[Federal Register Volume 65, Number 195 (Friday, October 6, 2000)]
[Proposed Rules]
[Pages 59774-59780]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-25652]



[[Page 59774]]

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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-114697-00]
RIN 1545-AY36


Nondiscrimination Requirements for Certain Defined Contribution 
Retirement Plans

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

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SUMMARY: This document contains proposed regulations that would 
prescribe conditions under which certain defined contribution 
retirement plans (sometimes referred to as ``new comparability'' plans) 
are permitted to demonstrate compliance with applicable 
nondiscrimination requirements based on plan benefits rather than plan 
contributions. This document also provides notice of a public hearing 
on these proposed regulations.

DATES: Written comments, requests to speak and outlines of oral 
comments to be discussed at the public hearing scheduled for January 
25, 2001, at 10 a.m., must be received by January 5, 2001.

ADDRESSES: Send submissions to: CC:M&SP:RU (REG-114697-00) room 5226, 
Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, 
DC 20044. Submissions may be hand delivered Monday through Friday 
between the hours of 8 a.m. and 5 p.m. to: CC:M&SP:RU (REG-114697-00), 
Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue NW., 
Washington, DC. Alternatively, taxpayers may submit comments 
electronically via the Internet by selecting the ``Tax Regs'' option of 
the IRS Home Page, or by submitting comments directly to the IRS 
Internet site at: http://www.irs.gov/tax_regs/reglist.html. The public 
hearing will be held in the IRS Auditorium (7th Floor), Internal 
Revenue Building, 1111 Constitution Avenue NW., Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, John T. 
Ricotta, 202-622-6060 or Linda S. F. Marshall, 202-622-6090; concerning 
submissions and the hearing, and/or to be placed on the building access 
list to attend the hearing, Sonya Cruse, 202-622-7180 (not toll-free 
numbers).

SUPPLEMENTARY INFORMATION:

Background

    This document contains proposed amendments to 26 CFR part 1 under 
section 401(a)(4) of the Internal Revenue Code of 1986 (Code).
    Section 401(a)(4) provides that a plan or trust forming part of a 
stock bonus, pension or profit-sharing plan of an employer shall not 
constitute a qualified plan under section 401(a) of the Code unless the 
contributions or benefits provided under the plan do not discriminate 
in favor of highly compensated employees (HCEs) (within the meaning of 
section 414(q)). Whether a plan satisfies this requirement depends on 
the form of the plan and its effect in operation.
    Section 415(b)(6)(A) provides that the computation of benefits 
under a defined contribution plan, for purposes of section 401(a)(4), 
shall not be made on a basis inconsistent with regulations prescribed 
by the Secretary. The legislative history of this provision explains 
that, in the case of target benefit and other defined contribution 
plans, ``regulations may establish reasonable earnings assumptions and 
other factors for these plans to prevent discrimination.'' Conf. Rep. 
No. 1280, 93d Cong., 2d Sess. 277 (1974).
    Under the section 401(a)(4) regulations, a plan can demonstrate 
that either the contributions or the benefits provided under the plan 
are nondiscriminatory in amount. Defined contribution plans generally 
satisfy the regulations by demonstrating that contributions are 
nondiscriminatory in amount, through certain safe harbors provided for 
under the regulations or through general testing.
    A defined contribution plan (other than an ESOP) may, however, 
satisfy the regulations on the basis of benefits by using ``cross-
testing'' pursuant to rules provided in Sec. 1.401(a)(4)-8 of the 
regulations. Under this cross-testing method, contributions are 
converted to equivalent benefits payable at normal retirement age and 
tested on the basis of these equivalent benefits. The conversion is 
done by making an actuarial projection of the benefits payable at 
normal retirement age that are attributable to the contributions. Thus, 
this cross-testing method effectively permits nonelective employer 
contributions under a defined contribution plan to be tested on the 
basis of the benefits attributable to those contributions, in a manner 
similar to the testing of employer-provided benefits under a defined 
benefit plan.
    In Notice 2000-14 (2000-10 I.R.B. 737), released February 24, 2000, 
the IRS and the Treasury Department initiated a review of issues 
related to use of the cross-testing method by so-called ``new 
comparability plans'' and requested public comments on this plan design 
from plan sponsors, plan participants and other interested parties. In 
general, new comparability plans are defined contribution plans that 
have built-in disparities between the allocation rates for 
classifications of participants consisting entirely or predominately of 
HCEs and the allocation rates for other employees.
    In a typical new comparability plan, HCEs receive high allocation 
rates, while nonhighly compensated employees (NHCEs), regardless of 
their age or years of service, receive comparatively low allocation 
rates. For example, HCEs in such a plan might receive allocations of 18 
or 20% of compensation, while NHCEs might receive allocations of 3% of 
compensation. A similar plan design, sometimes known as a ``super-
integrated'' plan, provides for an additional allocation rate that 
applies only to compensation in excess of a specified threshold, but 
the specified threshold (e.g., $100,000) or the additional allocation 
rate (e.g., 10%) is higher than the maximum threshold and rate allowed 
under the permitted disparity rules of section 401(l).
    These new comparability and similar plans rely on the cross-testing 
method to demonstrate compliance with the nondiscrimination rules by 
comparing the actuarially projected value of the employer contributions 
for the younger NHCEs with the actuarial projections of the larger 
contributions (as a percentage of compensation) for the older HCEs. As 
a result, these plans are able generally to provide higher rates of 
employer contributions to HCEs, while NHCEs are not allowed to earn the 
higher allocation rates as they work additional years for the employer 
or grow older. Notwithstanding the analytical underpinnings of cross-
testing, the IRS and the Treasury Department are concerned whether new 
comparability and similar plans are consistent with the basic purpose 
of the nondiscrimination rules under section 401(a)(4).
    A variety of public comments were submitted in response to Notice 
2000-14. Some comments expressed the view that changes in the 
application of the nondiscrimination rules to new comparability plans 
are unnecessary. These comments noted that in some cases such plans are 
adopted by employers that previously had no retirement plan for their 
employees. At the same time, many of these comments advanced 
suggestions as to the types of

