[Federal Register Volume 66, Number 126 (Friday, June 29, 2001)]
[Rules and Regulations]
[Pages 34535-34545]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-16326]


=======================================================================
-----------------------------------------------------------------------

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 8954]
RIN 1545-AY36


Nondiscrimination Requirements for Certain Defined Contribution 
Retirement Plans

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

-----------------------------------------------------------------------

SUMMARY: This document contains final regulations that permit certain 
defined contribution retirement plans to demonstrate compliance with 
the nondiscrimination requirements based on plan benefits rather than 
contributions. Under the final regulations, a defined contribution plan 
can test on a benefits basis if it provides broadly available 
allocation rates, age-based allocations, or passes a gateway requiring 
allocation rates for nonhighly compensated employees to be at least 5% 
of pay or at least one-third of the highest allocation rate for highly 
compensated employees. The regulations also permit qualified defined 
contribution and defined benefit plans that are tested together as a 
single, aggregated plan (and that are not primarily defined benefit or 
broadly available separate plans) to test on a benefits basis after 
passing a similar gateway, under which the allocation rate for 
nonhighly compensated employees need not exceed 7\1/2\% of pay. These 
final regulations affect employers that maintain qualified retirement 
plans and qualified retirement plan participants.

DATES: Effective Date: These regulations are effective June 29, 2001.
    Applicability Date: These regulations apply for plan years 
beginning on or after January 1, 2002.

FOR FURTHER INFORMATION CONTACT: John T. Ricotta, 202-622-6060 or Linda 
S.F. Marshall, 202-622-6090 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

    This document contains amendments to 26 CFR part 1 under section 
401(a)(4) of the Internal Revenue Code of 1986 (Code).
    Section 401(a)(4) provides that a plan or trust forming part of a 
stock bonus, pension, or profit-sharing plan of an employer shall not 
constitute a qualified plan under section 401(a) of the Code unless the 
contributions or benefits provided under the plan do not discriminate 
in favor of highly compensated employees (HCEs) (within the meaning of 
section 414(q)). Whether a plan satisfies this requirement depends on 
the form of the plan and its effect in operation.
    Section 415(b)(6)(A) provides that the computation of benefits 
under a defined contribution plan, for purposes of section 401(a)(4), 
shall not be made on a basis inconsistent with regulations prescribed 
by the Secretary. The legislative history of this provision explains 
that, in the case of target benefit and other defined contribution 
plans, ``regulations may establish reasonable earnings assumptions and 
other factors for these plans to prevent discrimination.'' Conf. Rep. 
No. 1280, 93d Cong., 2d Sess. 277 (1974).
    Under the section 401(a)(4) regulations, a plan can demonstrate 
that either the contributions or the benefits provided under the plan 
are nondiscriminatory in amount. Defined contribution plans generally 
satisfy the regulations by demonstrating that contributions are 
nondiscriminatory in amount, through certain safe harbors provided for 
under the regulations or through general testing.
    A defined contribution plan (other than an ESOP) may, however, 
satisfy the regulations on the basis of benefits by using cross-testing 
pursuant to rules provided in Sec. 1.401(a)(4)-8 of the regulations. 
Under this cross-testing method, contributions are converted, using 
actuarial assumptions, to equivalent benefits payable at normal 
retirement age, and these equivalent benefits are tested in a manner 
similar to the testing of employer-provided benefits under a defined 
benefit plan.
    In Notice 2000-14 (2000-10 I.R.B. 737), released February 24, 2000, 
the IRS and the Treasury Department initiated a review of issues 
related to use of the cross-testing method by so-called new 
comparability plans and requested public comments on this plan design 
from plan sponsors, participants and other interested parties. In 
general, new comparability plans are defined contribution plans that 
have built-in disparities between the allocation rates for 
classifications of participants consisting entirely or predominantly of 
HCEs and the allocation rates for other employees.
    In a typical new comparability plan, HCEs receive high allocation 
rates, while nonhighly compensated employees (NHCEs), regardless of 
their age or years of service, receive comparatively low allocation 
rates. For example, HCEs in such a plan might receive allocations of 18 
or 20% of compensation, while NHCEs might receive allocations of 3% of 
compensation. A similar plan design, sometimes known as a super-
integrated plan, provides for an additional allocation rate that 
applies only to compensation in excess of a specified threshold, but 
the specified threshold (e.g., $100,000) or the additional allocation 
rate (e.g., 10%) is higher than the maximum threshold and rate allowed 
under the permitted disparity rules of section 401(l).
    These new comparability and similar plans rely on the cross-testing 
method to demonstrate compliance with the nondiscrimination rules by 
comparing the actuarially projected value of the employer contributions 
for the younger NHCEs with the actuarial projections of the larger 
contributions (as a percentage of compensation) for the older HCEs. As 
a result, these plans are able generally to provide higher rates of 
employer contributions to HCEs, while NHCEs are not allowed to earn the 
higher allocation rates as they work additional years for the employer 
or grow older. Notwithstanding the analytical underpinnings of cross-
testing, the IRS and Treasury Department became concerned that new 
comparability and similar plans were not consistent with the basic 
purpose of the nondiscrimination rules under section 401(a)(4).
    After consideration of the comments received in response to Notice 
2000-14, the IRS and Treasury issued proposed regulations on this 
subject (REG-114697-00), which were published in the Federal Register 
on October 6, 2000 (65 FR 59774). The proposed regulations

[[Page 34536]]

preserved the cross-testing rules of the section 401(a)(4) regulations, 
but prescribed a gateway condition for new comparability and similar 
plans to meet in order to be eligible to use cross-testing to satisfy 
the nondiscrimination rules on the basis of benefits. However, defined 
contribution plans that provide broadly available allocation rates, as 
defined in the proposed regulations, did not have to satisfy the 
gateway. The definition of broadly available allocation rates under the 
proposed regulations covered plans that provide different allocation 
rates to different, nondiscriminatory groups of employees. Under the 
proposed regulations, the definition also covered plans that base 
allocations or allocation rates on age or years of service, that, in 
contrast to new comparability plans, provide an opportunity for 
participants to ``grow into'' higher allocation rates as they age or 
accumulate additional service.
    The proposed regulations also addressed a new comparability-type 
plan design that aggregates a defined benefit plan that benefits 
primarily HCEs with a defined contribution plan that benefits primarily 
NHCEs. This design would permit an employer to circumvent the minimum 
allocation gateway by aggregating (for purposes of the 
nondiscrimination rules) a new comparability or similar defined 
contribution plan with a defined benefit plan that provides only 
minimal benefits to NHCEs or covers only a relatively small number of 
NHCEs. In addition, a defined benefit plan that benefits primarily 
HCEs, and that is aggregated with a defined contribution plan for 
nondiscrimination testing, could produce results similar to a new 
comparability plan but with a potential for substantially more valuable 
benefits for HCEs. The proposed regulations provided a gateway for 
testing the aggregated plans on the basis of benefits that must be 
satisfied unless the aggregated defined contribution and defined 
benefit plan (the DB/DC plan) is primarily defined benefit in character 
(as defined in the proposed regulations), or unless each of the defined 
contribution and defined benefit portions of the DB/DC plan is a 
broadly available separate plan (as defined in the proposed 
regulations).
    Written comments responding to the notice of proposed rulemaking 
were received, and a public hearing was held on January 25, 2001, at 
the request of one commentator. After consideration of the comments, 
the proposed regulations are adopted as revised by this Treasury 
decision.

