating plans not previously 

aggregated under § 1.410(b)–7(d), or 

ceasing to permissively aggregate plans 

under § 1.410(b)–7(d)); 

(4) A reclassification of a substantial 

group of employees that has the same 

effect as amending the plan (e.g., a 

transfer of a substantial group of 

employees from one division to another 

division); or 

(5) A combination of any of 

paragraphs (c)(4)(iii)(A)(1) through (4) of 

this section. 

(B) Prior year subgroup. The term 

prior year subgroup means all NHCEs 

for the prior plan year who, in the prior 

year, were eligible employees under a 

specific plan that provides for employee 

contributions or matching contributions 

maintained by the employer and who 

would have been eligible employees in 

the prior year under the plan being 

tested if the plan coverage change had 

first been effective as of the first day of 

the prior plan year instead of first being 

effective during the plan year. The 

determination of whether an NHCE is a 

member of a prior year subgroup is 

made without regard to whether the 

NHCE terminated employment during 

the prior year. 

(C) Weighted average of the ACPs for 

the prior year subgroups. The term 

weighted average of the ACPs for the 

prior year subgroups means the sum, for 

all prior year subgroups, of the adjusted 

ACPs for the plan year. The term 

adjusted ACP with respect to a prior 

year subgroup means the ACP for the 

prior plan year of the specific plan 

under which the members of the prior 

year subgroup were eligible employees 

on the first day of the prior plan year, 

multiplied by a fraction, the numerator 

of which is the number of NHCEs in the 

prior year subgroup and denominator of 

which is the total number of NHCEs in 

all prior year subgroups. 

(iv) Example. The following example 

illustrate the application of this 

paragraph (c)(4). See also § 1.401(k)–

2(c)(4) for examples of the parallel rules 

applicable to the ADP test. The example 

is as follows:

Example. (i) Employer B maintains two 

plans, Plan N and Plan P, each of which 

provides for employee contributions or 

matching contributions. The plans were not 

permissively aggregated under § 1.410(b)–

7(d) for the 2005 testing year. Both plans use 

the prior year testing method. Plan N had 300 

eligible employees who were NHCEs for 

2005, and their ACP for that year was 6%. 

Plan P had 100 eligible employees who were 

NHCEs for 2005, and the ACP for those 

NHCEs for that plan was 4%. Plan N and 

Plan P are permissively aggregated under 

§ 1.410(b)–7(d) for the 2006 plan year. 

(ii) The permissive aggregation of Plan N 

and Plan P for the 2006 testing year under 

§ 1.410(b)–7(d) is a plan coverage change that 

results in treating the plans as one plan (Plan 

NP). Therefore, the prior year ACP for the 

NHCEs under Plan NP for the 2006 testing 

year is the weighted average of the ACPs for 

the prior year subgroups. 

(iii) The first step in determining the 

weighted average of the ACPs for the prior 

year subgroups is to identify the prior year 

subgroups. With respect to the 2006 testing 

year, an employee is a member of a prior year 

subgroup if the employee was an NHCE of 

Employer B for the 2005 plan year, was an 

eligible employee for the 2005 plan year 

under any section 401(k) plan maintained by 

Employer B, and would have been an eligible 

employee in the 2005 plan year under Plan 

NP if Plan N and Plan P had been 

permissively aggregated under § 1.410(b)–

7(d) for that plan year. The NHCEs who were 

eligible employees under separate plans for 

the 2005 plan year comprise separate prior 

year subgroups. Thus, there are two prior 

year subgroups under Plan NP for the 2006 

testing year: the 300 NHCEs who were 

eligible employees under Plan N for the 2005 

plan year and the 100 NHCEs who were 

eligible employees under Plan P for the 2005 

plan year. 

(iv) The weighted average of the ACPs for 

the prior year subgroups is the sum of the 

adjusted ACP with respect to the prior year 

subgroup that consists of the NHCEs who 

were eligible employees under Plan N, and 

the adjusted ACP with respect to the prior 

year subgroup that consists of the NHCEs 

who were eligible employees under Plan P. 

