Final Nondiscrimination Rules for Qualified Plans

 [4830-01-u]

 ACTION: Final regulations.

 SUMMARY: This document contains amendments to the final regulations under section 401(a)(4) of the Internal Revenue Code of 1986. They interpret the section 401(a)(4) requirement that contributions or benefits provided under a tax-qualified retirement plan not discriminate in favor of highly compensated employees. This section and the minimum coverage requirements of section 410(b) form a coordinated nondiscrimination rule that prohibits a tax-qualified retirement plan from being designed or operated in favor of highly compensated employees. These regulations reflect changes made by the Tax Reform Act of 1986 and by the Technical and Miscellaneous Revenue Act of 1988. The regulations provide the guidance necessary to comply with the law and affect sponsors of, and participants in, tax- qualified retirement plans.

 DATES: These regulations are effective January 1, 1994, and apply to plan years beginning on or after January 1, 1994, except as provided in the transition rules of section 1.401(a)(4)-13.

 FOR FURTHER INFORMATION CONTACT: Dave Munroe, Patricia McDermott, or Marjorie Hoffman at (202) 622-4606 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

BACKGROUND

On September 19, 1991, final regulations under section 401(a)(4) (T.D. 8360) were published in the Federal Register (56 FR 47524). In the Federal Register of August 10, 1992 (57 FR 35536), the Internal Revenue Service published proposed regulations to extend the effective date of the final regulations under section 401(a)(4) and related regulations generally to plan years beginning on or after January 1, 1994.

 On January 12, 1993, proposed regulations amending the final regulations were published in the Federal Register (58 FR 3876). Written comments were received from the public on the proposed regulations, and a public hearing was held on April 23, 1993. After consideration of all of the written comments received and the statements made at the public hearing, the proposed regulations are adopted as modified by this Treasury decision.

COORDINATION WITH OTHER GUIDANCE

 The regulations under section 401(a)(4) were developed in conjunction with regulations under related statutory nondiscrimination provisions governing tax-qualified retirement plans, principally sections 401(a)(17), 401(a)(26), 401(l), 410(b), 414(r), and 414(s). Proposed amendments to the regulations under sections 401(l), 410(b), and 414(s) were published on April 22, 1993. The Treasury and the Service intend in the near future to finalize those proposed regulations and to propose modifications to the regulations under section 414(r), on which employers will be able to rely pending final regulations. Together, these regulations provide coordinated and comprehensive guidance on those statutory provisions.

 This coordinated approach to the nondiscrimination requirements provides taxpayers with an integrated framework for applying the nondiscrimination provisions of the Internal Revenue Code. In addition, this approach makes it possible to simplify many of the related nondiscrimination rules. For example, the development of the rules under section 401(a)(4) permitted substantial simplification of the minimum participation rules previously proposed under section 401(a)(26) (finalized as T.D. 8375 on December 4, 1991, 56 FR 63410). Similarly, the Treasury and the Service will finalize a proposed revenue ruling (published in Announcement 93-12, 1993-4 I.R.B. 71) identifying the guidance that they propose to obsolete when the section 401(a)(4) regulations are effective.

 In conjunction with the development of the January 1993 proposed regulations under section 401(a)(4), the Treasury and the Service issued a proposed revenue procedure (published in Announcement 92-81, 1992-22 I.R.B. 56) reducing the frequency of testing where appropriate and describing the quality of data that may be used to substantiate compliance with the nondiscrimination regulation. The Treasury and the Service intend to finalize this guidance shortly, taking into account comments received on the proposed revenue procedure.

1. OVERVIEW OF REGULATIONS

 Section 401(a)(4) provides generally that a plan is a qualified plan only if the contributions or the benefits provided under the plan do not discriminate in favor of highly compensated employees. These final regulations are the exclusive means for determining whether the nondiscrimination requirement is satisfied. A plan, therefore, will satisfy section 401(a)(4) only if it complies both in form and in operation with these regulations. However, the regulations contain a direct delegation of authority allowing the Commissioner to provide, in revenue rulings, notices, and other guidance of general applicability, any additional rules that may be necessary or appropriate in applying the nondiscrimination requirements of section 401(a)(4).

