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401(k) Plans

  • 3752. What is a 401(k) plan?

    • A 401(k) plan generally is a profit sharing plan or stock bonus plan that provides for contributions to be made pursuant to a “cash or deferred arrangement” (“CODA”, see Q 3755) under which individual participants elect to take either amounts in cash or to have the amounts deferred under the plan. With the availability of Roth contributions under 401(k) plans, the employee also may elect to have Roth deferrals made on an after-tax basis to the CODA.

      In addition to the general qualification requirements (Q 3828 through Q 3925), special qualification rules apply to 401(k) plans (Q 3753 to Q 3798). Certain nondiscrimination requirements can be met by satisfying the requirements for safe harbor plans (Q 3765). There are requirements for SIMPLE 401(k) plans (Q 3770) and there are automatic enrollment plans for plan years beginning after 2007 (Q 3762).

      The elective deferral limits apply to individuals participating in more than one salary reduction plan, such as a 401(k) plan and a Section 403(b) tax sheltered annuity or SIMPLE IRA (Q 3760). There also are requirements that pertain to catch-up contributions by participants age fifty or over (Q 3761).

      Amounts deferred under a 401(k) plan are referred to as elective deferrals (Q 3760). Elective deferrals generally are excluded from a participant’s gross income for the year of the deferral and are treated as employer contributions to the plan.1 In the case of contributions to a qualified Roth contribution program (Q 3771), deferrals are made on an after-tax basis (i.e., they are treated as includable in income for withholding purposes).2

      A 401(k) plan may provide that all employer contributions are made pursuant to the election or may provide that the cash or deferred arrangement is in addition to ordinary employer contributions. Typically, the employer contributions are in the form of a percentage match for each dollar deferred by an employee. There are requirements that apply to matching contributions (Q 3794, Q 3798).

      Note: There have been a number of law and regulatory changes to certain substantive 401(k)
      limitation rules regarding hardship, loans and other pre-59½ distributions, especially in the case
      of areas officially declared to be national disaster areas, as for hurricanes, floods, and fires
      (Q 3791). Some changes, like extension of time to repay 401(k) loans, do not require a disaster
      justification.


      1. Treas. Reg. §1.401(k)-1(a).

      2. See IRC Sec. 402A.

  • 3753. What special qualification requirements apply to 401(k) plans?

    • To qualify, a 401(k) plan (or a plan that provides a 401(k) cash or deferred arrangement) generally must first be a qualified profit sharing or stock bonus plan.1

      Contributions to the plan made under a cash or deferred arrangement must satisfy the nondiscrimination in amount requirement (Q 3792), be subject to withdrawal restrictions (Q 3792), and will not be included in the employee’s gross income unless the employee elects to treat the contributions as designated Roth contributions (Q 3771).


      1. IRC Sec. 401(k); Treas. Reg. §1.401(k)-1(a)(1).

  • 3754. Are tax-exempt and governmental employers eligible to offer 401(k) plans?

    • Yes. Tax-exempt employers such as 501(c)(3) organizations are eligible to offer 401(k) arrangements.1 State and local government employers (including political subdivisions and agencies thereof) generally are prohibited from offering 401(k) arrangements to their employees, but certain rural cooperatives may do so.2


      1. IRC Sec. 401(k)(4)(B)(i). Of course, 403(b) plans are an option for nongovernmental tax-exempt employers and are also available to governmental tax-exempt employers, like school districts.

      2. See IRC Secs. 401(k)(1), 401(k)(2), 401(k)(4)(B)(ii).

  • 3755. What is a cash or deferred arrangement (“CODA”) in the context of a 401(k) plan?

    • A “cash or deferred arrangement” (“CODA”) is an arrangement under which an eligible employee may make a cash or deferred election with respect to contributions, accruals, or other benefits in a qualified plan.1 A cash or deferred election is any direct or indirect election (or modification of an earlier election) by an employee to have the employer either (1) provide an amount to the employee in the form of cash (or some other taxable benefit) that is not currently available, or (2) contribute an amount to a trust, or provide an accrual or other benefit under a plan deferring the receipt of compensation.2

      With respect to timing, the final regulations provide that “a contribution is made pursuant to a cash or deferred election only if the contribution is made after the election is made.”3 See Q 3928 with regard to deduction timing. Under final regulations, amounts contributed in anticipation of future performance of services generally are not treated as elective contributions. A very limited exception is provided for bona fide administrative convenience (e.g., a company bookkeeper is absent the day the funds normally would be transmitted to the plan) and not for a principal purpose of accelerating deductions.4 Special penalties and reporting requirements apply to listed transactions (Q 4094).5

      Automatic enrollment. For purposes of determining whether an election is a cash or deferred election, it is irrelevant whether the default that applies in the absence of an affirmative election is that the employee receives cash or that the employee contributes the specified amount to the trust.6 In plan years beginning after 2007, a safe harbor is available for plans that provide for automatic enrollment and satisfy certain additional requirements (Q 3762).

      A cash or deferred arrangement does not qualify as such if any other benefit provided by the employer, except for matching contributions, is conditioned on the employee’s making an election under the plan. “Other benefits” is illustrated in the regulations.7 The IRS has privately ruled that the purchase of a group long-term disability income policy that provided continuation of benefit accumulation for disabled employees did not violate this rule.8

      The IRS repeatedly has approved 401(k) plans involving a so-called “401(k) wraparound” nonqualified deferred compensation plan arrangement9, whereby contributions consisting of current year salary deferrals were held initially in a nonqualified deferred compensation plan (Q 3569). The IRS concluded that such deferrals were not impermissibly conditioned on the deferral election.10 Final regulations state that a plan will not fail to be qualified merely because it includes a nonqualified cash or deferred arrangement, but special requirements will apply to its nondiscrimination testing.11

      Elective deferral contributions to a 401(k) cash or deferred arrangement, including Roth contributions (Q 3771), are treated as employer contributions except when they are recharacterized (Q 3798).12 Contributions need not come from employer profits.13


      1. See Treas. Reg. §1.401(k)-1(a)(2).

      2. Treas. Reg. §1.401(k)-1(a)(3).

      3. Treas. Reg. §1.401(k)-1(a)(3)(iii)(B).

      4. See Treas. Reg. §1.401(k)-1(a)(3)(iii)(C)(2).

      5. See IRC Sec. 6707A.

      6. See Treas. Reg. §1.401(k)-1(a)(3)(ii).

      7. IRC Sec. 401(k)(4)(A); Treas. Reg. §1.401(k)-1(e)(6); see Let. Rul. 9250013.

      8. Let. Ruls. 200235043, 200031060.

      9. The IRS has also approved this design as to the nonqualified plan covered by Section 409A, but the DOL guidance governing the timeliness of plan contributions now need to be considered as well.

      10. See e.g., Let. Ruls. 199924067, 9807010, 9752017, 9530038.

      11. See Treas. Reg. §1.401(k)-1(a)(5)(iv).

      12. Treas. Reg. §1.401(k)-1(a)(4)(ii).

      13. IRC Sec. 401(a)(27).

  • 3756. What elective deferral limits are applicable to 401(k) plans?

    • The plan must provide that the amount any employee can elect to defer for any calendar year under the cash or deferred arrangement of any plan is limited to $19,500 in 2020 ($19,000 in 2019 and $18,500 in 2018), and is subject to indexing for inflation thereafter (Q 3760).1 Plans also may allow additional elective deferrals, known as catch-up contributions, by participants age fifty or over. These catch-up contributions, if made under the provisions of IRC Section 414(v), are not subject to the Section 401(a)(30) limit (Q 3761).2


      1. IRC Secs. 401(a)(30), 402(g)(1); IR-2015-118 (Oct. 21, 2015); Notice 2017-64, Notice 2018-83, Notice 2019-59.

      2. IRC Sec. 414(v)(3)(A).

  • 3757. What participation and coverage requirements apply to 401(k) plans?

    • Editor’s Note: Under prior law, employers were permitted to exclude workers who performed fewer than 1,000 hours of service per year from participation in the employer-sponsored 401(k).  The SECURE Act modified this rule in order to expand access for certain part-time employees.  Under the new law, employees who perform at least 500 hours of service for at least three consecutive years (and are at least twenty-one years old) must be allowed to participate in the employer-sponsored 401(k).  These long-term, part-time employees may, however, be excluded from coverage and nondiscrimination testing requirements.  This SECURE Act provision becomes effective for plan years beginning after December 31, 2020.  However, twelve-month periods beginning before January 1, 2021 are not taken into account for purposes of determining whether an employee qualifies.

      A plan may not require, as a condition of participation in the cash or deferred arrangement, that an employee complete a period of service beyond the later of age twenty-one or the completion of one year of service.1

      A cash or deferred arrangement must satisfy a nondiscriminatory coverage test (Q 3832).2 For purposes of applying those tests, all eligible employees are treated as benefiting under the arrangement, regardless of whether they actually make elective deferrals.3 An eligible employee is any employee who is directly or indirectly eligible to make a cash or deferred election under the plan for all or a portion of the plan year. An employee is not ineligible merely because he or she elects not to participate, is suspended from making an election under the hardship withdrawal rules, is unable to make an election because his or her compensation is less than a specified dollar amount, or because he or she may receive no additional annual additions under the IRC Section 415 limits (Q 3728, Q 3858).4

      Employers may apply an early participation test for certain younger or newer employees permitted to participate in a plan. If a plan separately satisfies the minimum coverage rules of IRC Section 410(b), taking into account only those employees who have not completed one year of service or are under age twenty-one, an employer may elect to exclude any eligible nonhighly compensated employees who have not satisfied the age and service requirements for purposes of the ADP test (Q 3792).5 This provision is designed to encourage employers to allow newer and younger employees to participate in a plan without having the plan’s ADP results “pulled down” by their often-lower rates of deferral. By making this election, an employer will be able to apply a single ADP test comparing the highly compensated employees who are eligible to participate in the plan to the nonhighly compensated who have completed one year of service and reached age twenty-one.

      If an employer includes a tax-exempt 501(c)(3) organization and sponsors both a 401(k) (or 401(m)) plan and a Section 403(b) plan, employees eligible to participate in the Section 403(b) plan generally can be treated as excludable employees for purposes of the 401(k) plan if (1) no employee of the 501(c)(3) organization is eligible to participate in the 401(k) (or 401(m)) plan and (2) at least 95 percent of the employees who are not 501(c)(3) employees are eligible to participate in the 401(k) or 401(m) plan.6

      Guidelines and transition rules for satisfying the coverage requirement during a merger or acquisition are set forth at Revenue Ruling 2004-11.7


      1. IRC Sec. 401(k)(2)(D).

      2. IRC Sec. 401(k)(3)(A)(i).

      3. Treas. Reg. §1.410(b)-3(a)(2)(i).

      4. Treas. Reg. §1.401(k)-6.

      5. IRC Sec. 401(k)(3)(F); Treas. Reg. §1.401(k)-2(a)(1)(iii).

      6. Treas. Reg. §1.410(b)-6(g).

      7. 2004-7 IRB 480.

  • 3758. What rules regarding nonforfeitability of benefits apply to 401(k) plans?

    • An employee must be fully vested at all times in his or her elective contributions and cannot be subject to the forfeitures and suspensions that are permitted by the IRC for benefits derived from employer contributions (Q 3859). Furthermore, such amounts cannot be taken into consideration in applying the vesting rules to other contributions.1

      Employer matching contributions and nonelective employer contributions that are taken into account for purposes of satisfying the special nondiscrimination rules applicable to cash or deferred arrangements (Q 3792) must be immediately nonforfeitable and subject to the withdrawal restrictions explained in Q 3789.2 All other contributions to a plan that includes a cash or deferred arrangement also are subject to these restrictions unless a separate accounting is maintained.3 Contributions made under a SIMPLE 401(k) plan are subject to special nonforfeitability requirements (Q 3770).


      1. IRC Sec. 401(k)(2)(C); Treas. Reg. §1.401(k)-1(c); see also Treas. Reg. §1.401(k)-1(c).

      2. See Treas. Reg. §§1.401(k)-1(c), 1.401(k)-1(d).

      3. Treas. Reg. §1.401(k)-1(e)(3).

  • 3759. What aggregation requirements apply to 401(k) plans?

    • Cash or deferred arrangements included in a plan generally are treated as a single cash or deferred arrangement for purposes of meeting the requirements discussed in Q 3754 through Q 3758, and for purposes of the coverage requirements of IRC Section 410(b).1 The deferral percentage taken into account under the ADP tests for any highly compensated employee who is a participant in two or more cash or deferred arrangements under plans of the participant’s employer that are required to be aggregated (as discussed above) is the average of the deferral percentages for the employee under each of the arrangements.2

      Restructuring may not be used to demonstrate compliance with the requirements of IRC Section 401(k).3


      1. See Treas. Reg. §1.401(k)-1(b)(4)(ii).

      2. IRC Sec. 401(k)(3)(B).

      3. Treas. Reg. §1.401(k)-1(b)(4)(iv)(B).

  • 3760. What is the limit on elective deferrals to employer-sponsored plans?

    • The IRC limits the total amount of “elective deferrals” any individual can exclude from income in a year. Elective deferrals, for this purpose, generally include all salary deferral contributions to all 401(k) plans (Q 3752 through Q 3771), 403(b) tax sheltered annuities (Q 4034), SAR-SEPs (Q 3702), and SIMPLE IRAs (Q 3703).1 Contributions under a Roth 401(k) feature (Q 3771) are subject to the same elective deferral limit as other 401(k) contributions.2

      The elective deferral limit for traditional and safe harbor 401(k) plans and for Section 403(b) tax sheltered annuities is $19,500 in 2020 (up from $19,000 in 2019, $18,500 in 2018, as indexed).3

      Elective deferral contributions to SIMPLE IRAs (Q 3703) and SIMPLE 401(k) plans (Q 3770) are subject to a limit of $13,500 in 2020, up from $13,000 in 2019.4 The limit on elective deferrals to tax sheltered annuity plans may be further increased in the case of certain long term employees of certain organizations (Q 4034).5

      The IRC Section 402(g)(1)(B) elective deferral limit is not required to be coordinated with the limit on Section 457 plans. As a result, an individual participating in both a 401(k) plan (or 403(b) plan) and a Section 457 plan in 2020 may defer as much as $39,000 (Q 3582).6

      Matching contributions made on behalf of self-employed individuals generally are not treated as elective deferrals for purposes of IRC Section 402(g)(1)(B). This treatment does not apply to qualified matching contributions that are treated as elective contributions for purposes of the ADP test (Q 3792).7

      Excess deferrals. Amounts deferred in excess of the ceiling (i.e., excess deferrals) are not excludable and, therefore, must be included in the individual’s gross income for the taxable year.8 In the case of participants age fifty or over, catch-up contributions permitted under IRC Section 414(v) are not treated as excess elective deferrals under IRC Section 402(g)(1)(C) (Q 3761).9

      If any amount is included in an individual’s income under these rules and plan language permits distributions of excess deferrals, the individual, prior to the first April 15 following the close of the individual’s taxable year, may allocate the excess deferrals among the plans under which the deferrals were made and the plans may distribute the excess deferrals (including any income allocated thereto, provided the plan uses a reasonable method of allocating income) not later than the first April 15 after the close of the plan’s taxable year.10 The amount of excess deferrals distributed under these rules is not included in income a second time as a distribution, but any income on the excess deferral is treated as earned and received, and includable in income in the taxable year in which distributed.11 If the plan so provides, distributions of excess deferrals may be made during the taxable year of the deferral if the individual and the plan designate the distribution as an excess deferral and the correcting distribution is made after the date on which the plan received the excess deferral.12

      Excess amounts that are not timely distributed are not included in the cost basis of plan distributions, even though they have previously been included in income.13 Thus, such amounts will be subjected to a second tax when distributed in the future. Any corrective distribution of less than the entire amount of the excess deferral is treated as a pro rata distribution of excess deferrals and income.14

      Planning Point: Due to the potential for double taxation, excess elective deferrals should be avoided, and, if they inadvertently occur, should be corrected by the applicable deadline. One common trap for the unwary may occur where an individual participates in more than one plan that allows elective deferrals. Perhaps he or she participates in a 401(k) plan at his or her regular place of employment, and also participates in a SIMPLE IRA plan sponsored by a side business. The limits on elective deferrals are applied to the individual and not just to the plan, so the individual easily might stay within the terms of the two plans and still violate the elective deferral limits by contributing the maximum amount to both plans. Martin Silfen, J.D., Brown Brothers Harriman Trust Co., LLC.

      See Q 3798 for rules on coordinating distributions of excess contributions and excess deferrals.15


      1. IRC Sec. 402(g)(3); Treas. Reg. §1.402(g)-1(b).

      2. See IRC Sec. 402A (a)(1). Similar rules have recently been adopted with respect to the federal Thrift Savings Plan. 77 Fed. Reg. 26417 (May 4, 2012).

      3. IRC Sec. 402(g)(1); Notice 2017-64, Notice 2018-83, Notice 2019-59.

      4. Notice 2018-83, Notice 2019-59.

      5. Treas. Reg. §1.402(g)-1(c).

      6. See IRC Sec. 457(c); Notice 2019-59.

      7. See IRC Sec. 402(g)(8).

      8. IRC Sec. 402(g)(1); Treas. Reg. §1.402(g)-1(a).

      9. Treas. Reg. §1.414(v)-1(g).

      10. Treas. Reg. §§1.402(g)-1(e)(2), 1.402(g)-1(e)(5).

      11. IRC Sec. 402(g)(2)(C); Treas. Reg. §1.402(g)-1(e)(8).

      12. Treas. Reg. §1.402(g)-1(e)(3).

      13. IRC Sec. 402(g)(2); Treas. Reg. §1.402(g)-1(e)(8).

      14. IRC Sec. 402(g)(2)(D); Treas. Reg. §1.402(g)-1(e)(10).

      15. See Treas. Reg. §1.401(k)-1(f)(5)(i).

  • 3761. What are the rules for catch-up contributions to employer sponsored retirement plans?