[[Page 59775]]

conditions that might be imposed on new comparability plans if changes 
in the rules are in fact proposed.
    Other comments expressed the view that the rules need to be changed 
to increase the contributions made for NHCEs in new comparability plans 
and similar tax-qualified plan designs. These comments suggested 
various methods for ensuring that NHCEs receive larger allocations of 
employer contributions under new comparability plans, including 
imposing a maximum ratio of the allocation rates for HCEs to those for 
NHCEs or requiring a minimum allocation rate for the NHCEs.
    Still other comments questioned the policy justification for 
permitting new comparability plans under the nondiscrimination rules 
governing tax-qualified plans because new comparability plan designs 
often provide such an overwhelming percentage of total plan allocations 
to HCEs, with only a modest percentage of the plan allocations going to 
the NHCEs. Some of these comments expressed concern that new 
comparability plans in some instances have been marketed as a technique 
for limiting most employees to lower allocation rates than they would 
receive under other defined contribution plan designs (such as salary 
ratio or age-weighted) and allocating the difference to one or more 
HCEs. They noted that, in some cases, the percentage of total plan 
allocations provided to the HCEs can exceed 90%.
    After consideration of the comments received, the IRS and Treasury 
are issuing these proposed regulations, which would prescribe 
conditions that new comparability and similar plans must satisfy if 
they are to use the cross-testing method. The proposed regulations 
preserve the existing cross-testing rules of the section 401(a)(4) 
regulations, and would not affect cross-tested defined contribution 
plans that provide broadly available allocation rates, as defined in 
the proposed regulations. The definition of broadly available 
allocation rates includes plans that base allocations or allocation 
rates on age or service. In contrast to new comparability plans, these 
plans provide an opportunity for participants to ``grow into'' higher 
allocation rates as they age or accumulate additional service.
    These proposed regulations would continue to permit new 
comparability plans. As suggested in various comments, the proposed 
regulations would set forth a minimum allocation ``gateway'' that would 
constrain the plan designs with the greatest disparity in favor of 
HCEs, while leaving many new comparability plan designs unchanged. A 
new comparability plan that satisfies the minimum allocation gateway 
could continue to use the existing cross-testing rules of the section 
401(a)(4) regulations.
    The proposed regulations also would prevent circumvention of the 
minimum allocation gateway by aggregating (for purposes of satisfying 
the nondiscrimination rules) a new comparability defined contribution 
plan with a defined benefit plan that provides only minimal benefits or 
covers only a relatively small number of the employees, or by 
aggregating a defined contribution plan with a defined benefit plan 
that benefits primarily HCEs. However, an aggregated defined 
contribution and defined benefit plan that is primarily defined benefit 
in character (as defined in the proposed regulations) could test for 
nondiscrimination on the basis of benefits in the same manner as under 
current law. Similarly, the ability to test for nondiscrimination on a 
benefits basis as under current law would be unrestricted if each of 
the defined contribution and defined benefit portions of the aggregated 
plan is a broadly available separate plan (as defined in the proposed 
regulations).
    The proposed regulations would not affect defined benefit plans 
except where a defined contribution plan is aggregated with a defined 
benefit plan for nondiscrimination purposes and thus is a part of a DB/
DC plan (as defined in Sec. 1.401(a)(4)-9). The proposed regulations 
would not apply merely because a plan sponsor maintains both a defined 
contribution plan and a defined benefit plan. The proposed regulations 
would not require aggregation of a defined contribution plan with a 
defined benefit plan or otherwise modify the existing rules regarding 
when plans are required or permitted to be aggregated.

Explanation of Provisions

A. Overview

    The basic structure of the proposed regulations permits defined 
contribution plans with broadly available allocation rates to test on a 
benefits basis (``cross-test'') in the same manner as under current 
law, and permits other defined contribution plans to cross-test once 
they pass a gateway that prescribes minimum allocation rates for NHCEs. 
Similarly, the proposed regulations permit a DB/DC plan to test on a 
benefits basis in the same manner as under current law if the DB/DC 
plan either is primarily defined benefit in character or consists of 
broadly available separate plans. Other DB/DC plans are permitted to 
test on a benefits basis once they pass a corresponding gateway 
prescribing minimum aggregate normal allocation rates for NHCEs.