 Section 1.401(a)(4)-1 of the regulations sets forth the three basic requirements a plan must satisfy under section 401(a)(4) and provides rules on how these requirements are applied. The first requirement is that either the contributions or the benefits provided under a plan must be nondiscriminatory in amount. Under the regulations, a plan generally is permitted to satisfy this requirement on the basis of either contributions or benefits, regardless of whether the plan is a defined contribution plan or a defined benefit plan. The second requirement is that the benefits, rights, and features provided under the plan must be made available to employees in a nondiscriminatory manner. The benefits, rights, and features subject to this requirement are optional forms of benefit (such as retirement annuities and single sum payments), ancillary benefits (such as disability benefits), and other rights and features (such as plan loans and investment options). The third requirement is that the effect of plan amendments (including grants of past service credit) and plan terminations must be nondiscriminatory.

The proposed regulations issued in January 1993, make a number of significant changes to the section 401(a)(4) requirements contained in the September 1991 regulations. These changes are intended to simplify substantially the regulatory requirements and to increase their flexibility. Major changes in the proposed regulations include the following:

• Allowing defined benefit plans to recognize service with another employer or during a leave of absence in a wide range of circumstances and expanding the circumstances in which benefits under such plans are determined without regard to offsets of benefits under other plans.

• Liberalizing the fresh-start rules (that permit benefits before a certain date to be disregarded) by allowing a plan to disregard benefit increases resulting from higher compensation after the fresh-start date for fresh starts that occur both before and after the effective date of the regulations.

• Modifying the general test by adding a facts-and-circumstances safety valve and eliminating the detailed rules used to determine accrual rates.

• Replacing objective testing for benefits provided to former employees with a flexible facts-and-circumstances analysis.

2. NONDISCRIMINATION IN AMOUNT OF CONTRIBUTIONS OR BENEFITS

 The regulations retain the two basic testing alternatives for determining nondiscrimination in the amount of contributions or benefits. Safe-harbor testing, which focuses primarily on the provisions of the plan, provides design-based or simplified testing methods for plans with essentially uniform benefits. The uniformity requirements of the safe harbors sufficiently reduce the risk of discrimination in the amount of contributions or benefits so that further testing of actual results is considered unnecessary. In contrast to safe-harbor testing, general testing focuses on actual results under the plan and permits plans providing for diversity in contributions or benefits to demonstrate that, despite this diversity, the plan satisfies the nondiscriminatory amounts requirement.

a. CHANGES AFFECTING SAFE-HARBOR TESTING

 Sections 1.401(a)(4)-2 and 1.401(a)(4)-3 of the proposed regulations contained a number of safe-harbor testing alternatives intended to cover many basic types of plan designs. These regulations finalize, with minor revisions, the specific requirements for safe harbors contained in the proposed regulations. In response to comments, the safe harbor for defined contribution plans with uniform points allocation formulas is modified to eliminate the requirement that points be provided for compensation. In addition, in order to facilitate use of the defined benefit plan safe harbors, the definition of uniform normal retirement age is expanded to provide generally that a plan's normal retirement provisions do not fail to be uniform merely because benefits commence on different dates for different employees, provided that each employee's normal retirement date does not differ by more than six months from a uniform normal retirement age.

 Representatives of multiemployer plans commented that it is common for these plans to condition receipt of a retroactive benefit increase on future service. As a result, the safe harbors were not available in testing the portion of the plan covering noncollectively bargained employees. The commentators noted that these conditions are contained in these plans as protection against potential windfalls to employees who return to work for a short period for any of the participating employers. In response to these comments, these regulations add a special rule in section 1.401(a)(4)-3(f) permitting a multiemployer plan to disregard such a service condition, provided that the condition applies to all employees in the multiemployer plan and the service required does not exceed five years.

 Some commentators have noted that the safe-harbor rules do not accommodate certain plans that meet the safe-harbor requirements in most but not all respects. The commentators have, therefore, suggested that a method be incorporated into the regulations to allow certain plans failing to meet the requirements for a safe harbor to show that this failure does not result in discrimination without requiring that the plan satisfy the general test.

