McKay Hochman - Commentary

This article concludes our analysis of final 401(k) regulation 1.401(k)-1. Topics include additional requirements for 401(k) plans and the effective date of the regulation.

Immediately below are the seven topics of 1.401(k)-1(e) and the general point for each of the seven sections. In addition, a detailed analysis is available via the link at each topic heading.

We have also included section 1.401(k)-1(g) on the effective date and a link to a full detailed explanation of that section.

1.401(k)-1(e)

1.

Qualified plan requirement

A CODA may only be part of a profit-sharing plan, stock bonus plan, pre-ERISA money purchase plan, or a rural cooperative plan that otherwise satisfies the qualification requirements of section 401(a).

2.

Election requirements

The amount that each eligible employee may defer as an elective contribution must be available to the employee in cash.

A CODA must provide an employee with an effective opportunity to make (or change) the cash or deferred election at least once during each plan year.

3.

Separate accounting requirement

Elective deferrals and amounts subject to the distribution restrictions of a CODA must have separate accounting.

4.

Limitations on CODAs of state and local governments

A CODA adopted prior to May 7, 1986 by a state or local government, subdivision or agency may continue to accept CODA and other contributions. No plans may be opened for the governmental entities after May 6, 1986.

Rural cooperatives and Indian Tribal governments are eligible for CODAs.

5.

One-year eligibility requirement

A CODA may not require any employee to complete a more than a one-year period of service to be eligible to make a cash or deferred election under the arrangement.

6.

Other benefits not contingent upon elective contributions

A CODA may not condition (directly or indirectly) any other benefit with the exception of matching contributions, upon the employee’s electing to make or not to make elective contributions under the arrangement.

7.

Plan provision requirement

The plan document must specify how the CODA will satisfy the 401(k) nondiscrimination testing requirements known as ADP testing.

1.401(k)-1(g)

Effective Date Section

The effective date is generally for plan years beginning on or after January 1, 2006. There is an early adoption rule permitting a plan to adopt the regulations as of the first plan year beginning after December 29, 2004, provided that all the final regulations are adopted.

1.401(k)-1(e) —detailed analysis

1.

Qualified Plan Requirement
A CODA may only be part of a:

(i)

profit-sharing plan,

(ii)

stock bonus plan,

(iii)

pre-ERISA money purchase plan, or

(iv)

a rural cooperative plan that otherwise satisfies the qualification requirements of section 401(a). (back to top)

2.

Election requirements-

(i)

Cash must be available.
The amount that each eligible employee may defer as an elective contribution must be available to the employee in cash.

Examples that do not satisfy the rules for being a qualified CODA:

Example 1
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 CODA.

Example 2
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 CODA, but would be treated as a matching contribution.

The cash availability requirement applies even if the CODA is part of a section 125 cafeteria plan.

(ii)

Frequency of elections
A CODA must provide an employee with the effective opportunity to make (or change) the 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:

º

the adequacy of notice of the availability of the election,

º

the period of time during which an election may be made, and

º

any other conditions that apply to the election. (back to top)

3.

Separate accounting requirement

(i)

General rule
A CODA must separately account for amounts that are nonforfeitable and which are subject to restrictions on distributions, i.e., elective deferrals, QNECs, QMACs, Safe Harbor 401(k) NEC or Safe Harbor 401(k) Matching Contributions.

º

The separate accounting requirement applies from the time the elective contribution, QMAC, QNEC and/or safe harbor 401(k) contribution is contributed and continues until such contributions are distributed. Separate accounting requires that contributions, withdrawals, gains, losses, and other credits or charges be separately allocated on a reasonable and consistent basis to the accounts that are subject to nonforfeitability requirements and distribution restrictions.

º

Subject to nondiscrimination requirements of section 401(a)(4), forfeitures do not have to be allocated to accounts in which benefits are nonforfeitable and subject to distribution restrictions. However, the plan document may be written to allow such reallocation to these accounts.

(ii)

Satisfaction of separate accounting requirement
All amounts held under a plan that includes a qualified CODA (and, if applicable, under another plan to which QNECs and QMACs are made) are subject to the nonforfeitability and distribution restriction requirements.
(back to top)

4.