    • Catch-up contributions are defined as additional elective deferrals by an eligible participant in an applicable employer plan, as defined in IRC Section 414(v) and regulations thereunder. Elective deferral for this purpose refers to the amounts described in IRC Section 402(g)(3) (Q 3760), but also includes amounts deferred to eligible Section 457 governmental plans.1 The provisions allowing catch-up contributions are among the retirement amendments of EGTRRA 2001 that became permanent under the Pension Protection Act of 2006 (“PPA 2006”).2

      For purposes of IRC Section 414(v), an applicable employer plan means:

      (1) employer plans qualified under IRC Section 401(a) (Q 3828);

      (2) Section 403(b) tax sheltered annuities (Q 4034);

      (3) eligible Section 457 governmental plans (457(b) plans);

      (4) salary reduction simplified employee pensions (i.e., SAR-SEPs (Q 3702); and

      (5) SIMPLE IRAs (Q 3703).3

      For this purpose, qualified plans, Section 403(b) plans, SAR-SEPs, and SIMPLE IRAs that are maintained by a controlled group of corporations, a group of trades or businesses under common control, or members of an affiliated service group (Q 3924) are considered one plan. In addition, if more than one eligible Section 457 governmental plan is maintained by the same employer, the plans will be treated as one plan.4

      Catch-up contributions permitted under IRC Section 414(v) do not apply to a catch-up eligible participant for any taxable year in which a higher catch-up amount is permitted under IRC Section 457(b)(3) during the last three years prior to the plan’s normal retirement year (Q 3582).5

      Dollar limit. A plan may not permit additional elective deferrals for any year in an amount greater than the lesser of (1) the indexed amount listed below or (2) the excess (if any) of the participant’s compensation as defined in IRC Section 415(c)(3) (Q 3858, Q 3728) over any other elective deferrals for the year made without regard to the catch-up limits.6 An employer that sponsors more than one plan must aggregate the elective deferrals treated as catch-up contributions for purposes of the dollar limit.7 An individual participating in more than one plan is subject to one annual dollar limit for all catch-up contributions during the taxable year.8

      The indexed dollar limit on catch-up contributions to SIMPLE IRAs and SIMPLE 401(k) plans is $3,000 in 2015-2020.9 The indexed dollar limit on catch-up contributions to all other 401(k) plans and to Section 403(b) plans, eligible Section 457 plans, and SAR-SEPs is $6,500 in 2020 (up from $6,000 for 2015-2019) plan years.10

      Eligible participant. An eligible participant with respect to any plan year is a plan participant who would attain age fifty before the end of the taxable year and with respect to whom no other elective deferrals may be made to the plan for the plan (or other applicable) year as a result of any limit or other restriction.11 For this purpose, every participant who will reach age fifty during a plan year is treated as having reached age fifty on the first day of the plan year, regardless of the employer’s choice of plan year and regardless of whether the participant survives to age fifty or terminates employment prior to his or her birthday.12

      Universal availability. A plan will not satisfy the nondiscrimination requirements of IRC Section 401(a)(4) unless all catch-up eligible participants who participate in any applicable plan maintained by the employer are provided with the effective opportunity to make the same election with respect to the dollar limits described above.13 This is known as the universal availability requirement. A plan will not fail to satisfy this requirement merely because it allows participants to defer an amount equal to a specified percentage of compensation for each payroll period and permits each catch-up eligible participant to defer a pro rata share of the dollar catch-up limit in addition to that amount.14

      For purposes of the universal availability requirement, all plans maintained by employers that are treated as a single employer under the controlled group, common control, or affiliated service group rules (Q 3922, Q 3924) generally must be aggregated.15 Exceptions to the aggregation rule apply to Section 457 plans and certain newly acquired plans.16

      Catch-up contributions are excluded from income in the same manner as elective deferrals.17 The calculation of the elective deferrals that will be considered catch-up contributions generally is made as of the end of the plan year by comparing the total elective deferrals for the plan year with the applicable plan year limit.18 Elective deferrals in excess of the plan, ADP, or IRC limits, but not in excess of the amount limitations described above, will be treated as catch-up contributions as determined on the last day of the plan year.19

      An employer may make, but is not required to make, matching contributions on catch-up contributions. If an employer does so, the contributions must satisfy the ACP test of IRC Section 402(m) (Q 3794).20 Reporting requirements for catch-up contributions are set forth in Announcement 2001-93.21


      1. IRC Secs. 414(v)(5)(B), 414(u)(2)(C) (USERRA rights); Treas. Reg. §1.414(v)-1(g)(2).

      2. See P.L. 109-280, Sec. 811.

      3. IRC Sec. 414(v)(6).

      4. IRC Sec. 414(v)(2)(D).

      5. IRC Sec. 414(v)(6)(C); Treas. Reg. §1.414(v)-1(a)(3).

      6. IRC Sec. 414(v)(2)(A).

      7. Treas. Reg. §1.414(v)-1(f)(1).

      8. Treas. Reg. §§1.402(g)-2(b), 1.414(v)-1(f)(3).

      9. IR-2015-118 (Oct. 21, 2015), Notice 2016-62, Notice 2017-64, Notice 2018-83, Notice 2019-59.

      10. IR-2015-118 (Oct. 21, 2015), Notice 2016-62, Notice 2017-64, Notice 2018-83, Notice 2019-59.

      11. IRC Sec. 414(v)(5).

      12. See Treas. Reg. §1.414(v)-1(g)(3).

      13. IRC Sec. 414(v)(4)(A); Treas. Reg. §1.414(v)-1(e).

      14. Treas. Reg. §1.414(v)-1(e).

      15. IRC Sec. 414(v)(4)(B).

      16. See Treas. Reg. §1.414(v)-1(e)(2) and (3).

      17. See IRC Sec. 402(g)(1)(C).

      18. Treas. Reg. §1.414(v)-1(b)(2).

      19. Treas. Reg. §1.414(v)-1(c).

      20. See T.D. 9072, 2003-2 C.B. 527.

      21. 2001-44 IRB 416.

  • 3762. What is a solo 401(k) plan?

    • A solo 401(k) plan refers to any 401(k) plan that covers only the business owner or the business owner and his or her spouse. These plans are subject to the same rules and requirements as any other 401(k) plan. Nondiscrimination testing is not required since the business does not have any common law employees who could have received disparate benefits. Solo 401(k) plans are a product of qualified plan reforms implemented by EGTRRA 2001, which substantially improved the tax favored treatment for employers sponsoring 401(k) plans. These changes were designed to encourage greater savings for retirement and to provide more incentive to businesses funding 401(k) plans.

      The first of these changes increased the deduction limit for profit sharing and stock bonus plans (which includes 401(k) plans) to 25 percent of compensation.1 Before 2002, profit sharing and stock bonus plans were subject to a deduction limit of 15 percent of compensation.

      Planning Point: For self-employed individuals, compensation is defined as net earnings less a deduction of 50 percent of self-employment tax and employee contributions. The IRS publishes a separate deduction and rate worksheet for self-employed individuals in Publication 560.

      Second, the definition of compensation for purposes of the 25 percent limit includes elective deferrals to a qualified plan, Section 403(b) plan, Section 457 plan, SEP, SIMPLE, or Section 125 FSA plan.2 This means that the payroll on which the 25 percent is based became higher than it was in earlier years, resulting in a higher deduction limit for employer contributions to the plan.

      Planning Point: If a self-employed individual also participates as an employee in another 401(k) plan, the limits on elective contributions are per individual, not per plan, so the aggregate contributions into all the plans cannot exceed the limit.

      After the EGTRRA 2001 amendments, elective deferrals no longer reduce the amount of employer contributions for purposes of calculating the 25 percent deduction limit.3 This means that a higher amount could be attributable to matching contributions, nonelective contributions or other amounts paid by the employer. The elective deferral limits increased as well: the limit is $19,500 for 2020, up from $19,000 for 2019, $18,500 for 2018 (Q 3760), and, for individuals age fifty or older, catch-up contributions are permitted ($6,500 in 2020 (Q 3761)).4

      Planning Point: These changes to the calculation of the employer deduction for all profit sharing plans, including 401(k) plans, led to a proliferation of solo 401(k) plans. Although the advantages to a sole proprietor or one person corporation can be significant, it is important to note that the plan is subject to the same minimum participation, coverage, nondiscrimination, and other requirements that apply to any other qualified defined contribution plan, in the event one or more employees are later added to the sponsoring employer.

      Third, total contributions to an employee’s account (excluding catch-up contributions) cannot exceed $57,000 in 2020 and $56,000 in 2019 ($55,000 in 2018).5


      1. See IRC Sec. 404(a)(3)(A).

      2. See IRC Sec. 404(a)(12).

      3. See IRC Sec. 404(n).

      4. See IRC Secs. 402(g)(1), 414(v)(2)(B); IR-2015-118 (Oct. 21, 2015), Notice 2016-62, Notice 2017-64, Notice 2018-83, Notice 2019-59.

      5. Notice 2017-64, Notice 2018-83, Notice 2019-59.

  • 3762.01. What are the basic qualification requirements for forming a multiple employer plan (MEP) under the final DOL regulations?

    • The DOL released final rules governing MEPs on July 31, 2019, which become applicable as of September 30, 2019.  In general, to quality as a multiple employer plan (MEP) under the final regulations, a plan must satisfy five basic requirements.[1]

      Under the DOL guidance, the association must have at least one substantial business purpose that is not related to offering the plan.  Additionally, the employer-members of the association must control the MEP’s activities and any employers that participate in the MEP must control the MEP both in substance and in form, whether directly or indirectly.

      The association must adopt a formal organizational structure, which includes bylaws, a governing body and other organizational aspects where relevant.  Only employees of the association’s employer-members and certain working owners may participate in the MEP.

      Under the DOL rules, some commonality of interest must exist between the employers participating in the MEP, such as the same industry or geographic location—a substantial expansion over prior rules, which required a more concrete nexus between participating MEP employers.  This meant that participating employers can be located in the same city, county, state or even multi-state region.  Companies operating in the same industry can join together even if they operate in entirely different regions.[2]  Financial services firms, however, cannot qualify under the expanded MEP regulations.

      The SECURE Act went even further in eliminating the common nexus rule altogether for certain MEPs.  Under the SECURE Act, even employers that do not operate in the same industry or in the same location can join together in an “open MEP” that can be administered by a pooled plan provider (generally, a financial services firm).[3]  The pooled plan provider must be named by the plan as a fiduciary, as plan administrator and responsible for all administrative duties.  The pooled plan provider must also register with the Treasury secretary as such.[4]

      Use of the pooled plan provider to act as both plan administrator and a fiduciary with respect to the plan is intended to ease both the administrative burden and fear of fiduciary liability for small business owners.  However, each employer participating in a plan with a pooled plan provider will be treated as plan sponsor with respect to the portion of the plan attributable to employees and beneficiaries of that employer.[5]

      The SECURE Act rules that apply to MEPs are effective for tax years beginning after 2020.  The SECURE Act directs the Treasury to issue additional guidance on many of these issues (including model plan language).  Before this guidance is released, however, the law provides that employers and pooled plan providers will not be treated as failing to meet a requirement if they make a good faith, reasonable effort in interpreting the new provisions.

       


      Planning Point: Under the SECURE Act, MEP availability was expanded even further to permit “open MEPs”, which are MEPs formed by employers with no commonality of interest other than offering the retirement benefits under the plan.


       

      [1] See DOL Reg. 2510.3-55(b)(1).

      [2] DOL Reg. 2510.3-55(b)(2).

      [3] IRC Sec. 413(e)

      [4] IRC Sec. 413(e)(3).

      [5] IRC Sec. 413(e)(3)(D).

       

  • 3762.02. What is a multiple employer plan (MEP)? Why might the MEP structure be attractive to small and mid-sized business owners?

    • A multiple employer plan (MEP), also known as an association retirement plan, is essentially a defined contribution plan that is open to employees of multiple employers.

      The DOL expanded the rules to allow more employers to participate in MEPs, which is especially valuable for small business owners who can now join with other entities to share in the costs and administrative burdens of providing a qualified retirement plan option for employees. The MEP structure can also encourage small business owners to offer a retirement savings option by limiting the fiduciary liability that can attach to the employer itself. While these benefits can be significant, see Q 3762.06 for a discussion of the “one bad apple rule” that small business owners should understand before adopting the MEP.

      Under previous law, the MEP structure was limited to small business owners with a strong connection, such as a common industry.

      Importantly, the SECURE Act also simplifies filing requirements for certain related defined contribution plans and individual account plans[1] by allowing them to file a single Form 5500.  This would further simplify some of the administrative burdens and costs associated with providing a retirement savings option through MEPs.  To be eligible, the plans must share:

      • The same trustee,
      • One or more of the same named fiduciaries,
      • The same administrator,
      • Plan years beginning on the same date, and
      • The same investments or investment options for participants and beneficiaries.[2]


      [1] As defined under IRC Sec. 414(i) or ERISA Section 3(34).

      [2] SECURE Act, Sec. 202.

  • 3762.03. Can working owners with no employees participate in MEPs?

    • Sole proprietors and other self-employed workers are entitled to participate in the MEP as both employer and employee.[1] To qualify, the owner must have an ownership right in a trade or business (partners in partnerships also qualify). The owner must earn wages or self-employment income from the trade or business by providing personal services to the business. Additionally, the working owner must meet one of two additional criteria:

      1. the owner must work at least an average of twenty hours per week or at least eighty hours per month in the business; or
      2. in the case of an MEP offered via a bona fide group or association of employers (i.e., not a PEO, see Q 3762.04), the owner must have wages or self-employment income from the business that at least covers the working owner’s cost of coverage for participation by the working owner (and any covered beneficiaries) in any group health plan sponsored by the association in which the individual participates.[2]

      For purposes of determining the working owner’s eligibility to participate in the MEP, the relevant date is when the individual first becomes eligible to participate, but verification of continuing eligibility must also be made over time. The DOL rule specifies only that reasonable monitoring procedures must be developed to ensure continued eligibility.[3]

      __________________

      [1].  DOL Reg. 2510.3-55(d)(1).

      [2]. DOL Reg. 2510.3-55(d)(2)(iii).

      [3]. DOL Reg. 2510.3-55(d)(3).

  • 3762.04. Can a professional employer organization (PEO) offer the MEP option? Are there any safe harbors for PEOs that choose to offer MEPs?

    • Professional employer organizations (PEOs) are permitted to offer MEPs under the final DOL regulations—effectively acting as the employer and “plan sponsor” under a contractual arrangement with the actual employer-members of the MEP.[1] The regulations also provided a safe harbor under which PEOs can offer MEPs by satisfying four criteria. To qualify, the PEO must:

      • assume responsibility for and pay wages to employees of the clients (employers) who join the MEP without regard to the receipt of payment from those clients (or the adequacy of any payments that are received);
      • assume responsibility for paying and performing reporting and withholding for all federal employment taxes for clients who adopt the MEP without regard to the receipt of payment from those clients (or the adequacy of any payments that are received);
      • play a definite and contractually specified role in recruiting, hiring and firing employees of the client adopting the MEP (in addition to the employer’s similar responsibilities); and
      • assume responsibility for and have substantial control over the functions and activities of any employee benefits that the contract with the client (employer) requires the PEO to provide without regard to the receipt of payment from those clients (or the adequacy of any payments that are received) with respect to the benefits.[2]

      ___________________

      [1]. DOL Reg. 2510.3-55(c)(1).

      [2]. DOL Reg. 2510.3-55(c)(2).

  • 3762.05. If employers use a PEO to provide the MEP option, do the participating employers have any fiduciary responsibilities with respect to the plan?

    • According to the preamble to the final regulations, participating employers retain some degree of fiduciary responsibility even if they use a PEO to administer the MEP. Although the guidance is not extensive, the preamble provides that the employer would be responsible for acting prudently in monitoring and selecting the relevant service provider. The employer would also be responsible for ensuring that employee contributions to the MEP are transferred in a timely manner.

  • 3762.06. What is the 'one bad apple rule' and why do business owners interested in the MEP structure need to be aware of it?

    • Under the “one bad apple rule,” the entire MEP could be disqualified based upon the actions of only one employer that participated in the plan—based upon the assumption that the MEP is to be treated a single unified plan.

      In 2019, the IRS and Treasury proposed rules that would mitigate the potential impact of the rule.1 The SECURE Act finalized those rules by eliminating the one bad apple rule in certain situations.2

      The SECURE Act essentially provides that if one employer’s actions would disqualify the plan, only that employer’s portion of the MEP will be disqualified.  Under the new rules, in the case of one participating employer’s failure to act in accordance with the qualification rules:

      (1) the assets of the plan attributable to employees of the employer will be transferred to a plan maintained only by that employer (or successor), to an eligible retirement plan under Section 402(c)(8)(B) for each person whose account is transferred (unless the Treasury determines that it is in the best interests of the participant for the assets to remain in the plan), and

      (2) the employer (and not the plan in which the failure occurred) will be held liable for any liabilities with respect to such plan attributable to the employees of the employer.3

      Under the IRS proposal, to continue as a qualified MEP after a single member-employer has taken action that would otherwise disqualify the entire plan, the plan must have established practices and procedures in place that are designed to ensure compliance with the qualification rules by all MEP participants.

      Presumably, future IRS guidance on the SECURE Act’s elimination of the one bad apple rule will mirror the previous IRS proposal. Essentially, under the new rules, the MEP would continue as a qualified plan so long as the qualification failure is isolated to a single employer, rather than a reflection of a widespread issue across the employers participating in the MEP. The plan administrator should have a process in place that would provide notice to the employer responsible for the failure, and such notice, as proposed, would include a description of the failure, actions necessary to remedy the failure, and notice that the relevant employer has only ninety days from the notice date to take remedial action.

      The plan should also provide a description of the consequences if the noncompliant employer fails to take the remedial action necessary and notice of the plan’s right to spin off the non-compliant employer’s portion of the plan and assets. After providing the initial notice and two subsequent notices containing additional information about the potential consequences of failing to take remedial action, the MEP will likely be required to notify all participants and the DOL, stop accepting contributions from the noncompliant party and implement the spin off procedures designed to terminate the noncompliant employer’s interests in the MEP.

      __________________

      1. See REG-121508-18, proposed July 3, 2019.

      2. IRC Sec. 413(e)(1), added by the SECURE Act.

      3. IRC Sec. 413(e)(2), added by the SECURE Act.

  • 3762.07. What do employers evaluating the MEP options have to know about various plan options after passage of the SECURE Act?

    • Beginning in 2021, under the SECURE Act, employers will be able to offer MEPs, association retirement plans (ARPs) and pooled employer plans (PEPs).  Clients should know the difference between the type of MEP available pre-2019, the MEP structure created by the 2019 DOL regulations and the different MEP rules that apply beginning in 2021 under the SECURE Act.  Technically, these are all different types of plans with different requirements that must be evaluated.  The DOL-created plans have been called “association retirement plans” (ARPs) to differentiate from the original “closed” MEP, and to clarify that ARPs must satisfy additional criteria in order to be treated as qualified plans. Under the SECURE Act, MEPs are also called pooled employer plans (PEPs)—another name for a type of MEP that meets certain additional requirements to avoid the commonality of interest requirement and one bad apple rule.

      Pre-2019, to participate in MEPs, all participating employers were required to share some strong type of common interest separate and apart from the retirement plan itself.  The need to share some type of affiliation or participate in the same industry sharply limited the availability of the “original” MEP—also called a “closed” MEP.

      The basic premise behind the idea of MEPs has remained the same—multiple small businesses join together to reduce the administrative burden and potential fiduciary responsibilities of offering a 401(k)-type retirement plan.  The DOL 2019 regulations expand MEP availability if certain criteria are satisfied.  Some in the industry began referring to these new MEPs as association retirement plans (ARPs) to differentiate from the original “closed” MEP, and to clarify that ARPs must satisfy additional criteria in order to be treated as qualified plans.  Essentially, the ARP is a type of MEP, and the terms have mostly been used interchangeably.

      Under the ARP structure, employers that share only the same geographic location or industry are permitted to join together in the MEP-ARP.  The participating employers can be located in the same city, county, state or even multi-state region.  Companies operating in the same industry can join together even if they operate in entirely different regions.  The ARP can be sponsored by a permitted group of employers if certain formalities are satisfied (the organization of employers must be bona fide, with organizational documents and control over the ARP in substance and in form, directly or indirectly, among other requirements).

      In the alternative, ARP members can now join together in a plan sponsored by a professional employer organization (PEO).  See Q 3762.04 and Q 3762.05.

      While the 2019 regulations were broadly seen as beneficial to interested small business owners, employers who choose this type of plan structure may continue to be subject to the “one bad apple” rule, absent further guidance from the IRS or DOL.

      Congress enacted the SECURE Act to even further ease the restrictions on the types of employers who can join together, assuming additional criteria are satisfied, and eliminate some of the risks associated with MEPs.  The SECURE Act permits MEP participation for employers who share no common interest apart from the desire to offer a retirement plan and eliminates the one bad apple rule.

      Under the SECURE Act, these types of MEPs are also called pooled employer plans (PEPs)—another name for a type of MEP that meets certain additional requirements to avoid the commonality of interest requirement and one bad apple rule.  The MEP-PEP, or open MEP, will be treated as a single retirement plan, so that the group will only be required to file a single Form 5500 to further reduce the administrative burdens for each of the individual employer-participants.

      This type of “open MEP” must be administered by a pooled plan provider (generally, a financial services firm).  Use of the pooled plan provider to act as both plan administrator and a fiduciary with respect to the plan is intended to ease both the administrative burden and fear of fiduciary liability for small business owners.

      The pooled plan provider must register as a fiduciary with the Treasury Department and the DOL.  The pooled plan provider also must have a trustee responsible for monitoring contributions and dealing with subsequent issues that arise.