 The Treasury and the Service have given extensive consideration to these comments. In evaluating a potential revision to safe-harbor testing to provide access for such plans, the Treasury and the Service are concerned that such a method would substantially undercut the design basis of the safe harbors and the assurance of nondiscrimination provided by the uniformity requirements. Consequently, the suggested change has not been made. Nevertheless, to the extent that the Service is able to identify appropriate means of facilitating access to safe-harbor testing, it is intended that the Commissioner will exercise the authority delegated under the regulations to provide alternative testing methods or procedures.

 The final regulations modify several other provisions of the proposed regulations that affect both safe-harbor testing and general testing. These changes, discussed below, increase the number of plans that are able to meet the nondiscriminatory amounts requirement on a safe-harbor basis.

b. CHANGES AFFECTING GENERAL TESTING

Both sections 1.401(a)(4)-2 and 1.401(a)(4)-3 of the regulations contain a general test for plans that are not using safe-harbor testing to demonstrate nondiscrimination in the amount of contributions or benefits. This test focuses on the actual allocation or accrual rates provided to employees in the plan and compares those rates to determine whether the plan discriminates in favor of highly compensated employees. A facts-and-circumstances safety valve is provided for an otherwise nondiscriminatory defined benefit plan that would pass the general test if no more than 5 percent of the highly compensated employees were disregarded. In response to comments, access to this 5-percent safety valve has been broadened by providing that 5 percent of the number of highly compensated employees may be determined by rounding fractional numbers to the nearest whole number. Although some comments suggested extending the safety-valve concept to defined contribution plans, the allocation rates in those plans do not generally have the sensitivity to employer demographics that make the safety valve necessary and appropriate for defined benefit plans. Therefore, the regulations do not adopt this suggestion.

 Changes to the general test for defined benefit plans in the proposed regulations substantially reduced the sensitivity of the general test to relatively minor differences in accrual rates, thereby making the results of the test more stable. As a result of these changes, and in the interest of simplification, the proposed regulations do not provide certain options contained in the September 1991 regulations, including, in particular, the floor on most valuable accrual rates and the option in specified cases to test most valuable accrual rates only.

 Certain commentators have requested reinstatement of both alternatives. The floor on most valuable accrual rates generally allowed substitution of an employee's higher most valuable accrual rate determined in a prior year for the employee's most valuable accrual rate determined in the current year. Use of the floor ensures that an employee's most valuable accrual rate does not decrease merely because the employee continues working beyond the age of greatest early retirement subsidy. This option has been reinstated in response to comments indicating that the continued utility of the rule outweighs any incremental complexity.

 However, the Treasury and the Service have not reinstated the option to test most valuable accrual rates only. This alternative was available only in limited circumstances and the requirements for access to the alternative were frequently misinterpreted. After consideration of the limited utility of the option, in conjunction with the significant simplification of the general test, the Treasury and the Service believe that the increased complexity and potential for confusion outweigh the utility of the option.

c. RULES APPLICABLE TO BOTH SAFE-HARBOR TESTING AND GENERAL TESTING

 The regulations contained in sections 1.401(a)(4)-3 and 1.401(a)(4)-13 provide rules for disregarding benefits accrued before a certain date in determining whether a defined benefit plan satisfies a safe harbor or in determining accrual rates under the general test. These "fresh-start" rules also allow plans to disregard certain increases in benefits due to increases in compensation after the fresh-start date. However, to narrow the potential for discrimination, the proposed regulations limited the increased benefit that can be disregarded to an amount determined by multiplying the benefit as of the fresh-start date by the ratio of the employee's current compensation to the employee's compensation as of the fresh-start date (the fraction method).

 Commentators have suggested that it would be administratively easier to substitute an employee's current compensation directly into the formula used to determine the pre-fresh-start benefits rather than to use the fraction method. In response to these comments, these regulations permit this substitution of current compensation, provided that this approach is not reasonably expected over time to discriminate significantly in favor of highly compensated employees.

 In response to comments, changes also have been made to the definition of average annual compensation. Average annual compensation, as defined in section 1.401(a)(4)-3(e) of the regulations, must be used under the plan's formula for purposes of the defined benefit plan safe harbors and for purposes of determining accrual rates under the general test. The proposed regulations permit periods of compensation to be disregarded in determining average annual compensation where an employee performs no services or performs services for less than a threshold of one half of a full- time work schedule. These regulations expand the permissible periods that can be disregarded by allowing an employer to select a threshold that does not exceed three-fourths of a full-time work schedule. The regulations also provide that the threshold may be prorated in the case of an employee whose normal work schedule is part time.