B. Gateway for Cross-Testing of New Comparability and Similar Plans

    The proposed regulations would require that a defined contribution 
plan that does not provide broadly available allocation rates (as 
defined in these proposed regulations) satisfy a gateway in order to be 
eligible to use the cross-testing rules to meet the nondiscrimination 
requirements of section 401(a)(4). A plan would satisfy this minimum 
allocation gateway if each NHCE in the plan has an allocation rate that 
is at least one third of the allocation rate of the HCE with the 
highest allocation rate; \1\ however, a plan would be deemed to satisfy 
this minimum allocation gateway if each NHCE received an allocation of 
at least 5% of the NHCE's compensation (within the meaning of section 
415(c)(3)).
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    \1\ For example, if any HCE had an allocation of 12% of 
compensation, all NHCEs in the plan would be required to have an 
allocation of at least 4% of compensation.
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    The proposed regulations would not change the general rule 
prohibiting aggregation of a 401(k) plan or 401(m) plan with a plan 
providing nonelective contributions. Accordingly, elective 
contributions and matching contributions would not be taken into 
account for purposes of the gateway. If an employer also provides a 
401(k) plan, however, then to the extent the HCEs are electing 
contributions under that plan, the highest HCE allocation rate may be 
lower than it otherwise would be, which, in turn would lower the 
minimum required allocation for the NHCEs under the gateway. Further, 
if the employer sponsors a safe harbor 401(k) plan that provides for 3% 
nonelective contributions, then, as noted in Notice 98-52 (1998-2 C.B. 
634), those nonelective contributions may be taken into account in 
determining the allocation rates for the NHCEs under section 401(a)(4), 
including the minimum allocation gateway.

C. Plans With Broadly Available Allocation Rates

    As suggested in Notice 2000-14, a plan that has broadly available 
allocation rates would not need to satisfy the minimum allocation 
gateway and may continue to be tested for nondiscrimination on the 
basis of benefits as under current law. In order to be broadly 
available, each allocation rate under the plan must be currently 
available to a group of employees that

[[Page 59776]]

satisfies section 410(b) (without regard to the average benefit 
percentage test). Thus, for example, if within one plan an employer 
provides different allocation rates for nondiscriminatory groups of 
employees at different locations or different profit centers, the plan 
would not need to satisfy the minimum allocation gateway in order to 
use cross testing.
    In addition, a plan that provides allocation rates that increase as 
an employee ages or accumulates additional service would be treated as 
having broadly available allocation rates, if the schedule of 
allocation rates satisfies certain conditions that permit participants 
to ``grow into'' higher allocation rates. The conditions are that the 
same schedule of allocation rates is available to all employees in the 
plan and that the schedule provides for smoothly increasing allocation 
rates at regular intervals of age or service.
    The proposed regulation would provide that in order for a schedule 
of allocation rates to increase smoothly, the allocation rate for each 
age or service band cannot be more than 5 percentage points higher than 
the allocation rate for the immediately preceding band and cannot be 
more than twice that allocation rate. For example, if the allocation 
rate for an age or service band were 6%, the allocation rate for the 
next higher age or service band could not exceed 11% (i.e., the lesser 
of 11% (6% plus 5%) and 12% (2 times 6%)).
    Further, in order for a schedule of allocation rates to be 
considered to be increasing smoothly, the ratio of the allocation rate 
for any age or service band to the allocation rate for the immediately 
preceding band cannot exceed the ratio of the allocation rates between 
the two immediately preceding bands. The proposed regulations would 
provide that the intervals for the age or service bands are regular if 
they are all of the same length (although this requirement generally 
would not apply to the first and last bands).
    The definition of broadly available allocation rates is designed to 
be sufficiently flexible to accommodate a wide variety of age- and 
service-based plans (including age-weighted profit-sharing plans that 
provide for allocations that result in the same equivalent accrual rate 
for all employees).
    The conditions described above relating to a plan's schedule of 
age-based or service-based allocation rates are intended to exempt from 
the minimum allocation gateway those plans in which NHCEs actually 
receive the benefit of higher rates as they attain higher ages or 
complete additional years of service. Without conditions such as these, 
plans can be designed to backload allocation rates excessively, 
providing for lengthy plateau periods in which rates increase little if 
at all, followed by sharp increases.
    Comments are invited on whether there are plans using schedules of 
allocation rates (such as schedules of rates based on points or 
otherwise combining age and service) that would fall outside the 
definition of broadly available allocation rates but that do afford 
sufficient opportunity for NHCEs to ``grow into'' higher allocation 
rates.

