4.72.2  Cash or Deferred Arrangements (Cont. 1)

4.72.2.10 
CODA Nondiscrimination

4.72.2.10.1 
ADP Test

4.72.2.10.1.4  (06-10-2015)
Limits on Double Counting of Certain Contributions

  1. When a plan changes from current year to prior year testing, NHCEs contributions are likely to be double counted.

    Example:

    If a plan used current year testing in 2014 then changed to prior year testing in 2015, the NHCEs 2014 elective deferrals are counted twice: They're counted once in 2014 in calculating the NHCE ADP under the current year testing method, and again in 2015 in calculating the NHCE ADP under the prior year testing method.

    Note:

    To limit double counting, plans can't use the QNECs and QMACs in prior year testing used in the preceding year's current year testing.(26 CFR 1.401(k)-2(a)(6)(vi)).

4.72.2.10.1.5  (06-10-2015)
Plan Provisions Regarding Testing Method

  1. A plan must specify which of the two testing methods (current year or prior year) it's using. If the employer changes a plan's testing method, it must amend the plan.

  2. Plans can incorporate the nondiscrimination tests in IRC 401(k)(3) and (m)(2) by reference. However, it must specify which of the two testing methods (current year or prior year) it is using. Further, for the first plan year rule, plans that incorporate these provisions by reference must specify whether the NHCEs ADP/ACP is three percent or the current year's ADP/ACP. See 26 CFR 1.401(k)-1(e)(7) and 26 CFR 1.401(m)-1(c)(2).

4.72.2.10.1.6  (06-10-2015)
Correction of ADP Test

  1. Plans may for correct excess contributions in these ways:

    • QMACs or QNECs

    • Distribution

    • Recharacterization

  2. A plan may:

    • Use any of the above correction methods.

    • Limit elective deferrals to prevent HCEs from making excess contributions.

    • Use a combination of these methods to avoid or correct excess contributions.

    Note:

    If the plan uses a combination of correction methods, it must consider making QNECs or QMACs before using distribution and recharacterization.

  3. Plans allowing designated Roth contributions may permit HCEs to have excess contributions distributed from their designated Roth accounts.

  4. Plans, generally must forfeit matching contributions (even QMACs) made for excess contributions or excess aggregate contributions to avoid having a discriminatory rate of match. The forfeitures won't cause the plan to violate IRC 411.

  5. Plans may contain a fail-safe formula or procedure for prospectively reducing HCEs’ elective deferrals so that no excess contributions arise.

  6. Plans can't do these actions for excess contributions for a plan year:

    • Keep them unallocated for a plan year.

    • Allocate them to a suspense account for future allocation.

    • Correct them using the retroactive correction rules of 26 CFR 1.401(a)(4)-11(g). See 26 CFR 1.401(a)(4)-11(g)(3)(vii) and (5).

  7. Plans may treat excess contributions allocated to a HCE as catch-up contributions under IRC 414(v) and ignore them for the ADP test.

  8. Plans using distribution to correct excess contributions must distribute them within 21/1 months (six months for certain EACAs) after the end of the plan year end of excess contributions to avoid a 10 percent excise tax on the excess contributions. See IRC 4979 and 26 CFR 54.4979-1. If the ADP test isn't corrected within the 12-months after the end of the failed plan year, the CODA is not qualified and the plan may be disqualified. Not correcting excess contributions will make the CODA nonqualified not only for the excess contribution plan year but also for all subsequent plan years the excess contributions remain in the trust.

4.72.2.10.1.6.1  (06-10-2015)
Determination of Excess Contributions

  1. "Excess contributions" are the aggregate amount of employer contributions made to the plan for HCEs for a plan year less the maximum amount of HCE contributions permitted under the ADP test.

  2. Determine the excess contributions using a leveling method based on HCEs' ADRs, beginning with the HCE with the highest percentage and continuing in descending order of ADR percentages until the target HCE ADP is reached. (See below.)

4.72.2.10.1.6.2  (06-10-2015)
Distribution of Excess Contributions

  1. Correcting excess contributions by distributing them generally involves four steps:

    1. Determine the total amount of excess contributions that the plan must distribute.

    2. Divide the excess contributions among HCEs.

    3. Determine the income on the excess contributions.

    4. Distribute the portion of excess contributions and income to each HCE.

  2. The amount of excess contributions is the amount of elective deferrals the plan must return to HCEs to pass the ADP test. Start with the HCE with the largest deferral percentage (ADR) and continue, by leveling, to the HCE(s) with the next highest ADR(s) until the plan passes the ADP test.

    Note:

    To identity the HCEs who receive excess contributions, begin with the HCE with the largest dollar amount of deferrals.

  3. Plans may recharacterize catch-up eligible HCE excess contributions as catch-up contributions (up to the catch-up limit) before they distribute them.

    Example:

    Employee Compensation Deferral ADR ADP
    A $100,000 $7,000 7.00 percent  
    B $90,000 $6,500 7.22 percent 6.41 percent
    C $80,000 $4,000 5.00 percent  
    D $20,000 $0 0.00 percent  
    E $10,000 $0 0.00 percent 3.33 percent
    F $10,000 $1,000 10.00 percent  

    D, E, and F are NHCEs. All employees are under age 50. Per the ADP test, the greatest acceptable ADP for HCEs (A, B and C) is 5.33 percent (3.33 percent plus 2). Since 6.41 percent is greater than 5.33 percent, the plan has excess contributions. The plan states that excess contributions will be distributed.
    To determine the amount of excess contributions, use the ratio leveling method which reduces the highest HCE ADR until the maximum allowed ADP (5.33 percent) is achieved, or until the next highest HCE ADR is reached, whichever occurs first. In this case, if B’s ADR is reduced to 7.00 percent, the HCE ADP will be 6.33 percent. This is not sufficient to satisfy the ADP test, so A’s and B’s ADRs must be further reduced to 5.50 percent ((x+x+5%)/3 = 5.33%). The amount of excess contributions is the contributions at the old ADRs ($7,000 and $6,500) less the contributions at the new ADRs ($5,500 and $4,950), for a total amount of $3,050. The plan must then distribute this amount from the HCEs' account(s) who has the highest dollar amount of contributions in the plan year ADP test until the contributions remaining in such employee’s account equals the plan-year contributions in the HCE’s account(s) with the next highest dollar amount and so on until the total is distributed (dollar leveling method). So, $500 must first be distributed to A, to make A’s contributions level with B’s, and the remaining amount of excess contributions, $2,550, is then allocated equally to A and B, so that each has $5,225 of elective deferrals remaining for the year. The excess contributions distributed to A and B must be adjusted for any earnings. (Note that the ADP test is deemed passed after these corrections even though running the test then would not produce a passing ADP for the HCEs.)

  4. Reduce any excess contributions distribution by excess deferrals previously distributed to the HCE for the same year. Similarly, reduce an excess deferral distribution by excess contributions previously distributed to the HCE for the same year. See 26 CFR 1.401(k)-2(b)(4)(i).

  5. Include distributed excess contributions' allocable gain or loss only through the end of the plan year.

    Exception:

    For plan years beginning between January 1, 2006, and December 31, 2007, include income for the plan year excess contributions from the plan year end to the distribution date (the "gap period" ). See 26 CFR 1.401(k)-2(b)(2)(iv).

  6. Plans can correct a failed ADP test by distributing excess contributions, adjusted for earnings, to certain HCEs by 12 months after the testing year end. It doesn't matter if the plan uses the prior year or current year testing method. But, if a plan doesn't distribute excess contributions by 12 months after the excess plan year, the CODA will not be qualified for the excess contribution year and all subsequent years until corrected.

  7. If plans don't distribute or recharacterize excess contributions within 2 1/1 months (six months in the case of certain EACAs) after the plan year end, the employer is liable for a 10-percent excise tax on these contributions. See IRM 4.72.2.10.1.7, IRC 4979 Tax. See 26 CFR 1.401(k)-2(b)(5)(iii).

  8. Individuals include corrective distributions of excess contributions and allocable income (except for the part that consists of designated Roth contributions) in their gross income in the tax year distributed, for plan years beginning on or after January 1, 2008. Plan trustees report the distribution on Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit- Sharing Plans, IRAs, Insurance Contracts, etc., using the appropriate code.

  9. Excess contributions/earnings distributions aren't subject to:

    • Consent rules under IRC 411(a)(11) and IRC 417.

    • Early withdrawal tax under IRC 72(t).