 The proposed regulations also provide an exception from the consecutive-year requirement for determining average annual compensation. The exception is limited to plans that do not use permitted disparity. Some commentators requested that this exception be extended to all plans. However, the Treasury and the Service believe that permitting the use of nonconsecutive-year compensation by plans that use permitted disparity would be inconsistent with the explicit section 401(l)(5)(C)(i) requirement for consecutive-year compensation contained in the definition of average annual compensation. Therefore, this requested change has not been made.

 Certain commentators also requested that employers be allowed to treat an affiliate (e.g., a joint venture) that is not a member of the employer's controlled group under section 414 of the Code as though it were a member of the employer's controlled group in the context of the nondiscrimination rules (including sections 401(a)(4) and 401(k)). The suggested change would eliminate separate employer- by-employer nondiscrimination testing of the multiple employer plans arising from the coverage of some or all joint venture employees in plans of the joint venture partners.

 While the regulations finalize significant changes to the service crediting rules intended to address many of these concerns, they do not adopt this proposed change. The statutory controlled group rules of section 414 provide a detailed definition of employer that is generally applicable for all qualification requirements and that does not contain an exception for section 401(a)(4). The Treasury and the Service believe that the section 414 definition of employer governs for purposes of section 401(a)(4) and that it is inappropriate to provide an inconsistent definition of employer in the context of nondiscrimination testing.

3. TESTING AND RETROACTIVE CORRECTION OF THE AVAILABILITY OF BENEFITS, RIGHTS, AND FEATURES

 The regulations in section 1.401(a)(4)-4 provide that optional forms of benefit, ancillary benefits, and other rights and features must be currently available to a group of employees that satisfies the nondiscriminatory classification requirement of section 410(b) without regard to the average benefit percentage test. In addition, the group of employees to whom these benefits, rights, and features are effectively available must not substantially favor highly compensated employees.

 In determining whether a benefit, right, or feature is currently available to a group of employees, the regulations provide that certain conditions imposed by a plan on the availability of a benefit, right, or feature may be disregarded. In response to comments, these regulations modify the proposed regulations by expanding the conditions that may be disregarded in determining current availability to include the following: 1) a requirement that a specified percentage of an employee's accrued benefit be nonforfeitable, 2) a requirement for execution of a waiver of rights under any federal or state law, and 3) a requirement for a particular family status (rather than only marital status as under the proposed regulations). In addition, in the case of multiemployer plans, a reasonable condition on the availability of an ancillary benefit or other right or feature requiring recent service may be disregarded, provided that all employees in the multiemployer plan are subject to the condition.

 Many commentators requested that the retroactive correction provisions of the proposed regulations be expanded to include a correction mechanism for the availability of benefits, rights and features. These commentators noted that, even though they carefully monitor their plans to ensure that these availability requirements are met on a continuing basis, failures will occur.

 In response to these comments, section 1.401(a)(4)-11(g) of these regulations is modified to permit certain corrective amendments to the availability of benefits, rights, and features. Because it is difficult or impossible, in many cases, to make a benefit, right, or feature meaningfully available on a retroactive basis, a corrective amendment increasing availability is required only on a prospective basis. However, in order to take the correction into account for a plan year, the group of employees to whom the benefit, right, or feature is available (after taking the amendment into account) generally must satisfy the nondiscriminatory requirement of section 410(b) using the safe-harbor percentage applicable to the plan. In addition, the amendment must remain in effect until the end of the plan year following the year in which the amendment is effective, and must not be part of a pattern of amendments used to correct repeated failures of the same benefit, right or feature. Other rules relating to retroactive correction also apply (e.g., the requirement that the correction be made no later than the 15th day of the 10th month after the close of a plan year).

 As an alternative to increasing availability, the regulations also permit an employer to make a corrective amendment by the last day of the plan year eliminating the benefit, right, or feature (to the extent permitted under section 41 1(d)(6)). In that case, the amendment will be treated as if it were in effect throughout the plan year for purposes of nondiscrimination testing. In addition, the regulations are modified to allow for retroactive correction for purposes of satisfying the section 401(k) and (m) coverage and availability requirements if certain conditions are satisfied.