      Small business clients should understand that, as employer, they continue to bear fiduciary responsibility with respect to selecting and monitoring the pooled plan provider.  Pooled plan providers can outsource investment decisions to another fiduciary (likely what is known as a “3(38) fiduciary”).  This arrangement does spread the costs of investment advice among the MEP participants to reduce expenses, but the extent of the employer’s fiduciary exposure still remains unclear under the law.

  • 3763. What is an automatic enrollment safe harbor 401(k) plan?

    • The Pension Protection Act of 2006 created a new safe harbor plan under Section 401(k) called a “qualified automatic contribution arrangement,” available for plan years beginning after 2007.1

      Plans that provide for automatic enrollment and meet certain other requirements for the safe harbor will satisfy the ADP/ACP requirements (Q 3753, Q 3792) and be excluded from the top heavy requirements (Q 3905 to Q 3911). For this treatment to apply, a plan must satisfy an automatic deferral requirement, an employer contribution requirement, and a notice requirement.2

      The automatic deferral requirement states that each employee eligible to participate in the plan must be treated as having elected to have the employer make elective contributions equal to a “qualified percentage.” The threshold amount of the automatic deferral percentage may not be less than 3 percent for the first year the employee’s deemed election applies. Employees may affirmatively elect out of the plan or elect a different deferral percentage. In the second year, this default percentage must increase to 4 percent, then 5 percent in the third year, and 6 percent in the fourth year and thereafter.3 A plan may provide for a higher percentage so long as it is applied uniformly, although the percentage may not exceed 10 percent. The contributions generally must continue until the last day of the plan year that begins after the date on which the first elective contribution under the automatic deferral requirement is made with respect to the employee.4

      An employer also must provide either a matching or a nonelective contribution. The match amount must be 100 percent of the first 1 percent of compensation deferred, plus 50 percent of the amount of elective contributions over 1 percent but not exceeding 6 percent of compensation deferred. If an employer provides a nonelective contribution, it must be an amount equal to 3 percent of compensation for each employee eligible to participate in the arrangement.5 The plan may impose a two year vesting requirement with respect to employer contributions, but employees then must be 100 percent vested after two years.6

      The written notice requirement is met if within a reasonable period before each plan year, each employee who is eligible to participate in the plan receives a written notice of his or her rights and obligations under the plan. The notice must be sufficiently accurate and comprehensive to apprise the employee of those rights and obligations, and it must be written in a manner that is calculated to be understood by the average employee to whom the plan applies. The notice must explain the employee’s right to elect not to have elective contributions made under the plan, or to have contributions made at a different percentage. If the plan allows the employee to choose from among two or more investment options, the notice must inform the employee how the account will be invested in the absence of any investment election. The employee also must have a reasonable period of time after receipt of the notice and before the first elective contribution to make one of the foregoing elections.7

      Relief Provisions

      Effective August 17, 2006, ERISA preempts any state laws that would “directly or indirectly prohibit or restrict the inclusion in any plan of an automatic contribution arrangement.”8 This provision is designed to resolve the problem of state laws that treat automatic withholding by a 401(k) arrangement as a prohibited garnishment of wages. The DOL is authorized to issue regulations establishing minimum standards that an arrangement would have to satisfy to qualify for the application of this provision.9

      For plan years beginning after 2007, relief from the 401(k) distribution restrictions (Q 3789) and the 10 percent penalty (Q 3957) is available during the first ninety days following the start of automatic deferrals, in the event that contributions are withheld erroneously. This relief applies not only to automatic enrollment safe harbor plans, but to other automatic enrollment plans that meet the definition of an “eligible automatic contribution arrangement.”10

      An eligible automatic contribution arrangement is a plan:

      (1) under which a participant may elect to have the employer make payment as contributions under the plan on behalf of the participant, or to the participant directly in cash;

      (2) under which the participant is treated as having elected to have the employer make such contributions in an amount equal to a uniform percentage of compensation provided under the plan until the participant specifically elects not to have such contributions made or elects a different percentage;

      (3) under which, in the absence of an investment election by the participant, the contributions are invested under the provisions of new ERISA Section 404(c)(5), in accordance with regulations described in Q 3764; and

      (4) that meets certain notice requirements.11

      The timing and content of the notice requirement is virtually identical to that of the automatic enrollment safe harbor, set forth above.12

      Refunds of excess contributions and excess aggregate contributions (Q 3798) from eligible automatic contribution arrangements will be subject to an extended time deadline. Instead of 2½ months, the plans will have six months to make refunds of such distributions.13


      1. See IRC Sec. 401(k)(13); P.L. 109-280, Sec. 902(g).

      2. See IRC Sec. 401(k)(13)(B).

      3. IRC Sec 401(k)(13)(C).

      4. See IRC Sec. 401(k)(13)(C)(iii).

      5. See IRC Sec. 401(k)(13)(D)(i).

      6. See IRC Sec. 401(k)(13)(D)(iii)(I).

      7. See IRC Sec. 401(k)(13)(E).

      8. See ERISA Sec. 514(e).

      9. PPA 2006, Sec. 902(f)(1).

      10. See IRC Sec. 414(w)(1).

      11. See IRC Sec. 414(w)(3).

      12. See IRC Sec. 414(w)(4).

      13. See IRC Sec. 4979(f).

  • 3764. When are default investments permitted under a 401(k) plan?

    • For plan years beginning after 2006, participants in individual account plans that meet specific notice requirements will be deemed to have exercised control over the assets in their accounts with respect to the amount of contributions and earnings that, in the absence of an investment election by the participants, are invested by the plan in accordance with regulations.1 Final regulations offer fiduciaries relief from liability for losses resulting from automatically investing participant accounts in a qualified default investment alternative (QDIA). In addition, the fiduciary would not be liable for the decisions made by the entity managing the QDIA. Fiduciaries, however, remain liable for prudently selecting and monitoring any QDIA under the plan.2

      For the regulatory relief to apply:

      (1) the assets must be invested in a QDIA, as defined below;

      (2) the participant or beneficiary on whose behalf the account is maintained must have had the opportunity to direct the investment of the assets in his or her account but did not do so;

      (3) the participant or beneficiary must be provided with a notice meeting requirements set forth in regulations, a summary plan description, and a summary of material modification at least thirty days before the first investment and at least thirty days before each plan year begins;

      (4) any material relating to the investment, such as account statements, prospectuses, and proxy voting material must be provided to the participant or beneficiary;

      (5) the participant or beneficiary must be permitted to make transfers to other investment alternatives at least once in any three month period without financial penalty; and

      (6) the plan must offer a “broad range of investment alternatives,” as defined in DOL Regulation Section 2550.404c-1(b)(3).3

      The notice required for a QDIA must:

      (1) describe the circumstances under which assets in the individual account of an individual or beneficiary may be invested on behalf of a participant or beneficiary in a QDIA;

      (2) explain the right of participants and beneficiaries to direct the investment of assets in their individual accounts;

      (3) describe the QDIA, including its investment objectives, risk and return characteristics (if applicable), and fees and expenses;

      (4) describe the right of the participants and beneficiaries on whose behalf assets are invested in a QDIA to direct the investment of those assets to any other investment alternative under the plan, without financial penalty, and

      (5) explain where the participants and beneficiaries can obtain investment information concerning the other investment alternatives available under the plan.4

      A qualified default investment alternative means an investment alternative that meets five requirements:

      (1) it does not hold or permit the acquisition of employer securities except as provided below;

      (2) it does not impose financial penalties or otherwise restrict the ability of the participant or beneficiary to make transfers from the default investment to another plan investment;

      (3) it is managed by an investment manager, a registered investment company, or a plan sponsor that is a named fiduciary;

      (4) it is diversified, to minimize the risk of large losses; and

      (5) it constitutes one of three investment products (for example, a life cycle fund, a balanced fund, and a managed account) described in the regulations, each of which offers long-term appreciation and capital preservation through a mix of equity and fixed income exposures.5

      Final regulations permit the use of capital preservation funds (money market or stable value funds) only for a limited duration of not more than 120 days after a participant’s initial elective deferral. After 120 days, funds must be redirected to one of the three regular qualified default investment alternatives.6

      (1) The first is for the acquisition of employer securities held or acquired by a registered investment company (or similar pooled investment vehicle that is subject to state or federal examination) with respect to which such investments are in accordance with the stated investment objectives of the investment vehicle and are independent of the plan sponsor or its affiliate.7 In the preamble to the proposed regulations, the DOL explained that this exception should accommodate large publicly traded employers whose default investment alternatives may include pooled investment vehicles that invest in such companies.8

      (2) A second exception is provided with respect to accounts managed by an investment management service for employer securities acquired as a matching contribution from the employer/plan sponsor or for employer securities acquired prior to management by the investment management service.9


      1. ERISA Section 404(c)(5).

      2. Labor Reg. §2550.404c-5(b).

      3. Labor Reg. §2550.404c-5(c).

      4. Labor Reg. §2550.404c-5(d).

      5. Labor Reg. §2550.404c-5(e).

      6. Labor Reg. §2550.404c-5(e).

      7. Labor Reg. §2550.404c-5(e)(1)(ii)(A).

      8. See 29 CFR Part 2550, 71 Fed. Reg. 56806 (Sept. 27, 2006).

      9. Labor Reg. §2550.404c-5(e)(1)(ii)(B).

  • 3765. What are the requirements for a 401(k) safe harbor plan?

    • The IRC requires that deferrals, matching, and after-tax employee contributions to 401(k) or 401(m) plans satisfy certain nondiscrimination tests. A plan that is designed to meet certain safe harbors is deemed to have met those testing requirements. These tests are referred to as the ADP test for salary deferrals and the ACP test for employee after-tax and matching employer contributions. The requirements for meeting the safe harbors of 401(k) and 401(m) plans include specific plan provisions that generally require a fully vested employer contribution, one or more advance notice requirements, and certain restrictions on the level of discretionary matching contributions.

      A plan may be designed to satisfy safe harbors for deferrals but not for the matching employer contribution.

      The safe harbor plan requirements prohibit placing restrictions on a participant’s right to receive the match or 3 percent of pay employer contribution. Thus, the contribution must be given to employees who terminate employment in the plan year (Q 3792, Q 3794). The safe harbor does not eliminate the requirement of ACP testing for employee after-tax contributions.1 In addition, 401(k) plans that meet the safe harbor of 401(k) and 401(m) generally are exempt from the top-heavy requirements (Q 3905 to Q 3911), except as explained below.2

      Regulations permit the required safe harbor contributions to be made to the 401(k) plan or other defined contribution plans of the employer.3 Except for the provisions described below, a safe harbor plan generally is subject to the same qualification requirements of IRC Section 401(a) as a traditional 401(k) plan.

      The fact that a plan is a safe harbor 401(k) does not prevent certain lower income taxpayers from being eligible to claim the saver’s credit for elective deferrals (Q 3645).

      The dollar limit on elective deferrals to a safe harbor plan is the same as for a traditional 401(k) plan (Q 3760).

      A safe harbor plan generally may also permit catch-up contributions by participants who are at least age fifty by the end of the plan year.4 The limit on catch-up contributions (Q 3761) to safe harbor plans is calculated in the same manner as if made to a nonsafe harbor 401(k) plan.5 The dollar limit for salary deferrals is $19,500 in 2020 ($19,000 in 2019, $18,500 in 2018) and the catch-up contribution limit is $6,500 for 2020.6

      Safe harbor 401(k) and 401(m) plans generally are exempt from the top-heavy requirements; where additional employer contributions are made (e.g., profit sharing), that exemption is lost.7


      1. See IRC Secs. 401(k)(12), 401(m)(11); Treas. Reg. §1.401(k)-3(a).

      2. IRC Sec. 416(g)(4)(H).

      3. IRC Sec. 401(k)(12)(F); see Treas. Reg. §1.401(k)-3(h)(4).

      4. See IRC Sec. 414(v).

      5. IRC Sec. 414(v)(2)(A).

      6. IRC Sec. 414(v)(2)(B)(i); Notice 2017-64, Notice 2018-83, Notice 2019-59.

      7. See IRC Sec. 416(g)(4)(H); Rev. Rul. 2004-13, 2004-7 IRB 485.

  • 3766. What notice must be provided to participants in a 401(k) safe harbor plan?

    • Every year, an employer must provide certain written notices to each employee eligible to participate in a plan. This notice must be provided prior to the start of the plan year. The written notice must include a statement as to which type of safe harbor contribution will be made to the plan (i.e., the safe harbor match or safe harbor nonelective contribution). The statement must explain:

      (1) how the contribution is calculated and whether any conditions exist to be eligible to use it, including a description of the levels of safe harbor matching contributions;

      (2) whether any other contributions may be made under the plan or to another plan on account of elective contributions or after-tax employee contributions made to the plan;

      (3) he plan to which safe harbor contributions will be made if it is different from the plan containing the cash or deferred arrangement;

      (4) the type and amount of compensation that may be deferred under the plan;

      (5) how to make cash or deferred elections, including any administrative requirements that apply to such elections;

      (6) the periods available under the plan for making cash or deferred elections;

      (7) withdrawal and vesting provisions applicable to contributions under the plan; and

      (8) information that makes it easy to obtain additional information about the plan, including an additional copy of the summary plan description and telephone numbers, addresses, and, if applicable, electronic addresses, of individuals or offices from whom employees can obtain such plan information.1

      A plan that fails to meet any of these requirements will fail to be a safe harbor plan and will require the ADP and/or ACP testing of the plan year.

      The timing requirementfor the notice requirement is satisfied if the notice is provided within a reasonable period before the beginning of the plan year. This requirement is deemed met if the notice is provided to each eligible employee at least thirty days, and not more than ninety days, prior to the end of the plan year (i.e., by December 1 for a calendar year).2

      Contingent Notice

      There is one type of 401(k) safe harbor plan that requires a contingent notice. This plan design allows the employer to wait until thirty days before the close of the plan year to decide if the plan will be a safe harbor plan by making the fully-vested 3 percent of compensation, nonelective safe harbor. This type of plan must provide a contingent notice before the start of the plan year and a second notice when the employer decides to make the safe harbor contribution. The contingent notice must set forth the same information as above, and also state that the plan may be amended during the plan year to include the 3 percent safe harbor contribution. If the employer elects to make the contribution, the plan must be amended to reflect the contribution. Both the amendment and the follow-up notice are required to be provided to each eligible employee at least thirty days prior to the end of the plan year (i.e., by December 1 for a calendar year plan).3

      Much of the information in the summary plan description can be cross referenced rather than set forth again in the notice.4 In either case, the notice must be sufficiently accurate and comprehensive to inform the employee of his or her rights and obligations and must be written in a manner calculated to be understood by the average employee eligible to participate.5


      1. Treas. Reg. §1.401(k)-3(d)(2)(ii).

      2. See Treas. Reg. §1.401(k)-3(d)(3).

      3. See Treas. Reg. §1.401(k)-3(f).

      4. Treas. Reg. §1.401(k)-3(d)(2)(iii).

      5. IRC Secs. 401(k)(12)(D), 401(m)(11)(A)(ii); see Treas. Reg. §1.401(k)-3(d)(2)(i).

  • 3767. What requirements apply to matching contributions in the context of a 401(k) safe harbor plan?

    • The safe harbor matching contribution requirement is met if a matching contribution is made to each nonhighly compensated employee in one of two ways: the basic match or the enhanced match. Both become an obligation of the employer for the plan year (with certain exceptions).

      The basic match is an employer contribution equal to 100 percent of the salary deferrals to the extent they do not exceed 3 percent of compensation, plus a match equal to 50 percent of the salary deferrals that exceed 3 percent but do not exceed 5 percent of the compensation.1

      The enhanced match is a matching contribution under a formula that provides matching contributions that are at least the total matching contributions made under the basic match, regardless of the employee’s rate of elective contributions.2

      The safe harbor match must be fully vested at all times. Matching of catch-up contributions is not required; if done, they must be provided for all participants.3

      In no event may the rate of matching contributions for a highly compensated employee exceed that for a nonhighly compensated employee.4 The IRC allows some variation on the basic formula described above, but the end result essentially must be the same as under these percentages and the rate of the match cannot go up with the rate of contributions.5

      Matching contributions may be offered on both elective deferrals and employee after-tax contributions, provided that the match on elective deferrals is not affected by the amount of employee contributions, or matching contributions are made with respect to the sum of an employee’s elective deferrals and employee contributions under the same terms as they are made with respect to elective deferrals.6

      The IRS has stated that matching contributions may be made on the basis of compensation paid for a payroll period, a month, a quarter, or at year-end.7 The selection of a pay period basis means that if the employee contributes more than is necessary to receive a match for the pay period, there is no requirement to increase the match in other periods when the employee defers less than enough to receive the maximum match. If an employee has restrictions placed on other deferrals (for example, takes an in-service hardship distribution), the plan will impose a six month suspension on participation to the same extent as required by a traditional 401(k) plan (Q 3790).Note, however, that the six month suspension requirement was eliminated under the Bipartisan Budget Act of 2018 (BBA 2018) for tax years beginning after 2018.While some changes made by the BBA 2018 are optional, this change is mandatory for plans.

      A plan that satisfies the ADP test through safe harbor matching contributions automatically will satisfy the ACP test for certain discretionary contributions and the safe harbor match. The discretionary match cannot exceed 40 percent of compensation and cannot be based on deferrals exceeding 6 percent of compensation (Q 3794).

      Likewise, a plan that satisfies the ADP test through the nonelective contribution safe harbor under Treasury Regulation Section 1.401(k)-3(b) automatically will satisfy the corresponding ACP test safe harbor as long as the same restrictions on matching contributions exist.10 If the plan provides for additional matching contributions, then the ACP must be prepared.11

      Nonelective Safe Harbor

      The nonelective safe harbor contribution requirement is met if an employer contribution is made on behalf of all eligible nonhighly compensated employees in an amount equal to at least 3 percent of the employee’s compensation.12 This contribution is made to the accounts of all participants who are eligible, not just those making salary deferrals.

      The nonelective contributions must be fully vested and subject to the withdrawal restrictions on IRC Section 401(k) plans (Q 3789).13

      One important advantage of the 3 percent safe harbor contribution is that it may be used to satisfy the nondiscrimination requirements of IRC Section 401(c)(4). It is not subject to the limitations that apply to QNECs for use in such testing (Q 3792). Contributions used to satisfy the 3 percent safe harbor contribution may not be taken into account in determining whether a plan satisfies the permitted disparity rules (i.e., Social Security integration) (Q 3853).14

      Discretionary Match to Safe Harbor Plan

      Safe harbor plans retain their ability to satisfy the ACP test for discretionary matching contributions if the contributions are limited in amount. Those limits require that discretionary matching contributions may be made where: (1) based on salary deferrals that are not in excess of 6 percent of the employee’s compensation and limited to no more than 4 percent of the participant’s compensation, (2) the rate of the employer’s matching contribution does not increase with the rate of the employee’s elective deferral or contribution, and (3) the matching contribution with respect to any highly compensated employee at any rate of employee contribution or rate of elective deferral is not greater than that made with respect to a nonhighly compensated employee.15

      If matching contributions are made in excess of this limitation, the ACP test will be required for the plan year.16


      1. IRC Secs. 401(k)(12)(B)(i), 401(m)(11)(A)(i).

      2. Treas. Reg. § 1.401(k)-2(c)(3).

      3. See Reg-142499-01, 66 Fed. Reg. 53555 (Oct. 23, 2001).

      4. IRC Secs. 401(k)(12)(B)(ii), 401(m)(11)(A)(i).

      5. See IRC Secs. 401(k)(12)(B)(iii), 401(m)(11)(A)(i); see Treas. Reg. §1.401(k)-3(c)(3).

      6. Treas. Reg. §1.401(k)-3(c)(5)(i).

      7. Treas. Reg. §1.401(k)-3(c)(5)(ii).

      8. See Treas. Reg. §1.401(k)-3(c)(6)(v)(B).

      9. Bipartisan Budget Act of 2018, P.L. 115-123, §41113.

      10. Treas. Reg. §§1.401(m)-3(b), 1.401(m)-3(c).

      11. See IRC Sec. 401(m)(11)(B).

      12. IRC Secs. 401(k)(12)(C), 401(m)(11)(A)(i).

      13. IRC Sec. 401(k)(12)(E)(i).

      14. IRC Sec. 401(k)(12)(E)(ii); Treas. Reg. §1.401(k)-3(h)(2).

      15. IRC Sec. 401(m)(11)(B).

      16. See 1996 Blue Book, p. 153.

  • 3768. Can an employer reduce or suspend 401(k) safe harbor nonelective contributions mid-year?