  10. See 26 CFR 1.402(c)-2, Q&A-4 for restrictions on individuals rolling over distributions of excess contributions.

4.72.2.10.1.6.3  (06-10-2015)
Recharacterization of Excess Contributions

  1. Plans can correct excess contributions by "recharacterizing" them as employee after-tax contributions. See IRC 401(k)(8)(A)(ii). Recharacterization treats excess contributions as though the plan distributed them to HCEs and then the HCE recontributed them to the plan as employee contributions. Determine excess contributions and the HCEs to whom they are allocated the same way as for distributions of excess contributions, except don't adjust the recharacterized amounts for earnings.

  2. Excess contributions, once recharacterized, are treated as voluntary after-tax employee contributions for ACP testing (26 CFR 1.401(k)-2(b)(3)). For most other compliance and testing purposes, recharacterized contributions remain treated as elective deferrals (26 CFR 1.401(k)-2(b)(3)(iii)(C)).

    Note:

    Before recharacterization can be used, the plan document must both permit employee contributions and provide for it as an available correction method.

  3. Excess contributions that are recharacterized are reported and appropriately coded on Form 1099-R. Individuals include them in gross income according to the same rules for actual distributions of excess contributions. See IRM 4.72.2.10.1.6.2 (8).

  4. Plans may use recharacterization only if it permits employee contributions. The amount recharacterized, when added to the HCE's other employee contributions, may not exceed the employee contributions limit stated in the plan separate from the ACP test. See 26 CFR 1.401(k)-2(b)(3)(iii)(B).

  5. Offset recharacterized amounts by any excess deferrals the plan previously distributed to HCEs.

  6. Plans may only recharacterize excess contributions by 2 1/1 months after the plan year of the excess. The employer or plan administrator must notify the affected HCEs that both:

    • The excess contributions are being recharacterized.

    • There are tax consequences of the recharacterization.

    Note:

    The date the last affected HCE receives notification is the recharacterization date. Use this date to determine if the plan satisfies the 21/1 month rule.

4.72.2.10.1.7  (06-10-2015)
IRC 4979 Tax

  1. The plan has 12 months after the end of the plan year being tested to correct excess contributions. The plan can distribute excess contributions any time during the 12-month period. However, if the employer doesn't distribute/recharacterize excess contributions by 21/1 months (six months for certain EACAs) after the plan year of excess, the employer is liable for a 10 percent excise tax on excess contributions (IRC 4979 and 26 CFR 1.401(k)-2(b)(5)).

    Exception:

    The tax doesn't apply if the plan sponsor makes corrective QNECs or QMACs (current year testing plans only) within 12 months after the end of the plan year. However, if the QNECs or QMACs are insufficient for the CODA to pass the ADP test, the tax applies to the remaining excess contributions.

  2. Plan sponsors report the tax on Form 5330, Return of Excise Taxes Related to Employee Benefit Plans and must pay it by 15 months after the plan year end. See 26 CFR 54.4979-1. If the employer has an extension of time to file the form, this is not an extension of time to correct the ADP test.

  3. The tax is a one-time tax, meaning if the plan sponsor doesn't correct the excess contributions for a plan year, the tax doesn't continue to the next tax year and applies only for that year.

4.72.2.10.1.8  (06-10-2015)
Examination Steps

  1. Review the plan's eligibility requirements and ensure that the plan is operating per the plan document.

  2. Review plan financial audit reports and corporate minutes for comments relating to eligibility provisions.

  3. Review plan financial audit reports and corporate minutes for comments on ADP testing and correction.

  4. Ask the plan administrator about the plan policy/procedures for ADP/ACP/402(g) testing (including correction). Analyze the testing method and results. Confirm the accuracy of each test.

  5. If the plan is a SIMPLE 401(k) plan, a safe harbor 401(k) plan or a QACA, review the plan language and verify the employer distributed the proper notices and made the required matching or nonelective deferrals. For QACAs, verify that the plan satisfies the uniform minimum default contribution requirement.

  6. Verify that all employees who are eligible to make EDs are counted in the ADP test, even if some do not make EDs.

    Note:

    Check the group of eligible employees to determine whether those who have satisfied the plan’s age and service requirements are allowed to make deferrals. Also ask if any other benefits are contingent on an employee's contribution to the CODA.

  7. Verify that these employees have been included as eligible with a deferral percentage of 0 in the ADP test - employees who:

    • Are eligible to make a deferral but can't because they're suspended from making deferrals (e.g., because of receiving a hardship distribution).

    • Didn't receive QNECs or QMACs treated as EDs.

  8. Compare the total number of eligible employees (including those who are eligible but for a plan provision requiring a ministerial or mechanical act) with the number of employees the plan used to run the ADP test. They should be the same.

  9. Examine these documents to verify employee compensation:

    • Payroll records

    • Forms W-2s

    • Time cards

    • Personnel records

    Note:

    If the plan year is not a calendar year, review the plan document to determine the period used and verify that the plan operates with those provisions. If the employer limits compensation to the part of the year in which the employee was eligible, verify that the plan’s terms allow it. Examine employees having limited compensation and verify that the plan used compensation earned since the employee participated in the plan.

  10. Verify that all compensation amounts are limited per IRC 401(a)(17). If the plan is not a safe harbor plan, examine the ADP test to verify that each individual’s ADR is calculated using the properly limited compensation.

    Note:

    Compensation used in the ADP test can either include or exclude elective deferrals deferred during the year. The definition of compensation in 26 CFR 1.414(s)-1 references IRC 415(c)(3), which includes elective deferrals in compensation (IRC 415(c)(3)(D)). But, 26 CFR 1.414(s)-1(c)(3) contains a safe harbor alternative definition of compensation that satisfies IRC 414(s) and does not count deferred compensation.

  11. Reconcile the Forms W-2 total participant deferral contributions to the ADP test total deferral amount.

  12. Using payroll and organization data, test check to see if the plan correctly determined the HCE group. Verify that an employee was considered an HCE if he/she met any of the following:

    1. Five percent owner during the year or preceding year.

    2. Compensation above the indexed dollar amount ($120,000 for 2015) for the preceding year.

    3. Was in the top-paid group that year, if the employer so elected.

  13. If a plan is disaggregated under IRC 410(b), make sure the employer runs the ADP test on each disaggregated plan. Apply the aggregation and disaggregation rules of 26 CFR 1.410(b)-7, as modified by 26 CFR 1.401(k) -1(b)(4), to find the "plan" (or plans) so that the ADP and ACP tests (or safe harbor, QACA or SIMPLE rules) can be applied to the proper employees. Ensure only plans with the same plan year end (PYE) are aggregated, if otherwise permitted.

    1. Review the plan document to determine the CODA eligibility requirements. If they are less than one year of service and/or less than age 21, the plan sponsor may apply the nondiscrimination testing on a disaggregation basis: run one ADP test for employees with less than one year of service and less than age 21, and another test for all other employees.

    2. Determine if any employees are covered by a collective bargaining agreement. If so, disaggregate these employees from employees not covered by a collective bargaining agreement for the ADP test. Review any lists identifying employees covered by a collective bargaining agreement, such as union due payment reports or payroll records showing union dues deductions. Compare the collectively bargained employees to the employees listed in the ADP test for that group.

    3. When you inspect the 5500 returns for all plans, determine if any other employer plan contains a CODA. If so, the plan sponsor may aggregate them for the ADP test, but only if they have the same plan year. Any plans aggregated for the ADP test must also be aggregated for coverage and discrimination tests. Ask the employer which plans were aggregated, if any. Verify from payroll records whether employees counted for the coverage and discrimination testing are the same employees in the ADP test if the plans were aggregated.

  14. Determine if any HCE participates in more than one of the employer's CODAs. If yes, combine his/her elective deferrals to determine ADRs. Use this ADR in the ADP test for all CODAs.

  15. Compare ADP calculations to Form W-2 (or payroll records if the plan year is a fiscal year) compensation and deferral amounts. Trace compensation and deferral amounts to source documents.

  16. Verify that the plan sponsor properly determined the ADP test for each group (HCE and NHCE) and the plan satisfied the ADP test following the testing method (current year or prior year) specified in the plan.

  17. For ADP test failures, verify that the plan sponsor accurately and timely corrected the failure.

    1. Review the plan document to see if it specified the correction method and if the plan sponsor followed it.

    2. Determine if the plan sponsor calculated the amount of excess contributions using the ratio leveling method.

  18. If the plan sponsor corrected the ADP test failure by distribution:

    1. Inspect cancelled checks or trust statements to determine the date of distribution of the excess contributions (plus attributable earnings).

    2. Inspect Form(s) 1099-R issued for distribution of excess contributions. Amounts distributed should include any gains or losses.

    3. If the distribution was made after 21/1 months following the excess plan year end, the IRC 4979 tax applies. Verify the employer filed Form 5330 and paid the excise tax. If not, solicit both.