4. NONDISCRIMINATION TESTING OF PLAN AMENDMENTS AND PLAN TERMINATIONS

 Section 1.401(a)(4)-5 of the regulations provides for facts-and- circumstances testing of the effect of plan amendments (including plan amendments granting past service), focusing on whether the timing of a plan amendment or series of amendments discriminates significantly in favor of highly compensated employees or highly compensated former employees. In addition, this section contains pre- termination restrictions on payments to certain highly compensated employees, to which these regulations make minor clarifying modifications.

5. EMPLOYEE CONTRIBUTIONS IN DEFINED BENEFIT PLANS AND IMPUTATION OF PERMITTED DISPARITY

 Section 1 .401(a)(4)-6 of the regulations contains rules for defined benefit plans that include employee contributions. In general, benefits derived from employer contributions must be tested separately from those derived from employee contributions. In order to facilitate nondiscrimination testing, the regulations contain simplified alternatives to the section 411(c) method for determining the portion of the benefit derived from employer contributions. Section 1.401(a)(4)-7 contains rules for taking permitted disparity into account in general testing. These regulations finalize, with minor revisions, the rules contained in these sections of the proposed regulations.

6. CROSS-TESTING

 Section 1.401(a)(4)-8 contains rules for testing defined contribution plans on the basis of benefits and defined benefit plans on the basis of contributions. This section sets forth the method for determining equivalent accrual rates in the case of a defined contribution plan or equivalent allocation rates in the case of a defined benefit plan and coordinates the testing of these rates with the general tests in sections 1.401(a)(4)-2 and 1.401(a)(4)-3. In response to comments, these rules have been modified to provide that an employer that is cross-testing a defined contribution plan by using the current plan year as the measurement period under the general test may disregard income, expenses, gains, and losses allocated during the current plan year that are attributable to the allocation for the current plan year. Thus, such an employer may generally test by taking into account only contributions and forfeitures allocated during the current plan year.

 This section also provides safe-harbor-testing rules for defined benefit plans that are part of a floor offset arrangement. The fresh- start rules in section 1.401(a)(4)-13 have been made more flexible in their application to floor offset plans that have been amended to eliminate the offset provision for future accruals.

 The September 1991 regulations in sections 1.401(a)(4)-8 and 1.401(a)(4)-13 also provided safe-harbor-testing rules for cash balance plans. Those rules generated significant comment. Because the Treasury and the Service are continuing to review these comments, amendments to those rules will be proposed at a later date.

7. PLAN AGGREGATION AND DISAGGREGATION

 Section 1.401(a)(4)-9 requires plans that are aggregated for purposes of section 410(b) to be aggregated for purposes of section 401(a)(4) testing. In general, an aggregated plan is tested under the same rules applicable to single plans. However, special rules are provided for an aggregated plan that includes one or more defined contribution plans and one or more defined benefit plans (DB/DC plan). This section also contains rules that allow a plan to be restructured and treated as consisting of separate component plans that may be tested separately under section 401(a)(4). In response to comments, minor modifications and clarifications have been made.

8. NONDISCRIMINATION TESTING OF FORMER EMPLOYEES

 The regulations require separate testing of former employees under section 1.401(a)(4)-10. As under the proposed regulations, the amount of contributions or benefits and the availability of benefits, rights, and features provided to former employees will be nondiscriminatory if all of the relevant facts and circumstances show that the plan does not discriminate significantly in favor of highly compensated former employees.

9. VESTING AND SERVICE CREDITING

 Section 1.401(a)(4)-11 contains facts-and-circumstances rules for determining whether the vesting and service crediting provisions of a plan are nondiscriminatory. Specifically, the rules allow plans to recognize service with another employer (either by granting pre- participation service when an employee transfers from the other employer or by imputing service after an employee has transferred to the other employer) or to impute service during a leave of absence or a period of reduced work schedule, provided that the following facts- and-circumstances standards are met: (i) all similarly-situated employees are treated in the same way, (ii) there is a legitimate business reason for crediting the service, and (iii) the crediting of the service does not discriminate significantly in favor of highly compensated employees.