The adjusted ACP for the prior year subgroup 

that consists of the NHCEs who were eligible 

employees under Plan N is 4.5%, calculated 

as follows: 6% (the ACP for the NHCEs under 

Plan N for the prior year) × 300/400 (the 

number of NHCEs in that prior year subgroup 

divided by the total number of NHCEs in all 

prior year subgroups), which equals 4.5%. 

The adjusted ACP for the prior year subgroup 

that consists of the NHCEs who were eligible 

employees under Plan P is 1%, calculated as 

follows: 4% (the ACP for the NHCEs under 

Plan P for the prior year) x 100/400 (the 

number of NHCEs in that prior year subgroup 

divided by the total number of NHCEs in all 

prior year subgroups), which equals 1%. 

Thus, the prior year ACP for NHCEs under 

Plan NP for the 2006 testing year is 5.5% (the 

sum of adjusted ACPs for the prior year 

subgroups, 4.5% plus 1%).

§ 1.401(m)–3 Safe harbor requirements. 

(a) ACP test safe harbor. Matching 

contributions under a plan satisfy the 

ACP safe harbor provisions of section 

401(m)(11) for a plan year if the plan 

satisfies the safe harbor contribution 

requirement of paragraphs (b) or (c) of 

this section for the plan year, the 

limitations on matching contributions of 

paragraph (d) of this section, the notice 

requirement of paragraph (e) of this 

section, the plan year requirements of 

paragraph (f) of this section, and the 

additional rules of paragraphs (g), (h) 

and (j) of this section, as applicable. 

Pursuant to section 401(k)(12)(E)(ii), the 

safe harbor contribution requirement of 

paragraphs (b) and (c) of this section 

must be satisfied without regard to 

section 401(l). The contributions made 

under paragraphs (b) and (c) of this 

section are referred to as safe harbor 

nonelective contributions and safe 

harbor matching contributions, 

respectively. 

(b) Safe harbor nonelective 

contribution requirement. A plan 

satisfies the safe harbor nonelective 

contribution requirement of this 

paragraph (b) if it satisfies the safe 

harbor nonelective contribution 

requirement of § 1.401(k)–3(b). 

(c) Safe harbor matching contribution 

requirement. A plan satisfies the safe 

harbor matching contribution 

78198 Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 

requirement of this paragraph (c) if it 

satisfies the safe harbor matching 

contribution requirement of § 1.401(k)–

3(c). 

(d) Limitation on contributions—(1) 

General rule. A plan that provides for 

matching contributions meets the 

requirements of this section only if it 

satisfies the limitations on contributions 

set forth in this paragraph (d). 

(2) Matching rate must not increase. A 

plan that provides for matching 

contributions meets the requirements of 

this paragraph (d) only if the ratio of 

matching contributions on behalf of an 

employee under the plan for a plan year 

to the employee’s elective deferrals and 

employee contributions, does not 

increase as the amount of an employee’s 

elective deferrals and employee 

contributions increases. 

(3) Limit on matching contributions. A 

plan that provides for matching 

contributions satisfies the requirements 

of this section only if—

(i) Matching contributions are not 

made with respect to elective deferrals 

or employee contributions that exceed 

6% of the employee’s safe harbor 

compensation (within the meaning of 

§ 1.401(k)–3(b)(2)); and 

(ii) Matching contributions that are 

discretionary do not exceed 4% of the 

employee’s safe harbor compensation. 

(4) Limitation on rate of match. A 

plan meets the requirements of this 

section only if the ratio of matching 

contributions on behalf of an HCE to 

that HCE’s elective deferrals or 

employee contributions (or the sum of 

elective deferrals and employee 

contributions) for that plan year is no 

greater than the ratio of matching 

contributions to elective deferrals or 

employee contributions (or the sum of 

elective deferrals and employee 

contributions) that would apply with 

respect to any NHCE for whom the 

elective deferrals or employee 

contributions (or the sum of elective 

deferrals and employee contributions) 

are the same percentage of safe harbor 

compensation. An employee is taken 

into account for purposes of this 

paragraph (d)(4) if the employee is an 

eligible employee under the cash or 

deferred arrangement with respect to 

which the contributions required by 

paragraph (b) or (c) of this section are 

being made for a plan year. A plan will 

not fail to satisfy this paragraph (d)(4) 

merely because the plan provides that 

matching contributions will be made 

separately with respect to each payroll 

period (or with respect to all payroll 

periods ending with or within each 

month or quarter of a plan year) taken 

into account under the plan for the plan 

year, provided that matching 

contributions with respect to any 

elective deferrals or employee 

contributions made during a plan year 

quarter are contributed to the plan by 

the last day of the immediately 

following plan year quarter. 