Explanation of Provisions

A. Overview

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

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

    These final regulations retain the rule in the proposed regulations 
that requires a defined contribution plan that does not provide broadly 
available allocation rates or certain age-based allocation rates (as 
these terms are defined in these final regulations) to satisfy a 
gateway in order to be eligible to use the cross-testing rules to meet 
the nondiscrimination requirements of section 401(a)(4). Under these 
final regulations, as under the proposed regulations, a plan satisfies 
this minimum allocation gateway if each NHCE in the plan has an 
allocation rate that is at least one third of the allocation rate of 
the HCE with the highest allocation rate, but a plan is deemed to 
satisfy the gateway if each NHCE receives an allocation of at least 5% 
of the NHCE's compensation (within the meaning of section 415(c)(3)).
    Several commentators raised questions about the interaction of the 
requirements under the proposed regulations and other regulatory rules 
relating to testing for nondiscrimination. For example, some 
commentators asked what was intended by the gateway requirement that 
all NHCEs receive the minimum required allocation. Except as 
specifically provided, the regulatory definitions and rules that apply 
for purposes of section 401(a)(4) also apply for purposes of these 
regulations. For example, the term employee, as used in these 
regulations, is defined in Sec. 1.401(a)(4)-12 as an employee (within 
the meaning of Sec. 1.410(b)-9) who benefits as an employee under the 
plan for the plan year, and an NHCE is defined in Sec. 1.401(a)(4)-12 
as an employee who is not an HCE. Thus, an individual who does not 
otherwise benefit under the plan for the plan year is not an employee 
under these regulations, hence not an NHCE, and need not be given the 
minimum required allocation under the gateway. Similarly, the 
allocation rate referred to in the gateway is determined under 
Sec. 1.401(a)(4)-2(c) as the allocations to an employee's account for a 
plan year, expressed either as a percentage of plan year compensation 
(which must be calculated using a definition of compensation that 
satisfies the requirements of section 414(s)) or as a dollar amount.
    The general rules and regulatory definitions applicable under 
section 410(b) apply also for purposes of these regulations. For 
example, these regulations do not change the general rule prohibiting 
aggregation of a 401(k) plan or 401(m) plan with a plan providing 
nonelective contributions. Accordingly, matching contributions are not 
taken into account for purposes of the gateway. Similarly, pursuant to 
Sec. 1.410(b)-6(b)(3), if a plan benefits employees who have not met 
the minimum age and service requirements of section 410(a)(1), the plan 
may be treated as two separate plans, one for those otherwise 
excludable employees and one for the other employees benefitting under 
the plan. Thus, if the plan is treated as two separate plans in this 
manner, cross-testing the portion of the plan benefitting the 
nonexcludable employees will not result in minimum required allocations 
under the gateway for the employees who have not met the section 
410(a)(1) minimum age and service requirements.
    One commentator suggested that the regulatory provision that 
permits a plan to satisfy the gateway requirement by providing an 
allocation of at least 5% of compensation within the meaning of section 
415(c)(3) not require that the allocation be based on a full year's 
compensation in the case of an employee who participates in the plan 
for only a portion of the plan year. The final regulations modify this 
requirement as suggested. The final regulations allow a plan to satisfy 
the gateway by providing an allocation of at least 5% of compensation 
within the meaning of section 415(c)(3), limited to a period otherwise 
permissible under the timing rules applicable under the definition of 
plan year compensation, in the same manner as the general rules under 
the section 401(a)(4) regulations. The definition of plan year 
compensation permits use of amounts

[[Page 34537]]

paid only during the period of participation within the plan year.
    Some commentators questioned whether it was necessary to require 
the use of compensation within the meaning of section 415(c)(3) for 
purposes of the 5% of compensation component of the minimum allocation 
gateway. One of these commentators argued that using compensation 
within the meaning of section 414(s) would be more appropriate. Two 
other commentators argued that, for this purpose, plans should be able 
to use a definition of compensation that would be a reasonable 
definition of compensation for purposes of section 414(s) without 
regard to whether the definition of compensation meets the 
nondiscrimination standard under the section 414(s) regulations.
    After consideration of these comments, the requirement that section 
415(c)(3) compensation be used for purposes of the 5% of compensation 
component of the minimum allocation gateway has been retained. For 
purposes of the ``one third'' component of the gateway, a definition of 
compensation that satisfies section 414(s) is an appropriate measure 
because this component is based on the ratio of HCE allocation rates to 
NHCE allocation rates. By contrast, the 5% of compensation component of 
the gateway does not reflect a comparison of NHCE allocations to HCE 
allocations, but is based on a particular level of NHCE allocations. 
Without the comparison between HCE and NHCE allocations, a rule 
permitting the use of a definition of compensation that satisfies 
section 414(s), but is less inclusive than total compensation, could 
lead to NHCE allocations that are significantly smaller than the 
minimum that is contemplated by the regulations. Therefore, it is 
appropriate to require the use of total compensation, as defined in 
section 415(c)(3), for the 5% allocation component of the gateway. 
Furthermore, permitting the use of a potentially discriminatory 
definition of compensation would be inconsistent with the 
nondiscrimination requirements in general, including the minimum 
allocation gateway.

C. Plans With Broadly Available Allocation Rates

    Like the proposed regulations, these final regulations provide that 
a plan that has broadly available allocation rates need not satisfy the 
minimum allocation gateway. In order to be broadly available, each 
allocation rate under the plan must be currently available to a group 
of employees that satisfies section 410(b) (without regard to the 
average benefit percentage test). Thus, if, within one plan, an 
employer provides different allocation rates for nondiscriminatory 
groups of employees at different locations or different profit centers, 
the plan would not need to satisfy the minimum allocation gateway in 
order to use cross-testing.
    For purposes of determining whether an allocation rate that was 
available only to employees who satisfied an age or service condition 
was currently available to a section 410(b) group, the proposed 
regulations allowed such a condition to be disregarded if certain 
standards were met. The final regulations retain this exception from 
the application of the minimum allocation gateway. However, this 
exception has been relocated and is now part of an expanded provision 
for plans with age-based allocations (see Plans with Age-Based 
Allocations portion of this preamble).
    In response to comments, the final regulations also liberalize the 
determination of whether a plan has broadly available allocation rates. 
First, the final regulations permit two allocation rates to be 
aggregated in a manner similar to the rule that permits aggregation of 
certain benefits, rights or features. This rule permits excess NHCEs 
with a higher allocation rate to be used to support a lower allocation 
rate. For example, under this rule, if under a plan there are two 
groups of participants, one group that receives an allocation rate of 
10% and another that receives an allocation rate of 3%, and if the 
group of employees who receive the 10% allocation rate satisfies 
section 410(b) (without regard to the average benefit percentage test), 
then the 10% rate and the 3% rate can be aggregated and treated as a 
single allocation rate for purposes of determining whether the plan has 
broadly available allocation rates. In addition, the final regulations 
provide that, in determining whether a plan provides broadly available 
allocation rates, differences in allocation rates resulting from any 
method of permitted disparity provided for under the section 401(l) 
regulations are disregarded.

D. Transition Allocations

    Several commentators raised the concern that a defined contribution 
plan may fail the broadly available test because of grandfathered 
allocation rates provided to employees who formerly participated in a 
defined benefit plan or provided to a group of employees in connection 
with a merger, acquisition, or other similar transaction. In response 
to these comments, the final regulations permit an employee's 
allocation to be disregarded, to the extent the employee's allocation 
is a transition allocation (as defined in the regulations) for the plan 
year. Transition allocations which can be disregarded can be defined 
benefit replacement allocations, pre-existing replacement allocations, 
or pre-existing merger and acquisition allocations (as defined in the 
regulations).
    In each case, the transition allocations must be provided to a 
closed group of employees and must be established under plan 
provisions. Once the allocations are established under the plan, they 
cannot be modified, except to reduce allocations for HCEs, or because 
of de minimis changes (such as a change in the definition of 
compensation to include section 132(f) elective reductions). A plan 
also does not violate this requirement because of an amendment that 
either adds or removes a provision applicable to all employees in the 
group eligible for the allocations under which each employee who is 
eligible for a transition allocation receives the greater of the 
transition allocation or another allocation for which the employee 
would otherwise be eligible. If the plan provides that all employees 
who are eligible for the transition allocation receive the greater of 
the transition allocation or an otherwise available allocation, the 
otherwise available allocation is considered currently available to all 
such employees, including employees for whom the transition allocation 
is greater.
    These final regulations set forth basic conditions for defined 
benefit replacement allocations. These conditions provide a framework 
that is designed to ensure that these allocations are provided in a 
manner consistent with the general principles underlying the provisions 
for broadly available allocation rates under these regulations. The 
regulations then delegate authority to the Commissioner to prescribe 
rules for defined benefit replacement allocations in revenue rulings, 
notices, and other guidance published in the Internal Revenue Bulletin. 
Rev. Rul. 2001-30 (2001-29 I.R.B.), dated July 16, 2001, published in 
conjunction with these final regulations, prescribes specific 
conditions for defined benefit replacement allocations that relate to 
the basic conditions set forth in the regulations. This division of the 
medium of guidance is designed to provide ongoing flexibility to the 
IRS and Treasury to respond to changing circumstances, or additional 
information relating to defined benefit replacement allocations.