  19. If the plan sponsor corrected the ADP test failure by recharacterization:

    1. Recharacterization of excess contributions must occur within 21/1 months following the excess plan year end. Inspect recharacterization notices issued to HCEs. Recharacterization is "deemed" to have occurred on the date of the last notice.

    2. Inspect Forms 1099-R to verify that recharacterized amounts were correctly reported. Earnings or losses on recharacterized amounts aren't taxable and should not be included in the amount reported on the Form 1099-R.

  20. If the plan sponsor corrected the ADP test failure by contributing QNECs and/or QMACs, inspect cancelled checks or trust statements to determine whether they made the contributions within one year after the PYE.

    Note:

    This correction method is not available for plans using the prior year testing method.

4.72.2.11  (06-10-2015)
Catch-Up Contributions

  1. Plans may permit participants age 50 or older to make additional elective deferrals, called "catch-up contributions," for tax years beginning after December 31, 2001 (IRC 414(v)).

  2. These plans can permit catch-up contributions:

    1. IRC 401(k) plans

    2. IRC 403(b) plans

    3. Governmental IRC 457(b) plans

    4. SARSEPs

    5. SIMPLE IRAs

  3. An eligible employee can make catch-up contributions only after reaching one of these limits:

    • The limit on regular elective deferrals, e.g., IRC 401(a)(30) or IRC 415.

    • The ADP limit.

    • A plan-provided limit.

  4. In 401(k) plans, don't consider catch-up contributions for:

    1. IRC 401(a)(30) limits.

    2. IRC 415(c) limits.

    3. Determining an employee’s ADR for the ADP test.

    4. Determining the average benefit percentage test under 26 CFR 1.410(b)-5 if the plan determines benefit percentages based on current year contributions.

      Exception:

      Include prior years' catch-up contributions in the account balances used in determining the average benefit percentages if the plan takes into account allocations for prior years.

    5. IRC 416

      Exception:

      Include prior years' catch-up contributions in the account balances used to determine if a plan is top-heavy under IRC 416(g).

  5. Catch-up contributions:

    1. Are treated just like other elective deferrals.

    2. Are subject to the same nonforfeitability and distribution rules as other elective deferrals.

    3. Can be pre-tax or designated Roth contributions.

  6. Catch-up contributions must satisfy a universal availability requirement. This means all catch-up eligible participants in all of an employer's 401(k) plans must be given an effective opportunity to make the same dollar amount of catch-up contributions. Employers may restrict employees' available amounts from which they can defer to participant compensation after other reductions (e.g., for applicable employment taxes) without violating the universal availability rule. The regulations offer a safe harbor that permit plans to use 75 percent of participants' compensation.

4.72.2.11.1  (06-10-2015)
Catch-Up Contribution Limits

  1. There are separate dollar limits (determined by the IRS and Treasury) for catch-up contributions for SIMPLE plans (SIMPLE 401(k) plans and SIMPLE IRA plans) and non-SIMPLE plans.

  2. Each limit is subject to annual COLA increases, but if an increase is not a multiple of $500, it's rounded down to the next lower multiple of $500.

  3. The limits apply to the employee’s taxable year that begins with or within the calendar year.

  4. See IRM 4.72.2.20, Annual Statutory Limits Applicable to CODAs. Column "IRC 414(v)(2)(B)(i)" is the non-SIMPLE plan catch-up limits. Column "IRC 414(v)(2)(B)(ii)" is the SIMPLE plan catch-up limits.

4.72.2.12  (06-10-2015)
SIMPLE 401(k) Plans

  1. SIMPLE 401(k) plans, described in IRC 401(k)(11) and IRC 401(m)(10):

    1. Can only be set up by employers with 100 or fewer employees earning at least $5,000 of SIMPLE compensation (see below) in the prior calendar year.

    2. Must be maintained on a calendar-year basis.

    3. Are deemed to satisfy the ADP and ACP tests.

    4. Are not subject to the top-heavy requirement.

    5. Closely follow the requirements for SIMPLE IRA in IRC IRC 408(p).

      Note:

      SIMPLE IRA plans are more popular with employers because the IRA plans are less burdensome to set up and maintain and have less administrative tasks. For example, SIMPLE IRAs aren't required to file Forms 5500.

  2. Employees covered under the SIMPLE 401(k) plan can't be covered under another plan of the employer.

  3. Employees can contribute up to the annual limit to their SIMPLE 401(k) accounts ($12,500 in 2015, plus an additional $3,000 if the employee is age 50 or older). See IRM 4.72.2.20.

  4. Employers must contribute each year, either:

    1. Matching contributions: the lesser of the eligible employee's elective deferrals for the year or three percent of the eligible employee's SIMPLE compensation for the entire calendar year.

    2. Nonelective contributions: two percent of the eligible employee's SIMPLE compensation for the entire calendar year, but the plan can limit the nonelective contribution to those eligible employees who received at least $5,000 of SIMPLE compensation from the employer for the entire calendar year.

  5. Employers must notify employees each year and allow them certain elections:

    1. The employer must notify each eligible employee within a reasonable time before each 60-day election period that he/she can make/modify a cash or deferred election and whether the employer will be making matching or nonelective contributions for the year.

    2. For an employee’s initial year of participation, he/she must be permitted to make a cash or deferred election during a 60-day period that includes either the day the employee becomes eligible or the day before.

    3. For subsequent years, the employee must be permitted to make or modify his/her cash or deferred election during the 60-day period before that calendar year.

    4. An eligible employee must be permitted to terminate his/her cash or deferred election at any time.

  6. All contributions to the plan must be fully vested at all times. The plan can't accept any contributions other than those described in IRM 4.72.2.12 (4) and rollover contributions.

  7. SIMPLE 401(k) plans must use a special, inclusive definition of compensation. See IRC 408(p)(6) and 26 CFR 1.401(k)-4(e)(5). SIMPLE compensation is the Form W-2 amount, including elective deferrals limited to the IRC 401(a)(17) amount which is indexed annually. See IRM 4.72.2.20.

4.72.2.13  (06-10-2015)
Safe Harbor 401(k) Plans

  1. Under IRC 401(k)(12), CODAs are treated as meeting the ADP test if they are a design-based safe harbor method. The CODA must meet certain contribution and notice requirements under 26 CFR 1.401(k)-3(a) through (h). If the plan also satisfies the requirements of IRC 401(m)(11) and doesn’t permit employee contributions, it will be treated as satisfying the ACP test as well. See 26 CFR 1.401(m)-3.

  2. For this IRM section, the term "safe harbor 401(k) plan" means a plan that meets the requirements of IRC 401(k)(12) (and IRC 401(m)(11), if applicable) and is not a QACA per IRC 401(k)(13) (and IRC 401(m)(12), if applicable). See IRM 4.72.2.14.1, Qualified Automatic Contribution Arrangements (QACAs).

  3. Plans that use the safe harbor methods to satisfy the ADP or ACP test are treated as using the current year testing method for that plan year. A plan can satisfy the ADP safe harbor without satisfying the ACP safe harbor, but a plan cannot satisfy the ACP safe harbor without satisfying the ADP safe harbor.

4.72.2.13.1  (06-10-2015)
Plan Provisions for Safe Harbor Plans

  1. Generally, employers intending to use the safe harbor provisions for a plan year must adopt those provisions before the first day of that plan year and those provisions must remain in effect for an entire 12-month plan year.

  2. A safe harbor 401(k) plan can have a short plan year: (i) in the first year of the plan or CODA, (ii) if the plan changes plan years and (iii) for the plan’s final plan year. See 26 CFR 1.401(k)-3(e).

  3. 26 CFR 1.401(k)-3(f) permits the sometimes called "maybe safe harbor plan," where the plan sponsor distributes a notice to employees at the normal time before a plan year stating that the plan may be amended before the end of the plan year to become a safe harbor plan with safe harbor nonelective contributions. Then, to become a safe harbor plan, the plan sponsor must amend the plan by 30 days before the plan year end and distribute a new notice to employees explaining the amendment.

  4. Under Announcement 2007-59, 2007-1 C.B. 1448, a plan will satisfy the requirements to be a safe harbor 401(k) plan even if it adds mid-year:

    1. A designated Roth contribution program.

    2. The deemed hardship rules for the designated beneficiary of a participant (under PPA section 826).

  5. Plan sponsors can generally, after May 18,2009, amend their safe-harbor plans mid-year to reduce or suspend safe harbor contributions under certain circumstances. See 26 CFR 1.401(k)-3(g). To suspend or reduce safe harbor contributions:

    1. An employer must either be operating at an economic loss per IRC 412(c)(2)(A) or have disclosed to employees in the annual notice that it's possible that they may reduce or suspend safe harbor contributions during the year.