(5) HCEs participating in multiple 

plans. The rules of section 401(m)(2)(B) 

and § 1.401(m)–2(a)(3)(ii) apply for 

purposes of determining the rate of 

matching contributions under paragraph 

(d)(4) of this section. However, a plan 

will not fail to satisfy the safe harbor 

matching contribution requirements of 

this section merely because an HCE 

participates during the plan year in 

more than one plan that provides for 

matching contributions, provided that—

(i) The HCE is not simultaneously an 

eligible employee under two plans that 

provide for matching contributions 

maintained by an employer for a plan 

year; and 

(ii) The period used to determine 

compensation for purposes of 

determining matching contributions 

under each such plan is limited to 

periods when the HCE participated in 

the plan. 

(6) Permissible restrictions on elective 

deferrals by NHCEs—(i) General rule. A 

plan does not satisfy the safe harbor 

requirements of this section, if elective 

deferrals or employee contributions by 

NHCEs are restricted, unless the 

restrictions are permitted by this 

paragraph (d)(6). 

(ii) Restrictions on election periods. A 

plan may limit the frequency and 

duration of periods in which eligible 

employees may make or change 

contribution elections under a plan. 

However, an employee must have a 

reasonable opportunity (including a 

reasonable period after receipt of the 

notice described in paragraph (e) of this 

section) to make or change a 

contribution election for the plan year. 

For purposes of this section, a 30-day 

period is deemed to be a reasonable 

period to make or change a contribution 

election. 

(iii) Restrictions on amount of 

contributions. A plan is permitted to 

limit the amount of contributions that 

may be made by an eligible employee 

under a plan, provided that each NHCE 

who is an eligible employee is permitted 

(unless the employee is restricted under 

paragraph (d)(6)(v) of this section) to 

make contributions in an amount that is 

at least sufficient to receive the 

maximum amount of matching 

contributions available under the plan 

for the plan year, and the employee is 

permitted to elect any lesser amount of 

contributions. However, a plan may 

require eligible employees to make 

contribution elections in whole 

percentages of compensation or whole 

dollar amounts. 

(iv) Restrictions on types of 

compensation that may be deferred. A 

plan may limit the types of 

compensation that may be deferred or 

contributed by an eligible employee 

under a plan, provided that each eligible 

NHCE is permitted to make 

contributions under a definition of 

compensation that would be a 

reasonable definition of compensation 

within the meaning of § 1.414(s)–1(d)(2). 

Thus, the definition of compensation 

from which contributions may be made 

is not required to satisfy the 

nondiscrimination requirement of 

§ 1.414(s)–1(d)(3). 

(v) Restrictions due to limitations 

under the Internal Revenue Code. A 

plan may limit the amount of 

contributions made by an eligible 

employee under a plan—

(A) Because of the limitations of 

section 402(g) or section 415; or

(B) Because, on account of a hardship 

distribution, an employee’s ability to 

make contributions has been suspended 

for 6 months in accordance with 

§ 1.401(k)–1(d)(3)(iv)(E). 

(e) Notice requirement. A plan 

satisfies the notice requirement of this 

paragraph (e) if it satisfies the notice 

requirement of § 1.401(k)–3(d). 