    • The IRS has issued final regulations that permit a safe harbor nonelective 401(k) plan to reduce or suspend safe harbor contributions mid-year if the plan contains a statement that such action is a possibility and the amendment does not become effective until thirty days after participants receive a supplemental notice of the mid-year amendment.1

      In Notice 2016-162, the IRS provided guidance on the safe harbor notice that must be provided to participants. The Notice also states that if it is not practicable for the revised safe harbor notice to be provided before the effective date of the change, the notice is considered to be provided timely if it is provided as soon as practicable, but not later than thirty days after the date the change is adopted. Notice 2016-16 also specifies changes to safe harbor plans that cannot be made mid-year unless required by applicable law to be made mid-year, such as a change mandated by a law change or court decision.

      Previously, an employer was only permitted to exit a safe harbor nonelective 401(k) plan if the employer was experiencing a substantial business hardship. Factors to be considered in making this determination included whether the employer was operating at an economic loss, general industry conditions and whether the employer would be able to continue the plan without eliminating the safe harbor contributions.

      As a result of the new regulations, an employer is able to design its plan to provide the option of reducing or eliminating safe harbor nonelective contributions regardless of profitability. The regulations are retroactively effective and apply to plan years beginning after May 18, 2009.3


      1. Treas. Reg. §§1.401(k)–3(d), 1.401(k)–3(g), and 1.401(m)-3(h).

      2. Notice 2016-16, 2016-7 I.R.B. 318, January 29, 2016.

      3. TD 9641.

  • 3769. How does a SIMPLE 401(k) plan differ from a 401(k) safe harbor plan?

    • SIMPLE 401(k) plans (Q 3770) also provide a design-based alternative to the use of a safe harbor plan. Some of the differences between safe harbor plans and SIMPLE 401(k) plans are as follows:

      (1) Employees covered by a SIMPLE 401(k) plan may not be participants in any other plan offered by the employer, although employees participating in a safe harbor plan may be covered by more than one plan.

      (2) SIMPLE 401(k) plans are subject to the lower dollar limits on elective deferrals and catch-up contributions that apply to SIMPLE IRAs, rather than those applicable to traditional 401(k) plans.

      (3) Employers offering a SIMPLE 401(k) plan may not offer any contributions other than those provided under the SIMPLE 401(k) requirements, although employers maintaining a safe harbor plan may do so within the limitations described in Q 3767.

      (4) Safe harbor plans may be offered by any employer, although SIMPLE 401(k) plans are available only to employers with 100 or fewer employees earning $5,000 or more in the preceding year.

      (5) Contributions required under a safe harbor design may be made to a separate plan of the employer, although contributions required under a SIMPLE 401(k) design must be made to the SIMPLE 401(k) plan.

      (6) A SIMPLE 401(k) plan must provide the required notice to employees at least sixty days before the beginning of the plan year while safe harbor 401(k) plans must provide notice at least thirty days before the beginning of the plan year.

      (7) A SIMPLE 401(k) plan cannot be established by completing IRS Form 5304-SIMPLE or IRS Form 5305-SIMPLE. It requires a formal written plan document.

      Planning Point: A SIMPLE 401(k) must file a Form 5500 but SIMPLE IRAs do not. Anyone considering a SIMPLE 401(k) plan can do the same funding in a SIMPLE IRA. Note that the penalties for failing to file a Form 5500 are steep and increase with every day the filing is late.  Pre-SECURE Act, the IRS could assess a penalty of up to $25 per day with a cap of $15,000 per year.  Effective for years beginning after December 31, 2019, the penalty has increased to $250 per day for late filers and up to $150,000 per plan year (note that the additional DOL penalty exceeds $2,000 per day with no annual cap).[1]

      [1]      IRC Sec. 6652(e).  See SECURE Act, Sec. 403.

  • 3770. What are the requirements for a SIMPLE 401(k) plan?

    • Of all the types of qualified plans that are permitted under the IRC, the SIMPLE 401(k) may be the least attractive to a plan sponsor. These plans retain all the eligibility, documentation, and reporting requirements of a qualified plan but are subject to the lower limits and other restrictions of a SIMPLE IRA. A SIMPLE 401(k) plan allows an eligible employer to satisfy the actual deferral percentage test for 401(k) plans (Q 3792) by meeting the plan design requirements described below, instead of performing annual ADP testing.1 For a comparison of the features of a SIMPLE 401(k) plan to those of a safe harbor 401(k) plan, see Q 3769.

      An eligible employer is one that had no more than 100 employees earning at least $5,000 of compensation from the employer for the preceding year.2 An eligible employer that establishes a SIMPLE 401(k) plan for a plan year and later ceases to be eligible generally will be treated as eligible for the following two years. If the failure to remain eligible was due to an acquisition, disposition, or similar transaction, special rules apply.3

      In addition to all the requirements of IRC Section 401(k), a SIMPLE 401(k) plan must meet the contribution and other requirements of SIMPLE IRAs. Those requirements include a contribution requirement, an exclusive plan requirement, and a vesting requirement (Q 3703, Q 3706).4

      The SIMPLE 401(k) contribution requirement includes the following: (1) eligible employees must be able to make salary deferral contributions to the plan, (2) the amount to which the election applies may not exceed $13,500 (in 2020), and (3) the employer must make matching contributions or nonelective contributions under one of the formulas described below.5

      A SIMPLE 401(k) plan also may permit catch-up salary deferral contributions by participants who have attained age fifty by the end of the plan year.6 The limit on catch-up contributions to SIMPLE 401(k) plans is the same as for SIMPLE IRAs. The maximum catch-up contribution is the lesser of $3,000 (in 2015-2020) or the excess (if any) of the participant’s compensation over any other elective deferrals for the year made without regard to the catch-up limits.7

      A SIMPLE 401(k) plan must satisfy a universal availability requirement for availability of catch-up contributions (Q 3761).8

      Under the matching formula option for SIMPLE 401(k) plans, the employer must match employee salary deferral contributions dollar-for-dollar up to 3 percent of the employee’s compensation.9 (Earlier guidance stated that matching of catch-up contributions was not required.)10

      Under the second option, the employer makes a contribution of 2 percent of compensation on behalf of each employee who is eligible to participate and who has at least $5,000 in compensation from the employer for the year, provided notice of the election is given prior to the sixty day election period.11

      The plan also must provide that no other contributions (other than rollover contributions) may be made to the plan other than those described above.12 This is the “exclusive plan requirement.” This requirement is met if no contributions were made, or no benefits accrued, for services during the year under any qualified plan of the employer on behalf of any employee eligible to participate in the cash or deferred arrangement, other than the contributions made to the SIMPLE 401(k) plan.13 The receipt of a reallocation of forfeitures under another plan of the employer will not cause a SIMPLE 401(k) participant to violate this requirement.14

      All contributions to a SIMPLE 401(k) plan must be nonforfeitable.15

      Employees generally must have the right to terminate participation at any time during the year, although the plan may preclude the employee from resuming participation until the beginning of the next year.16 Furthermore, each employee eligible to participate must have sixty days before the first day of any year (and sixty days before the first day the employee is eligible to participate) to elect whether to participate in the plan or to modify his or her deferral amount. The foregoing requirements are met only if the employer notifies each eligible employee of such rights within a reasonable time before the sixty day election period.17

      A SIMPLE 401(k) plan that meets the requirements set forth in IRC Section 401(k)(11) is not subject to the top-heavy rules (Q 3906) provided that the plan allows only the contributions required under IRC Section 401(k)(11).18 SIMPLE 401(k) plans are subject to the other qualification requirements of a 401(k) plan, including the $285,000 compensation limit (as indexed for 2020, $280,000 in 2019, $275,000 in 2018), the IRC Section 415 limits (Q 3728, Q 3858), and the prohibition on state and local governments operating a 401(k) plan (Q 3753).19 The IRC Section 404(a) limit on the deductibility of contributions to 25 percent of compensation (Q 3750) is increased in the case of SIMPLE 401(k) plans to the greater of 25 percent of compensation or the amount of contributions required under IRC Section 401(k)(11)(B).20


      1. See IRC Sec. 401(k)(11); Treas. Reg. §1.401(k)-4(a).

      2. IRC Secs. 401(k)(11)(D)(i), 408(p)(2)(C)(i).

      3. See IRC Secs. 408(p)(10), 401(k)(11)(D)(i), 408(p)(2)(C)(i)(II); Treas. Reg. §1.401(k)-4(b)(2).

      4. IRC Secs. 401(k)(11)(A), 401(k)(11)(D)(i).

      5. IRC Sec. 401(k)(11)(B); Notice 2019-59.

      6. See IRC Sec. 414(v).

      7. IRC Sec. 414(v)(2)(A); Notice 2017-64, Notice 2018-83, Notice 2019-59.

      8. IRC Sec. 414(v)(3)(B); Treas. Reg. §1.414(v)-1(e).

      9. Treas. Reg. §1.401(k)-4(e)(3).

      10. See REG-142499-01, 66 Fed. Reg. 53555 (Oct. 23, 2001).

      11. IRC Sec. 401(k)(11)(B)(ii); Treas. Reg. §1.401(k)-4(e)(4).

      12. IRC Sec. 401(k)(11)(B)(i)(III); Treas. Reg. §1.401(k)-4(e)(1).

      13. IRC Sec. 401(k)(11)(C); Treas. Reg. §1.401(k)-4(c).

      14. Treas. Reg. §1.401(k)-4(c)(2).

      15. IRC Sec. 401(k)(11)(A)(iii).

      16. Treas. Reg. §1.401(k)-4(d)(2)(iii).

      17. IRC Secs. 401(k)(11)(B)(iii), 408(p)(5)(B), 408(p)(5)(C); Treas. Reg. §1.401(k)-4(d)(3).

      18. IRC Sec. 401(k)(11)(D)(ii); Treas. Reg. §1.401(k)-4(h).

      19. Rev. Proc. 97-9, 1997-1 CB 624; Notice 2017-64, Notice 2018-83, Notice 2019-59.

      20. IRC Sec. 404(a)(3)(A)(ii).

  • 3771. What are the requirements of a Roth 401(k)?

    • A Roth 401(k) feature combines certain advantages of the Roth IRA with the convenience of 401(k) plan elective deferral-style contributions. The IRC states that if a qualified plan trust or a Section 403(b) annuity includes a qualified Roth contribution program, contributions to it that the employee designates to the Roth account, although not being excluded from the employee’s taxable income, will be treated as an elective deferral for plan qualification purposes.1 A qualified plan or Section 403(b) plan will not be treated as failing to meet any qualification requirement merely on account of including a qualified Roth contribution program.2

      A qualified Roth contribution program means a program under which an employee may elect to make designated Roth contributions in lieu of all or a portion of elective deferrals that the employee is otherwise eligible to make.3 For this purpose, a designated Roth contribution is any elective deferral that would otherwise be excludable from the gross income of the employee, but that the employee designates as not being excludable.4 Final regulations set forth the following requirements for designated Roth contributions:

      (1) The contribution must be designated irrevocably by the employee at the time of the cash or deferred election as a designated Roth contribution that is being made in lieu of all or a portion of the pre-tax elective contributions the employee is otherwise eligible to make under the plan.

      (2) The contribution must be treated by the employer as includable in the employee’s gross income at the time the employee would have received the amount in cash, if the employee had not made the cash or deferred election (i.e., it must be treated as wages subject to applicable withholding requirements).

      (3) The contribution must be maintained by the plan in a separate account, as provided under additional requirements set forth below.5

      A plan with a Roth contribution feature must provide for separate accounts for the designated Roth contributions of each employee and any earnings allocable to the account.6 Gains, losses, and other credits and charges associated with the Roth accounts must be separately allocated on a reasonable and consistent basis to the designated Roth account and other accounts under the plan. Forfeitures of any accounts may not be reallocated to the designated Roth account. No contributions other than designated Roth contributions and rollover Roth contributions (as described below) may be allocated to the Roth account. The separate accounting requirement applies from the time the designated Roth contribution is made until the designated Roth contribution account is completely distributed.7

      The maximum amount an employee may claim as a designated Roth contribution is limited to the maximum amount of elective deferrals permitted for the tax year, reduced by the aggregate amount of elective deferrals for the tax year for which no designation is made.8 Only one limit can be split between the Roth and salary deferrals of the employee each calendar year.

      Designated Roth contributions generally must satisfy the rules applicable to elective deferral contributions. Thus, for example, the nonforfeitability requirements and distribution limitations of Treasury Regulation Sections 1.401(k)-1(c) and (d) must be satisfied for Roth contributions. Designated Roth contributions are treated as elective deferral contributions for purposes of the Actual Deferral Percentage (“ADP”) test.9

      A designated Roth account is subject to the minimum distribution requirements of IRC Section 401(a)(9) (Q 3881 to Q 3898).10 A payment or distribution otherwise allowable from a designated Roth account may be rolled over to another designated Roth account of the individual from whose account the payment or distribution was made or to a Roth IRA of the individual.11 Rollover contributions to a designated Roth account under this provision are not taken into account for purposes of the limit on designated Roth contributions.12 Funds in a Roth IRA are not subject to the lifetime minimum distribution requirements that apply to Roth accounts in a qualified plan (Q 3683).

      The IRC states that any qualified distribution from a designated Roth account is excluded from gross income.13 A qualified distribution for this purpose is defined in the same manner as for Roth IRAs except that the provision for “qualified special purpose distributions” is disregarded (Q 3670).14 The term qualified distribution does not include distributions of excess deferrals (amounts in excess of the IRC Section 402(g) limit) or excess contributions (under IRC Section 401(k)(8)), or any income on them.15

      Nonexclusion period. A payment or distribution from a designated Roth account will not be treated as a qualified distribution if it is made within the five-year nonexclusion period. This period begins with the earlier of (1) the first taxable year for which the individual made a designated Roth contribution to any designated Roth account established for that individual under the same retirement plan, or (2) if a rollover contribution was made to the designated Roth account from another designated Roth account previously established for the individual under another retirement plan, the first taxable year for which the individual made a designated Roth contribution to the previously established account.16

      The IRC states that notwithstanding IRC Section 72, if any excess deferral attributable to a designated Roth contribution is not distributed on or before the first April 15 after the close of the taxable year in which the excess deferral was made, the excess deferral will not be treated as investment in the contract and will be included in gross income for the taxable year in which such excess is distributed.17 Furthermore, it adds that “Section 72 shall be applied separately with respect to distributions and payments from a designated Roth account and other distributions and payments from the plan.”18

      Planning Point: Even though designated Roth contributions are not excluded from income when contributed, they are treated as elective deferrals for purposes of IRC Section 402(g). Thus, to the extent total elective deferrals for the year exceed the 402(g) limit for the year, the excess amount can be distributed by April 15 of the year following the year of the excess without adverse tax consequences. However, if the excess deferrals are not distributed by that time, any distribution attributable to an excess deferral that is a designated Roth contribution is includible in gross income (with no exclusion from income for amounts attributable to basis under Section 72) and is not eligible for rollover. If there are any excess deferrals that are designated Roth contributions that are not corrected prior to April 15 of the year following the excess, the first amounts distributed from the designated Roth account are treated as distributions of excess deferrals and earnings until the full amount of those excess deferrals (and attributable earnings) are distributed.19


      1. As defined in IRC Sec. 402(g).

      2. IRC Secs. 402A(a), 402A(e)(1).

      3. IRC Sec. 402A(b)(1).

      4. IRC Sec. 402A(c)(1).

      5. Treas. Reg. §1.401(k)-1(f)(1).

      6. IRC Sec. 402A(b)(2).

      7. Treas. Reg. §1.401(k)-1(f)(2).

      8. IRC Sec. 402A(c)(2).

      9. See Treas. Reg. §1.401(k)-1(f)(3).

      10. Treas. Reg. §1.401(k)-1(f)(3).

      11. IRC Sec. 402A(c)(3).

      12. See IRC Sec. 402(A(c)(3)(B).

      13. IRC Sec. 402A(d)(1).

      14. IRC Sec. 402A(d)(2)(A). See IRC Sec. 408A(d)(2)(A)(iv).

      15. IRC Sec. 402A(d)(2)(C).

      16. IRC Sec. 402A(d)(2)(B).

      17. IRC Sec. 402A(d)(3).

      18. IRC Secs. 402A(d)(3), 402A(d)(4).

      19. TD 9324, 2007-2 IRB (May 29, 2007).

  • 3772. How are qualified distributions from a designated Roth 401(k) or 403(b) account taxed?

    • A designated Roth account is an option that is available under a 401(k) or a 403(b) plan to which designated Roth contributions (Q 3771) are made.1 Where a distribution from the designated Roth account satisfies certain requirements (referred to as a “qualified distribution,” see below), distributions from the account are free of income tax, even if not rolled over. For details on the requirements of a Roth 401(k) feature, see Q 3771.

      Qualified distributions. The taxation of a distribution from a designated Roth account depends on whether the distribution constitutes a qualified distribution. A qualified distribution generally is a distribution received after a five-taxable-year period and that meets any of the following qualified purposes for this rule:

      (1) It is made after the employee reaches age 59½.

      (2) It is attributable to the employee’s being disabled within the meaning of IRC Section 72(m)(7).

      (3) It is made after the employee’s death.2

      This definition is the same as that used for Roth IRAs except that the provision for “qualified special purpose distributions” is disregarded (Q 3670).3

      The term qualified distribution does not include distributions of excess deferrals that arise in correction of either an excess deferral under the IRC Section 402(g) limit or an excess contribution under IRC Section 401(k)(8), or any income attributable to such a distribution.4


      1. See IRC Sec. 402A(b)(2)(A); Treas. Reg. §1.402A-1, A-1.

      2. See IRC Sec. 402A(d)(1), Treas. Reg. §1.402A-1, A-2.

      3. IRC Sec. 402A(d)(2)(A). See IRC Sec. 408A(d)(2)(A)(iv).

      4. IRC Sec. 402A(d)(2)(C).

  • 3773. How are nonqualified distributions from a designated Roth 401(k) or 403(b) account taxed?

    • A nonqualified distribution from a designated Roth account generally is partially nontaxable. The portion of the distribution that constitutes the employee contribution is not taxable, and the portion that relates to earnings on those contributions is taxable.1 A nonqualified distribution may be rolled over to a Roth IRA. The funds in a designated Roth account are not subject to the ordering rules that determine the tax treatment of Roth IRA distributions (Q 3670) unless they are rolled over to a Roth IRA.2

      The preamble to the proposed regulations illustrated the pro rata treatment of nonqualified distributions as follows: If a nonqualified distribution of $5,000 is made from an employee’s designated Roth account when the account consists of $9,400 of designated Roth contributions and $600 of earnings, the distribution consists of $4,700 of designated Roth contributions (that are not includible in the employee’s gross income) and $300 of earnings (that are includible in the employee’s gross income).

      Amounts not treated as qualified. Certain amounts that are not eligible rollover distributions never can be treated as qualified distributions, and always will be currently includible in income. These include corrective distributions of excess deferrals, excess contributions and attributable income (Q 3798), deemed distributions resulting from violations of the plan loan requirements (Q 3943), and the cost of current life insurance protection (Q 3937).3


      1. See Treas. Reg. §1.402A-1, A-3; IRC Sec. 72(e)(8).

      2. See Treas. Reg. §1.408A-10, A-1.

      3. See Treas. Reg. §§1.402(g)-1(e)(8)(iv), 1.402A-1, A-2(c), 1.402A-1, A-11.

  • 3774. How is the five-year holding period of qualified distributions from designated Roth 401(k) or 403(b) accounts determined?