    2. The notice must state that the plan sponsor won't suspend or reduce contributions until at least 30 days after the plan sponsor gives a supplemental notice and that employees will be given a reasonable opportunity to change their deferral (or employee contributions, if applicable).

    3. If a reduction or suspension occurs, the plan is subject to the ADP (and ACP) test for the entire plan year.

  6. Plan sponsors could amend mid-year for:

    1. In-plan Roth rollovers rules in Notice 2010-84 and Notice 2013-74 during transition periods.

    2. Changes resulting from United States v. Windsor in Notice 2014-37.

4.72.2.13.2  (06-10-2015)
Special Compensation Definition for Safe Harbor Plans

  1. Generally, apply the same definitions as used in other CODAs, including the annual compensation limit in IRC 401(a)(17. But, to determine safe harbor matching and nonelective contributions, plans must use "safe harbor compensation" . This is the normal definition of compensation, which incorporates the compensation definition in 26 CFR 1.414(s)-1.

    Exception:

    The last sentence in 26 CFR 1.414(s)-1(d)(2)(iii) (permitting a plan to disregard all compensation that exceeds a specified dollar amount) does not apply.

  2. Also, a safe harbor 401(k) plan can restrict the type of compensation from which participants can defer if each eligible NHCE may make elective deferrals under a "reasonable definition" of compensation per 26 CFR 1.414(s)-1(d)(2). The definition is not required to satisfy the nondiscrimination requirement of 26 CFR 1.414(s)-1(d)(3). But, the plan must permit each eligible NHCE to make elective deferrals to receive the maximum matching contributions under the plan for the plan year, and the employee must be permitted to elect any lesser amount of elective deferrals.

    Example:

    A 401(k) plan defines compensation as "all salary, wages, bonuses, and other remuneration not exceeding $75,000." The plan does not satisfy the ADP/ACP test safe harbors because the definition of compensation excludes compensation over $75,000.

    Example:

    A 401(k) plan allows employees to make elective deferrals only from basic compensation, defined as salary, regular wages, bonuses and commissions, and excluding overtime pay. This is a reasonable definition of compensation per 26 CFR 1.414(s)-1(d)(2), but could be discriminatory. The plan's safe harbor matching contribution is 100 percent of the employee's elective deferrals that do not exceed three percent of the employee's safe harbor compensation. Compensation for the matching formula is defined as compensation under IRC 415(c)(3). Per the plan, each NHCE who is an eligible employee is permitted to make elective deferrals of at least three percent of the employee's compensation under IRC 415(c)(3) (that is the amount of elective deferrals sufficient to receive the maximum amount of matching contribution available under the plan). This plan's definitions of compensation satisfy the safe harbor rules.

4.72.2.13.3  (06-10-2015)
ADP Test Safe Harbor Requirements

  1. To satisfy the ADP safe harbor, a CODA must satisfy both:

    • Safe harbor contribution requirement

    • Notice requirement of IRC 401(k)(12) and 26 CFR 1.401(k)-3.

  2. Plans satisfy the safe harbor contribution requirement if they contribute matching or nonelective contributions to all eligible employees under the plan. This means, for example, that the plan can't state it'll pay contributions to only employees employed on the last day of the plan year or to employees who have at least 1,000 hours of service in the plan year. The safe harbor contribution requirement must be satisfied without considering permitted disparity in IRC IRC 401(l).

  3. Plans may satisfy the matching contribution requirement by providing either the basic matching formula or an enhanced matching formula.

    1. The basic matching formula requires qualified matching contributions (QMACs) to each eligible NHCE of 100 percent of his/her elective deferrals up to three percent of the employee’s compensation, and 50 percent of the employee’s elective deferrals that exceed three percent of the employee’s compensation but don't exceed five percent of the employee’s compensation.

    2. An enhanced matching formula requires QMACs to each eligible NHCE under a formula that provides an aggregate amount of QMACs at least equal to the aggregate amount that would have been provided under the basic matching formula at any elective contribution rate, and the rate of matching contributions may not increase as an employee’s rate of elective deferrals increases.

    Example:

    A plan states that it makes QMACs at the following rates: 100 percent of an employee's elective deferrals that do not exceed two percent of compensation and 75 percent of the employee's elective deferrals that exceed two percent but do not exceed five percent of compensation. This formula doesn't satisfy the enhanced matching formula because the aggregate amount provided by this formula is not at least equal to the amount the basic matching formula would've provided at all rates of elective deferrals. The basic matching formula requires the plan to make QMACs of 100 percent on the amount of the employee's elective deferrals that do not exceed three percent of compensation. Under the plan's formula, however, the amount of QMACs at three percent is only 75 percent, and therefore, less than 100 percent. See 26 CFR 1.401(k)-3(c)(7) for additional examples.

    Note:

    Plans that contain a formula that satisfies the ADP test safe harbor will still pass the ADP test safe harbor if they also give discretionary matches. Bit, the discretionary matches must be limited to four percent of each employee’s compensation. See 26 CFR 1-401(m)-3(d)(3).

  4. A matching formula doesn't satisfy the safe harbor test if, at any rate of elective deferrals, its rate of matching contributions for an eligible HCE is greater than its rate of matching contributions for an eligible NHCE at the same rate of elective deferrals. For example, a plan covers Divisions A and B, both of which have NHCEs and HCEs. The plan has a basic matching formula for Division A and an enhanced matching formula for Division B, (100 percent match of each employee's elective deferrals up to four percent of a Division B employee's IRC 415(c)(3) compensation). The rate of match for a Division B HCE at the elective deferrals rate of four percent is greater than a Division A NHCE's rate of match at the same rate of elective deferrals. So, the plan wouldn't satisfy the ADP test safe harbor.

  5. Plans may permit matching contributions to be made on a payroll-period basis without having to "true-up" for the whole year if the plan sponsor contributes them by the end of the immediately following plan year quarter. (See IRC 1.401(k)-3(c)(5)(ii)).

  6. Generally, plans don't meet the matching contribution requirement if they restrict NHCEs elective deferrals. But, plans may limit elective deferrals for:

    1. The periods during which employees can make or change their deferral elections.

    2. The amount of elective deferrals that an employee can make, for example, an employer can require that elective deferrals be made in whole percentages of pay or in whole dollar amounts.

    3. The types of compensation that may be deferred.

    4. IRC 402(g) or IRC 415 or, after a hardship distribution, to satisfy the 6-month suspension period in 26 CFR 1.401(k)-1(d)(3)(iv)(E).

  7. If a plan sponsor uses any of the restrictions in IRM 4.72.2.13.3 (6), they must follow certain conditions. For example, as discussed earlier, although a plan sponsor may limit the amount of elective deferrals a participant can make, the employer must permit each eligible NHCE to make sufficient elective deferrals to receive the maximum amount of matching contributions in the plan. See IRM 4.72.2.13.2 (2) for an explanation of restricting types of compensation that a participant may defer.

  8. Instead of making safe harbor matching contributions, an employer can make safe harbor nonelective deferrals. The nonelective contribution requirement is satisfied if, under the terms of the plan, the employer is required to make qualified nonelective contributions (QNECs) for each eligible NHCE of at least three percent of his/her compensation.

  9. Safe harbor matching and nonelective contributions can be used to satisfy the safe harbor requirements for only one plan.

4.72.2.13.3.1  (06-10-2015)
Notice Requirement

  1. The ADP test safe harbor notice requirement requires a plan sponsor to provide a written notice to each eligible employee for the plan year that:

    1. Describes the participants rights and obligations under the plan

    2. Satisfies the content and timing requirement of 26 CFR 1.401(k)3(d).

    The notice must be in writing or in such other form as may be approved by the IRS Commissioner. See 26 CFR 1.401(a)-21 for using electronic media to provide applicable notices in retirement plans.

  2. The notice must be accurate and comprehensive enough so that employees know their rights. The notice must be written in a manner so that the average employee eligible to participate in the plan understands it. The notice must accurately describe:

    1. The safe harbor matching contribution or safe harbor nonelective contribution formula used by the plan (including a description of the safe harbor matching contribution levels, if any, available under the plan).

    2. Any other plan contributions or matching contributions to another plan on account of elective deferrals or employee contributions under this plan (including the potential for discretionary matching contributions) and the conditions when the plan makes these contributions.

    3. The plan that the employer will make the safe harbor contributions to (if different than the plan containing the CODA).

    4. The type and amount of compensation that participants may defer under the plan.

    5. How to make cash or deferred elections, including any administrative requirements that apply to elections.

    6. The periods available under the plan to make cash or deferred elections.

    7. Withdrawal and vesting provisions applicable to contributions under the plan.

    8. 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 individuals or offices from whom employees can obtain such plan information.