[[Page 34538]]

    The basic conditions that allocations must satisfy in order to be 
defined benefit replacement allocations are as follows: (1) The 
allocations are provided to a group of employees who formerly 
benefitted under an established nondiscriminatory defined benefit plan 
of the employer or of a prior employer that provided age-based 
equivalent allocation rates; (2) the allocations for each employee were 
reasonably calculated, in a consistent manner, to replace the 
retirement benefits that the employee would have been provided under 
the defined benefit plan if the employee had continued to benefit under 
the defined benefit plan; (3) no employee who receives the allocation 
receives any other allocations under the plan for the plan year (except 
as provided in these regulations); and (4) the composition of the group 
of employees who receive the allocations is nondiscriminatory.
    Rev. Rul. 2001-30 fleshes out these basic conditions for 
determining whether an allocation is a defined benefit replacement 
allocation. Under the revenue ruling, the defined benefit plan's 
benefit formula applicable to the group of employees must be one that 
generated equivalent normal allocation rates (determined without regard 
to changes in accrual rates attributable to changes in an employee's 
years of service) that increased from year to year as employees 
attained higher ages. Further, if the defined benefit plan was 
sponsored by the employer, the defined benefit plan satisfied sections 
410(b) and 401(a)(4), without regard to section 410(b)(6)(C) and 
without aggregating with any other plan, for the plan year which 
immediately precedes the first plan year for which the allocations are 
provided. Finally, the defined benefit plan must be one that has been 
established and maintained without substantial change for at least the 
5 years ending on the date benefit accruals under the defined benefit 
plan cease (with one year substituted for 5 years in the case of a 
defined benefit plan of a former employer).
    In order to be defined benefit replacement allocations for the plan 
year, the allocations for each employee in the group must be reasonably 
calculated, in a consistent manner, to replace the employee's 
retirement benefits under the defined benefit plan based on the terms 
of the defined benefit plan (including the section 415(b)(1)(A) limit) 
as in effect immediately prior to the date accruals under the defined 
benefit plan cease. In addition, the group of employees who receive the 
allocations in a plan year must satisfy section 410(b) (determined 
without regard to the average benefit percentage test of Sec. 1.410(b)-
5).
    Although the regulations and Rev. Rul. 2001-30 prescribe conditions 
for the defined benefit replacement allocations, they still leave 
employers with flexibility in structuring these benefits. For example, 
there is more than one way in which the allocations may reasonably be 
calculated, such as a level percentage of pay for each year or an 
amount that increases as the employee ages.
    The final regulations provide special rules applicable to 
allocations that are either pre-existing replacement allocations or 
pre-existing merger and acquisition allocations. Allocations are pre-
existing replacement allocations if the allocations are provided 
pursuant to a plan provision adopted before June 29, 2001, are provided 
to employees who formerly benefitted under a defined benefit plan and 
are reasonably calculated, in a consistent manner, to replace some or 
all of the retirement benefits that the employee would have received 
under the defined benefit plan and any other plan or arrangement of the 
employer if the employee had continued to benefit under such defined 
benefit plan and such other plan or arrangement. Allocations are pre-
existing merger and acquisition allocations if the allocations were 
established in connection with a stock or asset acquisition, merger, or 
other similar transaction occurring prior to August 28, 2001, for a 
group of employees who were employed by the acquired trade or business 
prior to a specified date, provided that the class of employees 
eligible for the allocations is closed no later than two years after 
the transaction (or January 1, 2002, if earlier), the allocations are 
provided pursuant to a plan amendment adopted by the date the class was 
closed, and the allocations for each employee in the group are 
reasonably calculated, in a consistent manner, to replace some or all 
of the retirement benefits that the employee would have received under 
any plan of the employer if the new employer had continued to provide 
the retirement benefits that the prior employer was providing for 
employees of the trade or business.

E. Plans With Age-Based Allocations

    These final regulations provide a separate exception from the 
application of the minimum allocation gateway for certain plans with 
age-based allocation rates. This provision incorporates the exception 
under the proposed regulations for plans with gradual age or service 
schedules, and expands the exception to include plans that provide for 
allocation rates based on a uniform target benefit allocation.
    A plan has a gradual age or service schedule if the schedule of 
allocation rates under the plan's formula is available to all employees 
in the plan and provides for allocation rates that increase smoothly at 
regular intervals. The rules applicable to the schedule of allocation 
rates are designed to be sufficiently flexible to accommodate a wide 
variety of age- or service-based plans (including age-weighted profit-
sharing plans that provide for allocations resulting in the same 
equivalent accrual rate for all employees). The final regulations 
clarify that a plan projecting future age or service may not use 
imputed disparity in determining whether the allocation rates under the 
schedule increase smoothly at regular intervals. In response to 
comments, the final regulations also accommodate smoothly increasing 
schedules of allocation rates that are based on the sum of age and 
years of service. In addition, to conform with the rules for 
computation of service under Sec. 1.401(a)(4)-12, references to service 
have been changed to years of service.
    The requirement that the allocation rates under a schedule increase 
smoothly at regular intervals provides important protection for 
employees, because this requirement limits the exception from the 
minimum allocation gateway to plans in which NHCEs actually receive the 
benefit of higher rates as they attain higher ages or complete 
additional years of service. Some commentators expressed concern that 
employers could be forced to reduce allocations to younger or shorter-
service NHCEs in order to satisfy the conditions for allocation rates 
that increase smoothly at regular intervals. In response to these 
comments, the final regulations provide that a plan's schedule of 
allocation rates does not fail to increase smoothly at regular 
intervals merely because a specified minimum uniform allocation rate is 
provided for all employees or because the minimum benefit described in 
section 416(c)(2) is provided for all non-key employees (either because 
the plan is top heavy or without regard to whether the plan is top 
heavy) if one of two alternative conditions is satisfied. These two 
alternative conditions are intended to limit the potential use of a 
minimum allocation to provide a schedule of rates that delivers 
allocations similar to those under a new comparability plan (i.e., a 
flat allocation rate applicable for all employees below a certain age, 
followed by a sharply increasing schedule of rates that effectively 
benefits only HCEs)

[[Page 34539]]

without satisfying the minimum allocation gateway.
    A plan satisfies the first alternative condition if the allocation 
rates under the plan that exceed the specified minimum rate could form 
part of a schedule of allocation rates that increase smoothly at 
regular intervals (as defined in these regulations) in which the lowest 
allocation rate is at least 1% of plan year compensation. The second 
alternative condition, available for a plan using an age-based 
schedule, allows the use of a minimum allocation rate if, for each age 
band above the minimum allocation rate, the allocation rate applicable 
for that band is less than or equal to the allocation rate that would 
yield an equivalent accrual rate at the highest age in the band that is 
the same as the equivalent accrual rate determined for the oldest 
hypothetical employee who would receive just the minimum allocation 
rate. Thus, under this condition, the allocation rates above the 
minimum allocation rate do not rise more steeply than expected under an 
age-weighted profit-sharing plan generally intended to provide the same 
accrual rate at all ages.
    The exception to the minimum allocation gateway for plans with age-
based allocation rates also applies to certain uniform target benefit 
plans that do not comply with the safe-harbor testing method provided 
in Sec. 1.401(a)(4)-8(b)(3).\1\ A plan has allocation rates based on a 
uniform target benefit allocation if it would comply with the 
requirements for a safe harbor target benefit plan in Sec. 1.401(a)(4)-
8(b)(3) except that the interest rate for determining the actuarial 
present value of the stated plan benefit and the theoretical reserve is 
lower than a standard interest rate, the stated benefit is calculated 
assuming compensation increases, or the plan computes the current year 
contribution using the actual account balance instead of the 
theoretical reserve.
---------------------------------------------------------------------------

    \1\ No exception to the minimum allocation gateway is needed for 
target benefit plans that comply with the safe-harbor testing 
provisions of Sec. 1.401(a)(4)-8(b)(3), because they are deemed to 
satisfy section 401(a)(4) with respect to an equivalent amount of 
benefits.
---------------------------------------------------------------------------