(f) Plan year requirement—(1) General 

rule. Except as provided in this 

paragraph (f) or in paragraph (g) of this 

section, a plan will fail to satisfy the 

requirements of section 401(m)(11) and 

this section unless plan provisions that 

satisfy the rules of this section are 

adopted before the first day of that plan 

year and remain in effect for an entire 

12-month plan year. In addition, except 

as provided in paragraph (h) of this 

section, a plan which includes 

provisions that satisfy the rules of this 

section will not satisfy the requirements 

of § 1.401(m)–1(b) if it is amended to 

change such provisions for that plan 

year. Moreover, if, as described in 

paragraph (j)(4) of this section, safe 

harbor matching or nonelective 

contributions will be made to another 

plan for a plan year, provisions under 

that other plan specifying that the safe 

harbor contributions will be made and 

providing that the contributions will be 

QNECs or QMACs must also be adopted 

before the first day of that plan year. 

(2) Initial plan year. A newly 

established plan (other than a successor 

plan within the meaning of § 1.401(m)–

2(c)(2)(iii)) will not be treated as 

violating the requirements of this 

paragraph (f) merely because the plan 

year is less than 12 months, provided 

that the plan year is at least 3 months 

long (or, in the case of a newly 

Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 78199

established employer that establishes 

the plan as soon as administratively 

feasible after the employer comes into 

existence, a shorter period). Similarly, a 

plan will not fail to satisfy the 

requirements of this paragraph (f) for the 

first plan year in which matching 

contributions are provided under the 

plan provided that—

(i) The plan is not a successor plan; 

and 

(ii) The amendment providing for 

matching contributions is made 

effective at the same time as the 

adoption of a cash or deferred 

arrangement that satisfies the 

requirements of § 1.401(k)–3, taking into 

account the rules of § 1.401(k)–3(e)(2). 

(3) Change of plan year. A plan that 

has a short plan year as a result of 

changing its plan year will not fail to 

satisfy the requirements of paragraph 

(f)(1) of this section merely because the 

plan year has less than 12 months, 

provided that—

(i) The plan satisfied the requirements 

of this section for the immediately 

preceding plan year; and 

(ii) The plan satisfies the 

requirements of this section (determined 

without regard to paragraph (h) of this 

section) for the immediately following 

plan year or for the immediately 

following 12 months if the immediately 

following plan year is less than 12 

months. 

(4) Final plan year. A plan that 

terminates during a plan year will not 

fail to satisfy the requirements of 

paragraph (f)(1) of this section merely 

because the final plan year is less than 

12 months, provided that the plan 

satisfies the requirement of this section 

through the date of termination and 

either—

(i) The plan would satisfy the 

requirements of paragraph (h) of this 

section, treating the termination of the 

plan as a reduction or suspension of safe 

harbor matching contributions, other 

than the requirement that employees 

have a reasonable opportunity to change 

their cash or deferred elections and, if 

applicable, employee contribution 

elections; or 

(ii) The plan termination is in 

connection with a transaction described 

in section 410(b)(6)(C) or the employer 

incurs a substantial business hardship, 

comparable to a substantial business 

hardship described in section 412(d). 

(g) Plan amendments adopting 

nonelective safe harbor contributions.

Notwithstanding paragraph (f)(1) of this 

section, a plan that provides for the use 

of the current year testing method may 

be amended after the first day of the 

plan year and no later than 30 days 

before the last day of the plan year to 

adopt the safe harbor method of this 

section, effective as of the first day of 

the plan year, using nonelective 

contributions under paragraph (b) of 

this section if the plan satisfies the 

requirements of § 1.401(k)–3(f). 

(h) Permissible reduction or 

suspension of safe harbor matching 

contributions—(1) General rule. A plan 

that provides for safe harbor matching 

contributions will not fail to satisfy the 

requirements of section 401(m)(2) for a 

plan year merely because the plan is 

amended during a plan year to reduce 

or suspend safe harbor matching 

contributions on future elective 

deferrals and, if applicable, employee 

contributions provided—

(i) All eligible employees are provided 

the supplemental notice in accordance 

with paragraph (h)(2) of this section; 

(ii) The reduction or suspension of 

safe harbor matching contributions is 

effective no earlier than the later of 30 

days after eligible employees are 

provided the notice described in 

paragraph (h)(2) of this section and the 

date the amendment is adopted; 

(iii) Eligible employees are given a 

reasonable opportunity (including a 

reasonable period after receipt of the 

supplemental notice) prior to the 

reduction or suspension of safe harbor 

matching contributions to change their 

cash or deferred elections and, if 

applicable, their employee contribution 

elections; 

(iv) The plan is amended to provide 

that the ACP test will be satisfied for the 

entire plan year in which the reduction 

or suspension occurs using the current 

year testing method described in 

§ 1.401(m)–2(a)(1)(ii); and 

(v) The plan satisfies the requirements 

of this section (other than this paragraph 

(h)) with respect to amounts deferred 

through the effective date of the 

amendment. 