    • A Roth contribution is deemed to be made on the first day of the first taxable year for which the employee first made any designated Roth contributions. Thus, for a calendar year plan, all contributions in the first year would be deemed made on January 1 of that year. Starting with that date, the five-year period ends at the end of the fifth consecutive taxable year following that date. The beginning of the five-year period for a designated Roth account does not change even if the employee receives a distribution of the entire account and subsequently makes additional designated Roth contributions under the plan.

      If an employee makes deferrals to designated Roth accounts under more than one plan, the employee will have two or more separate five-year periods of participation that are calculated independently of one another unless the employee makes a direct rollover of a Roth distribution from one plan to another plan.1 If a direct rollover occurs, the five-year holding period for the receiving plan is deemed to begin on the earlier of beginning of the five-year holding period for the distributing plan or the beginning of the five-year holding period for the receiving plan. This calculation differs from the five-year period calculation under a Roth IRA in which the five year period starts with the date a Roth contribution was made to any Roth IRA (Q 3670).

      Planning Point: A client planning to make deferrals to a designated Roth account for the next year should begin deferrals in the current year. This will begin the five-year period one year earlier, so qualified distributions can be made one year earlier.


      1. Treas. Reg. §1.402A-1, A-4.

  • 3775. Can the owner of a designated Roth 401(k) or 403(b) account roll those funds into another retirement account?

    • A rollover of a designated Roth account distribution that is not includable in income may be made only to another designated Roth account of the individual from whose account the payment or distribution was made or to a Roth IRA of the individual either through a sixty-day rollover or a direct rollover. A plan receiving a designated Roth account rollover must agree to separately account for the amount that is not includable in income. Furthermore, if such a rollover is made to another plan, it must be made as a direct rollover to assure that there is proper accounting in the recipient plan. In other words, a rollover to a plan is not available if the distribution has been made directly to the employee. In that case, however, an employee would have the option of rolling over the distribution to a Roth IRA within sixty days.1

      If a rollover is made from a designated Roth account under another plan, the five-year period for the receiving plan begins on the first day that the employee made designated Roth contributions to the other plan, if earlier.2

      If a rollover is made from a designated Roth account to a Roth IRA, the period that the rolled over funds were in the designated Roth account does not count toward the five taxable year period for determining qualified distributions from the Roth IRA. If the Roth IRA was established in an earlier year, the five-year period for determining qualified distributions from the Roth IRA applies to distributions of rolled over amounts.3 Furthermore, the entire amount of any qualified distribution rolled over to a Roth IRA is treated as basis in the Roth IRA. As a result, a subsequent distribution from the Roth IRA of that amount would not be includable in the owner’s gross income.4

      Planning Point: A client who does not have a Roth IRA and anticipates rolling over an amount from a designated Roth account to a Roth IRA should consider establishing a Roth IRA before the year the rollover is anticipated. This will start the five-year holding period.


      1. See IRC Sec. 402A(c)(3); Treas. Reg. §1.402A-1, A-5.

      2. Treas. Reg. §1.402A-1, A-4(b).

      3. Treas. Reg. §1.408A-10, A-4.

      4. See Treas. Reg. §1.408A-10, A-3(a).

  • 3776. What should a taxpayer consider when deciding whether to roll funds from an employer-sponsored 401(k) into an IRA?

    • For a taxpayer who has reached age fifty-five, but has not yet reached age 59½, the tax advantages of allowing the funds to remain in the 401(k) are clear. If the taxpayer were to roll the funds into an IRA, a 10 percent penalty tax would apply to any withdrawals made before the taxpayer reaches age 59½ (in addition to the otherwise applicable ordinary income tax rate), unless another exception such as disability or a series of substantially equal periodic payments applies. A taxpayer who leaves employment once reaching age fifty-five can withdraw funds from the 401(k) without incurring the 10 percent penalty for early withdrawals.1

      If a taxpayer plans to work past the age when distributions become mandatory (age 70½), the taxpayer can avoid the required distributions by leaving the funds in the employer-sponsored 401(k). Unless the plan requires earlier distributions, as long as the taxpayer continues to work and does not own 5 percent or more of the company, he or she can avoid taking distributions from a 401(k). Distributions from an IRA are required to begin when the taxpayer turns 70½, regardless of whether he or she has actually retired.2

      Further, if a taxpayer holds stock in the employer within the 401(k) plan, the taxpayer may qualify for favorable tax treatment if the stock is left in the 401(k). After distribution from the 401(k) to a non-qualified account, a sale of the employer stock may qualify for taxation at the taxpayer’s long-term capital gains tax rate under the net unrealized appreciation rules, rather than the ordinary income tax rate that would apply to the appreciation on the stock if it was rolled into the IRA and later sold and the sales proceeds distributed. (See Q 3960.)

      Taxpayers may wish to keep funds in an employer-sponsored 401(k) after leaving employment because it may be possible to borrow against those funds, though these loans are limited and must be repaid relatively quickly. A loan against an IRA balance is not an option (penalties and taxes would apply to the IRA as though it were a distribution). Using an IRA as collateral for a loan is also treated as a distribution, subject to taxes and penalties.

      If the 401(k) offers attractive investment options, the taxpayer may wish to keep the funds invested in the 401(k). Further, if the 401(k) has lower fees than available in an IRA, the taxpayer may benefit from leaving the funds in the 401(k). Because recently enacted disclosure rules require 401(k) plan sponsors to disclose administrative expenses and fees to participants, there is evidence to suggest that 401(k) fees may be decreasing.


      1. IRC Sec. 72(t).

      2. Treas. Reg. §1.408-8, A-3.

  • 3777. What is the separate accounting requirement applicable to a designated Roth 401(k) or 403(b) account?

    • For a designated Roth account, the plan must maintain separate accounts and recordkeeping for each employee’s designated Roth contributions and any earnings that are allocated to the contributions.1 The separate accounting requirement is violated by “any transaction or accounting methodology involving an employee’s designated Roth account and any other accounts under the plan or plans of an employer that has the effect of directly or indirectly transferring value from another account into the designated Roth account.” A transaction that merely exchanges investments between accounts at fair market value will not violate the separate accounting requirement.2


      1. IRC Sec. 402A(b)(2).

      2. Treas. Reg. 1.402A-1, A-13(a).

  • 3778. What in-plan rollovers are permitted with respect to designated Roth 401(k) or 403(b) accounts?

    • Section 402A(c)(4) allows plans to permit rollovers from Section 401(k) plans to designated Roth accounts in the same plan (“in-plan Roth rollovers”). The rollover may be accomplished by a direct rollover or a sixty day rollover.1 Amounts can be rolled over even if they would not otherwise be distributable.2

      In-plan Roth direct rollovers simply change the plan account in which the amount is held and the tax character. They are not treated as a distribution for situations involving plan loans, spousal annuities, participant consent before an immediate distribution of an accrued benefit in excess of $5,000, and elimination of optional forms of benefit.3

      A qualified distribution is included in gross income as if it were not rolled over to a designated Roth account. The taxable amount of the in-plan Roth rollover is the amount that would be includible in a participant’s gross income if the rollover were made to a Roth IRA. This amount is equal to the fair market value of the distribution reduced by any basis the participant has in the distribution.4 The taxable amount of a distribution that an individual rolls over in an in-plan Roth rollover generally is includible in gross income in the taxable year in which the distribution occurs.

      Prior to 2018, a rollover to a Roth IRA could be unwound. This option was eliminated by the 2017 tax reform legislation. An in-plan rollover could never be unwound (recharacterized) because the recharacterization rule in Section 408A(d)(6) applied only to contributions to IRAs.5 In-plan Roth direct rollovers are not subject to the otherwise mandatory 20 percent withholding and cannot be withheld for voluntary withholding.6

      A written explanation of the in-plan Roth feature must be provided to the participant with the written explanation that the plan provides to individuals receiving an eligible rollover distribution.7


      1. Notice 2010-84, Q&A-1.

      2. Notice 2013-74, Q&A -1.

      3. Notice 2010-84, Q&A-4.

      4. See Notice 2009-75, 2009-35 I.R.B. 436.

      5. Notice 2010-84, Q&A-6.

      6. Notice 2013-74, Q&A-4.

      7. Notice 2010-84, Q&A-5.

  • 3779. What rules apply toRoth 401(k) rollovers?

    • Since 2013, funds from traditional 401(k) accounts may be rolled over into Roth 401(k) accounts without a penalty tax (even if they are not otherwise distributable without penalty).

      The amount that a plan participant can roll over is not limited. Any amount rolled over pursuant to this provision is treated as a distribution that was contributed in a qualified rollover contribution within the meaning of IRC Section 408A. This provision applies to 401(k) plans, 403(b) plans and governmental 457(b) plans.1

      As under prior law, the amount that is rolled over from a traditional 401(k) into a Roth 401(k) is included in gross income. The taxable amount of the Roth rollover must be included in the participant’s gross income. The taxable amount of an in-plan Roth rollover is the amount that would be includible in a participant’s gross income if the rollover were made to a Roth IRA. This amount is equal to the fair market value of the distribution reduced by any basis the participant has in the distribution.2 The taxable amount of a distribution that an individual rolls over in an in-plan Roth rollover generally is includible in gross income in the taxable year in which the rollover occurs.

      The expanded rollover treatment is optional, so that plan administrators have discretion as to whether to adopt an amendment permitting expanded use of this type of rollover. The amendment must be made no later than the last day of the first plan year in which the amendment is to be effective.

      See Q 3781 for distribution restrictions that apply following a 401(k) to Roth 401(k) rollover.


      1. American Taxpayer Relief Act of 2012, Pub. Law No. 112-240, Sec. 902.

      2. Notice 2009-75, 2009-35 IRB 436; Notice 2010-84, 2010-51 IRB 872.

  • 3780. What is the difference between an after-tax 401(k) contribution and a Roth contribution? What should individuals understand when deciding whether to allocate their retirement funds to after-tax or Roth contributions?

    • Each year, individuals have the ability to defer up to the traditional annual pre-tax contribution limit to a 401(k) plan ($19,500 in 2020, or $26,000 for clients age 50 and over) and up to the individual limit to IRAs and Roth IRAs ($6,000 or $7,000 with the catch-up). The after-tax contribution rules allow the individual to defer more than the annual pre-tax limit (for a total of up to $57,000 or 100 percent of compensation in 2020) to their traditional 401(k). While these contributions are made with after-tax dollars, they are not the same as Roth contributions (which also come from after-tax funds, and are discussed below). Like pre-tax contributions, after-tax contributions cannot be withdrawn from the 401(k) without penalty except according to the terms of the plan (which will typically allow for penalty-free distributions only in the event of the client reaching age 59½, dying, retiring, becoming disabled or upon the occurrence of certain hardships).

      The primary difference between the after-tax 401(k) contribution and the Roth contribution is the tax treatment of earnings on the investment. While all Roth contributions are permitted to grow on a tax-free basis (i.e., the entire amount of the withdrawal will generally be tax-free), earnings on after-tax contributions will eventually be taxed at ordinary income tax rates. As a result, only individuals who are already contributing the maximum pre-tax and Roth amounts to their retirement accounts should consider the after-tax contribution option (generally, these will be high net worth clients seeking to amass a larger retirement nest egg).

      Individuals should also consider maximizing their HSA contributions (which are contributed on a pre-tax basis, grow tax-free and can be withdrawn tax-free to cover medical expenses) before considering after-tax 401(k) contributions. This is because the actual benefit of the aftertax contribution is tax-deferred investing and the eventual ability to move the after-tax funds into a Roth account, from which point they will grow tax-free. Both Roth accounts and HSAs allow the funds to grow tax-free from the beginning, which will maximize the value of the contribution through compounded earnings over time. For high net worth clients, however, the after-tax 401(k) option can be valuable because all of the earnings are tax-deferred—conversely, with traditional taxable accounts (such as a mutual fund), the individual will have to pay taxes on appreciation each year, albeit usually at the lower capital gains rate. This group of taxpayers may actually benefit from the ability to allow all of their investment and earnings to grow tax-deferred over a period of many years. These individuals must keep in mind that they may not be able to withdraw their after-tax 401(k) contributions freely and without penalty, however.

      Importantly, under relatively new IRS regulations, at retirement the taxpayer can now bifurcate the funds in his or her 401(k), transferring after-tax funds into a Roth IRA (from that point, the after-tax funds grow tax-free) and the earnings into a traditional IRA (because those earnings had never been taxed, they will eventually be subject to ordinary income tax rates).

  • 3781. Are amounts rolled over to a Roth 401(k) subject to distribution restrictions after the rollover?

    • Yes. Although the American Taxpayer Relief Act of 2012 expanded the rules to allow rollovers from traditional 401(k) accounts to Roth 401(k) accounts of otherwise nondistributable amounts, the IRS has issued guidance providing that distribution restrictions will still apply after such amounts are rolled over.

      Any amount that is rolled over from a traditional 401(k) to a Roth 401(k) remains subject to the same distribution restrictions that applied to the amounts before the rollover.1 As a result, if an individual makes a rollover from a traditional 401(k) to a Roth 401(k) before reaching age 59½, for example, the rolled over amounts cannot be withdrawn from the Roth 401(k) on a penalty-free basis unless one of the other events described in IRC Section 401(k)(2)(B) has occurred (i.e., unless he or she reaches age 59½ or there has been a separation from service, death or disability).


      1. Notice 2013-74, 2013-52 IRB 819.

  • 3782. Are otherwise nondistributable amounts that are rolled over from a 401(k) to a Roth 401(k) subject to withholding?

    • The withholding requirements of IRC Section 3405 do not apply to otherwise nondistributable amounts that are rolled over from a traditional 401(k) into a Roth 401(k) because such a rollover must be accomplished through a direct rollover.1

      Further, because a nondistributable rollover cannot, by definition, be distributed to the taxpayer, a taxpayer is not permitted to voluntarily elect that a portion of the distribution be subject to withholding for purposes of meeting the taxpayer’s tax obligations with respect to the rollover. As a result, IRS guidance specifically advises that a taxpayer who elects to roll 401(k) funds into a Roth 401(k) may wish to increase withholding or make estimated payments in order to avoid an underpayment penalty.2


      1. Notice 2013-74, 2013-52 IRB 819.

      2. IRC Sec. 3402(p); Notice 2013-74, 2013-52 IRB 819.

  • 3783. What is the exception to the 401(k) required minimum distribution (RMD) rules that can apply when a plan participant has reached age 70½, but continues to work?

    • While the general rules governing retirement accounts require nearly every individual account owner to begin taking RMDs by April 1 of the year following the year in which he or she turns
      70½, an exception exists for employer-sponsored 401(k) accounts owned by employees who continue working past age 70½. If the plan allows, a participant who leaves funds in the 401(k) can avoid RMDs if he or she remains employed with the employer who sponsors the plan (the participant can also continue to make contributions to the 401(k)).

      Importantly, the current employer must sponsor the 401(k)—a participant cannot change employers and defer RMDs beyond age 70½ if a former employer sponsors the relevant 401(k). However, it does not appear that the IRS provides a concrete definition of what it means to continue working past age 70½, so it may be possible for the participant to continue working on a reduced hours basis and still defer his or her RMDs past the traditional required beginning date.

      The exception does not apply if the plan is an IRA (whether a traditional, SEP or SIMPLE IRA (RMDs do not apply to Roth IRAs during the original account owner’s lifetime)). Additionally, because not all 401(k) plans permit this exception, the individual must be careful to ensure that his or her plan actually does allow the funds to remain in the plan to avoid steep 50 percent penalty that applies to missed RMDs.

      If the individual has more than one 401(k) and the plans allow for rollovers, it may be possible for he or she to roll all 401(k) funds into the 401(k) of a current employer and delay RMDs on all of the funds if the still working exception applies. Combining accounts will also simplify RMD planning once the participant stops working, because the RMD on each account would otherwise have to be determined separately.

      While a plan participant may generally avoid taking RMDs from his or her 401(k) as long as he or she continues working past age 70½, many small business owners will not be able to take advantage of this exception. This is because the exception does not apply to participants who are five percent owners of the business sponsoring the retirement plan. Individuals who own a portion of the business sponsoring the 401(k) must also be aware of the constructive ownership rules that apply when determining whether he or she is a five percent owner. Ownership interests held by certain members of the participant’s family (i.e., a spouse, children, parents, etc.) and by certain entities in which the participant holds a controlling stake will be added to the ownership interest that the participant holds directly in determining whether the 5 percent threshold has been crossed.

       

  • 3784. Can a plan restrict the types of 401(k) contributions that can be converted to a Roth 401(k)?

    • Yes. A plan that adopts an amendment permitting in-plan rollovers from traditional 401(k) accounts to Roth 401(k) accounts can, subject to otherwise applicable nondiscrimination requirements, restrict the types of contributions that can be rolled over. Further, the plan amendment can limit the frequency of these rollovers.1

      For example, otherwise nondistributable amounts may be permissibly rolled over, it is up to the plan itself to determine whether it will allow these rollovers. For administrative convenience, a plan may provide that it will only permit rollovers of otherwise distributable amounts or that nondistributable amounts can only be rolled over at certain intervals.


      1. Notice 2013-74, 2013-52 IRB 819.

  • 3785. What is an eligible investment advice arrangement?

    • ERISA contains a general prohibition against providing services to a plan for a fee. It is a prohibited transaction unless exempted either in the law or by regulations. There is a statutory exemption for investment advice rendered by a fiduciary advisor under an “eligible investment advice arrangement.” These requirements are designed to allow the plan fiduciary to meet the obligations under ERISA in the hiring of an investment advisor.1 The provisions discussed here generally are effective with respect to advice provided after December 31, 2006.

      On October 25, 2011, the Employee Benefits Security Administration of the U.S. Department of Labor issued final regulations implementing a statutory exemption from ERISA’s prohibited transaction rules that allows fiduciary advisors to offer plan participants and beneficiaries investment advice for a fee under eligible investment advice arrangements.2 The exemption, discussed below, was mandated by the Pension Protection Act of 2006 and is available for transactions occurring on or after December 27, 2011 that provide sufficient safeguards to ensure there is no conflict of interest.

      The final rules do not affect the applicability of the DOL’s prior guidance on the application of the prohibited transaction rules and existing prohibited transaction exemptions to investment advice arrangements.

      The Final Regulations

      The statutory exemption allows fiduciary investment advisors to receive compensation from investment vehicles that they recommend if either (1) the investment advice is based on a computer model certified as unbiased which applies generally accepted investment theories, or (2) the advisor is compensated on a “level-fee” basis (i.e., fees do not vary based on investments selected by the participant). The final regulations provide detailed guidance to advisors on compliance with these conditions.

      The regulations also show advisors how to comply with other conditions and safeguards in the statutory exemption, including:

      •     requiring that a plan fiduciary (independent of the investment advisor or its affiliates) authorize the advice arrangement;

      •     imposing recordkeeping requirements for investment advisors relying on the exemption;

      •     requiring that computer models be certified in advance as unbiased and meeting the exemption’s requirements by an independent expert;

      •     establishing qualifications and a selection process for the investment expert who must perform the above certification;

      •     clarifying that the level-fee requirement does not permit investment advisors (including their employees) to receive compensation from any party (including affiliates) that varies on the basis of the investments that participants select;

      •     establishing an annual audit of both computer model and level-fee advice arrangements, including the requirement that the auditor be independent from the investment advice provider;

      •     requiring disclosures by advisors to plan participants.3

      Fee Disclosures

      In February 2012, the DOL issued final regulations on fee disclosure4 and provided a Sample Guide to Initial Disclosures.5 In its final rule, the DOL extended the deadline for disclosures to July 1, 2012. In May 2012, the DOL issued a Field Assistance Bulletin providing guidance on frequently asked questions about participant-level disclosure requirements.6

      See Q 3786 for information about establishing an eligible investment advice arrangement and Q 3787 for a detailed discussion of who is a fiduciary advisor for purposes of an eligible investment advice arrangement.