F. Application to Defined Contribution Plans That Are Combined With 
Defined Benefit Plans (DB/DC Plans)

    These regulations prescribe rules for testing defined contribution 
plans that are aggregated with defined benefit plans for purposes of 
sections 401(a)(4) and 410(b). These rules apply in situations in which 
the employer aggregates the plans because one of the plans does not 
satisfy sections 401(a)(4) and 410(b) standing alone. These rules do 
not apply to safe harbor floor-offset arrangements described in 
Sec. 1.401(a)(4)-8(d), or to the situation in which plans are 
aggregated solely for purposes of satisfying the average benefit 
percentage test of Sec. 1.410(b)-5.
    These regulations retain the rule of the proposed regulations that 
the combination of a defined contribution plan and a defined benefit 
plan may demonstrate nondiscrimination on the basis of benefits if the 
combined plan (the DB/DC plan) is primarily defined benefit in 
character, consists of broadly available separate plans (as these terms 
are defined in the regulations), or satisfies a minimum aggregate 
allocation gateway requirement that is generally similar to the minimum 
allocation gateway for defined contribution plans that are not combined 
with a defined benefit plan.
1. Gateway for Benefits Testing of Combined Plans
    In order to apply this minimum aggregate allocation gateway, the 
employee's aggregate normal allocation rate is determined by adding the 
employee's allocation rate under the defined contribution plan to the 
employee's equivalent allocation rate under the defined benefit plan. 
This aggregation allows an employer that provides NHCEs with both a 
defined contribution and a defined benefit plan to take both plans into 
account in determining whether the minimum aggregate allocation gateway 
is met.
    Under the gateway, if the aggregate normal allocation rate of the 
HCE with the highest aggregate normal allocation rate under the plan 
(HCE rate) is less than 15%, the aggregate normal allocation rate for 
all NHCEs must be at least one-third of the HCE rate. If the HCE rate 
is between 15% and 25%, the aggregate normal allocation rate for all 
NHCEs must be at least 5%. If the HCE rate exceeds 25%, then the 
aggregate normal allocation rate for each NHCE must be at least 5% plus 
one percentage point for each 5-percentage-point increment (or portion 
thereof) by which the HCE rate exceeds 25% (e.g., the NHCE minimum is 
6% for an HCE rate that exceeds 25% but not 30%, and 7% for an HCE rate 
that exceeds 30% but not 35%).
    Several commentators expressed a concern that the minimum aggregate 
allocation gateway in the proposed regulations could require 
contributions for NHCEs that would make DB/DC plans too expensive for 
employers in certain circumstances. This could occur in cases where one 
HCE had a very high equivalent allocation rate on account of age or 
some other factor, and could prompt such an employer to redesign its 
plans in ways that could disadvantage NHCEs. In response to these 
comments, these final regulations provide that a plan is deemed to 
satisfy this minimum aggregate allocation gateway if the aggregate 
normal allocation rate for each NHCE is at least 7\1/2\% of 
compensation within the meaning of section 415(c)(3), determined over a 
period otherwise permissible under the timing rules applicable under 
the definition of plan year compensation.
    These regulations retain the rule that, in determining the 
equivalent allocation rate for an NHCE under a defined benefit plan, a 
plan is permitted to treat each NHCE who benefits under the defined 
benefit plan as having an equivalent allocation rate equal to the 
average of the equivalent allocation rates under the defined benefit 
plan for all NHCEs benefitting under that plan. This averaging rule 
recognizes the grow-in feature inherent in traditional defined benefit 
plans (i.e., the defined benefit plan provides higher equivalent 
allocation rates at higher ages).
2. Primarily Defined Benefit in Character
    Like the proposed regulations, these final regulations provide that 
a DB/DC plan that is primarily defined benefit in character is not 
subject to the gateway requirement and may continue to be tested for 
nondiscrimination on the basis of benefits as under former law. A DB/DC 
plan is primarily defined benefit in character if, for more than 50% of 
the NHCEs benefitting under the plan, the normal accrual rate 
attributable to benefits provided under defined benefit plans for the 
NHCE exceeds the equivalent accrual rate attributable to contributions 
under defined contribution plans for the NHCE. For example, a DB/DC 
plan is primarily defined benefit in character where the defined 
contribution plan covers only salaried employees, the defined benefit 
plan covers only hourly employees, and more than half of the NHCEs 
participating in the DB/DC plan are hourly employees participating only 
in the defined benefit plan.
    Some comments suggested a loosening of the standard as to when a 
DB/DC plan is primarily defined benefit in character, but no changes 
have been made. The Treasury and IRS believe that the determination of 
whether a DB/DC plan is primarily defined benefit in character should 
be based on the relative size of the defined benefit accruals and the 
defined contribution allocations for individual employees, as reflected 
in the actual benefits testing

[[Page 34540]]

that is being done under section 401(a)(4). In particular, the 
actuarial assumptions used to determine whether a DB/DC plan is 
primarily defined benefit in character must be the same assumptions 
that are used to apply the cross-testing rules.
3. Broadly Available Separate Plans
    Like the proposed regulations, these final regulations provide that 
a DB/DC plan that consists of broadly available separate plans may 
continue to be tested for nondiscrimination on the basis of benefits as 
under current law, even if it does not satisfy the gateway requirement. 
A DB/DC plan consists of broadly available separate plans if the 
defined contribution plan and the defined benefit plan, tested 
separately, would each satisfy the requirements of section 410(b) and 
the nondiscrimination in amount requirement of Sec. 1.401(a)(4)-
1(b)(2), assuming satisfaction of the average benefit percentage test 
of Sec. 1.410(b)-5. Thus, the defined contribution plan must separately 
satisfy the nondiscrimination requirements (taking into account these 
regulations as applicable), but for this purpose assuming satisfaction 
of the average benefit percentage test. Similarly, the defined benefit 
plan must separately satisfy the nondiscrimination requirements, 
assuming for this purpose satisfaction of the average benefit 
percentage test. In conducting the required separate testing, all plans 
of a single type (defined contribution or defined benefit) within the 
DB/DC plan are aggregated, but those plans are tested without regard to 
plans of the other type.
    This alternative is useful, for example, where an employer 
maintains a defined contribution plan that provides a uniform 
allocation rate for all covered employees at one business unit and a 
safe harbor defined benefit plan for all covered employees at another 
unit, and where the group of employees covered by each of those plans 
is a group that satisfies the nondiscriminatory classification 
requirement of section 410(b). Because the employer provides broadly 
available separate plans, it may continue to aggregate the plans and 
test for nondiscrimination on the basis of benefits, as an alternative 
to using the qualified separate line of business rules or demonstrating 
satisfaction of the average benefit percentage test.

G. Use of Component Plans

    As under the proposed regulations, the rules set forth in these 
final regulations cannot be satisfied using component plans under the 
restructuring rules. Although some commentators requested that 
restructuring be permitted for this purpose, the IRS and Treasury have 
determined that such use of component plans would be inconsistent with 
the purpose of these regulations.

Effective Date

    These regulations apply for plan years beginning on or after 
January 1, 2002.

Special Analyses

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

Drafting Information

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

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

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

    Authority: 26 U.S.C. 7805 * * *

    Par. 2. In Sec. 1.401(a)(4)-0, the entry for Sec. 1.401(a)(4)-
8(b)(1), is revised to read as follows:


Sec. 1.401(a)(4)-0    Table of contents.

* * * * *


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

* * * * *
    (b) * * *
    (1) General rule and gateway.
* * * * *

    Par. 3. In Sec. 1.401(a)(4)-8, paragraph (b)(1) is revised to read 
as follows:


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

* * * * *
    (b) Nondiscrimination in amount of benefits provided under a 
defined contribution plan--(1) General rule and gateway--(i) General 
rule. Equivalent benefits under a defined contribution plan (other than 
an ESOP) are nondiscriminatory in amount for a plan year if--
    (A) The plan would satisfy Sec. 1.401(a)(4)-2(c)(1) for the plan 
year if an equivalent accrual rate, as determined under paragraph 
(b)(2) of this section, were substituted for each employee's allocation 
rate in the determination of rate groups; and
    (B) For plan years beginning on or after January 1, 2002, the plan 
satisfies one of the following conditions--
    (1) The plan has broadly available allocation rates (within the 
meaning of paragraph (b)(1)(iii) of this section) for the plan year;
    (2) The plan has age-based allocation rates that are based on 
either a gradual age or service schedule (within the meaning of 
paragraph (b)(1)(iv) of this section) or a uniform target benefit 
allocation (within the meaning of paragraph (b)(1)(v) of this section) 
for the plan year; or
    (3) The plan satisfies the minimum allocation gateway of paragraph 
(b)(1)(vi) of this section for the plan year.
    (ii) Allocations after testing age. A plan does not fail to satisfy 
paragraph (b)(1)(i)(A) of this section merely because allocations are 
made at the same rate for employees who are older than their testing 
age (determined without regard to the current-age rule in paragraph (4) 
of the definition of testing age in Sec. 1.401(a)(4)-12) as they are 
made for employees who are at that age.
    (iii) Broadly available allocation rates--(A) In general. A plan 
has broadly available allocation rates for the plan year if each 
allocation rate under the plan is currently available during the plan 
year (within the meaning of Sec. 1.401(a)(4)-4(b)(2)), to a group of 
employees that satisfies section 410(b) (without regard to the average 
benefit percentage test of Sec. 1.410(b)-5). For this purpose, if two 
allocation rates could be permissively aggregated under 
Sec. 1.401(a)(4)-4(d)(4), assuming the allocation rates were treated as 
benefits, rights or features, they may be aggregated and treated as a 
single allocation rate. In addition, the disregard of age and service 
conditions described in Sec. 1.401(a)(4)-4(b)(2)(ii)(A)