  3. Plan sponsors must give the notice to each eligible employee at least 30 days and not more than 90 days before each plan year begins. If an employee becomes eligible after the 90th day before the plan year begins, the plan sponsor is deemed to satisfy the timing requirement if they give the notice by 90 days before the employee becomes eligible (and by the date the employee becomes eligible).

    Exception:

    But, if it is not practical to provide the notice on or before the date an employee becomes eligible, a notice will be deemed timely if the plan sponsor provides it as soon as practical after that date and the employee is permitted to defer from all compensation earned form his/her eligibility date. This means, for a new employee who is immediately eligible to participate in the plan, if it is not practical for the plan sponsor to give this employee a notice on or before his/her hire date, they must give the notice (and allow the employee to make a deferral election) before the employee’s first payday.

4.72.2.13.4  (06-10-2015)
ACP Test Safe Harbor

  1. Plans meet the ACP test safe harbor for their matching contributions if they satisfy the ADP test safe harbor and limit matching contributions per IRC 401(m)(11) and 26 CFR 1-401(m)-3(d).

  2. There are three ways to satisfy the matching contribution limits:

    1. The plan can provide the "basic matching formula," described in IRM 4.72.2.13.3 (3) the ADP test safe harbor, and have no other matching contributions.

    2. The plan can provide an "enhanced matching formula," described above in the ADP test safe harbor, but the matching contributions may not be made for an employee's contributions or elective deferrals in excess of six percent of the employee's compensation, and the plan doesn't have other matching contributions.

    3. For any other plan, the matching contributions can't be made for elective deferrals or employee contributions that in the aggregate exceed 6 percent of the employee’s compensation; the rate of matching contributions doesn't increase as the rate of employee contributions or elective deferrals increases, and for employees at the same rate of elective deferrals or employee contributions; and the matching contribution for any HCE at any rate of an employee contribution or rate of elective deferral is not greater than that for an NHCE.

  3. Plans may restrict the elective deferrals or employee contributions used to determine matching contributions only as permitted under the rules for the ADP test safe harbor. See IRM 4.72.2.13.3 (6) above.

  4. Plans that provide discretionary matches (in addition to nondiscretionary matches needed to satisfy the ADP test safe harbor) can satisfy the ACP test safe harbor if the discretionary matches in the aggregate aren't greater than four percent of the employee's compensation.

  5. Plans that don't meet the ACP test safe harbor must meet the ACP test for their employee contributions and matching contributions. But, if the plan satisfies the ACP safe harbor, but must perform the ACP test because it has employee contributions, it may use only the employee contributions and ignore all matches. See 26 CFR 1-401(m)-2(a)(5)(iv).

4.72.2.13.5  (06-10-2015)
Multiple CODAs and Multiple Plans

  1. For employers with multiple plans, the ADP test safe harbor matching contributions or nonelective contributions may be made to the plan that contains the CODA or to another IRC 401(a) or IRC 403(a) defined contribution plan. If the employer makes safe harbor contributions to another defined contribution plan, they must satisfy the safe harbor contribution requirement in the same way as if the contributions were made to the CODA plan. Consequently, each employee eligible under the plan containing the CODA must be eligible under the same conditions under the other defined contribution plan (that is, both plans must have identical eligibility/participation requirements).

  2. If a plan sponsor makes safe harbor contributions to another defined contribution plan, that plan may (but is not required to) to be aggregated with the plan containing the CODA. Both plans must have the same plan year.

  3. The rules for aggregating and disaggregating CODAs and plans also apply to the ADP/ACP test safe harbor requirements.

    1. All CODAs in a plan are treated as a single CODA that must satisfy the safe harbor contribution requirement and the notice requirement.

    2. Two plans (per 26 CFR 1.410(b)-7(b)) treated as a single plan under permissive aggregation are treated as a single plan for the safe harbor methods.

    3. Conversely, a plan (within the meaning of IRC 414(l)) that includes a CODA covering both collectively bargained employees and noncollectively bargained employees is treated as two plans for IRC 401(k), and the ADP both plan don't need to satisfy the ADP test safe harbor for one of the plans to take advantage it.

    4. The rule in IRC 401(k)(3)(F) (permitting a plan to disregard certain employees) doesn't apply to safe harbor plans. See 26 CFR 1-401(k)-3(h).

  4. HCEs are prohibited from receiving a higher rate of match than an NHCE. Apply the rules under IRC 401(m)(2)(B) and 26 CFR 1.401(m)-2(a)(3)(ii) to determine the rate of matching contributions under 26 CFR 1.401(m)-3(d)(4).

    Caution:

    If a HCE is eligible in two of an employer's plans for a plan year and i) only one plan intends to satisfy the ADP/ACP test using the safe harbor methods, ii) the other plan's matching contribution formula doesn't use the safe harbor methods, then the non-safe harbor formula may provide greater matching contributions than the safe harbor plan's formula. Make sure HCEs don't receive a higher rate of match than NHCEs.

4.72.2.14  (06-10-2015)
Automatic Contribution Arrangements (ACAs)

  1. An automatic contribution arrangement (ACA), also known as "automatic enrollment," or auto enroll, is a plan feature where the plan sponsor reduces a participant's compensation by a specified amount and contributes it to the plan unless the participant elects not to have compensation reduced or to have it reduced by a different amount. In a CODA, the plan sponsor contributes these amounts as elective deferrals. To facilitate the automatic enrollment of more employees in plans, PPA section 902 (as amended by WRERA), added IRC 401(k)(13), IRC 401(m)(12), and IRC 414(w) in 2006. Other legal cites offer guidance and sample amendments for auto enroll.

  2. The statutory changes affecting automatic enrollment:

    Citation Effective Date IRC section Description
    PPA section 902 (as amended by WRERA) Plan years beginning on or after January 1, 2008 IRC 401(k)(13) and IRC 401(m)(12) Adds Qualified Automatic Contribution Arrangements (QACAs) - an alternative design-based safe harbor that requires automatic contributions at a specified level, certain employer contributions, notices, and other. If met, CODA is deemed to pass the ADP test (and ACP test for matching contributions).
    PPA section 902 (as amended by WRERA) Plan years beginning on or after January 1, 2008 IRC 414(w) Gives auto enroll plans limited relief from the distribution restrictions under IRC 401(k)(2)(B)
    Treas. Regs. on ACAs, 74 CFR 8200, pub. Feb. 24, 2009   401(k) and 401(m) Contains amendments to IRC 401(k), IRC 401(m) and new rule for IRC 414(w) to reflect PPA changes.
    Rev. Rul. 2009-30, 2009-39 I.R.B 391     Provides guidance on how automatic enrollment in an IRC 401(k) plan can work when it has an escalator feature.

    Note:

    An escalator feature means that the amount of an employee’s compensation that is contributed to the plan, without the employee’s affirmative election, is increased periodically according to the terms of the plan.

    Notice 2009-65, 2009-39 IRB 413     Provides two sample amendments that IRC 401(k) sponsors can use to add auto enroll features to their plans:
    • Amendment to add a basic ACA with an escalation feature.

    • Amendment to add an EACA with an escalation feature.

4.72.2.14.1  (06-10-2015)
Qualified Automatic Contribution Arrangements (QACAs)

  1. CODAs with QACAs that meet the requirements under IRC 401(k)(13) and IRC 401(m)(12) are deemed to pass the ADP and ACP tests. To be a QACA, the plan must provide certain levels of automatic contributions, certain matching or nonelective contributions and satisfy a notice requirement. See 26 CFR 1-401(k)-3.

  2. In QACAs, the deferral percentage an employee is automatically enrolled at (sometimes referred to as the "default percentage" or "default deferral" ) must meet certain minimums that increase over time, assuming the employee doesn’t affirmatively elect something else. Generally, a QACA applies to all employees eligible to make deferrals under the plan, but automatic enrollment applies only to those eligible employees without an affirmative election for elective deferrals in place. A plan may provide that employees’ affirmative elections for elective contributions expire after a certain period or event, so that unless the employee makes a new election he/she will be automatically enrolled at the appropriate default percentage.

  3. When an employer first adds a QACA to a CODA, the plan can either:

    • Honor existing affirmative elections

    • Require all employees to make new affirmative elections to avoid being automatically enrolled at the default percentage. See IRM 4.72.2.14.3 for the uniformity requirement.

