Introduction

On July 16, as we went to press, the IRS issued new regulations for 401(k) plans incorporating a variety of IRS pronouncements and law changes that occurred after 1994 - the last time the 401(k) regulations were amended.  The new regulations were issued in proposed format, allowing for the public to make comments before they are finalized.  Public hearings are schedules for November 12, 2003.  Written and electronic comments on the proposed regulations must be received by the IRS by October 22, 2003.  We will be testifying at that hearing.  If there is a special issue that you would like to see us address, please send Rich an e-mail at rhochman@mhco.com

Effective Date is After Issuance of Final Regulations

The general effective date of the regulations is for plan years beginning 12 months after the date the final regulations are published in the Federal Register.  However, the IRS intends to include in the preamble of the final regulations an option for plan sponsors to implement the final regulations as of the first plan year beginning after the date the final regulations are published in the Federal Register.  Therefore, if the IRS issues final regulation in 2004, the first time they would be required to be used would be in 2005.  Thus, the proposed regulations do not have any immediate impact on the current day-to-day operation of 401(k) plans.  Unlike many proposed regulations, these were not written with the provision that says that you may rely on them in the interim, before they are finalized.

Many issues were clarified, such as what constitutes a cash or deferred arrange and what qualifies an elective deferral.  Among the major changes is a requirement to calculate interest during the gap period on an excess deferral (presented below).  As anticipated, the "bottom-up" or targeted QNEC as we know it, will be severely restricted in its use.  The proposed restriction would require a QNEC that is greater than 5% of compensation to be rigorously tested.  Keep in mind that the proposal does not require immediate discontinuance and therefore, current practices may continue until the effective date of the final regulations.  There are also some significant issues that were not addressed.

Contents of the topics addressed in the web analysis of the proposed regulations appear below.  For the details of each of these topics, check out our "Hot Topics" Number 27 on our website at www.mhco.com.

CODA, ELECTIVE CONTRIBUTIONS AND MATCHING CONTRIBUTIONS

• Dividends paid to an ESOP are excluded from the definition of a CODA
• No prefunding of elective deferrals
• No prefunding of matching contributions
• "Effective opportunity" to receive cash versus deferral defined
• Elective contributions may be limited by amounts withheld for payroll withholding for benefits and taxes
• Anti-abusive provisions clarified
• ESOP and Non-ESOP portion of plan may be aggregated for ADP/ACP testing but not for coverage
• Single Testing Method for all CODAs under a plan
• Nonqualified CODAs – Rules retained for handling a loss of qualified CODA status

RESTRICTIONS ON WITHDRAWALS

• "Severance from employment" replaces the "same desk rule" and the word "retirement"
• IRS requests comment on employee to leased employee change
• Hardship rules clarified
• Plans that may be maintained after a CODA plan termination
• Plan-to-plan transfer requires withdrawal restrictions to be maintained, tranferor plan responsible

ADP AND ACP TESTING

• Otherwise excludable testing rules retained
• HCE in multiple plans with different plan years, aggregate HCE's ADR by plan year being tested
• QNECs/QMACs permitted in ADP
• Double counting elective contributions or matching contributions-Correcting ADP failure for HCE participating in multiple plans with CODAs
• Taxable year of recharacterization of elective contribution to after-tax contribution
• Elective deferrals not allowed in ACP test if a plan is not subject to ADP testing
• Prior year testing

BOTTOM-UP QNECS:  NEW PROPOSED RULES WILL REQUIRE BROADER GROUP TO RECEIVE QNEC

• Background
• The new targeted QNEC rules for ADP testing
• The new targeted QNEC rules for ACP testing

 GAP INCOME ON EXCESS CONTRIBUTIONS

• Safe harbor method of allocating gap period income
• Alternative method for allocating plan year and gap period income

 401(k) SAFE HARBOR FROM ADP TESTING

• Rate of match not higher for HCE’s limited to the mate made to the safe harbor plan
• Safe harbor 401(k) short plan year exceptions
• Safe harbor 401(k) plan contribution to other plan
• Accounting for contribution timing for safe harbor plan

 401(k) SAFE HARBOR FROM ACP TESTING

• Safe harbor ACP plans may not have last-day or 1,000 hour requirement
• HCE in a safe harbor plan from ACP changing to another matching plan(s) within a controlled group

 ITEMS NOT ADDRESSED IN THE PROPOSED REGULATIONS

• Timeframes for amending plans to change ADP/ACP testing related provisions
• Permitted Disparity Issue