Limitations on CODAs of state and local governments

(i)

General rule

After May 6, 1986, a CODA may not be adopted by:

º

a state or local government or

º

a political subdivision thereof, or

º

any agency or instrumentality thereof (a governmental unit)

An employer that has made a legally binding commitment to adopt a CODA is treated as having adopted the arrangement on that date.

NOTE: A CODA adopted prior to May 7, 1986 by any of the entities listed above (or a predecessor thereof) may continue to accept CODA and other contributions.

(ii)

Rural cooperative plans and Indian tribal governments
The following entities may have a CODA:

–

a rural cooperative plan,

–

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 above entities. (back to top)

5.

One-year eligibility requirement

A CODA may not require any employee to complete more than a one-year period of service to be eligible to make a cash or deferred election under the arrangement. (back to top)

6.

Other benefits not contingent upon elective contributions —

(i)

General rule
A CODA may not condition (directly or indirectly) any other benefit 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 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 CODA 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 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 CODA.

(ii)

Definition of other benefits
The other benefits that may not be contingent on electing to defer include, but are not limited to, the following:

–

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, except as noted above);

–

financial planning services;

–

subsidized retirement benefits;

–

stock options;

–

property subject to section 83; and

–

dependent care assistance.

–

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.

Other issues:
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 dollar-for-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 CODA 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

º

Any benefit under an excess benefit plan described in section 3(36) of ERISA, that is dependent on the employee’s electing to make or not to make elective contributions is not treated as being contingent upon making elective deferrals.

º

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 being contingent upon making elective deferrals.

(iv)

Nonqualified deferred compensation
Except as otherwise noted in the immediately preceding paragraph, participation in a nonqualified deferred compensation plan is treated as being contingent to the extent that an employee may receive additional deferred compensation under the nonqualified plan based on whether 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 how the above rules are applied:

Example 1
Employer T maintains a CODA 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 CODA. Participation in the nonqualified plan is a contingent benefit, because R’s and C’s participation is conditioned on their electing not to make elective contributions under the CODA.

Example 2
Employer T maintains a CODA 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 CODA 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 CODA, the right to participate in the nonqualified plan is a contingent benefit. (back to top)

7.

Plan provision requirement
A plan that includes a CODA must provide methods for the plan to satisfy one of the specific alternatives for 401(k) nondiscrimination testing. If there are optional choices, the plan must reflect which of the optional choices will apply.

For example, a plan that uses the ADP test must specify whether it is using the current year testing method or prior year testing method. In addition, 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.

Similarly, a plan that uses the safe harbor 401(k) method must specify whether the safe harbor contribution will be the nonelective safe harbor contribution or the matching safe harbor contribution and the plan may not be written to provide that ADP testing will be performed if the requirements for the safe harbor are not satisfied.

A plan may incorporate by reference the ADP testing provisions of section 401(k)(3) and section 1.401(k)-2 if that is the nondiscrimination test being applied. The IRS Commissioner has authority to publish further guidance of general applicability in the Internal Revenue Bulletin that will specify the options that will apply under the plan if incorporation by reference is used.

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1.401(k)-1(f) SPECIAL RULES FOR DESIGNATED ROTH CONTRIBUTIONS ARE BEING ISSUED AS THEIR OWN FINAL REGULATIONS. [RESERVED]

1.401(k)-1(g) EFFECTIVE DATE FOR THE FINAL 401(k) & 401(m) REGULATIONS

(1)

General rule
This regulation will apply to plan years that begin on or after January 1, 2006, except as otherwise provided below.

(2)

Early implementation permitted
A plan may apply the final 401(k) regulations to any plan year that ends after December 29, 2004, provided the plan applies all of the final regulations i.e. §§1.401(k)-1 through 1.401(k)-6 and §§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 for the first plan year beginning on or after January 1, 2006, the provisions of the final 401(k) regulations 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 the general rule above.

(4)

Applicability of prior regulations
For any plan year before a plan applies the final regulations (either under the general rule or the early implementation rule above), the version of regulation §1.401(k)-1 that appeared in the April 1, 2004, edition of 26 CFR part 1 will apply to the extent that it reflects the statutory provisions of section 401(k) in effect for the relevant year. (back to top)

The IRS final 401(k) regulations.

Bill Grossman, QPA

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