D. Application to Defined Contribution Plans That Are Combined With 
Defined Benefit Plans

    The proposed regulations would prescribe rules for testing defined 
contribution plans that are aggregated with defined benefit plans for 
purposes of sections 401(a)(4) and 410(b). These rules would apply in 
situations in which the employer aggregates the plans because one of 
the plans does not satisfy sections 401(a)(4) and 410(b) standing 
alone.
1. Gateway for Benefits Testing of Combined Plans
    Under the proposed regulations, the combination of a defined 
contribution plan and a defined benefit plan may demonstrate 
nondiscrimination on the basis of benefits if the combined plan is 
primarily defined benefit in character, consists of broadly available 
separate plans (as these terms are defined in the proposed 
regulations), or satisfies a gateway requirement. This minimum 
aggregate allocation gateway is generally similar to the minimum 
allocation gateway for defined contribution plans that are not combined 
with a defined benefit plan. To apply this minimum aggregate allocation 
gateway, the employee's aggregate normal allocation rate is determined 
by adding the employee's allocation under the defined contribution plan 
to the employee's equivalent allocation under the defined benefit plan. 
The use of aggregation would allow an employer that provides both a 
defined contribution and a defined benefit plan to the NHCEs to take 
both plans into account in determining whether the minimum aggregate 
allocation gateway is met.
    Under the gateway, if the aggregate normal allocation rate of the 
HCE with the highest aggregate normal allocation rate under the plan 
(HCE rate) is less than 15%, the aggregate normal allocation rate for 
all NHCEs must be at least \1/3\ of the HCE rate. If the HCE rate is 
between 15% and 25%, the aggregate normal allocation rate for all NHCEs 
must be at least 5%. If the HCE rate exceeds 25%, then the aggregate 
normal allocation rate for each NHCE must be at least 5% plus one 
percentage point for each 5-percentage-point increment (or portion 
thereof) by which the HCE rate exceeds 25% (e.g., the NHCE minimum is 
6% for an HCE rate that exceeds 25% but not 30%, and 7% for an HCE rate 
that exceeds 30% but not 35%, etc.).
    In addition, in determining the equivalent allocation rate for an 
NHCE under a defined benefit plan, a plan is permitted to treat each 
NHCE who benefits under the defined benefit plan as having an 
equivalent allocation rate equal to the average of the equivalent 
allocation rates under the defined benefit plan for all NHCEs 
benefitting under that plan. This averaging rule recognizes the ``grow-
in'' feature inherent in traditional defined benefit plans (i.e., the 
defined benefit plan provides higher equivalent allocation rates at 
higher ages).
    Comments are invited on possible special situations involving DB/DC 
plans, such as situations arising as a result of a merger or 
acquisition or a situation in which some HCEs in a DB/DC plan have 
unusually high equivalent normal allocation rates for reasons other 
than the design of the plan. Comments are invited as to whether the 
regulations should address such special circumstances and, if so, how 
(e.g., through a maximum required rate for NHCEs under a DB/DC plan or 
other approaches).
2. Primarily Defined Benefit in Character
    A combined plan that is primarily defined benefit in character 
would not be subject to the gateway requirement and may continue to be 
tested for nondiscrimination on the basis of benefits as under current 
law. A combined plan would be primarily defined benefit in character 
if, for more than 50% of the NHCEs benefitting under the plan, the 
normal accrual rate attributable to benefits provided under defined 
benefit plans for the NHCE exceeds the equivalent accrual rate 
attributable to contributions under defined contribution plans for the 
NHCE. For example, a DB/DC plan would be primarily defined benefit in 
character where the defined contribution plan covers only salaried 
employees, the defined benefit plan covers only hourly employees, and 
more than half of the NHCEs participating in the DB/DC plan are hourly 
employees participating only in the defined benefit plan.

[[Page 59777]]

3. Broadly Available Separate Plans
    A combined plan that consists of broadly available separate plans 
would not be subject to the gateway requirement and may continue to be 
tested for nondiscrimination on the basis of benefits as under current 
law. A DB/DC plan consists of broadly available separate plans if the 
defined contribution plan and the defined benefit plan each would 
satisfy the requirements of section 410(b) and the nondiscrimination in 
amount requirement of Sec. 1.401(a)(4)-1(b)(2) if each plan were tested 
separately, assuming satisfaction of the average benefit percentage 
test of Sec. 1.410(b)-5. Thus, the defined contribution plan must 
separately satisfy the nondiscrimination requirements (taking into 
account these proposed regulations as applicable), but for this purpose 
assuming satisfaction of the average benefit percentage test. 
Similarly, the defined benefit plan must separately satisfy the 
nondiscrimination requirements, assuming for this purpose satisfaction 
of the average benefit percentage test. In conducting the required 
separate testing, all plans of a single type (defined contribution or 
defined benefit) within the DB/DC plan are aggregated, but those plans 
are tested without regard to plans of the other type.
    This alternative would be useful, for example, where an employer 
maintains a defined contribution plan that provides a uniform 
allocation rate for all covered employees at one business unit and a 
safe harbor defined benefit plan for all covered employees at another 
unit, where the group of employees covered by each plan is a group that 
satisfies the nondiscriminatory classification requirement of section 
410(b). Because the employer provides broadly available separate plans, 
it may continue to aggregate the plans and test for nondiscrimination 
on the basis of benefits, as an alternative to using the qualified 
separate line of business rules or demonstrating satisfaction of the 
average benefit percentage test.

E. Use of Component Plans and Permitted Disparity

    Component plans under the restructuring rules cannot be used for 
the determination of whether a defined contribution plan provides 
broadly available allocation rates or satisfies the minimum allocation 
gateway, or the determination of whether a DB/DC plan satisfies the 
minimum aggregate allocation gateway, is primarily defined benefit in 
character, or consists of broadly available separate plans. For 
purposes of the two gateways and determining whether a DB/DC plan is 
primarily defined benefit in character, allocation rates and equivalent 
allocation rates are determined without the use of permitted disparity. 
For purposes of determining whether a DB/DC plan consists of broadly 
available separate plans, permitted disparity may be used in the 
defined contribution plan or the defined benefit plan but not in both 
plans with respect to each employee who participates in both.

Proposed Effective Date

    The regulations are proposed to be applicable for plan years 
beginning on or after January 1, 2002.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in Executive Order 
12866. Therefore, a regulatory assessment is not required. It also has 
been determined that section 553(b) of the Administrative Procedure Act 
(5 U.S.C. chapter 5) does not apply to these regulations, and because 
the regulation does not impose a collection of information on small 
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not 
apply. Pursuant to section 7805(f) of the Code, these proposed 
regulations will be submitted to the Chief Counsel for Advocacy of the 
Small Business Administration for comment on their impact on small 
business.