      1. IRC Secs. 4975(d)(17), 4975(f)(8).

      2. DOL Reg. §2550.408g-1.

      3. DOL Reg. §2550.408g-1.

      4. DOL Reg. §2550.408b-2.

      5. Available at https://www.dol.gov/sites/default/files/ebsa/employers-and-advisers/plan-administration-and-compliance/retirement/408b2sampleguide.pdf (Feb. 12, 2012).

      6. Field Assistance Bulletin 2012-2 (May 7, 2012).

  • 3786. How is an eligible investment advice arrangement established?

    • An eligible investment advice arrangement may be established in either of two ways: (1) the arrangement may provide that any fees (including commissions or other compensation) received by the fiduciary for investment advice, or with respect to the sale, holding, or acquisition of any security or other property for purposes of investment of plan assets, do not vary depending on the basis of any investment option selected, or (2) the arrangement may use a computer model that meets specified criteria, described below, in connection with the provision of investment advice by a fiduciary advisor to a participant or beneficiary.1

      The use of either method requires the plan fiduciary to comply with the statutory requirements of this exemption. Those requirements include:

      (1) that the advisor must act as an independent fiduciary;

      (2) proper authorization to provide the services;

      (3) compliance with an audit requirement;

      (4) disclosure of all relevant information including meeting certain standards for presentation of information;

      (5) the maintenance of proper records; and

      (6) that the fees charged the plan are reasonable.2

      The fee leveling requirement is met if the fees, commissions, or any revenue sharing by the advisor do not vary based upon the recommendations provided. This applies to the affiliate of the advisor.3

      Computer Model

      The computer model must:

      (1) apply generally accepted investment theories that take into account the historic returns of different asset classes over defined periods of time;

      (2) use relevant information about the participant, such as age, life expectancy, retirement age, risk tolerance, other assets or sources of income, and preferences as to certain types of investments;

      (3) use prescribed objective criteria to provide asset allocation portfolios comprised of investment options offered under the plan;

      (4) operate in a manner that is not biased toward investments offered by the fiduciary advisor, or a person in material affiliation or contractual relationship with the fiduciary advisor; and

      (5) take into account all investment options under the plan in specifying how a participant’s account should be invested and not be inappropriately weighted with respect to any investment option.4

      The person who develops or markets the computer model or investment advice program may be treated as a fiduciary advisor under certain circumstances.5

      The utilization of the computer model must be certified by an “eligible investment expert” as meeting the foregoing criteria, and the only advice provided under the arrangement can be that generated by the computer model and any transaction requested by the participant.6 The arrangement also must be audited annually and must meet detailed written disclosure requirements. Records of compliance must be maintained for six years.7

      An eligible investment advice arrangement must be expressly authorized by a plan fiduciary other than the person offering the investment advice. Notifications required for participants and beneficiaries must be written in a clear and conspicuous manner, calculated to be understood by the average plan participant.8 The DOL is directed to issue a model form for this purpose.9


      1. IRC Sec. 4975(f)(8)(B).

      2. IRC Sec. 4975(f)(8)(D) through (I).

      3. IRC Sec. 4975(f)(8)(B)(i)(I).

      4. IRC Sec. 4975(f)(8)(C)(ii); DOL Reg. §2550.408g-1(b)(4).

      5. IRC Sec. 4975(f)(8)(J)(i).

      6. IRC Sec. 4975(f)(8)(C)(iii), 4975(f)(8)(C)(iv).

      7. IRC Sec. 4975(f)(8)(I).

      8. IRC Sec. 4975(f)(8)(H)(i).

      9. IRC Sec. 4975(f)(8)(H)(ii).

  • 3787. Who is a fiduciary advisor for purposes of an eligible investment advice arrangement?

    • A “fiduciary advisor” for purposes of this provision is a person who provides investment advice to the participant or beneficiary and is one of the following:

      (1) a Registered Investment Advisor (“RIA”) in the state in which the fiduciary maintains its principal office and place of business;

      (2) a bank or similar financial institution, but only if the advice is provided through a trust department that is subject to periodic examination and review by federal or state banking authorities;

      (3) an insurance company qualified to do business under the laws of a state;

      (4) a person registered as a broker or dealer under the Securities Exchange Act of 1934;

      (5) an affiliate of any of the persons described in (1) through (4); or

      (6) an employee, agent, or registered representative of a person described in (1) through (5) who satisfies the requirements of applicable insurance, banking, and securities laws relating to the provision of the advice.1


      1. IRC Sec. 4975(f)(8)(J)(i); DOL Reg. §2550.408g-1(c)(2)(i).

  • 3788. What is a combination defined benefit/401(k) plan?

    • For plan years beginning after December 31, 2009, an “eligible combined plan” (i.e., a combination defined benefit/401(k) plan) is available to employers with two to 500 employees.1

      The assets of the plan will be held in a single trust, and the defined benefit and 401(k) components generally will be subject to their already-existing qualification requirements. The plan will be required to file only one Form 55002 and will have a single plan document.3 The top heavy rules (Q 3905 to Q 3911) will be deemed satisfied for a combined defined benefit/401(k) plan, and the 401(k) portion will be exempt from ADP/ACP testing (Q 3753, Q 3792).4

      The plan’s design generally will be subject to the following requirements:

      (1) The benefit requirement for the defined benefit portion will be satisfied if the annual accrued benefit of each participant is not less than 1 percent of final average pay times up to twenty years of service, or if the plan is a cash balance plan providing pay credits not less than the percentage of compensation determined under the following formula:

      Participant’s age as of beginning of year

      Cash balance pay credit percentage ofcompensation

      30 or less

      2

      30 or over, less than 40

      4

      40 or over, less than 50

      6

      50 or over

      8

      For this purpose, “final average pay” is determined using up to five years during which the participant had the highest aggregate compensation from the employer.5

      (2) The contribution requirement will be met if the 401(k) plan provides for an automatic contribution arrangement (see below) and requires the employer to match 50 percent of elective deferrals of up to 4 percent of compensation.6 Nonelective contributions are not precluded but will not count toward satisfying this requirement.7

      (3) Employees must be 100 percent vested after three years of service with respect to the defined benefit portion of the plan. Matching contributions under the defined contribution portion must be nonforfeitable, including those in excess of the required match. Any nonelective contributions may be subject to a maximum three-year cliff vesting schedule.8

      (4) All contributions, benefits, rights, and features must be provided uniformly to all participants.9

      (5) The foregoing requirements must be met without taking into account permitted disparity and amounts under other plans.10

      These criteria are the only circumstances under which a combination defined benefit/401(k) plan may constitute a single plan and trust.

      A 401(k) plan will be treated as an automatic contribution arrangement if it provides a default elective contribution percentage of 4 percent and meets specific notice requirements. Employees must receive a notice explaining their right not to have contributions withheld, or to have them made at a different rate, and they must have a reasonable period of time after receipt of the notice to make such elections.11


      1. IRC Secs. 414(x)(2)(A), 4980D(d)(2).

      2. Regulations proposed in July 2016 (RIN 1210-AB63) are designed to modernize and improve the Form 5500 reporting procedures, and will generally be effective for the 2019 plan year, presumptively once they have been finalized.

      3. See IRC Secs. 414(x)(2), 414(x)(6).

      4. IRC Secs. 414(x)(3), 414(x)(4).

      5. IRC Sec. 414(x)(2)(B).

      6. IRC Sec. 414(x)(2)(C).

      7. IRC Sec. 414(x)(2)(C)(ii).

      8. IRC Sec. 414(x)(2)(D).

      9. IRC Sec. 414(x)(2)(E).

      10. See IRC Sec. 414(x)(2)(F).

      11. See IRC Sec. 414(x)(5).

  • 3789. What restrictions apply to distributions from 401(k) plans?

    • Amounts held by the trust that are attributable to employer contributions made pursuant to the election to defer may not be distributed to participants or beneficiaries prior to:

      (1) the employee’s death, disability, or severance from employment;

      (2) certain plan terminations, without the establishment or maintenance of another defined contribution plan;

      (3) in the case of a profit sharing or stock bonus plan, the employee’s reaching age 59½;

      (4) experiencing financial hardship (Q 3790) (for years beginning before January 1, 2019, limited to distributions from a profit sharing or stock bonus plan and not permitted from other plans); or

      (5) in the case of a qualified reservist distribution, the date of the reservist’s order or call.1

      These occurrences are referred to as “distributable events.” Amounts may not be distributable merely by reason of completion of a stated period of participation or the lapse of a fixed number of years.2 A qualified hurricane distribution (Q 621) will be treated as satisfying the distribution requirements of IRC Section 401(k)(2)(B).3

      The cost of life insurance protection as per Table 2001 or the insurer’s qualifying lower published term rates (Q 3937) provided under the plan is not treated as a distribution for purposes of these rules. Neither is the making of a loan that is treated as a deemed distribution even if the loan is secured by the employee’s elective contributions or is includable in the employee’s income under IRC Section 72(p).

      The reduction of an employee’s accrued benefit derived from elective contributions (i.e., an offset distribution) by reason of a default on a loan is treated as a distribution (Q 3942).4 The IRS has privately ruled that a transfer of 401(k) elective deferrals or rollovers to purchase service credits would not constitute an impermissible distribution from the plan and are not a violation of the separate accounting requirement.5

      Restrictions on distributions of elective contributions generally continue to apply even if the amounts are transferred to another qualified plan of any employer.6 Amounts transferred to a 401(k) plan by a direct rollover from another plan do not have to be subject to these restrictions.7 See Q 3772 for discussion of in-plan Roth distributions. See Q 3779 for a discussion of penalty-free rollovers from 401(k) plan accounts into Roth 401(k) accounts. Final regulations state that rollover amounts may be excepted from the timing restrictions on distributions applicable to a receiving plan, provided there is a separate accounting for such amounts.8

      If an eligible retirement plan separately accounts for amounts attributable to rollover contributions to the plan, distributions of those amounts are not subject to the restrictions on permissible timing that apply, under the applicable requirements of the Internal Revenue Code, to distributions of other amounts from the plan. Accordingly, the plan may permit the distribution of amounts attributable to rollover contributions at any time pursuant to an individual’s request.

      Thus, for example, if the receiving plan is a money purchase pension plan and the plan separately accounts for amounts attributable to rollover contributions, a plan provision permitting the in-service distribution of those amounts will not disqualify the plan.9


      1. See IRC Sec. 72(t)(2)(G)(iii); Q 3674. See IRC Sec. 401(k)(2)(B)(1); Treas. Reg. §1.401(k)-1(d)(1).

      2. IRC Sec. 401(k)(2)(B).

      3. IRC Sec. 1400Q(a)(6)(B).

      4. Treas. Reg. §1.401(k)-1(d)(5)(ii).

      5. Let. Ruls. 200335035, 199914055.

      6. Treas. Reg. §1.401(k)-1(d)(2).

      7. Treas. Reg. §1.401(k)-1(d)(5)(iv).

      8. Treas. Reg. §1.401(k)-1(d)(5)(iv); see also Rev. Rul. 2004-12, 2004-7 IRB 478.

      9. Rev. Rul. 2004-12, 2004-7 IRB.

  • 3790. What requirements apply to hardship withdrawals from a 401(k) plan?

    • Editor’s Note: The 2017 Tax Act created new rules governing hardship distributions made because of qualified 2016 disasters. See Q 3791 for details.

      Hardship withdrawals may be made from a 401(k) plan only if the distribution is made on account of an immediate and heavy financial need and the distribution is necessary to satisfy the financial need.1 The distribution may not exceed the employee’s maximum distributable amount. Hardship withdrawals generally may not be rolled over (Q 3985).2 Not all plans provide for hardship withdrawals, and plan sponsors must first look to the plan documents before determining whether a hardship distribution can be made. The final regulations cited here took effect for plan years beginning on or after January 1, 2006.3

      The Pension Protection Act of 2006 called for regulations modifying the hardship requirements to state that if an event constitutes a hardship with respect to a participant’s spouse or dependent, it constitutes a hardship with respect to the participant, to the extent permitted under the plan.4

      An employee’s maximum distributable amount generally is equal to the employee’s total elective contributions as of the date of distribution reduced by the amount of previous distributions on account of hardship.

      Early in 2018, Congress passed the Bipartisan Budget Act of 2018 (BBA 2018), which modified this rule to expand the amounts that may be withdrawn as hardship distributions.  Beginning in tax years that begin after December 31, 2018, the following amounts may also be distributed as hardship distributions (1) amounts contributed by the employer to a profit sharing or stock bonus plan, (2) qualified nonelective contributions (QNECs), (3) qualified matching contributions (QMACs) and (3) earnings on any of these types of contribution.6


      Planning Point: The changes enacted by BBA 2018 are not all mandatory, meaning that plan sponsors have the option of modifying their plans to implement the new rules.  Plan sponsors operating safe harbor 401(k)s may wish to proceed with caution in implementing the changes, as Treasury has yet to issue guidance on whether the regulatory safe harbor will be satisfied if the plan retains (1) the six-month waiting period for contributions following a hardship distribution or (2) the requirement that the participant first take a plan loan before a hardship distribution is available.  Plans must also consider the “leakage” problem in allowing participants to withdraw QNECs or QMACs, or in permitting hardship distributions before plan loans (which must be repaid).


      A distribution will be deemed to be made on account of “an immediate and heavy financial need” if it is made on account of any of the following:

      The determinations of whether the participant has “an immediate and heavy financial need” and whether other resources are “reasonably available” to meet the need are to be made on the basis of all relevant facts and circumstances. Beginning for hardship distributions taken on or after January 1, 2020, the employee must provide a written representation stating that the employee does not have cash or other liquid assets reasonably available to satisfy the need (under BBA 2018). An example of “an immediate and heavy financial need” is the need to pay funeral expenses of a family member. A financial need will not fail to qualify as an immediate and heavy financial need merely because it was foreseeable or voluntarily incurred by the employee.7

      A distribution will be deemed to be made on account of “an immediate and heavy financial need” if it is made on account of any of the following:

      (1) “medical expenses” incurred by the employee, spouse, or dependents that would be deductible as itemized deductions under section 213(d) without regard to the 10 percent (7.5 percent for 2017-20208) of AGI floor;

      (2) the purchase (excluding mortgage payments) of the employee’s principal residence;

      (3) payment of tuition, related educational fees, and room and board expenses for the next twelve months of post-secondary education for the employee, spouse, children, or dependents (note that the educational expenses must be for education incurred in the following twelve months, the IRS has ruled that a participant cannot take a hardship distribution to repay student loans incurred for past education);

      (4) payments necessary to prevent eviction of the employee from his or her principal residence or foreclosure on the mortgage on his or her principal residence;

      (5) funeral or burial expenses for the employee’s parent, spouse, children, or other dependents (as defined prior to 2005); and

      (6) expenses for the repair or damage to the employee’s principal residence that would qualify for the casualty deduction under IRC Section 165 (without regard to the 10 percent floor).9

      This list may be expanded by the IRS but only by publication of documents of general applicability.10 Apparently, to be the taxpayer’s “principal residence” for this purpose, the home must be the residence of the employee, not merely that of his or her family.11


      Planning Point:  While the rules governing plan hardship distributions were not directly changed by the 2017 Tax Act, many plans that follow safe harbor standards and allow participants to withdraw funds to cover losses that are deductible as casualty losses may need to reevaluate their plan provisions.  This is because, for 2018-2025, individuals may only treat losses sustained in a federal disaster area as deductible casualty losses under IRC Section 165.  Unless subsequent guidance is released to change the safe harbor rules governing hardship distributions, plans may need to change the terms of their plan to comply with the new Section 165 rules.


      A distribution is not necessary to satisfy such an immediate and heavy financial need (and will not qualify as a hardship withdrawal) to the extent the amount of the distribution exceeds the amount required to relieve the financial need. The amount of an immediate and heavy financial need may include any amounts necessary to pay any federal, state, or local income taxes or penalties reasonably anticipated to result from the distribution.12

      The distribution also will not be treated as necessary to satisfy an immediate and heavy financial need to the extent the need can be satisfied from other resources that are reasonably available. However, the BBA 2018 eliminated the requirement that a plan participant first taken any available plan loan before the distribution could qualify as a hardship distribution.13

      A distribution may be treated as necessary if the employer reasonably relies on the employee’s representation that the need cannot be relieved:

      (1) through reimbursement or compensation by insurance or otherwise,

      (2) by reasonable liquidation of the employee’s assets,

      (3) by cessation of elective contributions or employee contributions,

      (4) by other distributions or nontaxable loans from any plans (the requirement that a participant first take any available plan loan was eliminated by the BBA 2018, but the requirement that the employee consider any ESOP dividend distributions was retained), or

      (5) by loans from commercial sources.

      Notwithstanding these provisions, an employee need not “take counterproductive actions” (such as a plan loan that might disqualify the employee from obtaining other financing) if the effect would be to increase the amount of the need.14

      The final regulations governing hardship distributions also provide that with respect to employee representations of financial hardship, the employee can reasonably represent that he or she has no cash or liquid assets reasonably available to satisfy the relevant financial need if the only cash or liquid assets available to that employee are necessary to pay some other expense (such as rent) in the near future.15 Employees can also make representations of financial need over the phone if the employer records the call.16

      Plan sponsors are also entitled to impose a minimum distribution amount for hardship distributions so long as the requirement is not found to be discriminatory.17

      Regulations state that a distribution will be deemed to be “necessary” to meet a financial need (deemed or otherwise) if the employee has obtained all other distributions and nontaxable loans (prior to 2019) currently available under all of the employer’s plans and, prior to 2019, the employee is prohibited from making elective contributions and employee contributions to the plan and all other plans of the employer for a period of at least six months after receipt of the hardship distribution.18 The regulations have been modified to eliminate the prohibition on contributions during the six month period following receipt of a hardship distribution, although the final regulations have clarified that the new rule applies only to contributions to qualified plans.  Therefore, nonqualified plans, including those subject to IRC Section 409A, may continue to suspend deferrals for six months following the hardship distribution.19

      The IRS has released internal guidance that it will use when examining a 401(k) plan to evaluate whether hardship distributions have been properly substantiated. The new guidance clarifies that, as part of the verification process for determining whether the participant has an immediate and heavy financial need, the employer or plan sponsor must review either the source documents supporting that need (such as contracts or foreclosure notices), or a summary of those documents.  If only a summary is provided, an IRS agent reviewing the case will look to whether a notice was provided to the withdrawing participant before he or she is entitled to the hardship withdrawal.  The notice must contain a statement that provides the following information:

      (1) the distribution is taxable,

      (2) additional taxes could apply,

      (3) the amount of the distribution cannot exceed the participant’s “immediate and heavy financial need”,

      (4) the distribution cannot be made from earnings on elective contributions or qualified nonelective contributions or matching contributions (QNECs and QMACs) (the prohibition on making the distribution from QNECs, QMACs, and earnings was eliminated for tax years beginning after December 31, 2018),20 and

      (5) all source documents must be retained and provided to the employer or administrator upon request at any time.

      The guidance also provides that specific information should be obtained by the plan administrator to substantiate a summary. If the summary is incomplete or inconsistent on its face, the IRS examining agent may ask for source documents.21


      1. Treas. Reg. §1.401(k)-1(d)(3)(i).

      2. IRC Sec. 402(c)(4). See also IRC Sec. 401(k)(2)(B).

      3. See Treas. Reg. §1.401(k)-1(g).

      4. See Pub. L. 109-280, Sec. 826.

      5. Treas. Reg. §1.401(k)-1(d)(3)(ii).

      6. IRC Sec. 401(k)(14)(A).

      7. Treas. Reg. §1.401(k)-1(d)(3)(iii)(A).

      8.The year-end spending package that became law late in 2019 extended the 7.5% threshold through 2020.