[[Page 34541]]

does not apply for purposes of this paragraph (b)(1)(iii)(A).
    (B) Certain transition allocations. In determining whether a plan 
has broadly available allocation rates for the plan year within the 
meaning of paragraph (b)(1)(iii)(A) of this section, an employee's 
allocation may be disregarded to the extent that the allocation is a 
transition allocation for the plan year. In order for an allocation to 
be a transition allocation, the allocation must comply with the 
requirements of paragraph (b)(1)(iii)(C) of this section and must be 
either--
    (1) A defined benefit replacement allocation within the meaning of 
paragraph (b)(1)(iii)(D) of this section; or
    (2) A pre-existing replacement allocation or pre-existing merger 
and acquisition allocation, within the meaning of paragraph 
(b)(1)(iii)(E) of this section.
    (C) Plan provisions relating to transition allocations--(1) In 
general. Plan provisions providing for transition allocations for the 
plan year must specify both the group of employees who are eligible for 
the transition allocations and the amount of the transition 
allocations.
    (2) Limited plan amendments. Allocations are not transition 
allocations within the meaning of paragraph (b)(1)(iii)(B) of this 
section for the plan year if the plan provisions relating to the 
allocations are amended after the date those plan provisions are both 
adopted and effective. The preceding sentence in this paragraph 
(b)(1)(iii)(C)(2) does not apply to a plan amendment that reduces 
transition allocations to HCEs, makes de minimis changes in the 
calculation of the transition allocations (such as a change in the 
definition of compensation to include section 132(f) elective 
reductions), or adds or removes a provision permitted under paragraph 
(b)(1)(iii)(C)(3) of this section.
    (3) Certain permitted plan provisions. An allocation does not fail 
to be a transition allocation within the meaning of paragraph 
(b)(1)(iii)(B) of this section merely because the plan provides that 
each employee who is eligible for a transition allocation receives the 
greater of such allocation and the allocation for which the employee 
would otherwise be eligible under the plan. In a plan that contains 
such a provision, for purposes of determining whether the plan has 
broadly available allocation rates within the meaning of paragraph 
(b)(1)(iii)(A) of this section, the allocation for which an employee 
would otherwise be eligible is considered currently available to the 
employee, even if the employee's transition allocation is greater.
    (D) Defined benefit replacement allocation. An allocation is a 
defined benefit replacement allocation for the plan year if it is 
provided in accordance with guidance prescribed by the Commissioner 
published in the Internal Revenue Bulletin (see 
Sec. 601.601(d)(2)(ii)(b) of this chapter) and satisfies the following 
conditions--
    (1) The allocations are provided to a group of employees who 
formerly benefitted under an established nondiscriminatory defined 
benefit plan of the employer or of a prior employer that provided age-
based equivalent allocation rates;
    (2) The allocations for each employee in the group were reasonably 
calculated, in a consistent manner, to replace the retirement benefits 
that the employee would have been provided under the defined benefit 
plan if the employee had continued to benefit under the defined benefit 
plan;
    (3) Except as provided in paragraph (b)(1)(iii)(C) of this section, 
no employee who receives the allocation receives any other allocations 
under the plan for the plan year; and
    (4) The composition of the group of employees who receive the 
allocations is nondiscriminatory.
    (E) Pre-existing transition allocations--(1) Pre-existing 
replacement allocations. An allocation is a pre-existing replacement 
allocation for the plan year if the allocation satisfies the following 
conditions--
    (i) The allocations are provided pursuant to a plan provision 
adopted before June 29, 2001;
    (ii) The allocations are provided to employees who formerly 
benefitted under a defined benefit plan of the employer; and
    (iii) The allocations for each employee in the group are reasonably 
calculated, in a consistent manner, to replace some or all of the 
retirement benefits that the employee would have received under the 
defined benefit plan and any other plan or arrangement of the employer 
if the employee had continued to benefit under such defined benefit 
plan and such other plan or arrangement.
    (2) Pre-existing merger and acquisition allocations. An allocation 
is a pre-existing merger and acquisition allocation for the plan year 
if the allocation satisfies the following conditions--
    (i) The allocations are provided solely to employees of a trade or 
business that has been acquired by the employer in a stock or asset 
acquisition, merger, or other similar transaction occurring prior to 
August 28, 2001, involving a change in the employer of the employees of 
the trade or business;
    (ii) The allocations are provided only to employees who were 
employed by the acquired trade or business before a specified date that 
is no later than two years after the transaction (or January 1, 2002, 
if earlier);
    (iii) The allocations are provided pursuant a plan provision 
adopted no later than the specified date; and
    (iv) The allocations for each employee in the group are reasonably 
calculated, in a consistent manner, to replace some or all of the 
retirement benefits that the employee would have received under any 
plan of the employer if the new employer had continued to provide the 
retirement benefits that the prior employer was providing for employees 
of the trade or business.
    (F) Successor employers. An employer that accepts a transfer of 
assets (within the meaning of section 414(l)) from the plan of a prior 
employer may continue to treat any transition allocations provided 
under that plan as transition allocations under paragraph 
(b)(1)(iii)(B) of this section, provided that the successor employer 
continues to satisfy the applicable requirements set forth in 
paragraphs (b)(1)(iii)(C) through (E) of this section for the plan 
year.
    (iv) Gradual age or service schedule--(A) In general. A plan has a 
gradual age or service schedule for the plan year if the allocation 
formula for all employees under the plan provides for a single schedule 
of allocation rates under which--
    (1) The schedule defines a series of bands based solely on age, 
years of service, or the number of points representing the sum of age 
and years of service (age and service points), under which the same 
allocation rate applies to all employees whose age, years of service, 
or age and service points are within each band; and
    (2) The allocation rates under the schedule increase smoothly at 
regular intervals, within the meaning of paragraphs (b)(1)(iv)(B) and 
(C) of this section.
    (B) Smoothly increasing schedule of allocation rates. A schedule of 
allocation rates increases smoothly if the allocation rate for each 
band within the schedule is greater than the allocation rate for the 
immediately preceding band (i.e., the band with the next lower number 
of years of age, years of service, or age and service points) but by no 
more than 5 percentage points. However, a schedule of allocation rates 
will not be treated as increasing smoothly if the ratio of the 
allocation rate for any band to the rate for the immediately preceding 
band is more than 2.0 or if it exceeds the ratio of

[[Page 34542]]

allocation rates between the two immediately preceding bands.
    (C) Regular intervals. A schedule of allocation rates has regular 
intervals of age, years of service or age and service points, if each 
band, other than the band associated with the highest age, years of 
service, or age and service points, is the same length. For this 
purpose, if the schedule is based on age, the first band is deemed to 
be of the same length as the other bands if it ends at or before age 
25. If the first age band ends after age 25, then, in determining 
whether the length of the first band is the same as the length of other 
bands, the starting age for the first age band is permitted to be 
treated as age 25 or any age earlier than 25. For a schedule of 
allocation rates based on age and service points, the rules of the 
preceding two sentences are applied by substituting 25 age and service 
points for age 25. For a schedule of allocation rates based on service, 
the starting service for the first service band is permitted to be 
treated as one year of service or any lesser amount of service.
    (D) Minimum allocation rates permitted. A schedule of allocation 
rates under a plan does not fail to increase smoothly at regular 
intervals, within the meaning of paragraphs (b)(1)(iv)(B) and (C) of 
this section, merely because a minimum uniform allocation rate is 
provided for all employees or the minimum benefit described in section 
416(c)(2) is provided for all non-key employees (either because the 
plan is top heavy or without regard to whether the plan is top heavy) 
if the schedule satisfies one of the following conditions--
    (1) The allocation rates under the plan that are greater than the 
minimum allocation rate can be included in a hypothetical schedule of 
allocation rates that increases smoothly at regular intervals, within 
the meaning of paragraphs (b)(1)(iv)(B) and (C) of this section, where 
the hypothetical schedule has a lowest allocation rate no lower than 1% 
of plan year compensation; or
    (2) For a plan using a schedule of allocation rates based on age, 
for each age band in the schedule that provides an allocation rate 
greater than the minimum allocation rate, there could be an employee in 
that age band with an equivalent accrual rate that is less than or 
equal to the equivalent accrual rate that would apply to an employee 
whose age is the highest age for which the allocation rate equals the 
minimum allocation rate.
    (v) Uniform target benefit allocations. A plan has allocation rates 
that are based on a uniform target benefit allocation for the plan year 
if the plan fails to satisfy the requirements for the safe harbor 
testing method in paragraph (b)(3) of this section merely because the 
determination of the allocations under the plan differs from the 
allocations determined under that safe harbor testing method for any of 
the following reasons--
    (A) The interest rate used for determining the actuarial present 
value of the stated plan benefit and the theoretical reserve is lower 
than a standard interest rate;
    (B) The stated benefit is calculated assuming compensation 
increases at a specified rate; or
    (C) The plan computes the current year contribution using the 
actual account balance instead of the theoretical reserve.
    (vi) Minimum allocation gateway--(A) General rule. A plan satisfies 
the minimum allocation gateway of this paragraph (b)(1)(vi) if each 
NHCE has an allocation rate that is at least one third of the 
allocation rate of the HCE with the highest allocation rate.
    (B) Deemed satisfaction. A plan is deemed to satisfy the minimum 
allocation gateway of this paragraph (b)(1)(vi) if each NHCE receives 
an allocation of at least 5% of the NHCE's compensation within the 
meaning of section 415(c)(3), measured over a period of time permitted 
under the definition of plan year compensation.
    (vii) Determination of allocation rate. For purposes of paragraph 
(b)(1)(i)(B) of this section, allocations and allocation rates are 
determined under Sec. 1.401(a)(4)-2(c)(2), but without taking into 
account the imputation of permitted disparity under Sec. 1.401(a)(4)-7. 
However, in determining whether the plan has broadly available 
allocation rates as provided in paragraph (b)(1)(iii) of this section, 
differences in allocation rates attributable solely to the use of 
permitted disparity described in Sec. 1.401(l)-2 are disregarded.
    (viii) Examples. The following examples illustrate the rules in 
this paragraph (b)(1):