Comments and Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any electronic or written comments 
(preferably a signed original and eight (8) copies) that are submitted 
timely to the IRS. In addition to the other requests for comments set 
forth in this document, the IRS and Treasury also request comments on 
the clarity of the proposed rule and how it may be made easier to 
understand. All comments will be available for public inspection and 
copying.
    A public hearing has been scheduled for January 25, 2001, at 10 
a.m. in the IRS Auditorium (7th Floor), Internal Revenue Building, 1111 
Constitution Avenue NW., Washington, DC. Due to building security 
procedures, visitors must enter at the 10th street entrance, located 
between Constitution and Pennsylvania Avenues, NW. In addition, all 
visitors must present photo identification to enter the building. 
Because of access restrictions, visitors will not be admitted beyond 
the immediate entrance area more than 15 minutes before the hearing 
starts. For information about having your name placed on the building 
access list to attend the hearing, see the FOR FURTHER INFORMATION 
CONTACT section of this preamble.
    The rules of 26 CFR 601.601(a)(3) apply to the hearing.
    Persons who wish to present oral comments at the hearing must 
submit written comments and submit an outline of the topics to be 
discussed and the time to be devoted to each topic (signed original and 
eight (8) copies) by January 5, 2001.
    A period of 10 minutes will be allotted to each person for making 
comments.
    An agenda showing the scheduling of the speakers will be prepared 
after the deadline for receiving outlines has passed. Copies of the 
agenda will be available free of charge at the hearing.

Drafting Information

    The principal authors of these regulations are John T. Ricotta and 
Linda S. F. Marshall of the Office of the Division Counsel/Associate 
Chief Counsel (Tax Exempt and Government Entities). However, other 
personnel from the IRS and Treasury participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805 * * *
    Par. 2. In Sec. 1.401(a)(4)-8, paragraph (b)(1) is revised to read 
as follows:


Sec. 1.401(a)(4)-8  Cross-testing.

* * * * *
    (b) Nondiscrimination in amount of benefits provided under a 
defined contribution plan--(1) General rule and gateway--(i) General 
rule. Equivalent benefits under a defined contribution plan (other than 
an ESOP) are nondiscriminatory in amount for a plan year if--
    (A) The plan would satisfy Sec. 1.401(a)(4)-2(c)(1) for the plan 
year if an equivalent accrual rate, as determined under paragraph 
(b)(2) of this section, were substituted for each employee's allocation 
rate in the determination of rate groups; and

[[Page 59778]]

    (B) For plan years beginning on or after January 1, 2002, if the 
plan does not have broadly available allocation rates (within the 
meaning of paragraph (b)(1)(iii) of this section) for the plan year, 
the plan satisfies the minimum allocation gateway of paragraph 
(b)(1)(iv) of this section for the plan year.
    (ii) Allocations after testing age. A plan does not fail to satisfy 
paragraph (b)(1)(i)(A) of this section merely because allocations are 
made at the same rate for employees who are older than their testing 
age (determined without regard to the current-age rule in paragraph (4) 
of the definition of testing age in Sec. 1.401(a)(4)-12), as they are 
made for employees who are at that age.
    (iii) Broadly available allocation rates--(A) In general. A plan 
has broadly available allocation rates for the plan year if each 
allocation rate under the plan is currently available during the plan 
year (within the meaning of Sec. 1.401(a)(4)-4(b)(2)), to a group of 
employees that satisfies section 410(b) (without regard to the average 
benefit percentage test of Sec. 1.410(b)-5). For this purpose, the 
disregard of age and service conditions described in Sec. 1.401(a)(4)-
4(b)(2)(ii)(A) applies only if the plan provides an allocation formula 
under which the allocation rates for all employees benefitting under 
the plan are determined using a single schedule of rates that are based 
solely on either age or service, and only if the allocation rates under 
the schedule increase smoothly at regular intervals, within the meaning 
of paragraphs (b)(1)(iii)(B) and (C) of this section. A plan does not 
fail to provide broadly available allocation rates merely because it 
provides the minimum benefit described in section 416(c)(2).
    (B) Smoothly increasing schedule of allocation rates. A plan uses a 
single schedule of allocation rates that are based solely on age or 
service if it uses a single schedule of allocation rates that consists 
of a series of either age or service bands under which the same 
allocation rate applies to all employees whose age is within each age 
band or whose years of service are within each service band. A schedule 
of allocation rates increases smoothly if the allocation rate for each 
age or service band within the schedule is greater than the allocation 
rate for the immediately preceding band (i.e., the age or service band 
with the next lower number of years of age or service) but by no more 
than 5 percentage points. However, a schedule of allocation rates will 
not be treated as increasing smoothly if the ratio of the allocation 
rate for any age or service band to the rate for the immediately 
preceding band is more than 2.0 or if it exceeds the ratio of 
allocation rates between the two immediately preceding bands.
    (C) Regular intervals. A schedule of allocation rates has regular 
intervals of age or service if each age or service band, other than the 
band associated with the highest age or years of service, is the same 
length. For this purpose, if the schedule is based on age, the first 
age band will be deemed to be of the same length as the other bands if 
it ends at or before age 25. If the first age band ends after age 25, 
then, in determining whether the length of the first band is the same 
as the length of other bands, the starting age for the first age band 
is permitted to be treated as age 25 or any age earlier than 25.
    (iv) Minimum allocation gateway. A plan satisfies the minimum 
allocation gateway of this paragraph (b)(1)(iv) if each NHCE has an 
allocation rate that is at least one third of the allocation rate of 
the HCE with the highest allocation rate. However, a plan is deemed to 
satisfy this minimum allocation gateway if each NHCE receives an 
allocation of at least 5% of the NHCE's compensation within the meaning 
of section 415(c)(3).
    (v) Determination of allocation rates. For purposes of this 
paragraph (b)(1), allocations and allocation rates are determined under 
Sec. 1.401(a)(4)-2(c)(2), but without taking into account the 
imputation of permitted disparity under Sec. 1.401(a)(4)-7 in applying 
the minimum allocation gateway of paragraph (b)(1)(iv) of this section.
    (vi) Examples. The following examples illustrate the rules in this 
paragraph (b)(1):