      9. Treas. Reg. §1.401(k)-1(d)(3)(iii)(B).

      10. Treas. Reg. §1.401(k)-1(d)(3)(v).

      11. See ABA Joint Committee on Employee Benefits, Meeting with IRS and Department of Treasury Officials, May 7, 2004 (Q&A-18).

      12. Treas. Reg. §1.401(k)-1(d)(3)(iv)(A).

      13. IRC Sec. 401(k)(14)(B).

      14. Treas. Reg. §1.401(k)-1(d)(3)(iv)(C), (D).

      15. See Preamble to the Final Regulations, 84 FR 49651.

      16. See Preamble to the Final Regulations, 84 FR 49651.

      17. See Preamble to the Final Regulations, 84 FR 49651. See also Treas. Reg. 1.401(k)-1(d)(3)(iv).

      18. Treas. Reg. §1.401(k)-1(d)(3)(iv)(E).

      19. P.L. 115-123 (Bipartisan Budget Act), Section 41113.

      20. P.L. 115-123 (Bipartisan Budget Act), Section 41114.

      21. The substantiation guidelines are available at https://www.irs.gov/pub/foia/ig/spder/tege-04-0217-0008.pdf (last accessed April 15, 2019).

  • 3791. What special rules governing retirement plan distributions were implemented for 2016 and 2017 disaster areas?

    • Editor’s Note: The 2019 Tax Certainty and Disaster Relief Act extended the rules governing qualified disaster distributions from retirement accounts, discussed below for victims of disasters that occurred in 2018 through sixty days after enactment of the bill (December 20, 2019).  The distribution itself must be made within 180 days after enactment of the law to qualify.  See Q 3791.01.

      The 2017 Tax Act,1 the 2017 Disaster Tax Relief and Airport and Airway Extension Act,2 and the Bipartisan Budget Act of 2018,3 include special tax relief for taxpayers affected by certain presidentially declared disasters that occurred in 2016 and 2017.

      A 2016 qualified disaster is a major disaster that was declared in 2016 by the president. A 2016 qualified disaster distribution is any distribution received from an eligible retirement plan in 2016 or 2017 if the recipient’s main home was located in a 2016 qualified disaster area and the recipient sustained an economic loss from the disaster.

      A 2017 qualified disaster is limited to Hurricane Harvey and Tropical Storm Harvey, Hurricane Irma, Hurricane Maria, and the California wildfires. To be a 2017 qualified disaster distribution, the following requirements must be met:

      1. The distribution was made:

      a. After August 22, 2017, and before January 1, 2019, for Hurricane Harvey or Tropical Storm Harvey (both referred to as Hurricane Harvey);

      b. After September 3, 2017, and before January 1, 2019, for Hurricane Irma;

      c. After September 15, 2017, and before January 1, 2019, for Hurricane Maria; or

      d. After October 7, 2017, and before January 1, 2019, for California wildfires.

      2. The recipient’s main home was located in a disaster area listed below on the date or any date in the period shown for that area.

      a. August 23, 2017, for the Hurricane Harvey disaster area.

      b. September 4, 2017, for the Hurricane Irma disaster area.

      c. September 16, 2017, for the Hurricane Maria disaster area.

      d. October 8, 2017 to December 31, 2017, for the California wildfire disaster area.

      3. The recipient sustained an economic loss because of Hurricane Harvey, Hurricane
      Irma, Hurricane Maria, or the California wildfires.

      None of the Acts define economic loss. Examples of economic loss include loss, damage, or destruction of real or personal property; loss related to displacement from a home; and loss of livelihood due to temporary or permanent layoff.4 There is no requirement that the amount of the qualified disaster distribution relate to the amount of the taxpayer’s economic loss from the disaster or be made on account of the disaster.

      The Acts provide special rules for distributions from retirement accounts (qualified plans, 403(a)s, 403(b)s, governmental 457(b)s, and traditional, SEP, SIMPLE, and Roth IRAs). Distributions from retirement accounts made because of a qualified disaster are exempt from the 10 percent early distribution penalty (or 25 percent early distribution penalty for certain SIMPLE IRA distributions) if the penalty would otherwise be imposed under IRC Section 72(t). Qualified disaster distributions are treated as meeting the applicable plan’s distribution requirements. The amount that may be treated as a qualified disaster area distribution is limited to $100,000 (the amount for any given year must be reduced by the amounts treated as 2016 disaster area distributions in prior years).

      If a taxpayer is affected by multiple qualifying disasters, the $100,000 limit is applied separately to each disaster distribution. Taxpayers may recognize income attributable to a qualified disaster distribution over a three-year period beginning with the year the qualified disaster distribution was made (unless an election to the contrary is made).

      In addition, taxpayers are also permitted a three-year period from the day after the distribution is received to make a repayment of qualified disaster distributions that is eligible for tax-free rollover treatment to an eligible retirement plan or made on account of a hardship. These repayments may be made at once or via a series of payments and will essentially be treated as though they were rollovers made within the sixty-day window. A repayment to an IRA is not considered a rollover for purposes of the one-rollover-per year limitation for IRAs. The following types of distributions cannot be repaid:

      • Qualified disaster distributions received as a beneficiary other than as a surviving spouse

      • Required minimum distributions

      • Periodic payments other than from an IRA that are for 10 years or more, the recipient’s life or life expectancy or the joint lives or life expectancies of the recipient and their beneficiary.

      Plans that make such a distribution also are protected against potential disqualification. Plans that permit qualified 2016 disaster distributions must be amended by the last day of the plan year beginning on or after January 1, 2018. Plans that permit qualified 2017 disaster distributions must be amended by the last day of the plan year beginning on or after January 1, 2019.

      Taxpayers who received certain distributions from retirement plans to buy or construct a principal residence but did not buy or construct the residence because of Hurricane or Tropical Storm Harvey, Hurricane Irma, Hurricane Maria, or the California wildfires had the opportunity to recontribute the distributions to an eligible retirement plan. The distributions had to be repaid before March 1, 2018 for repayments as a result of a hurricane or July 1, 2018 for repayments due to the California wildfires. A distribution that was not repaid before the applicable date may be taxable for 2017 and subject to the 10 percent additional tax on early distributions (or the 25 percent additional tax on certain SIMPLE IRA distributions).

      Individuals affected by a qualified disaster (as extended by the 2019 law) qualify for relaxed rules on loans from qualified plans. The plan administrator may increase the regular $50,000 limit on plan loans to $100,000 and the 50 percent of vested benefit limit to 100 percent. For individuals affected by a hurricane, the loan must have been made between September 29, 2017 and December 31, 2018. For someone affected by the California wildfires, the loan must have been made during the period beginning February 9, 2018 and ending on December 31, 2018. In addition, loan payments due during a specified period ending on December 31, 2018 may be suspended for one year by the plan administrator. The period begins on:

      • August 23, 2017 if the recipient’s home was located in the Hurricane Harvey disaster area
      • September 4, 2017 if the recipient’s home was located in the Hurricane Irma disaster area
      • September 16, 2017 if the recipient’s home was located in the Hurricane Maria disaster area; or
      • October 8, 2017 if the recipient’s home was located in the California wildfire disaster area.

      Casualty losses associated with a qualified 2016 or 2017 disaster are deductible regardless
      of whether total losses exceed 10 percent of the taxpayer’s adjusted gross income (AGI), so
      long as the loss exceeds $500 per casualty. Taxpayers who do not itemize their deductions may
      increase their standard deduction by the net qualified disaster loss.


      1. Section 11028, 2017 Tax Act, P.L> 115-.

      2. Title V, Disaster Tax Relief and Airport and Airway Extension Act of 2017, P.L. 115-63.

      3. Subdivision 2, Title I, Bipartisan Budget Act of 2018, P.L. 115-123.

      4. 2017 IRS Publication 976, Disaster Relief.

  • 3791.01. What special rules governing retirement plan distributions were implemented for 2018 and 2019 disaster areas?

    • The 2019 Tax Certainty and Disaster Relief Act extended the rules governing qualified disaster distributions from retirement accounts, discussed below for victims of disasters that occurred in 2018 through 60 days after enactment of the bill (December 20, 2019).  Qualified disaster areas generally include any area the President declares as such.  The term “qualified disaster area” does not include the California wildfire disaster area, as defined in the 2018 Bipartisan Budget Act.

      The distribution itself must be made within 180 days after enactment of the law to qualify.  In general, the benefits of taking a distribution under the SECURE Act’s expansion of the disaster relief option are:

      • The taxpayer is exempt from the penalty on early distributions,
      • The taxpayer is exempt from withholding requirements on the distribution,
      • The taxpayer can elect to treat the distribution as having been distributed over a three-year period (or within the single year of distribution, and
      • The taxpayer is able to repay the distribution within three years of receiving the distribution.[1]

      Individuals affected by a qualified disaster qualify for relaxed rules on loans from qualified plans. The plan administrator may increase the regular $50,000 limit on plan loans to $100,000 and the 50 percent of vested benefit limit to 100 percent.


      [1]      The Taxpayer Certainty and Disaster Relief Act of 2019, Sec. 202.

  • 3792. How does a 401(k) plan satisfy the nondiscrimination in amount requirement?

    • A cash or deferred arrangement will be treated as meeting the nondiscrimination requirement of IRC Section 401(a)(4) if it satisfies the Actual Deferral Percentage (“ADP”) test (Q 3793).1 A plan can satisfy the ADP test by annually meeting the requirements of the ADP test itself, by satisfying the design-based requirements for a SIMPLE 401(k) plan (Q 3770), or by satisfying the design-based requirements for a safe harbor plan (Q 3765).2

      In plan years beginning after December 31, 2007, a “qualified automatic contribution arrangement” will satisfy the ADP test requirement (Q 3762).3 The final regulations cited here took effect for plan years beginning on or after January 1, 2006.4

      A plan will not be treated as violating the ADP test merely on account of the making of (or right to make) catch-up contributions by participants age fifty or over under the provisions of IRC Section 414(v) so long as a universal availability requirement is met (Q 3761).5

      Salary reductions that give rise to the saver’s credit (Q 3645) may be taken into account for purposes of satisfying the ADP test.6 If the plan provides for employee after-tax contributions or employer matching contributions, those contributions must meet the requirements of IRC Section 401(m) (Q 3794). If the plan includes a profit sharing component (i.e., nonelective contributions that are not QNECs, other than as part of one of the designs explained in Q 3770 and Q 3765), that portion of the plan will be subject to nondiscrimination in amount testing (Q 3838).

      A cash or deferred arrangement in which all of the eligible employees for a plan year are highly compensated employees (Q 3919) will be deemed to satisfy the ADP test for the plan year.7 A 401(k) plan also is subject to age and service, coverage, and other requirements (Q 3753).

      Final regulations treat all governmental plans (within the meaning of IRC Section 414(d)) as meeting the coverage and nondiscrimination requirements.8 The IRC states that state and local governmental plans, to the limited extent that they are eligible to offer a cash or deferred arrangement (Q 3753), meet the requirements of IRC Section 401(k)(3).9 Under earlier guidance, plans established and maintained for its employees by the federal government or by any agency or instrumentality of it, are treated as meeting the requirements of IRC Section 401(k)(3) until the first day of the first plan year beginning on or after the date final regulations were issued (December 29, 2004).10


      1. IRC Sec. 401(k)(3)(C).

      2. IRC Secs. 401(k)(3)(A)(ii), 401(k)(11)(A), 401(k)(12)(A); Treas. Reg. §1.401(k)-1(b)(1).

      3. IRC Sec. 401(k)(13).

      4. Treas. Reg. §1.401(k)-1(g).

      5. IRC Sec. 414(v)(3)(B).

      6. Ann. 2001-106, 2001-44 IRB 416, A-10.

      7. Treas. Reg. §1.401(k)-2(a)(1)(ii).

      8. Treas. Reg. §1.401(k)-1(b)(2).

      9. IRC Sec. 401(k)(3)(G); see Notice 2001-46, 2001-2 CB 122, as modified by Notice 2003-6, 2003-3 IRB 298.

      10. Notice 2003-6, above; T.D. 9169, 69 FR 78154.

  • 3793. What is the Actual Deferral Percentage (ADP) test? How is the ADP test satisfied?

    • The actual deferral percentage test requires that the Actual Deferral Percentage (“ADP”) of eligible highly compensated employees (Q 3919) be compared to the ADP of all other eligible employees, and that it satisfy one of the following tests:

      Test 1:The actual deferral percentage for eligible highly compensated employees (Q 3919) for the plan year does not exceed the actual deferral percentage of all other eligible employees for the preceding plan year, multiplied by 1.25.

      Test 2: The actual deferral percentage for eligible highly compensated employees for the plan year does not exceed by more than 2 percent that of all other eligible employees for the preceding plan year and the actual deferral percentage for highly compensated employees for the plan year is not more than the actual deferral percentage of all other eligible employees for the preceding plan year multiplied by two.

      The IRC provides two methods of applying the ADP test: a prior year testing method, and a current year testing method. The method described above is the prior year testing method (as set forth in the IRC), but the current year method is available by election.1 Under the current year testing method, the ADP results of nonhighly compensated employees for the current year (instead of the preceding year) are used in each test. The ability of plan sponsors to switch between the current and prior year testing methods is limited.2 The plan document must reflect which testing method the plan is using for a testing year.3

      Qualified Matching Contributions (“QMACs”) and Qualified Nonelective Contributions (“QNECs”) are employer matching contributions and nonelective contributions, respectively, that are subject to the same nonforfeitability (Q 3753) and withdrawal restrictions (Q 3789) as elective deferral contributions. Under certain circumstances, elective contributions used to pass the ADP test may include QMACs and QNECs that are made with respect to employees eligible under the cash or deferred arrangement.4 Specific requirements for such use are set forth in regulations.5

      QMACs and QNECs may be used only once. In other words, contributions that are treated as elective contributions for purposes of the ADP test may not be taken into account for purposes of the ACP test under IRC Section 401(m) and are not otherwise taken into account in determining whether any other contributions or benefits are nondiscriminatory under IRC Section 401(a)(4). Similarly, QNECs that are treated as matching contributions for purposes of the ACP test may not be used to satisfy the ADP test.6

      Calculation of Actual Deferral Percentage

      The actual deferral percentage for a group of eligible employees is the average of the actual deferral ratios of employees in the group for the plan year as calculated separately for each employee and to the nearest 1/100 of 1 percent.7

      An employee’s actual deferral ratio is determined by dividing the amount of elective contributions (including amounts treated as elective contributions) made to the trust on his or her behalf for the plan year by his or her compensation for the plan year, calculated to the nearest 1/100 of 1 percent.8 Only contributions allocated to the employee’s account for the plan year and related to compensation that, but for the election to defer, would have been received during the plan year (or, if attributable to services performed during the plan year, within 2½ months after the close of the plan year) are considered in applying the ADP test. Designated Roth contributions (Q 3771) are treated as elective deferral contributions for purposes of the ADP test.9

      Compensation, for purposes of calculating actual deferral percentages, generally means compensation for services performed for an employer, which is includable in gross income (Q 3857). An employer may limit the period taken into account to that portion of the plan year (or calendar year) in which the employee was an eligible employee, provided that this limit is applied uniformly to all eligible employees.10

      Miscellaneous Provisions

      Although a plan must, by its terms, provide that the ADP test will be met; it may incorporate by reference the 401(k) nondiscrimination provisions of the IRC and regulations.11


      1. See IRC Sec. 401(k)(3)(A).

      2. See IRC Sec. 401(k)(3)(A); Treas. Reg. §1.401(k)-2(c)(1)(ii).

      3. Treas. Reg. §1.401(k)-1(e)(7).

      4. IRC Sec. 401(k)(3)(D)(ii).

      5. See Treas. Reg. §1.401(k)-2(a)(6).

      6. See Treas. Reg. §1.401(k)-2(a)(6)(vi).

      7. Treas. Reg. §1.401(k)-2(a)(2)(i).

      8. Treas. Reg. §1.401(k)-2(a)(3).

      9. See Treas. Reg. §1.401(k)-1(f)(4).

      10. Treas. Reg. §1.401(k)-6.

      11. Treas. Reg. §1.401(k)-1(e)(7).

  • 3794. What special rules apply to employer matching contributions? What rules apply to employee contributions?

    • A defined contribution plan that provides for employee contributions or matching contributions, typically a 401(k) plan (Q 3753), must satisfy the Actual Contribution Percentage (“ACP”) test or one of the alternatives to it (see Q 3795) to meet the nondiscrimination in amount requirement of IRC Section 401(a)(4).1 With respect to matching contributions only, two alternative plan designs are available that are deemed to satisfy the ACP test: a SIMPLE 401(k) plan (Q 3770), or a safe harbor design (Q 3765).2 In plan years beginning after December 31, 2007, a “qualified automatic contribution arrangement” will satisfy the ACP test requirement with respect to matching contributions (Q 3762).3

      Matching contributions are subject to a three year cliff or five year graduated vesting schedule (Q 3859).

      A plan will not be treated as violating the ACP test merely on account of the making of, or the right to make, catch-up contributions by participants age fifty or over under the provisions of IRC Section 414(v) so long as a universal availability requirement is met (Q 3761).4

      All after-tax employee contributions are subject to ACP testing even if one of the design-based alternatives is used. After-tax employee contributions for this purpose do not include designated Roth contributions (Q 3771). The term also does not include rollover amounts, repayment of loans, or any other amounts transferred from another plan.5

      The contributions that are required under a safe harbor plan (Q 3765) may not be used to satisfy the ACP test for after-tax employee contributions. Any employer matching or nonelective contributions in excess of the amount required to satisfy the safe harbor rules for a qualified cash or deferred arrangement can be taken into account for purposes of satisfying the ACP test.6 Voluntary after-tax employee contributions that give rise to the Saver’s Credit (Q 3645) may be taken into account for purposes of satisfying the ACP test.7

      Of course, the plan must satisfy the general nondiscrimination requirements applicable to all qualified plans (Q 3838). In particular, the availability of matching and employee contributions, as well as any other benefits, rights, and features under the plan, must be nondiscriminatory (Q 3850).8


      1. IRC Sec. 401(m)(1).

      2. IRC Secs. 401(m)(10), 401(m)(11).

      3. IRC Sec. 401(m)(12).

      4. IRC Sec. 414(v)(3)(B).

      5. Treas. Reg. §1.401(m)-1(a)(3)(ii).

      6. See General Explanation of Tax Legislation Enacted in the 104th Congress (JCT-12-96), p. 153 (the 1996 Blue Book).

      7. Ann. 2001-106, 2001-44 IRB 416, A-10.

      8. Treas. Reg. §1.401(m)-1(a)(1)(ii).

  • 3795. What is the actual contribution percentage (ACP) test that must be satisfied by defined contribution plans that provide for employee contributions or employer matching contributions?

    • The IRC provides two methods of applying the ACP test: a prior year testing method, and a current year testing method.1 The prior year method is specified in the IRC and the current year method is available by election.2 A plan generally must specify which of these two methods it is using.3

      Prior year testing method. Under the prior year testing method, a defined contribution plan that provides for employee or matching contributions meets the ACP test if the contribution percentage for eligible highly compensated employees for the plan year does not exceed the greater of (1) 125 percent of the contribution percentage for all other eligible employees for the preceding plan year, or (2) the lesser of (i) 200 percent of the contribution percentage for all other eligible employees for the preceding plan year or (ii) such contribution percentage for all other employees for the preceding plan year plus two percentage points.4

      Current year testing method. Under the current year testing method, the ACP results of nonhighly compensated employees for the current year, also known as the “testing year,” are compared with those of highly compensated employees for the current year. The plan satisfies the ACP test if the contribution percentage for eligible highly compensated employees for the plan year does not exceed the greater of (1) 125 percent of the contribution percentage for all other eligible employees for the plan year or (2) the lesser of (x) 200 percent of the contribution percentage for all other eligible employees for the plan year or (y) such contribution percentage for all other employees for the plan year plus two percentage points.5

      A plan is not required to use the same method under the ACP test as it uses under the ADP test (Q 3792), but special rules must be followed if different methods are used.6

      Planning Point: Make sure to accurately count highly compensated employees using the family aggregation rules, which treat the spouse, child, grandparent, or parent of a 5 percent owner as a 5 percent owner. Remember that family members may have different last names.7

      Changes in Testing Method

      Change from current year testing method to prior year testing method. A plan that elects to continue using the current year testing method may be subject to certain restrictions if an employer wants to change to the prior year testing method: one governs the revocability of the election, and a second limits the “double counting” of certain contributions.