4.72.2.14.2  (06-10-2015)
QACAs Default Percentage Requirements

  1. QACAs must satisfy a series of minimum default contribution percentages (IRC 401(k)(13)(C)(iii)). The default percentages can't exceed 10 percent of an employee’s compensation and must be applied uniformly. The default percentage must be at least:

    1. Three percent during the initial period.

    2. Four percent during the first plan year following the initial period.

    3. Five percent during the second plan year following the initial period.

    4. Six percent during the third and subsequent plan years following the initial period.

  2. An employee’s "initial period" begins when he or she first makes default contributions under the QACA and ends on the last day of the plan year following the plan year after first making default contributions. If an employee makes an affirmative election before the default contribution would've begun, then the initial period hasn't begun for the employee because no default contributions were made for him/her. Note that a plan could simplify matters by having just one default percentage, for example, six percent, with no increase. The default percentage under the QACA is limited so as not to exceed the limits of IRC 401(a)(17), 402(g) (determined with or without catch-up contributions in IRC 402(g)(1)(C) or IRC 402(g)(7)) and IRC 415.

  3. The minimum percentages are based on the date the initial period begins, regardless of whether the employee is eligible to make elective contributions under the plan after that date. See 26 CFR 1.401(k)-3(j)(2)(iv).

    Example:

    An employee is ineligible to make contributions under the plan for six months because the employee had a hardship withdrawal. The six-month period includes a date when his/her default minimum percentage is set to increase. The default percentage must reflect that increase when the employee is permitted to resume contributions.

    Note:

    But, a plan may treat an employee who didn't have default contributions for an entire plan year as if he/she had not had any for any prior plan year as well.

    Example:

    An employee terminates and remains terminated for at least one full plan year and is rehired in a subsequent plan year. The plan can determine the employee’s initial period for default contributions as either beginning immediately, or subject to a new initial period determination, even if the employee already had default deferrals made.

  4. For plan years beginning on or after January 1, 2010, use safe harbor compensation as defined in 26 CFR 1.401(k)-3(b)(2) to determine default contributions.

4.72.2.14.3  (06-10-2015)
QACAs Uniformity Requirements

  1. The default percentage must be applied uniformly to all eligible employees under the QACA (IRC 401(k)(13)(C)(iii))

  2. A plan will not fail to satisfy this uniformity requirement per 26 CFR 1.401(k)-3(j)(2)(iii) even if:

    1. The percentage varies based on the number of years (or portions of years) since the beginning of an eligible employee's initial period.

    2. The rate of elective deferrals under a cash or deferred election in effect for an employee immediately before the effective date of the default percentage under the QACA is not reduced.

    3. The rate of elective deferrals is limited so as not to exceed the limits of IRC 401(a)(17), IRC 402(g) (determined with or without catch-up contributions described in IRC 402(g)(1)(C) or IRC 402(g)(7)), and IRC 415.

    4. The default election provided is not applied during the period an employee is not permitted to make elective contributions in order for the plan to satisfy the requirements of 26 CFR 1.401(k)-3(c)(6)(v)(B) (six-month suspension following a hardship withdrawal).

4.72.2.14.4  (06-10-2015)
QACAs Safe Harbor Contribution Requirements

  1. To satisfy QACA requirements, the employer is required to make:

    1. Safe harbor matching contributions on behalf of each eligible NHCE of 100 percent of the first one percent of elective deferrals + 50 percent of elective deferrals in excess of one percent and up to six percent.

    2. Safe harbor nonelective contributions on behalf of eligible NHCE of at least three percent of the employee's compensation even if the employee doesn't make an elective contribution or employee contribution.

  2. The safe harbor contributions must be available to all NHCEs in the CODA including those who made affirmative elections. Also, although the statute specifies required contributions for NHCEs, most plans provide safe harbor contributions to both HCEs and NHCEs equally.

  3. The QACA safe harbor matching and nonelective contributions must be nonforfeitable after no more than two years of service. Apart from the different matching formula and the two-year vesting requirement, all the rules applicable to safe harbor contributions to a (IRC 401(k)(12)) safe harbor plan apply to a QACA:

    • Contributions are based on safe harbor compensation - see IRM 4.72.2.14.2 (4).

    • The plan may have enhanced matching formulas.

    • The safe harbor matching and nonelective contributions are subject to the same distribution restrictions as QNECs and QMACs.

4.72.2.14.5  (06-10-2015)
QACAs Notice requirements

  1. A QACA must satisfy the same notice requirements that apply to safe harbor plans (IRC 401(k)(12)) but have some additional content and timing requirements.

  2. A QACA's additional content requirements are that the notice must explain:

    1. The level of default contributions that the employer/plan sponsor will make on the employee’s behalf absent his/her affirmative election.

    2. The employee’s right to elect not to have elective deferrals made to the plan or to have them made in a different amount than the default percentage.

    3. How the plan will invest contributions under the QACA.

  3. A CODA satisfies the QACA notice's timing requirement only if it is provided early enough so that the employee has a reasonable period of time after receiving it to make a deferral election. After giving the notice to an employee, the plan can't delay the default election beyond the earlier of:

    1. Two paydays after the notice.

    2. The first payday at least 30 days after the notice.

4.72.2.14.6  (06-10-2015)
Eligible Automatic Contribution Arrangements (EACAs)

  1. An EACA is an automatic contribution arrangement that may permit a participant to withdraw default contributions without penalty and, under certain circumstances, permits an extra 31/1 months to distribute excess contributions and excess aggregate contributions. An EACA has a notice requirement and a uniformity requirement, but doesn't have mandatory employer contributions or a required level of default contributions. See 26 CFR 1.414(w)-1 and 26 CFR 54.4979-1(c).

  2. Unlike a QACA, an EACA doesn't need to cover all employees eligible to make deferrals under the CODA; only those specified in the plan are "covered employees." A "covered employee" receives the annual EACA notices and is subject to default contributions if he/she doesn't make an affirmative election. The plan must state whether an employee who makes an affirmative election remains covered under the EACA. So, if a plan states that an employee who makes an affirmative election is no longer an EACA covered employee, then the employee isn't required to receive the notice after he/she makes an affirmative election.

  3. An EACA's default elective contribution must be a uniform percentage of compensation; however, the percentage can vary in a similar way as that permitted in a QACA. See 26 CFR 1.414(w)-1(b)(2).

  4. All automatic contribution arrangements intended to be EACAs within a plan (or within the disaggregated plan under IRC 1.410(b)-7, for a plan subject to IRC 410(b)) must be aggregated. For example, if a single plan within the meaning of IRC 414(l) covering employees in two separate divisions has two different ACAs that are intended to be EACAs, the two ACAs can constitute EACAs only if the default elective deferrals under the arrangements are the same percentage of compensation. However, if portions of the plan are mandatorily disaggregated under the IRC 410(b) coverage tests, then the EACA in the disaggregated portion of the plan doesn't need to be aggregated with those in the rest of the plan and they could have different default percentages and still be EACAs.

  5. The EACA notice requirements are similar to the QACA notice requirements. See 26 CFR 1.414(w)-1(b)(3). But, if the EACA permits participants to withdraw default contributions, the notice must explain this to covered employees.

  6. An EACA allows employees who had default deferrals withdrawn from their pay to get the money back.

    Note:

    Before EACAs, employees who didn’t realize they were going to have their pay reduced under an ACA often couldn't take these deferrals because of the distribution restrictions that apply to elective deferrals. The plan was also at a disadvantage, having to maintain small account balances for employees who never wanted to make deferrals stopped them with an affirmative election.

  7. An EACA provides limited relief from the distribution restrictions under IRC 401(k)(2)(B) and permits employees to elect to withdraw (permissible withdrawal) their default elective deferrals (and attributable earnings) within a specific time period without penalty. The employee must elect within 90 days after their first default elective contribution is made. A plan may set an earlier deadline that the employee must elect to withdraw default elective contributions. But, if a plan offers a permissible withdrawal for covered employees, their election period must be at least 30 days. The effective date of an employee's withdrawal election must be by the earlier of:

    1. Two paydays after the date he/she elects to withdraw.

    2. The first payday at least 30 days after he/she elects to withdraw.

  8. Plans don't take use the permissible withdrawal amounts in the ADP test or to determine IRC 402(g) elective deferral limits. Employees include the withdrawn amount (except designated Roth contributions) in gross income for the tax year it's made. It's not subject to the additional income tax under IRC 72(t). The plan may not charge a higher fee for a permissible withdrawal under IRC 414(w) than for other withdrawals.

  9. The IRC 4979 excise tax doesn't apply to an EACA if the plan distributes excess contributions and excess aggregate contributions plus their earnings within 6 months (instead of 21/1 months) after the plan year end. The extension to six months applies only if the EACA covers all eligible employees.

  10. Plans must forfeit matching contributions (and earnings) allocated to permissible withdrawn default contributions. The plan may state that the sponsor won't make matching contributions for any withdrawn elective contributions under IRC 414(w).