    Example 1. (i) Plan M is a defined contribution plan that 
provides an allocation formula under which allocations are provided 
to all employees according to the following schedule:

------------------------------------------------------------------------
                                                               Ratio of
                                                              allocation
                                                               rate for
                                                 Allocation    band to
               Years of service                     rate      allocation
                                                 (percent)     rate for
                                                             immediately
                                                              preceding
                                                                 band
------------------------------------------------------------------------
0-5...........................................          3.0          N/A
6-10..........................................          4.5         1.50
11-15.........................................          6.5         1.44
16-20.........................................          8.5         1.31
21-25.........................................         10.0         1.18
26 or more....................................         11.5         1.15
------------------------------------------------------------------------

    (ii) Because Plan M provides that allocation rates for all 
employees are determined using a single schedule based solely on 
service, the plan is permitted to disregard the service requirement 
in determining whether the allocation rates are broadly available 
(within the meaning of paragraph (b)(1)(iii) of this section), if 
the allocation rates under the schedule increase smoothly at regular 
intervals.
    (iii) The schedule of allocation rates under Plan M does not 
increase by more than 5 percentage points between adjacent bands and 
the ratio of the allocation rate for any band to the allocation rate 
for the immediately preceding band is never more than 2.0 and does 
not increase. Therefore, the allocation rates increase smoothly. In 
addition, the bands (other than the highest band) are all 5 years 
long, so the increases occur at regular intervals. Accordingly, the 
service requirement is disregarded and each allocation rate is 
broadly available within the meaning of paragraph (b)(1)(iii) of 
this section, as each allocation rate is currently available to all 
employees in the Plan.
    (iv) Under paragraph (b)(1)(i) of this section, Plan M satisfies 
the nondiscrimination in amount requirement of Sec. 1.401(a)(4)-
1(b)(2) on the basis of benefits if it satisfies paragraph 
(b)(1)(i)(A) of this section, regardless of whether it satisfies the 
minimum allocation gateway of paragraph (b)(1)(iv) of this section.
    Example 2. (i) Plan N is a defined contribution plan that 
provides an allocation formula under which allocations are provided 
to all employees according to the following schedule:

------------------------------------------------------------------------
                                                               Ratio of
                                                              allocation
                                                               rate for
                                                 Allocation    band to
                      Age                           rate      allocation
                                                 (percent)     rate for
                                                             immediately
                                                              preceding
                                                                 band
------------------------------------------------------------------------
under 25......................................          3.0          N/A
25-34.........................................          6.0         2.00
35-44.........................................          9.0         1.50
45-54.........................................         12.0         1.33
55-64.........................................         16.0         1.33
65 or older...................................         21.0         1.31
------------------------------------------------------------------------

    (ii) Because Plan N provides that allocation rates for all 
employees are determined using a single schedule based solely on 
age, the plan is permitted to disregard the age requirement in 
determining whether the allocation rates are broadly available 
(within the meaning of paragraph (b)(1)(iii) of this section), if 
the allocation rates under the schedule increase smoothly at regular 
intervals.
    (iii) The schedule of allocation rates under Plan N does not 
increase by more than 5 percentage points between adjacent bands and 
the ratio of the allocation rate for any band to the allocation rate 
for the immediately preceding band is never more than 2.0 and does 
not increase. Therefore, the allocation rates increase smoothly. In 
addition, the bands are all 10 years long (other than the highest 
band and the first band, which is deemed to be the same length as 
the other bands because it ends prior to age 25), so the increases 
occur at regular intervals. Accordingly, the age requirement is 
disregarded and each allocation rate is broadly available within the 
meaning of paragraph (b)(1)(iii) of this section, as each

[[Page 59779]]

allocation rate is currently available to all employees in the Plan.
    (iv) Under paragraph (b)(1)(i) of this section, Plan N satisfies 
the nondiscrimination in amount requirement of Sec. 1.401(a)(4)-
1(b)(2) on the basis of benefits if it satisfies paragraph 
(b)(1)(i)(A) of this section, regardless of whether it satisfies the 
minimum allocation gateway of paragraph (b)(1)(iv) of this section.
    Example 3. (i) Plan O is a profit-sharing plan maintained by 
Employer A that covers all of Employer A's employees, consisting of 
two HCEs, X and Y, and 7 NHCEs. Employee X's compensation is 
$170,000 and Employee Y's compensation is $150,000. The allocation 
for Employees X and Y is $30,000 each, resulting in an allocation 
rate of 17.6% for Employee X and 20% for Employee Y. Under Plan O, 
each NHCE receives an allocation of 5% of compensation within the 
meaning of section 415(c)(3).
    (ii) Because the allocation rate for X is not currently 
available to any NHCE, Plan O does not have broadly available 
allocation rates and must satisfy the minimum allocation gateway of 
paragraph (b)(1)(iv) of this section.
    (iii) The highest allocation rate for any HCE under Plan O is 
20%. Accordingly, Plan O would satisfy the minimum allocation 
gateway of paragraph (b)(1)(iv) of this section if all NHCEs have an 
allocation rate of at least 6.67%, or if all NHCEs receive an 
allocation of at least 5% of compensation within the meaning of 
section 415(c)(3).
    (iv) Under Plan O, each NHCE receives an allocation of 5% of 
compensation within the meaning of section 415(c)(3). Accordingly, 
Plan O satisfies the minimum allocation gateway of paragraph 
(b)(1)(iv) of this section.
    (v) Under paragraph (b)(1)(i) of this section, Plan O satisfies 
the nondiscrimination in amount requirement of Sec. 1.401(a)(4)-
1(b)(2) on the basis of benefits if it satisfies paragraph 
(b)(1)(i)(A) of this section.
* * * * *
    Par. 3. Section 1.401(a)(4)-9 is amended by adding paragraph 
(b)(2)(v) and revising paragraph (c)(3)(ii) to read as follows:


Sec. 1.401(a)(4)-9  Plan aggregation and restructuring.