    Example 1. (i) Plan M, a defined contribution plan without a 
minimum service requirement, provides an allocation formula under 
which allocations are provided to all employees according to the 
following schedule:

------------------------------------------------------------------------
                                                               Ratio of
                                                              allocation
                                                               rate for
                                                 Allocation    band to
          Completed years of service             rate  (in    allocation
                                                  percent)     rate for
                                                             immediately
                                                              preceding
                                                                 band
------------------------------------------------------------------------
0-5...........................................          3.0        (\1\)
6-10..........................................          4.5         1.50
11-15.........................................          6.5         1.44
16-20.........................................          8.5         1.31
21-25.........................................         10.0         1.18
26 or more....................................         11.5        1.15
------------------------------------------------------------------------
\1\ Not applicable.

    (ii) Plan M provides that allocation rates for all employees are 
determined using a single schedule based solely on service, as 
described in paragraph (b)(1)(iv)(A)(1) of this section. Therefore, 
if the allocation rates under the schedule increase smoothly at 
regular intervals as described in paragraph (b)(1)(iv)(A)(2) of this 
section, then the plan has a gradual age or service schedule 
described in paragraph (b)(1)(iv) of this section.
    (iii) The schedule of allocation rates under Plan M does not 
increase by more than 5 percentage points between adjacent bands and 
the ratio of the allocation rate for any band to the allocation rate 
for the immediately preceding band is never more than 2.0 and does 
not increase. Therefore, the allocation rates increase smoothly as 
described in paragraph (b)(1)(iv)(B) of this section. In addition, 
the bands (other than the highest band) are all 5 years long, so the 
increases occur at regular intervals as described in paragraph 
(b)(1)(iv)(C) of this section. Thus, the allocation rates under the 
plan's schedule increase smoothly at regular intervals as described 
in paragraph (b)(1)(iv)(A)(2) of this section. Accordingly, the plan 
has a gradual age or service schedule described in paragraph 
(b)(1)(iv) of this section.
    (iv) Under paragraph (b)(1)(i) of this section, Plan M satisfies 
the nondiscrimination in amount requirement of Sec. 1.401(a)(4)-
1(b)(2) on the basis of benefits if it satisfies paragraph 
(b)(1)(i)(A) of this section, regardless of whether it satisfies the 
minimum allocation gateway of paragraph (b)(1)(vi) of this section.
    Example 2. (i) The facts are the same as in Example 1, except 
that the 4.5% allocation rate applies for all employees with 10 
years of service or less.
    (ii) Plan M provides that allocation rates for all employees are 
determined using a single schedule based solely on service, as 
described in paragraph (b)(1)(iv)(A)(1) of this section. Therefore, 
if the allocation rates under the schedule increase smoothly at 
regular intervals as described in paragraph (b)(1)(iv)(A)(2) of this 
section, then the plan has a gradual age or service schedule 
described in paragraph (b)(1)(iv) of this section.
    (iii) The bands (other than the highest band) in the schedule 
are not all the same length, since the first band is 10 years long 
while other bands are 5 years long. Thus, the schedule does not have 
regular intervals as described in paragraph (b)(1)(iv)(C) of this 
section. However, under paragraph (b)(1)(iv)(D) of this section, the 
schedule of

[[Page 34543]]

allocation rates does not fail to increase smoothly at regular 
intervals merely because the minimum allocation rate of 4.5% results 
in a first band that is longer than the other bands, if either of 
the conditions of paragraph (b)(1)(iv)(D)(1) or (2) of this section 
is satisfied.
    (iv) In this case, the schedule of allocation rates satisfies 
the condition in paragraph (b)(1)(iv)(D)(1) of this section because 
the allocation rates under the plan that are greater than the 4.5% 
minimum allocation rate can be included in the following 
hypothetical schedule of allocation rates that increases smoothly at 
regular intervals and has a lowest allocation rate of at least 1% of 
plan year compensation:

------------------------------------------------------------------------
                                                               Ratio of
                                                              allocation
                                                               rate for
                                                 Allocation    band to
          Completed years of service             rate  (in    allocation
                                                  percent)     rate for
                                                             immediately
                                                              preceding
                                                                 band
------------------------------------------------------------------------
0-5...........................................          2.5        (\1\)
6-10..........................................          4.5         1.80
11-15.........................................          6.5         1.44
16-20.........................................          8.5         1.31
21-25.........................................         10.0         1.18
26 or more....................................         11.5        1.15
------------------------------------------------------------------------
\1\ Not applicable.

    (v) Accordingly, the plan has a gradual age or service schedule 
described in paragraph (b)(1)(iv) of this section. Under paragraph 
(b)(1)(i) of this section, Plan M satisfies the nondiscrimination in 
amount requirement of Sec. 1.401(a)(4)-1(b)(2) on the basis of benefits 
if it satisfies paragraph (b)(1)(i)(A) of this section, regardless of 
whether it satisfies the minimum allocation gateway of paragraph 
(b)(1)(vi) of this section.
    Example 3. (i) Plan N, a defined contribution plan, provides an 
allocation formula under which allocations are provided to all 
employees according to the following schedule:

------------------------------------------------------------------------
                                                               Ratio of
                                                              allocation
                                                               rate for
                                                 Allocation    band to
                      Age                        rate  (in    allocation
                                                  percent)     rate for
                                                             immediately
                                                              preceding
                                                                 band
------------------------------------------------------------------------
Under 25......................................          3.0        (\1\)
25-34.........................................          6.0         2.00
35-44.........................................          9.0         1.50
45-54.........................................         12.0         1.33
55-64.........................................         16.0         1.33
65 or older...................................         21.0        1.31
------------------------------------------------------------------------
\1\ Not applicable.

    (ii) Plan N provides that allocation rates for all employees are 
determined using a single schedule based solely on age, as described 
in paragraph (b)(1)(iv)(A)(1) of this section. Therefore, if the 
allocation rates under the schedule increase smoothly at regular 
intervals as described in paragraph (b)(1)(iv)(A)(2) of this 
section, then the plan has a gradual age or service schedule 
described in paragraph (b)(1)(iv) of this section.
    (iii) The schedule of allocation rates under Plan N does not 
increase by more than 5 percentage points between adjacent bands and 
the ratio of the allocation rate for any band to the allocation rate 
for the immediately preceding band is never more than 2.0 and does 
not increase. Therefore, the allocation rates increase smoothly as 
described in paragraph (b)(1)(iv)(B) of this section. In addition, 
the bands (other than the highest band and the first band, which is 
deemed to be the same length as the other bands because it ends 
prior to age 25) are all 5 years long, so the increases occur at 
regular intervals as described in paragraph (b)(1)(iv)(C) of this 
section. Thus, the allocation rates under the plan's schedule 
increase smoothly at regular intervals as described in paragraph 
(b)(1)(iv)(A)(2) of this section. Accordingly, the plan has a 
gradual age or service schedule described in paragraph (b)(1)(iv) of 
this section.
    (iv) Under paragraph (b)(1)(i) of this section, Plan N satisfies 
the nondiscrimination in amount requirement of Sec. 1.401(a)(4)-
1(b)(2) on the basis of benefits if it satisfies paragraph 
(b)(1)(i)(A) of this section, regardless of whether it satisfies the 
minimum allocation gateway of paragraph (b)(1)(vi) of this section.
    Example 4. (i) Plan O, a defined contribution plan, provides an 
allocation formula under which allocations are provided to all 
employees according to the following schedule:

------------------------------------------------------------------------
                                                               Ratio of
                                                              allocation
                                                               rate for
                                                 Allocation    band to
                      Age                        rate  (in    allocation
                                                  percent)     rate for
                                                             immediately
                                                              preceding
                                                                 band
------------------------------------------------------------------------
Under 40......................................            3        (\1\)
40-44.........................................            6         2.00
45-49.........................................            9         1.50
50-54.........................................           12         1.33
55-59.........................................           16         1.33
60-64.........................................           20         1.25
65 or older...................................           25        1.25
------------------------------------------------------------------------
\1\ Not applicable.