4.72.2.15  (06-10-2015)
Designated Roth Contributions

  1. Plans may permit designated Roth contributions for tax years beginning on or after January 1, 2006 (IRC 402A by EGTRRA Section 617).

  2. Amendments to the final IRC 401(k) and IRC 401(m) regulations for designated Roth contributions were published in the Federal Register on January 3, 2006, 71 CFR 6, and these regulations were amended by final regulations published April 30, 2007, 72 CFR 21103.

  3. With the introduction of designated Roth contributions, participants may designate elective contributions as either designated Roth contributions (after-tax elective contributions) or pre-tax elective contributions. See 26 CFR 1.401(k)-1(f).

  4. Plans may permit employees who make elective contributions to designate some of the contributions as designated Roth contributions. See IRC 402A. Designated Roth contributions are elective contributions under a qualified CODA that are:

    1. Designated irrevocably by the employee at the time of his/her cash or deferred election as designated Roth contributions that are being made in lieu of all or a portion of the pre-tax elective contributions the employee is eligible to make under the plan.

    2. Treated by the employer as includible in the employee’s gross income at the time he/she would've received the contribution in cash if he/she didn't make a cash or deferred election.

    3. Maintained in a separate plan account.

  5. Because designated Roth contributions are "after-tax," any plan distribution of them is tax-free to the participant. But, a plan distribution from a designated Roth account (including earnings) that is a "qualified distribution" is completely tax-free. Under 26 CFR 1.402A-1, Q&A-2, a qualified distribution is one that is made both:

    • After five years of participation in the Roth arrangement.

    • At age 591/1, after death or because the participant is disabled.

  6. Corrective distributions and any other amounts described in 26 CFR 1.402(c)-2, Q&A-4 (amounts that can't be rolled over) aren't qualified distributions. See 26 CFR 1.402A-1, Q&A-2 and -11. Because all qualified distributions from a designated Roth account are tax-free, it’s important to ensure that the plan doesn't allocate improper amounts into this account, such as extra earnings or forfeitures. Also, the plan must separately allocate losses and charges on a reasonable and consistent basis to the designated Roth account and other accounts under the plan.

    Note:

    The only contributions that can go into a designated Roth account are designated Roth contributions currently deducted from the employee’s pay, rollovers from an employee's other designated Roth account and in-plan rollovers. See 26 CFR 1.401(k)-1(f)(3), 26 CFR 1.402A-1, Q&A-13, Notice 2010–84 and Notice 2013–74.

  7. ) An employee’s designated Roth account and his/her other accounts under the plan are treated as accounts under two separate plans (per IRC 414(l)) to apply the rules for:

    • Permissible restrictions on an employee’s direct rollover choices (26 CFR 1.401(a)(31)-1, Q&A-9, Q&A-10 and Q&A-11).

    • Automatic rollover rules for mandatory distributions under IRC 401(a)(31)(B)(i)(1).

  8. Plans correcting an ADP test failure for a plan year may permit an HCE who has elective contributions for a year of both pre-tax and designated Roth contributions to elect whether the excess contributions is pre-tax elective contributions or designated Roth contributions. See 26 CFR 1.401(k)-2(b)(1)(ii). Also, if an employee has excess deferrals, the employee may have some control over allocating the excess to designated Roth contributions. See 26 CFR 1.402(g)-1(e)(2)(i).

  9. Amounts in a designated Roth account can only be rolled over to an employee's other designated Roth account or Roth IRA.

  10. Except as described above, designated Roth contributions are treated like any other elective contributions following the rules in 26 CFR 1.401(k)-1(f)(4). Designated Roth Contributions:

    • Are counted in the ADP test.

    • Can be catch-up contributions.

    • Can be default elective contributions under an ACA.

    • Are subject to the required minimum distribution rules under IRC 401(a)(9).

    • Are treated as employer contributions for purposes of IRC 401(a), IRC 401(k), IRC 402, IRC 404, IRC 409, IRC 411, IRC 412, IRC 415, IRC 416 and IRC 417.

    Note:

    Roth IRAs aren't subject to IRC 401(a)(9)(A) (IRC 408). But, designated Roth accounts under a CODA don't have comparable IRC 401(a)(9) rules (IRC 402A). Therefore, designated Roth accounts in a plan are subject to the IRC 401(a)(9)(A) and (B) rules in the same way as pre-tax elective contribution accounts (26 CFR 1.401(k)-1(f)(4)(i)).

  11. Employees must include any pre-tax amounts they roll over from their plan accounts to their designated Roth account in the same plan (an "in-plan Roth rollover" ) in their gross income. Effective after 2012, participants may directly roll over amounts which may not otherwise be distributable as an in-plan Roth rollover. For example, participants may now roll over an amount from his/her pre-tax elective deferral account to his/her Roth account in the same plan even if they are under 591/1 and otherwise ineligible to receive a distribution of elective deferrals.

    Note:

    The rollover must be done directly (i.e., not via a 60-day rollover) and the amounts rolled over are still subject to the distribution restrictions that apply to elective deferrals. See Notice 2013-74.

4.72.2.16  (06-10-2015)
Contingent Benefits

  1. An employer may not directly or indirectly condition another employer benefit (other than matching contributions) upon an employee's election to make or not make elective contributions. If the employer conditions an employer benefit upon elective contributions, the CODA is not qualified. This rule prevents employers from encouraging employees to make or not make elective contributions by linking valuable benefits to their contribution or lack of a contribution. See 26 CFR 1.401(k)-1(e)(6).

  2. These other benefits include:

    • Benefits under a DB plan

    • Nonelective employer contributions to a DC plan

    • Benefits under a nonqualified plan

    • The right to make employee contributions

    • The right to health and life insurance

    • The right to employment.

  3. Treat employee participation in a nonqualified plan as a contingent benefit only when the employee may receive additional deferred compensation under the nonqualified plan depending on the whether they make/don't make elective contributions.

    Note:

    Don't treat an employee's participation in a nonqualified plan as a contingent benefit if their participation is conditioned on making the maximum deferrals under IRC 402(g) or the plan terms. See 26 CFR 1.401(k)-1(e)(6)(iii) and (iv).

4.72.2.16.1  (06-10-2015)
Examination Steps

  1. Ask the employer if they tie any benefits other than matching contributions to elective contributions. In certain circumstances you may need to request an interview with employees who make or fail to make elective contributions to see if they get any special treatment from the employer.

  2. Determine whether there is a nonqualified plan linked with the CODA. If there is, ensure the nonqualified plan doesn't have conditions in its form or operation that are dependent on an employee's participation, lack of participation, or reduced participation in the CODA.

4.72.2.17  (06-10-2015)
Cafeteria Plans

  1. Employers may have "cafeteria plans" (IRC 125). A cafeteria plan allows an employee to select among various types of employer benefits by specifying where an employer contribution should be spent.

  2. Cafeteria plans are permitted to offer a contribution to a qualified CODA as one of its options, but if it does, the cafeteria plan must offer a cash payment option to the employee equal to the amount contributed to the cafeteria plan.

4.72.2.17.1  (06-10-2015)
Examination Step

  1. Ask whether the employer has a cafeteria plan that allows a contribution to the CODA. Review the cafeteria plan options to ensure that one of the listed options is to receive a cash payment.

4.72.2.18  (06-10-2015)
Top-Heavy Rules

  1. CODAs (but not SIMPLE 401(k) plans, certain safe harbor 401(k) plans or QACAs) are subject to the top-heavy rules in IRC 416. If a plan with a CODA is top-heavy, it must provide each nonkey employee employed on the last day of the plan year a contribution of:

    • Three percent of the employee's compensation for the entire year or,

    • If lesser, the same percentage as the key employee with the highest percentage contribution.

    Example:

    If the highest percentage contribution given to a key employee is 4 percent, then nonkey employees must each receive a 3 percent contribution. But, if the key employee with the highest percentage contribution got a 2 percent contribution, then the plan sponsor only need to give nonkey employees a 2 percent contribution.

  2. To determine the top-heavy minimum contribution percentage, consider these key employee contributions:

    • IRC 401(k) deferrals

    • Employee after-tax contributions (voluntary and mandatory)

    • Matching contributions

    • Discretionary employer contributions

    • Forfeitures

    • QNECs

  3. Consider key employee elective contributions to determine the minimum contribution required for nonkey employees. Don't consider NHCE elective contributions to determine if the plan satisfies the minimum contribution.

    Example:

    If a profit-sharing plan only has elective contributions, all participants made 2 percent deferrals and the plan was top-heavy, the employer must make a 2 percent contribution to the plan for all the nonkey employees because even though the nonkeys made 2 percent deferrals, the employer can't consider them as employer contributions for the top-heavy minimum. See IRC 416(c)(2)(B)(i) and 26 CFR 1.416-1, M-20.