(2) Notice of suspension requirement.

The notice of suspension requirement of 

this paragraph (h)(2) is satisfied if each 

eligible employee is given notice that 

satisfies the requirements of § 1.401(k)–

3(g)(2). 

(i) [Reserved] 

(j) Other rules—(1) Contributions 

taken into account. A contribution is 

taken into account for purposes of this 

section for a plan year under the same 

rules as § 1.401(k)–3(h)(1). 

(2) Use of safe harbor nonelective 

contributions to satisfy other 

nondiscrimination tests. A safe harbor 

nonelective contribution used to satisfy 

the nonelective contribution 

requirement under paragraph (b) of this 

section may also be taken into account 

for purposes of determining whether a 

plan satisfies section 401(a)(4) under the 

same rules as § 1.401(k)–3(h)(2). 

(3) Early participation rules. Section 

401(m)(5)(C) and § 1.401(m)–

2(a)(1)(iii)(A) which provide an 

alternative nondiscrimination rule for 

certain plans that provide for early 

participation, does not apply for 

purposes of section 401(m)(11) and this 

section. Thus, a plan is not treated as 

satisfying this section with respect to 

the eligible employees who have not 

completed the minimum age and service 

requirements of section 410(a)(1)(A) 

unless the plan satisfies the 

requirements of this section with 

respect to such eligible employees. 

(4) Satisfying safe harbor contribution 

requirement under another defined 

contribution plan. Safe harbor matching 

or nonelective contributions may be 

made to another defined contribution 

plan under the same rules as § 1.401(k)–

3(h)(4). Consequently, each NHCE under 

the plan providing for matching 

contributions must be eligible under the 

same conditions under the other defined 

contribution plan and the plan to which 

the contributions are made must have 

the same plan year as the plan providing 

for matching contributions. 

(5) Contributions used only once. Safe 

harbor matching or nonelective 

contributions cannot be used to satisfy 

the requirements of this section with 

respect to more than one plan. 

(6) Plan must satisfy ACP with respect 

to employee contributions. If the plan 

provides for employee contributions, in 

addition to satisfying the requirements 

of this section, it must also satisfy the 

ACP test of § 1.401(m)–2. See 

§ 1.401(m)–2(a)(5)(iv) for special rules 

under which the ACP test is permitted 

to be performed disregarding some or all 

matching when this section is satisfied 

with respect to the matching 

contributions.

§ 1.401(m)–4 Special rules for mergers, 

acquisitions and similar events. [Reserved]

§ 1.401(m)–5 Definitions. 

Unless otherwise provided, the 

definitions of this section govern for 

purposes of section 401(m) and the 

regulations thereunder. 

Actual contribution percentage (ACP).

Actual contribution percentage or ACP

means the ACP of the group of eligible 

employees as defined in § 1.401(m)–

2(a)(2)(i). 

Actual contribution percentage (ACP) 

test. Actual contribution percentage test

or ACP test means the test described in 

§ 1.401(m)–2(a)(1). 

Actual contribution ratio (ACR).

Actual contribution ratio or ACR means 

the ACR of an eligible employee as 

defined in § 1.401(m)–2(a)(3). 

78200 Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 

Actual deferral percentage (ADP) test.

Actual deferral percentage test or ADP 

test means the test described in 

§ 1.401(k)–2(a)(1). 