    (ii) Plan O provides that allocation rates for all employees are 
determined using a single schedule based solely on age, as described 
in paragraph (b)(1)(iv)(A)(1) of this section. Therefore, if the 
allocation rates under the schedule increase smoothly at regular 
intervals as described in paragraph (b)(1)(iv)(A)(2) of this 
section, then the plan has a gradual age or service schedule 
described in paragraph (b)(1)(iv) of this section.
    (iii) The bands (other than the highest band) in the schedule 
are not all the same length, since the first band is treated as 15 
years long while other bands are 5 years long. Thus, the schedule 
does not have regular intervals as described in paragraph 
(b)(1)(iv)(C) of this section. However, under paragraph 
(b)(1)(iv)(D) of this section, the schedule of allocation rates does 
not fail to increase smoothly at regular intervals merely because 
the minimum allocation rate of 3% results in a first band that is 
longer than the other bands, if either of the conditions of 
paragraph (b)(1)(iv)(D)(1) or (2) of this section is satisfied.
    (iv) In this case, in order to define a hypothetical schedule 
that could include the allocation rates in the actual schedule of 
allocation rates, each of the bands below age 40 would have to be 5 
years long (or be treated as 5 years long). Accordingly, the 
hypothetical schedule would have to provide for a band for employees 
under age 30, a band for employees in the range 30-34 and a band for 
employees age 35-39.
    (v) The ratio of the allocation rate for the age 40-44 band to 
the next lower band is 2.0. Accordingly, in order for the applicable 
allocations rates under this hypothetical schedule to increase 
smoothly, the ratio of the allocation rate for each band in the 
hypothetical schedule below age 40 to the allocation rate for the 
immediately preceding band would have to be 2.0. Thus, the 
allocation rate for the hypothetical band applicable for employees 
under age 30 would be .75%, the allocation rate for the hypothetical 
band for employees in the range 30-34 would be 1.5% and the 
allocation rate for employees in the range 35-39 would be 3%.
    (vi) Because the lowest allocation rate under any possible 
hypothetical schedule is less than 1% of plan year compensation, 
Plan O will be treated as satisfying the requirements of paragraphs 
(b)(1)(iv)(B) and (C) of this section only if the schedule of 
allocation rates satisfies the steepness condition described in 
paragraph (b)(1)(iv)(D)(2) of this section. In this case, the 
steepness condition is not satisfied because the equivalent accrual 
rate for an employee age 39 is 2.81%, but there is no hypothetical 
employee in the band for ages 40-44 with an equal or lower 
equivalent accrual rate (since the lowest equivalent accrual rate 
for hypothetical employees within this band is 3.74% at age 44).
    (vii) Since the schedule of allocation rates under the plan does 
not increase smoothly at regular intervals, Plan O's schedule of 
allocation rates is not a gradual age or service schedule. Further, 
Plan O does not provide uniform target benefit allocations. 
Therefore, under paragraph (b)(1)(i) of this section, Plan O cannot 
satisfy the nondiscrimination in amount requirement of 
Sec. 1.401(a)(4)-1(b)(2) for the plan year on the basis of benefits 
unless either Plan O provides for broadly available allocation rates 
for the plan year as described in paragraph (b)(1)(iii) of this 
section (i.e., the allocation rate at each age is provided to a 
group of employees that satisfies section 410(b) without regard to 
the average benefit percentage test), or Plan O satisfies the 
minimum allocation gateway of paragraph (b)(1)(vi) of this section 
for the plan year.
    Example 5. (i) Plan P is a profit-sharing plan maintained by 
Employer A that covers all of Employer A's employees, consisting of 
two HCEs, X and Y, and 7 NHCEs. Employee X's compensation is 
$170,000 and Employee

[[Page 34544]]

Y's compensation is $150,000. The allocation for Employees X and Y 
is $30,000 each, resulting in an allocation rate of 17.65% for 
Employee X and 20% for Employee Y. Under Plan P, each NHCE receives 
an allocation of 5% of compensation within the meaning of section 
415(c)(3), measured over a period of time permitted under the 
definition of plan year compensation.
    (ii) Because the allocation rate for X is not currently 
available to any NHCE, Plan P does not have broadly available 
allocation rates within the meaning of paragraph (b)(1)(iii) of this 
section. Furthermore, Plan P does not provide for age based-
allocation rates within the meaning of paragraph (b)(1)(iv) or (v) 
of this section. Thus, under paragraph (b)(1)(i) of this section, 
Plan P can satisfy the nondiscrimination in amount requirement of 
Sec. 1.401(a)(4)-1(b)(2) for the plan year on the basis of benefits 
only if Plan P satisfies the minimum allocation gateway of paragraph 
(b)(1)(vi) of this section for the plan year.
    (iii) The highest allocation rate for any HCE under Plan P is 
20%. Accordingly, Plan P would satisfy the minimum allocation 
gateway of paragraph (b)(1)(vi) of this section if all NHCEs have an 
allocation rate of at least 6.67%, or if all NHCEs receive an 
allocation of at least 5% of compensation within the meaning of 
section 415(c)(3) (measured over a period of time permitted under 
the definition of plan year compensation).
    (iv) Under Plan P, each NHCE receives an allocation of 5% of 
compensation within the meaning of section 415(c)(3) (measured over 
a period of time permitted under the definition of plan year 
compensation). Accordingly, Plan P satisfies the minimum allocation 
gateway of paragraph (b)(1)(vi) of this section.
    (v) Under paragraph (b)(1)(i) of this section, Plan P satisfies 
the nondiscrimination in amount requirement of Sec. 1.401(a)(4)-
1(b)(2) on the basis of benefits if it satisfies paragraph 
(b)(1)(i)(A) of this section.
* * * * *

    Par. 4. Section 1.401(a)(4)-9 is amended by adding paragraph 
(b)(2)(v) and revising paragraph (c)(3)(ii) to read as follows:


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

* * * * *
    (b) * * *
    (2) * * *
    (v) Eligibility for testing on a benefits basis--(A) General rule. 
For plan years beginning on or after January 1, 2002, unless, for the 
plan year, a DB/DC plan is primarily defined benefit in character 
(within the meaning of paragraph (b)(2)(v)(B) of this section) or 
consists of broadly available separate plans (within the meaning of 
paragraph (b)(2)(v)(C) of this section), the DB/DC plan must satisfy 
the minimum aggregate allocation gateway of paragraph (b)(2)(v)(D) of 
this section for the plan year in order to be permitted to demonstrate 
satisfaction of the nondiscrimination in amount requirement of 
Sec. 1.401(a)(4)-1(b)(2) on the basis of benefits.
    (B) Primarily defined benefit in character. A DB/DC plan is 
primarily defined benefit in character if, for more than 50% of the 
NHCEs benefitting under the plan, the normal accrual rate for the NHCE 
attributable to benefits provided under defined benefit plans that are 
part of the DB/DC plan exceeds the equivalent accrual rate for the NHCE 
attributable to contributions under defined contribution plans that are 
part of the DB/DC plan.
    (C) Broadly available separate plans. A DB/DC plan consists of 
broadly available separate plans if the defined contribution plan and 
the defined benefit plan that are part of the DB/DC plan each would 
satisfy the requirements of section 410(b) and the nondiscrimination in 
amount requirement of Sec. 1.401(a)(4)-1(b)(2) if each plan were tested 
separately and assuming that the average benefit percentage test of 
Sec. 1.410(b)-5 were satisfied. For this purpose, all defined 
contribution plans that are part of the DB/DC plan are treated as a 
single defined contribution plan and all defined benefit plans that are 
part of the DB/DC plan are treated as a single defined benefit plan. In 
addition, if permitted disparity is used for an employee for purposes 
of satisfying the separate testing requirement of this paragraph 
(b)(2)(v)(C) for plans of one type, it may not be used in satisfying 
the separate testing requirement for plans of the other type for the 
employee.
    (D) Minimum aggregate allocation gateway--(1) General rule. A DB/DC 
plan satisfies the minimum aggregate allocation gateway if each NHCE 
has an aggregate normal allocation rate that is at least one third of 
the aggregate normal allocation rate of the HCE with the highest such 
rate (HCE rate), or, if less, 5% of the NHCE's compensation, provided 
that the HCE rate does not exceed 25% of compensation. If the HCE rate 
exceeds 25% of compensation, then the aggregate normal allocation rate 
for each NHCE must be at least 5% increased by one percentage point for 
each 5-percentage-point increment (or portion thereof) by which the HCE 
rate exceeds 25% (e.g., the NHCE minimum is 6% for an HCE rate that 
exceeds 25% but not 30%, and 7% for an HCE rate that exceeds 30% but 
not 35%).
    (2) Deemed satisfaction. A plan is deemed to satisfy the minimum 
aggregate allocation gateway of this paragraph (b)(2)(v)(D) if the 
aggregate normal allocation rate for each NHCE is at least 7\1/2\% of 
the NHCE's compensation within the meaning of section 415(c)(3), 
measured over a period of time permitted under the definition of plan 
year compensation.
    (3) Averaging of equivalent allocation rates for NHCEs. For 
purposes of this paragraph (b)(2)(v)(D), a plan is permitted to treat 
each NHCE who benefits under the defined benefit plan as having an 
equivalent normal allocation rate equal to the average of the 
equivalent normal allocation rates under the defined benefit plan for 
all NHCEs benefitting under that plan.
    (E) Determination of rates. For purposes of this paragraph 
(b)(2)(v), the normal accrual rate and the equivalent normal allocation 
rate attributable to defined benefit plans, the equivalent accrual rate 
attributable to defined contribution plans, and the aggregate normal 
allocation rate are determined under paragraph (b)(2)(ii) of this 
section, but without taking into account the imputation of permitted 
disparity under Sec. 1.401(a)(4)-7, except as otherwise permitted under 
paragraph (b)(2)(v)(C) of this section.
    (F) Examples. The following examples illustrate the application of 
this paragraph (b)(2)(v):