      The election to use the current year testing method ordinarily will not be revocable except with the permission of the IRS.8 Regulations provide for limited circumstances under which a plan will be permitted to change from the current year testing method to the prior year testing method.9 A plan that changes from the current year testing method to the prior year testing method also is subject to limitations designed to prevent double counting of certain contributions.10 Plans using the prior year testing method may change back to the current year method for any subsequent testing year.11

      Special rules apply in the first plan year; essentially a plan other than a successor plan may designate the ACP of nonhighly compensated employees at 3 percent in the first plan year that the plan uses the prior year testing method. The employer may elect to use the plan’s first year ACP results instead.12 The plan document must specify the method that will be used.13

      Miscellaneous Rules

      Plans that accept rollover contributions generally assume the risk that the contributions qualify for rollover treatment (Q 3983). The IRS has determined that where a plan accepted a rollover contribution that, in fact, did not qualify for rollover, the amount involved was received by the plan as a voluntary employee contribution, which had to be considered for purposes of the ACP test.14

      Matching contributions, other than QMACs (Q 3792), on behalf of self-employed individuals are not treated as an elective employer contribution for purposes of the limit on elective deferrals under IRC Section 402(g).15

      See Q 3796 for information on qualified nonelective contributions (QNECs) and Q 3797 for information on calculating the actual contribution percentage.


      1. IRC Sec. 401(m)(2)(A).

      2. IRC Sec. 401(m)(2)(A); Treas. Reg. §1.401(m)-2(a)(2)(ii).

      3. Treas. Reg. §1.401(m)-1(c)(2).

      4. IRC Sec. 401(m)(2)(A); Treas. Reg. §§1.401(m)-2(a)(2)(ii).

      5. IRC Sec. 401(m)(2)(A); Treas. Reg. §§1.401(m)-2(a)(1), 401(m)-2(a)(2)(ii).

      6. Treas. Reg. §1.401(m)-2(c)(3).

      7. See 401(k) Plan Fix-It Guide, at http://www.irs.gov/Retirement-Plans/401k-Plan-Fix-It-Guide-The-Plan-Failed-The-401k-ADP-and-ACP-Nondiscrimination-Tests.

      8. IRC Sec. 401(m)(2)(A).

      9. Treas. Reg. §§1.401(m)-2(c)(1), 1.401(k)-2(c)(1)(ii).

      10. Treas. Reg. §1.401(m)-2(a)(6)(vi).

      11. IRC Sec. 401(m)(2)(A). See Treas. Reg. §1.401(m)-2(c)(1).

      12. Treas. Reg. §1.401(m)-2(c)(2)(i).

      13. Treas. Reg. §1.401(m)-1(c)(2).

      14. See Let. Rul. 8044030.

      15. IRC Sec. 402(g)(8).

  • 3796. What is a qualified nonelective contribution (QNEC)? Can QNECs be taken into account in determining whether a defined contribution plan satisfies the ACP test?

    • A “QNEC” is any employer contribution (other than elective contributions and matching contributions) with respect to which the employee does not have an election to receive the amount in cash and that satisfies the nonforfeitability and withdrawal restrictions applicable to elective deferrals to qualified cash or deferred (401(k)) arrangements (Q 3753 and Q 3789).1 Elective and qualified nonelective contributions (“QNECs”) may be taken into account in determining whether a plan satisfies the ACP test, provided certain requirements are met.2

      Employer matching contributions that are treated as elective contributions for purposes of the actual deferral percentage (“ADP”) test applicable to cash or deferred arrangements (Q 3792) are not subject to the ACP test above and may not be used to help employee contributions or other matching contributions to satisfy this test. Similarly, a QNEC that is treated as an elective contribution is subject to the ADP test and is not taken into account as a matching contribution for purposes of the ACP test.3 Essentially, a QNEC is a supplemental employer contribution that is tested as if it were an elective deferral for purposes of the ADP test.

      Under limited circumstances set forth in regulations, an employer may elect to include certain elective contributions and QNECs in computing the contribution percentage.4 To be taken into account in the calculation of the ACP for a year under the prior year testing method, a QNEC must be contributed no later than the end of the twelve month period following the applicable year, even though that year is different than the plan year being tested.5

      On July 20, 2018, the IRS published regulations that modify the definitions of QNEC to allow employers to use forfeitures in order to pass nondiscrimination testing that applies to qualified plans. This amendment generally broadens the definition of contributions that qualify as QNECs and permits plan sponsors that allow the use of forfeiture accounts to offset future employer contributions under the plan. Therefore, the final regulations would require that QNECs be fully vested and subject to certain distribution restrictions only when they are allocated to the participant’s account, rather than when they are first contributed to the plan. The changes apply to taxable years ending on or after July 20, 2018.


      1. IRC Sec. 401(m)(4); Treas. Reg. §§1.401(m)-5, 1.401(k)-1(c)-(d).

      2. See Treas. Reg. §1.401(m)-2(a)(6).

      3. Treas. Reg. §1.401(m)-2(a)(6)(vi).

      4. IRC Sec. 401(m)(3); Treas. Reg. §1.401(m)-2(a)(6).

      5. Treas. Reg. §1.401(m)-2(a)(6)(i).

      6. REG-131643-15.

  • 3797. How is the actual contribution percentage (ACP) calculated in determining whether the ACP test is satisfied?

    • The ACP for a group of eligible employees is the average of their actual contribution ratios (“ACRs”) for the year, computed separately for each employee and to the nearest one-hundredth of one percent. An employee’s ACR is (1) the sum of matching contributions and employee contributions (including any QNECs taken into account) divided by(2) the employee’s compensation (Q 3881).1 Special rules apply for the first year a plan, other than a successor plan, is in existence.2

      Compensation for this purpose generally is the same as under IRC Section 414(s) (Q 3857), based on the plan year or the calendar year ending within the plan year; the period selected must be applied uniformly for every eligible employee under the plan.3

      A matching contribution is (1) any employer contribution, including a discretionary contribution, to a defined contribution plan on account of an employee contribution to a plan maintained by the employer, (2) any employer contribution, including a discretionary contribution, to a defined contribution plan on account of an elective deferral (Q 3760),4 and (3) any forfeiture allocated on the basis of employee contributions, matching contributions, or elective contributions.5

      For purposes of the ACP test, employee contributions generally are contributions that are designated or treated at the time of contribution as after-tax employee contributions, and are allocated to an individual account for each eligible employee.6

      Matching contributions are taken into account for a plan year only if such contributions are (1) allocated to the employee’s account under the terms of the plan as of a date within the plan year, (2) made on behalf of an employee on account of the employee’s contributions (elective or otherwise) for the plan year, and (3) actually paid to the trust no later than the end of the twelve month period immediately following the close of the plan year.7

      Matching contributions that do not satisfy these requirements may not be considered in applying the ACP test for any plan year, but instead must meet the general test for the nondiscriminatory amount requirement (Q 3838) by treating them as if they were nonelective contributions and were the only nonelective employer contributions for the year.8

      An eligible employee generally is any employee who is directly or indirectly eligible to make a contribution or to receive a matching contribution (including those derived from forfeitures) for all or a portion of the plan year. Employees who would be eligible to make contributions were it not for a suspension or an election not to participate also are considered eligible.9

      Under a special rule for early participation, a plan that separately satisfies the minimum coverage rules (Q 3832), taking into account only those employees who have not completed one year of service or are under age twenty-one, may ignore, for purposes of the ACP test, eligible nonhighly compensated employees who have not met the age and service requirements in applying the ACP test.10 This provision is designed to encourage employers to include younger employees in the plan without the concern that they will “pull down” the ACP test results.

      Although a plan must, by its terms, provide that the ACP test will be met, it may incorporate by reference the IRC Section 401(m) nondiscrimination provisions.11


      1. Treas. Reg. §1.401(m)-2(a)(3)(i).

      2. IRC Secs. 401(m)(3), 401(k)(3)(E).

      3. Treas. Reg. §1.401(m)-5.

      4. As defined in Treas. Reg. §1.402(g)-1(b).

      5. IRC Sec. 401(m)(4)(A); Treas. Reg. §1.401(m)-1(a)(2).

      6. See Treas. Reg. §1.401(m)-1(a)(3) for details.

      7. Treas. Reg. §1.401(m)-2(a)(4)(iii).

      8. Treas. Reg. §1.401(m)-2(a)(5).

      9. See IRC Sec. 401(m)(5); Treas. Reg. §1.401(m)-5.

      10. IRC Sec. 401(m)(5)(C); Treas. Reg. §1.401(m)-3(j)(3).

      11. Treas. Reg. §1.401(m)-1(c)(2).

  • 3798. What happens if a 401(k) plan fails its nondiscrimination testing?

    • A plan’s continued tax qualification is conditioned on its meeting the operational requirements of IRC Section 401(c). For a 401(k) plan, that includes passage of annual ADP and ACP testing. When that testing fails, a plan is required either to make certain additional contributions for the nonhighly compensated employees (Q 3800) or certain distributions to the highly compensated employees (Q 3799).1 Thus, a failure to make these corrections for a failed test is an operational failure that could lead to a loss of the plan’s tax qualification.

      When a 401(k) plan fails the ADP testing and elects to distribute certain deferrals to highly compensated employees, those deferrals are referred to as excess contributions.

      When a plan’s matching contributions fail the ACP testing and the plan elects to distribute certain matching contributions to highly compensated employees, those matching contributions are referred to as excess aggregate contributions (Q 3801). The complexity of the ADP and ACP tests, as well as that of the rules that follow, have led many employers to implement design-based plans that are deemed to satisfy these tests (Q 3765, Q 3770).2


      1. See Rev. Proc. 2013-12 Appendices A (section 3) and B (section 2), as modified by Rev. Proc. 2015-28, 2015-16 IRB 920 and Rev. Proc. 2016-51, 2016-42 IRB 465.

      2. See Treas. Reg. §§1.401(k)-1(g), 1.401(m)-1(d).

  • 3799. What are the rules that apply when a 401(k) plan fails its nondiscrimination testing and elects to distribute excess contributions in order to correct the failure?

    • An otherwise qualified 401(k) plan with a failed ADP test will not be disqualified if, before the end of the following plan year, any excess contributions are distributed along with any allocable income. Additional contributions (“QNECs”) may be made to the plan by the employer to the accounts of the nonhighly compensated employees sufficient to pass ADP testing.1 Another seldom-used option permits recharacterization of these deferrals by treating them as if they had been distributed to the employee and then contributed by the employee to the plan on an after-tax basis. These after-tax employee contributions then are included in the ACP testing. Excess contributions may not remain unallocated in the plan or held in a suspense account for allocation in future years.2

      Excess contributions are to be distributed (or otherwise corrected) within 2½ months after the end of the plan year to avoid the employer being subject to a 10 percent excise tax on the amount distributed.3 A plan that contains an automatic enrollment (even if not an “eligible automatic contribution arrangement”) is subject to an extended time period for distributing refunds of excess contributions of six months rather than 2½ months.4

      An excess contribution may consist of elective salary deferrals, Roth employee contributions, QNECs and QMACs, and certain employer contributions, all of which are included in ADP testing.5 A plan will specify whether an ordering of the distributions is required (Q 3737). Salary deferrals and Roth contributions that exceed $19,500 in 2020 are referred to as “excess deferrals” (Q 3760) and should not be confused with excesscontributions. Special rules apply for coordinating distributions of excess contributions and excess deferrals.6

      Excess contributions and income thereon distributed to an employee are treated as earned and received by the employee in the year in which the distributions are made.7

      Where the plan specifies, or where the employer elects to make corrective distributions of excess contributions and the distribution is not made within 2½ months after the close of the plan year (or six months if the plan has an automatic enrollment feature), two requirements are triggered. The employer pays a penalty of 10 percent of the excess distribution,8 and a statutory twelve month period applies. If the distribution occurs more than twelve months after the close of the plan year, the plan has an operational failure that must be corrected under EPCRS to avoid the plan’s disqualification.9

      Corrective distributions of excess contributions may be made without regard to the spousal consent rules (Q 3872).10 Corrective distributions may not be considered for purposes of satisfying the minimum distribution requirements (Q 3881 to Q 3898).11


      1. Treas. Reg. §54.4979-1(c)(4); Rev. Proc. 2013-12 Appendices A (section 3), as modified by Rev. Proc. 2015-28, 2015-16 IRB 920 and Rev. Proc. 2016-51, 2016-42 IRB 465.

      2. IRC Sec. 401(k)(8); Treas. Reg. §1.401(k)-2(b)(1).

      3. IRC Sec. 4979; Treas. Reg. §§1.401(k)-2(b)(5), 54.4979-1.

      4. Treas. Reg. §1.401(k)-2(b)(5)(iii).

      5. IRC Sec. 401(k)(8)(B). See Treas. Reg. §§1.401(k)-6, 1.401(k)-2(b)(2)(iii).

      6. See Treas. Reg. §1.401(k)-2(b)(4)(i).

      7. IRC Sec. 4979(f)(2).

      8. Treas. Reg. §§1.401(k)-2(b)(5), 54.4979-1(a)(4).

      9. Treas. Reg. §1.401(k)-2(b)(5).

      10. Treas. Reg. §1.401(k)-2(b)(2)(vii)(A).

      11. Treas. Reg. §1.401(k)-2(b)(2)(vii)(C).

  • 3800. What is a QNEC and how can a 401(k) plan that has failed its nondiscrimination testing use QNECs to correct the failure?

    • A plan may provide for an employer to make fully vested contributions for certain nonhighly compensated employees. These contributions then are included as deferrals in the ADP testing and, if sufficiently significant, can cause the plan to satisfy the ADP testing.

      Recharacterization. Excess contributions of highly compensated employees may be recharacterized as after-tax employee contributions only to the extent that the recharacterized amount, together with the amount of any actual after-tax contributions, satisfies the ACP testing.1 This amount is treated the same as a match in that testing.Note that these recharacterization rules are different than the recharacterization of Roth IRA conversions eliminated under the 2017 tax reform legislation.

      Recharacterized excess contributions must be included in an employee’s gross income on the earliest date any elective contributions made on behalf of the employee during the plan year would have been received. The payor or plan administrator must report such amounts as employee contributions to the IRS and the employee.3 These recharacterized contributions continue to be treated as employer contributions that are elective contributions for all other purposes under the IRC (for example, they remain subject to the nonforfeitability and withdrawal requirements applicable to elective contributions).4

      On July 20, 2018, the IRS published final regulations that modify the definitions of QNEC to allow employers to use forfeitures in order to pass nondiscrimination testing that applies to qualified plans. Under the proposal, QNECs need to be nonforfeitable and subject to certain distribution restrictions when they are allocated to participants’ accounts, rather than when they are first contributed to the plan. This amendment generally broadens the definition of contributions that qualify as QNECs and permits plan sponsors that allow the use of forfeiture accounts to offset future employer contributions under the plan. Therefore, the final regulations would require that QNECs be fully vested only when they are allocated to the participant’s account. The changes apply to taxable years ending on or after July 20, 2018.5


      1. Treas. Reg. §1.401(k)-2(b)(3)(i).

      2. Treas. Reg. §1.401(k)-2(b)(3)(ii).

      3. See Treas. Reg. §1.401(k)-2(b)(3)(ii).

      4. See Treas. Reg. §1.401(k)-2(b)(3)(iii)(C).

      5. T.D. 9835.

  • 3801. What are excess aggregate contributions and how can a 401(k) plan that has failed its nondiscrimination testing use them to correct the failure?

    • Excess aggregate contributions are the excess of the aggregate amount of employee contributions and employer matching contributions (including any QNECs or elective deferrals treated as matching contributions) made on behalf of highly compensated employees over the maximum amount permitted under the ACP test (Q 3794).1 Distributions or forfeitures of excess aggregate contributions must be made to highly compensated employees under a process identified in regulations.2

      A plan will not be disqualified for a failed ACP test for any plan year if, within the twelve month period following the close of that plan year, the excess aggregate contributions (including any income thereon) are distributed (or forfeited) by the plan.3

      Any corrective distribution of less than the entire amount of the excess aggregate contributions is treated as a pro rata distribution of excess aggregate contributions and income.4 No early (premature) distribution penalty tax is imposed on the distribution.5 Corrective distributions may be made without regard to the spousal consent rules (Q 3872).6 Furthermore, corrective distributions may not be considered for purposes of satisfying the required minimum distribution rules (Q 3881 to Q 3898).7

      If the total amount of excess aggregate contributions (and income) is not distributed within the twelve month period following the close of the plan year, the plan will be treated as having an operational failure and will need to be corrected under EPCRS to retain its tax qualification.8

      A penalty will be imposed on the employer unless the excess is distributed within 2½ months after the end of the plan year. The employer will be subject to a 10 percent excise tax.9 For plan years beginning after 2007, a plan that satisfies the definition of any automatic contribution feature (Q 3762) is permitted an extended time period for distributing refunds of excess contributions. The extension for making the correction is from 2½ months to six months.10

      Distributions of excess aggregate contributions (and income) are treated as received by the recipient in the taxable year of the employee ending with or within the plan year for which the original contribution was made. If the total excess amount, including any excess contributions to a 401(k) plan as discussed above, that is distributed to the recipient under the plan for the plan year is less than $100, it is includable in the taxable year distributed.11 Amounts distributed more than 2½ months after the plan year are includable in gross income for the taxable year of the employee in which distributed.12

      Instead of distributing excess aggregate contributions, an employer may, to the extent permitted by the terms of the plan, correct the excess by making additional QNECs that, when combined (Q 3794) with employee contributions and matching contributions, satisfy the ACP test. Excess aggregate contributions may not be corrected by forfeiting vested matching contributions, by recharacterization, by failing to make matching contributions required under the plan, by refusing to allocate the excess aggregate contributions, or by holding contributions in a suspense account for allocation in future years.13

      In the case of a plan that includes a cash or deferred arrangement, the determination of excess aggregate contributions is made after determining excess deferrals (Q 3760) and excess contributions to the cash or deferred arrangement (Q 3792).14


      1. IRC Sec. 401(m)(6)(B); Treas. Reg. §1.401(m)-5.

      2. IRC Sec. 401(m)(6)(C). For an example of this allocation, see Treas. Reg. §1.401(m)-2(b)(3)(ii). See also Rev. Proc. 2013-12, Appendix B.

      3. IRC Sec. 401(m)(6); Treas. Reg. §1.401(m)-2(b)(1).

      4. Treas. Reg. §1.401(m)-2(b)(3)(iv).

      5. Treas. Reg. §1.401(m)-2(b)(2)(vi).

      6. Treas. Reg. §1.401(m)-2(b)(3)(i).

      7. Treas. Reg. §1.401(m)-2(b)(3)(iii).

      8. Treas. Reg. §1.401(m)-2(b)(4)(ii).

      9. IRC Sec. 4979; Treas. Reg. §1.401(m)-2(b)(4)(i).

      10. IRC Secs. 401(k)(13), 401(m)(12), 414(w), Treas. Reg. §1.401(m)-2(b)(4)(iii).

      11. Treas. Reg. §1.401(m)-2(b)(2)(vi)(B).

      12. Treas. Reg. §1.401(m)-2(b)(2)(vi)(A).

      13. Treas. Reg. §1.401(m)-2(b)(1)(iii).

      14. IRC Sec. 401(m)(6)(D).