  4. Plans can use any combination of these contributions to satisfy the top-heavy minimum contribution requirements:

    • Discretionary employer contributions

    • Forfeitures

    • Matching contributions

    • QNECs

    Reminder:

    Before 2002, plans couldn't count matching contributions made to nonkey employees towards satisfying the nonkey minimum contribution if they were used in the ACP or ADP test. See IRC 416(c)(2)(A) as amended by section 613 of EGTRRA.

    Caution:

    If another plan provides the top-heavy minimums, and the eligibility requirements are not the same for both plans, then the IRC 401(k)'s eligible participants plan may not be receiving the minimum benefit in the other plan. Therefore, they must receive the minimum benefit in the IRC 401(k) plan.

4.72.2.18.1  (06-10-2015)
Examination Steps

  1. If the employer has another plan, determine which plan provides the top-heavy minimum benefit.

  2. Verify that all CODA-eligible nonkey employees who are employed on the last day of the plan year receive the top-heavy minimum benefit. If this benefit is provided in another plan, verify all the CODA-eligible non-key employees receive a top-heavy minimum benefit under the employer’s other plan.

    Reminder:

    Include employees as "eligible employees" if they meet the plan's eligibility requirements even if they choose not to make elective deferrals.

    If you find discrepancies, request a complete list of all employees employed on the last day of the plan year who met the CODA's eligibility requirements. Inspect payroll or other employment records to verify eligible employees.

  3. Verify that all eligible nonkey employees under the plan receive an employer contribution of at least 3 percent of compensation, (or the highest contribution to any key employee, if less than 3 percent).

4.72.2.19  (06-10-2015)
Compensation and IRC 415

  1. A IRC 401(k) plan may have several definitions of compensation, which must be stated in the plan document. The general CODA definition of compensation is compensation as defined in IRC 414(s). The IRC 414(s) definition of compensation is also used in the ADP and ACP tests. See 26 CFR 1.401(k)-6.

  2. The IRC 414(s) compensation definition states that compensation means IRC 415(c)(3) compensation with an option to exclude amounts contributed under a salary reduction agreement (such as elective contributions). IRC 414(s) also states that the Secretary of the Treasury may provide alternative definitions of compensation that do not favor HCEs. 26 CFR 1.414(s)-1 provide these alternative definitions. But, as already discussed, the safe harbor 401(k) and QACA mandatory employer contributions must use "safe harbor compensation" and may use a modified 414(s) definition of compensation for deferrals. See 26 CFR 1.401(k)-3(b)(2) and 26 CFR 1.401(k)-(c)(6)(iv). For plan years beginning on or after January 1, 2010, QACA default contributions must also use safe harbor compensation.

  3. Effective for compensation payable in plan years beginning on or after July 1, 2007, a CODA can only include amounts that are compensation within the meaning of IRC 415(c) and 26 CFR 1.415(c)-2. See 26 CFR 1.401(k)-1(e)(8).

  4. Under 26 CFR 1.415(c)-2(e)(3)(i) and (ii), plans must include certain post severance compensation as IRC 415 compensation if the employer pays it by the later of:

    1. 2 1/1 months after an employee's severance from employment.

    2. The end of the limitation year that includes the employee's severance from employment date.

  5. Under 26 CFR 1.415(c)-2(e)(3)(iii) and (4) a plan may include in compensation

    • Certain leave cashouts and deferred compensation.

    • Certain salary continuation payment for military service and disabled participants.

    Note:

    See Rev. Rul. 2009-31 and Rev. Rul. 2009-32 for guidance on contributing the value of leave cashout amounts to 401(k) plans, on an annual basis and after severance from employment.

  6. The maximum amount of "annual additions" that can be made to a participant’s account for a "limitation year" is in IRC 415(c). A limitation year is a 12-month period used by the plan for 415 purposes, but it almost always the plan year.

    Note:

    Carefully review plans with a limitation year different from the plan year when checking for timeliness of interim amendments related to compensation changes. Most interim amendment due dates are tied to the due date of income tax returns corresponding to applicable plan years. However, changes to 415 requirements are generally determined instead with reference to corresponding limitation years.

  7. Annual additions include:

    • Employer contributions

    • Employee contributions

    • Forfeitures

    Note:

    Annual additions also include excess contributions and excess aggregate contributions, even if distributed.

  8. Annual additions don't include:

    • Catch-up contributions. So if a plan recharacterizes a portion of a HCE’s elective contributions as catch-up contributions, they are not counted for IRC 415 limits. See IRC 1.415(c)-1(b)(1) and (2).

    • Excess deferrals distributed by April 15. See IRC 1.415(c)-1(b)(2)(ii)(D).

  9. Excess annual additions are amounts allocated to a participant in excess of the IRC 415 limitation. For limitation years beginning on or after July 1, 2007, plans can correct excess annual additions only by using the Employee Plans Compliance Resolution System (EPCRS). See Rev. Rul. 2013-12, section 6.06, 2013-4 IRB 313.

    Reminder:

    For limitation years beginning before July 1, 2007, plans were allowed to correct excess annual additions through certain allocation or distribution techniques in 26 CFR 1.415-6(b)(6) of the 1981 Regulation under certain circumstances.

4.72.2.19.1  (06-10-2015)
Examination Steps:

  1. Review Form 5500, Schedule H or I, Item 2(f), for distributions the plan made to correct IRC 415 excess annual additions.

  2. Review plan financial audit reports and corporate minutes for comments that address IRC 415 concerns.

  3. Check the W-2 information for IRC 415 excess amounts.

  4. Determine whether the employer maintains more than one plan. If yes, verify that annual addition calculations include:

    • All contributions for an individual to all the employer's defined contribution plans.

    • All employee contributions to all the employer's defined benefit plans.

  5. Consider contributions an individual made to all of an employer's defined contribution plans and defined benefit plans when you test to see if he/she exceeded the limits.

  6. Ensure that a participant's elective deferrals to all IRC 401(k) plans and similar arrangements and his/her salary reduction contributions to cafeteria plans are included in compensation for IRC 415 testing.

  7. Review the plan document for appropriate 415 limitation and correction language. Appropriate correction language for 415 purposes would require a Voluntary Correction Program submission. Under post-2007 final 415 Regs., EPCRS is the only applicable 415 correction. Review the plan document for IRC 415 limitation language. If there were IRC 415 excesses during the year, verify that the correction method was acceptable under EPCRS.

  8. Check the plan for compensation definition(s) for allocations and elective contributions and make sure the plan sponsor used these definitions in operation.

4.72.2.20  (06-10-2015)
Annual Statutory Limits Applicable to CODAs

  1. COLA Increases for Dollar Limitations on Benefits and Contributions

    Year IRC 408(p)(2) IRC 402(g) IRC 401(a)(17) IRC 414(q) IRC 415(c) TaxableWage Base IRC 414(v)(2)(B)(i) IRC 414(v)(2)(B)(ii)
    2015 12,500 18,000 265,000 120,000 53,000 118,500 6,000 3,000
    2014 12,000 17,500 260,000 115,000 52,000 117,000 5,500 2,500
    2013 12,000 17,500 255,000 115,000 51,000 113,700 5,500 2,500
    2012 11,500 17,000 250,000 115,000 50,000 110,100 5,500 2,500
    2011 11,500 16,500 245,000 110,000 49,000 106,800 5,500 2,500
    2010 11,500 16,500 245,000 110,000 49,000 106,800 5,500 2,500
    2009 11,500 16,500 245,000 110,000 49,000 106,800 5,500 2,500
    2008 10,500 15,500 230,000 105,000 46,000 102,000 5,000 2,500
    2007 10,500 15,500 225,000 100,000 45,000 97,500 5,000 2,500
    2006 10,000 15,000 220,000 100,000 44,000 94,200 5,000 2,500
    2005 10,000 14,000 210,000 95,000 42,000 90,000 4,000 2,000
    2004 9,000 13,000 205,000 90,000 41,000 87,900 3,000 1,500
    2003 8,000 12,000 200,000 90,000 40,000 87,000 2,000 1,000
    2002 7,000 11,000 200,000 90,000 40,000 84,900 1,000 500
    2001 6,500 10,500 170,000 85,000 35,000 80,400    
    2000 6,000 10,500 170,000 85,000 30,000 76,200    
    1999 6,000 10,000 160,000 80,000 30,000 72,600    
    1998 6,000 10,000 160,000 80,000 30,000 68,400    
    1997 6,000 9,500 160,000   30,000 65,400    
    1996   9,500 150,000   30,000 62,700    

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