Compensation. Compensation means 

compensation as defined in section 

414(s) and § 1.414(s)–1. The period used 

to determine an employee’s 

compensation for a plan year must be 

either the plan year or the calendar year 

ending within the plan year. Whichever 

period is selected must be applied 

uniformly to determine the 

compensation of every eligible 

employee under the plan for that plan 

year. A plan may, however, limit the 

period taken into account under either 

method to that portion of the plan year 

or calendar year in which the employee 

was an eligible employee, provided that 

this limit is applied uniformly to all 

eligible employees under the plan for 

the plan year. See also section 

401(a)(17) and § 1.401(a)(17)–1(c)(1). For 

this purpose, in case of an HCE whose 

ACR is determined under § 1.401(m)–

2(a)(3)(ii), period of participation 

includes periods under another plan for 

which matching contributions or 

employee contributions are aggregated 

under § 1.401(m)–2(a)(3)(ii). 

Current year testing method. Current 

year testing method means the testing 

method under which the applicable year 

is the current plan year, as described in 

§ 1.401(k)–2(a)(2)(ii) or 1.401(m)–

2(a)(2)(ii) 

Elective contributions. Elective 

contributions means elective 

contributions as defined in § 1.401(k)–6. 

Elective deferrals. Elective deferrals

means elective deferrals described in 

section 402(g)(3). 

Eligible employee—(1) General rule.

Eligible employee means an employee 

who is directly or indirectly eligible to 

make an employee contribution or to 

receive an allocation of matching 

contributions (including matching 

contributions derived from forfeitures) 

under the plan for all or a portion of the 

plan year. For example, if an employee 

must perform purely ministerial or 

mechanical acts (e.g., formal application 

for participation or consent to payroll 

withholding) in order to be eligible to 

make an employee contribution for a 

plan year, the employee is an eligible 

employee for the plan year without 

regard to whether the employee 

performs these acts. 

(2) Conditions on eligibility. An 

employee who is unable to make 

employee contributions or to receive an 

allocation of matching contributions 

because the employee has not 

contributed to another plan is also an 

eligible employee. By contrast, if an 

employee must perform additional 

service (e.g., satisfy a minimum period 

of service requirement) in order to be 

eligible to make an employee 

contribution or to receive an allocation 

of matching contributions for a plan 

year, the employee is not an eligible 

employee for the plan year unless the 

service is actually performed. An 

employee who would be eligible to 

make employee contributions but for a 

suspension due to a distribution, a loan, 

or an election not to participate in the 

plan, is treated as an eligible employee 

for purposes of section 401(m) for a plan 

year even though the employee may not 

make employee contributions or receive 

an allocation of matching contributions 

by reason of the suspension. Finally, an 

employee does not fail to be treated as 

an eligible employee merely because the 

employee may receive no additional 

annual additions because of section 

415(c)(1). 

(3) Certain one-time elections. An 

employee is not an eligible employee 

merely because the employee, no later 

than the employee’s first becoming 

eligible under any plan or arrangement 

described in section 219(g)(5)(A) and 

providing for employee or matching 

contributions, is given a one-time 

opportunity to elect, and the employee 

in fact does elect, not to be eligible to 

make employee contributions or to 

receive allocations of matching 

contributions under the plan or any 

other plan or arrangement maintained 

by the employer (including plans not 

yet established) for the duration of the 

employee’s employment with the 

employer. In no event is an election 

made after December 23, 1994, treated 

as a one-time irrevocable election under 

this paragraph if the election is made by 

an employee who previously became 

eligible under another plan or 

arrangement (whether or not 

terminated) of the employer. 

Eligible HCE. Eligible HCE means an 

eligible employee who is an HCE. 

Eligible NHCE. Eligible NHCE means 

an eligible employee who is not an HCE. 

Employee. Employee means an 

employee within the meaning of 

§ 1.410(b)–9. 

Employee contributions. Employee 

contributions means employee 

contributions as defined in § 1.401(m)–

1(a)(3). 

Employee stock ownership plan 

(ESOP). Employee stock ownership plan

or ESOP the portion of a plan that is an 

ESOP within the meaning of § 1.410(b)–

7(c)(2). 

Employer. Employer means an 

employer within the meaning of 

§ 1.410(b)–9. 

Excess aggregate contributions. Excess 

aggregate contributions means, with 

respect to a plan year, the amount of 

excess aggregate contributions 

apportioned to an HCE under 

§ 1.401(m)–2(b)(2)(iii). 