* * * * *
    (b) * * *
    (2) * * *
    (v) Eligibility for testing on a benefits basis--(A) General rule. 
For plan years beginning on or after January 1, 2002, unless, for the 
plan year, a DB/DC plan is primarily defined benefit in character 
(within the meaning of paragraph (b)(2)(v)(B) of this section) or 
consists of broadly available separate plans (within the meaning of 
paragraph (b)(2)(v)(C) of this section), the DB/DC plan must satisfy 
the minimum aggregate allocation gateway of paragraph (b)(2)(v)(D) of 
this section for the plan year in order to be permitted to demonstrate 
satisfaction of the nondiscrimination in amount requirement of 
Sec. 1.401(a)(4)-1(b)(2) on the basis of benefits.
    (B) Primarily defined benefit in character. A DB/DC plan is 
primarily defined benefit in character if, for more than 50% of the 
NHCEs benefitting under the plan, the normal accrual rate for the NHCE 
attributable to benefits provided under defined benefit plans that are 
part of the DB/DC plan exceeds the equivalent accrual rate for the NHCE 
attributable to contributions under defined contribution plans that are 
part of the DB/DC plan.
    (C) Broadly available separate plans. A DB/DC plan consists of 
broadly available separate plans if the defined contribution plan and 
the defined benefit plan that are part of the DB/DC plan each would 
satisfy the requirements of section 410(b) and the nondiscrimination in 
amount requirement of Sec. 1.401(a)(4)-1(b)(2) if each plan were tested 
separately and assuming that the average benefit percentage test of 
Sec. 1.410(b)-5 were satisfied. For this purpose, all defined 
contribution plans that are part of the DB/DC plan are treated as a 
single defined contribution plan and all defined benefit plans that are 
part of the DB/DC plan are treated as a single defined benefit plan. In 
addition, if permitted disparity is used for an employee for purposes 
of satisfying the separate testing requirement of this paragraph 
(b)(2)(v)(C) for plans of one type, it may not be used in satisfying 
the separate testing requirement for plans of the other type for the 
employee.
    (D) Minimum aggregate allocation gateway. A DB/DC plan satisfies 
the minimum aggregate allocation gateway of this paragraph (b)(2)(v)(D) 
if each NHCE has an aggregate normal allocation rate that is at least 
one third of the aggregate normal allocation rate of the HCE with the 
highest such rate (HCE rate), or, if less, 5% of the NHCE's 
compensation, provided that the HCE rate does not exceed 25% of 
compensation. If the HCE rate exceeds 25% of compensation, then the 
aggregate normal allocation rate for each NHCE must be 5% increased by 
one percentage point for each 5-percentage-point increment (or portion 
thereof) by which the HCE rate exceeds 25% (e.g., the NHCE minimum is 
6% for an HCE rate that exceeds 25% but not 30%, and 7% for an HCE rate 
that exceeds 30% but not 35%). For purposes of this paragraph 
(b)(2)(v)(D), a plan is permitted to treat each NHCE who benefits under 
the defined benefit plan as having an equivalent normal allocation rate 
equal to the average of the equivalent normal allocation rates under 
the defined benefit plan for all NHCEs benefitting under that plan.
    (E) Determination of rates. For purposes of this paragraph 
(b)(2)(v), the normal accrual rate and the equivalent normal allocation 
rate attributable to defined benefit plans, the equivalent accrual rate 
attributable to defined contribution plans and the aggregate normal 
allocation rate are determined under paragraph (b)(2)(ii) of this 
section, but without taking into account the imputation of permitted 
disparity under Sec. 1.401(a)(4)-7, except as otherwise permitted under 
paragraph (b)(2)(v)(C) of this section.
    (F) Examples. The following examples illustrate the application of 
this paragraph (b)(2)(v):

    Example 1. (i) Employer A maintains Plan M, a defined benefit 
plan, and Plan N, a defined contribution plan. All HCEs of Employer 
A are covered by Plan M (at a 1% accrual rate), but not covered by 
Plan N. All NHCEs of Employer A are covered by Plan N (at a 3% 
allocation rate), but not covered by Plan M. Because Plan M does not 
satisfy section 410(b) standing alone, Plans M and N are aggregated 
for purposes of satisfying sections 410(b) and 401(a)(4).
    (ii) Because none of the NHCEs participate in the defined 
benefit plan, the aggregated DB/DC plan is not primarily defined 
benefit in character within the meaning of paragraph (b)(2)(v)(B) of 
this section nor does it consist of broadly available separate plans 
within the meaning of paragraph (b)(2)(v)(C) of this section. 
Accordingly, the aggregated Plan M and Plan N must satisfy the 
minimum aggregate allocation gateway of paragraph (b)(2)(v)(D) of 
this section in order to satisfy the nondiscrimination in amount 
requirement of Sec. 1.401(a)(4)-1(b)(2) on the basis of benefits.