    Example 1. (i) Employer A maintains Plan M, a defined benefit 
plan, and Plan N, a defined contribution plan. All HCEs of Employer 
A are covered by Plan M (at a 1% accrual rate), but are not covered 
by Plan N. All NHCEs of Employer A are covered by Plan N (at a 3% 
allocation rate), but are not covered by Plan M. Because Plan M does 
not satisfy section 410(b) standing alone, Plans M and N are 
aggregated for purposes of satisfying sections 410(b) and 401(a)(4).
    (ii) Because none of the NHCEs participate in the defined 
benefit plan, the aggregated DB/DC plan is not primarily defined 
benefit in character within the meaning of paragraph (b)(2)(v)(B) of 
this section nor does it consist of broadly available separate plans 
within the meaning of paragraph (b)(2)(v)(C) of this section. 
Accordingly, the aggregated Plan M and Plan N must satisfy the 
minimum aggregate allocation gateway of paragraph (b)(2)(v)(D) of 
this section in order be permitted to demonstrate satisfaction of 
the nondiscrimination in amount requirement of Sec. 1.401(a)(4)-
1(b)(2) on the basis of benefits.
    Example 2. (i) Employer B maintains Plan O, a defined benefit 
plan, and Plan P, a defined contribution plan. All of the six 
employees of Employer B are covered under both Plan O and Plan P. 
Under Plan O, all employees have a uniform normal accrual rate of 1% 
of compensation. Under Plan P, Employees A and B, who are HCEs, 
receive an allocation rate of 15%, and participants C, D, E and F, 
who are NHCEs, receive an allocation rate of 3%. Employer B 
aggregates Plans O and P for purposes of satisfying sections 410(b) 
and 401(a)(4). The equivalent normal allocation and normal accrual 
rates under Plans O and P are as follows:

[[Page 34545]]



------------------------------------------------------------------------
                                                Equivalent   Equivalent
                                                  normal       normal
                                                allocation     accural
                                                rates for     rates for
                                                  the 1%     the 15%/3%
                   Employee                      accural     allocation
                                                under plan  under plan P
                                                O (defined    (defined
                                                 benefit    contribution
                                                plan)  (in   plan)  (in
                                                 percent)     percent)
------------------------------------------------------------------------
HCE A (age 55)...............................         3.93          3.82
HCE B (age 50)...............................         2.61          5.74
C (age 60)...................................         5.91           .51
D (age 45)...................................         1.74          1.73
E (age 35)...................................          .77          3.90
F (age 25)...................................          .34          8.82
------------------------------------------------------------------------

    (ii) Although all of the NHCEs benefit under Plan O (the defined 
benefit plan), the aggregated DB/DC plan is not primarily defined 
benefit in character because the normal accrual rate attributable to 
defined benefit plans (which is 1% for each of the NHCEs) is greater 
than the equivalent accrual rate under defined contribution plans 
only for Employee C. In addition, because the 15% allocation rate is 
available only to HCEs, the defined contribution plan cannot satisfy 
the requirements of Sec. 1.401(a)(4)-2 and does not have broadly 
available allocation rates within the meaning of Sec. 1.401(a)(4)-
8(b)(1)(iii). Further, the defined contribution plan does not 
satisfy the minimum allocation gateway of Sec. 1.401(a)(4)-
8(b)(1)(vi) (3% is less than
1/3 of the 15% HCE rate). Therefore, the defined contribution plan 
within the DB/DC plan cannot separately satisfy Sec. 1.401(a)(4)-
1(b)(2) and does not constitute a broadly available separate plan 
within the meaning of paragraph (b)(2)(v)(C) of this section. 
Accordingly, the aggregated plans are permitted to demonstrate 
satisfaction of the nondiscrimination in amounts requirement of 
Sec. 1.401(a)(4)-1(b)(2) on the basis of benefits only if the 
aggregated plans satisfy the minimum aggregate allocation gateway of 
paragraph (b)(2)(v)(D) of this section.
    (iii) Employee A has an aggregate normal allocation rate of 
18.93% under the aggregated plans (3.93% from Plan O plus 15% from 
Plan P), which is the highest aggregate normal allocation rate for 
any HCE under the plans. Employee F has an aggregate normal 
allocation rate of 3.34% under the aggregated plans (.34% from Plan 
O plus 3% from Plan P) which is less than the 5% aggregate normal 
allocation rate that Employee F would be required to have to satisfy 
the minimum aggregate allocation gateway of paragraph (b)(2)(v)(D) 
of this section.
    (iv) However, for purposes of satisfying the minimum aggregate 
allocation gateway of paragraph (b)(2)(v)(D) of this section, 
Employer B is permitted to treat each NHCE who benefits under Plan O 
(the defined benefit plan) as having an equivalent allocation rate 
equal to the average of the equivalent allocation rates under Plan O 
for all NHCEs benefitting under that plan. The average of the 
equivalent allocation rates for all of the NHCEs under Plan O is 
2.19% (the sum of 5.91%, 1.74%, .77%, and .34%, divided by 4). 
Accordingly, Employer B is permitted to treat all of the NHCEs as 
having an equivalent allocation rate attributable to Plan O equal to 
2.19%. Thus, all of the NHCEs can be treated as having an aggregate 
normal allocation rate of 5.19% for this purpose (3% from the 
defined contribution plan and 2.19% from the defined benefit plan) 
and the aggregated DB/DC plan satisfies the minimum aggregate 
allocation gateway of paragraph (b)(2)(v)(D) of this section.
* * * * *
    (c) * * *
    (3) * * *
    (ii) Restructuring not available for certain testing purposes. The 
safe harbor in Sec. 1.401(a)(4)-2(b)(3) for plans with uniform points 
allocation formulas is not available in testing (and thus cannot be 
satisfied by) contributions under a component plan. Similarly, 
component plans cannot be used for purposes of determining whether a 
plan provides broadly available allocation rates (as defined in 
Sec. 1.401(a)(4)-8(b)(1)(iii)), determining whether a plan has a 
gradual age or service schedule (as defined in Sec. 1.401(a)(4)-
8(b)(1)(iv)), determining whether a plan has allocation rates that are 
based on a uniform target benefit allocation (as defined in 
Sec. 1.401(a)(4)-8(b)(1)(v)), or determining whether a plan is 
primarily defined benefit in character or consists of broadly available 
separate plans (as defined in paragraphs (b)(2)(v)(B) and (C) of this 
section). In addition, the minimum allocation gateway of 
Sec. 1.401(a)(4)-8(b)(1)(vi) and the minimum aggregate allocation 
gateway of paragraph (b)(2)(v)(D) of this section cannot be satisfied 
on the basis of component plans. See Secs. 1.401(k)-1(b)(3)(iii) and 
1.401(m)-1(b)(3)(iii) for rules regarding the inapplicability of 
restructuring to section 401(k) plans and section 401(m) plans.
* * * * *

    Par. 5. Section 1.401(a)(4)-12 is amended by adding a sentence to 
the end of the definition of Standard mortality table to read as 
follows:


Sec. 1.401(a)(4)-12  Definitions.

* * * * *
    Standard mortality table. * * * The applicable mortality table 
under section 417(e)(3)(A)(ii)(I) is also a standard mortality table.
* * * * *

Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
    Approved: June 21, 2001.
Mark A. Weinberger,
Assistant Secretary of the Treasury.
[FR Doc. 01-16326 Filed 6-28-01; 8:45 am]
BILLING CODE 4830-01-P