Excess contributions. Excess 

contributions means with respect to a 

plan year, the amount of excess 

contributions apportioned to an HCE 

under § 1.401(k)–2(b)(2)(iii). 

Excess deferrals. Excess deferrals

means excess deferrals as defined in 

§ 1.402(g)–1(e)(3). 

Highly compensated employee (HCE).

Highly compensated employee or HCE

has the meaning provided in section 

414(q). 

Matching contributions. Matching 

contribution is defined in § 1.401(m)–

1(a)(2). 

Nonelective contributions.

Nonelective contributions means 

employer contributions (other than 

matching contributions) with respect to 

which the employee may not elect to 

have the contributions paid to the 

employee in cash or other benefits 

instead of being contributed to the plan. 

Non-employee stock ownership plan 

(non-ESOP). Non-employee stock 

ownership plan or non-ESOP means the 

portion of a plan that is not an ESOP 

within the meaning of § 1.410(b)–7(c)(2). 

Non-highly compensated employee 

(NHCE). Non-highly compensated 

employee or NHCE means an employee 

who is not an HCE. 

Plan. Plan means plan as defined in 

§ 1.401(m)–1(b)(4).

Prior year testing method. Prior year 

testing method means the testing 

method under which the applicable year 

is the prior plan year, as described in 

§ 1.401(k)–2(a)(2)(ii) or 1.401(m)–

2(a)(2)(ii) 

Qualified matching contributions 

(QMAC). Qualified matching 

contributions or QMAC means matching 

contributions that satisfy the 

requirements of § 1.401(k)–1(c) and (d) 

at the time the contribution is made, 

without regard to whether the 

contributions are actually taken into 

account as elective contributions under 

§ 1.401(k)–2(a)(6). See also § 1.401(k)–

2(b)(4)(iii) for a rule providing that a 

matching contribution does not fail to 

qualify as a QMAC solely because it is 

forfeitable under section 411(a)(3)(G) 

because it is a matching contribution 

with respect to an excess deferral, 

excess contribution, or excess aggregate 

contribution. 

Qualified nonelective contributions 

(QNEC). Qualified nonelective 

contributions or QNEC means employer 

contributions, other than elective 

contributions or matching contributions, 

that satisfy the requirements of 

§ 1.401(k)–1(c) and (d) at the time the 

Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 / Rules and Regulations 78201

contribution is made, without regard to 

whether the contributions are actually 

taken into account under the ADP test 

under § 1.401(k)–2(a)(6) or the ADP test 

under § 1.401(m)–2(a)(6).

PART 602—OMB CONTROL NUMBERS 

UNDER THE PAPERWORK 

REDUCTION ACT

■ Par. 6. The authority citation for part 

602 continues to read as follows:

Authority: 26 U.S.C. 7808.

■ Par. 7. In § 602.101, paragraph (b) is 

amended by revising the entry for 

‘‘1.401(k)–1’’ to read as follows:

§ 602.101 OMB Control numbers.

* * * * *

(b) * * *

CFR part or section where 

identified and described 

Current OMB 

control No. 

* * * * * 

1.401(k)–1 ............................. 1545–1039 

1545–1069 

1545–1669 

* * * * * 

■ Par. 8. In § 602.101, paragraph (b) is 

amended by adding entries in numerical 

order to the table to read, in part, as 

follows:

§ 602.101 OMB Control numbers.

* * * * *

(b) * * *

CFR part or section where 

identified and described 

Current OMB 

control No. 

*****

1.401(k)–2 ............................. 1545–1669 

1.401(k)–3 ............................. 1545–1669 

1.401(k)–4 ............................. 1545–1669 

*****

1.401(m)–3 ........................... 1545–1699 

*****

Mark E. Matthews, 

Deputy Commissioner for Services and 

Enforcement. 

Approved: December 15, 2004. 

Gregory F. Jenner, 

Acting Assistant Secretary of the Treasury.

[FR Doc. 04–28011 Filed 12–28–04; 8:45 am] 

BILLING CODE 4830–01–P