    Example 2. (i) Employer B maintains Plan O, a defined benefit 
plan, and Plan P, a defined contribution plan. All of the six 
employees of Employer B are covered under both Plan O and Plan P. 
Under Plan O, all employees have a uniform normal accrual rate of 1% 
of compensation. Under Plan P, Employees A and B, who are HCEs, 
receive an allocation rate of 15%, and participants C, D, E and F, 
who are NHCEs, receive an allocation rate of 3%. Employer B 
aggregates Plans O and P for purposes of satisfying sections 410(b) 
and 401(a)(4). The equivalent normal allocation and normal accrual 
rates under Plans O and P are as follows:

------------------------------------------------------------------------
                                                Equivalent   Equivalent
                                                  normal       normal
                                                allocation     accrual
                                                rates for     rates for
                                                  the 1%     the 15%/3%
                   Employee                      accrual     allocations
                                                under Plan  under Plan P
                                                O (defined    (defined
                                                 benefit    contribution
                                                  plan)         plan)
                                                 percent       percent
------------------------------------------------------------------------
HCE A (age 55)...............................         3.93          3.82
HCE B (age 50)...............................         2.61          5.74

[[Page 59780]]

 
C (age 60)...................................         5.91           .51
D (age 45)...................................         1.73          1.73
E (age 35)...................................          .77          3.90
F (age 25)...................................          .34          8.82
------------------------------------------------------------------------


    (ii) Although all of the NHCEs benefit under the Plan O (the 
defined benefit plan), the aggregated DB/DC plan is not primarily 
defined benefit in character because the normal accrual rate 
attributable to defined benefit plans (which is 1% for all the 
NHCEs) is greater than the equivalent accrual rate under defined 
contribution plans only for Employee C. In addition, because the 15% 
allocation rate is only available to HCEs, the defined contribution 
plan cannot satisfy the requirements of Sec. 1.401(a)(4)-2 and does 
not have broadly available allocation rates within the meaning of 
Sec. 1.401(a)(4)-8(b)(1)(iii). Further, the defined contribution 
plan does not satisfy the minimum allocation gateway of 
Sec. 1.401(a)(4)-8(b)(1)(iv) (3% is less than \1/3\ of the 15% HCE 
rate). Therefore, the defined contribution plan within the DB/DC 
plan cannot separately satisfy Sec. 1.401(a)(4)-1(b)(2) and does not 
constitute a broadly available separate plan within the meaning of 
paragraph (b)(2)(v)(C) of this section. Accordingly, the aggregated 
plans can satisfy the nondiscrimination in amounts requirement of 
Sec. 1.401(a)(4)-1(b)(2) on the basis of benefits only if the 
aggregated plans satisfy the minimum aggregate allocation gateway of 
paragraph (b)(2)(v)(D) of this section.
    (iii) Employee A has an aggregate normal allocation rate of 
18.93% under the aggregated plans (3.93% from Plan O plus 15% from 
Plan P), which is the highest aggregate normal allocation rate for 
any HCE under the plans. Employee F has an aggregate normal 
allocation rate of 3.34% under the aggregated plans (.34% from Plan 
O plus 3% from Plan P) which is less than the 5% aggregate normal 
allocation rate that Employee F would be required to have to satisfy 
the minimum aggregate allocation gateway of paragraph (b)(2)(v)(D) 
of this section.
    (iv) However, for purposes of satisfying the minimum aggregate 
allocation gateway of paragraph (b)(2)(v)(D) of this section, 
Employer B is permitted to treat each NHCE who benefits under the 
Plan O (the defined benefit plan) as having an equivalent allocation 
rate equal to the average of the equivalent allocation rates under 
Plan O for all NHCEs benefitting under that plan. The average of the 
equivalent allocation rates for all the NHCEs under Plan O is 2.19% 
(the sum of 5.91%, 1.73%, .77%, and .34%, divided by 4). 
Accordingly, Employer B is permitted to treat all the NHCEs as 
having an equivalent allocation rate attributable to Plan O equal to 
2.19%. Thus, all NHCEs can be treated as having an aggregate normal 
allocation rate of 5.19% for this purpose (3% from the defined 
contribution plan and 2.19% from the defined benefit plan) and the 
aggregated DB/DC plan satisfies the minimum aggregate allocation 
gateway of paragraph (b)(2)(v)(D) of this section.
* * * * *
    (c) * * *
    (3) * * *
    (ii) Restructuring not available for certain testing purposes. 
The safe harbor in Sec. 1.401(a)(4)-2(b)(3) for plans with uniform 
points allocation formulas is not available in testing (and thus 
cannot be satisfied by) contributions under a component plan. 
Similarly, component plans cannot be used for purposes of 
determining whether a plan provides broadly available allocation 
rates (as defined in Sec. 1.401(a)(4)-8(b)(1)(iii)), or determining 
whether a plan is primarily defined benefit in character or consists 
of broadly available separate plans (as defined in paragraphs 
(b)(2)(v)(B) and (C) of this section). In addition, the minimum 
allocation gateway of Sec. 1.401(a)(4)-8(b)(1)(iv) and the minimum 
aggregate allocation gateway of paragraph (b)(2)(v)(D) of this 
section cannot be satisfied on the basis of component plans. See 
Secs. 1.401(k)-1(b)(3)(iii) and 1.401(m)-1(b)(3)(iii) for rules 
regarding the inapplicability of restructuring to section 401(k) 
plans and section 401(m) plans.

David A. Mader,
Acting Deputy Commissioner of Internal Revenue.
[FR Doc. 00-25652 Filed 10-5-00; 8:45 am]
BILLING CODE 4830-01-P