 In response to comments, these regulations clarify that the pre- participation and imputed service rules apply to defined contribution plans, as well as to defined benefit plans. However, service crediting generally is not relevant for amounts testing of defined contribution plans except to determine whether a plan meets the uniform points allocation formula safe harbor. In addition, the rules for cross-testing defined contribution plans allow only years of service in which an employee has benefited under the plan to be taken into account. The limits under section 415(c) also may limit the extent to which service and compensation outside the controlled group may be taken into account under a defined contribution plan.

10. DEFINITIONS

 The regulations contain a number of important definitions used in applying the rules contained in the regulations. In addition to the change to the definition of uniform normal retirement age described in the earlier discussion of safe-harbor testing, the regulations incorporate modifications to certain definitions which were proposed in related regulations.

11. EFFECTIVE DATES

 The regulations generally are effective for plan years beginning on or after January 1, 1994, or, in the case of governmental plans and plans maintained by tax-exempt organizations, for plan years beginning on or after January 1, 1996. For plan years beginning on or after the first day of the first plan year to which the amendments made by section 1112(a) of the Tax Reform Act of 1986 (TRA '86) apply and before the applicable regulatory effective date, section 1.401(a)(4)-13 provides that a plan must be operated in accordance with a reasonable, good faith interpretation of the requirements of section 401(a)(4), taking into account pre-existing guidance and the amendments made by TRA '86 to related Code provisions, such as sections 401(l), 401(a)(17), and 410(b). Whether compliance is reasonable and in good faith generally will be determined on the basis of all relevant facts and circumstances, including the extent to which the employer has consistently resolved unclear issues in its favor. Reasonable, good faith compliance will be deemed to exist, however, if a plan is operated in accordance with the 1990 proposed regulations, the September 1991 regulations, the January 1993 proposed regulations, or these final regulations.

 In Notice 92-36, 1992-2 C.B. 364, the Service provided transition relief and extended the date by which plan amendments to comply with TRA '86 must be made generally until the close of the first plan year for which these regulations are effective. This extended amendment date and related transition relief, combined with the reasonable, good faith compliance standard, are designed to ensure that plan sponsors have a reasonable period in which to amend qualified plans.

GOVERNMENTAL PLANS

 The regulations retain the special transition rule for governmental plans. Thus, section 401(a)(4) is deemed satisfied in the case of governmental plans described in section 414(d) for plan years beginning before 1996. Some commentators have suggested that governmental plans should not be subject to nondiscrimination testing. However, in the absence of statutory provisions excepting governmental plans from these requirements, the regulations recognize their applicability. Nevertheless, the Treasury and the Service recognize that governmental plans may have certain unique features relating to the sponsoring employer's status as a governmental entity. Comments have been received on such features, and additional comments are specifically requested from governmental employers regarding appropriate modifications to the regulations to take into account the operation of governmental plans.

PLANS MAINTAINED BY MORE THAN ONE EMPLOYER

 Multiple employer plans must satisfy section 401(a)(4) on an employer-by-employer basis rather than on the basis of participating employers in the aggregate. Any noncollectively bargained portion of a multiemployer plan is tested as a multiple employer plan. The consequences of failure to satisfy section 401(a)(4) with respect to any component of this testing process may affect the plan for all participating employers. The regulations do not provide an exception to this rule. However, where a multiemployer plan or a multiple employer plan fails to satisfy section 401(a)(4), the Commissioner could, in a proper case, treat the plan as satisfying section 401(a)(4) for innocent employers by requiring corrective and remedial action with respect to the plan. Such remedial action could include allowing the withdrawal of an offending employer, allowing a disqualifying defect to be cured within a reasonable period of time after the plan administrator has or should have knowledge of the disqualifying event or was otherwise notified by the Service of the disqualifying defect, or requiring plan amendments to prevent future disqualifying events. In addition, it is anticipated that guidance on data collection and testing will be provided for multiemployer plans in the proposed revenue procedure on substantiating compliance when that document is finalized.

EFFECT ON OTHER LAWS

 Compliance with the provisions of these regulations does not ensure compliance with other applicable Federal laws, including, but not limited to, the provisions of Title 1 of the Employee Retirement Income Security Act of 1974, which are administered by the Secretary of Labor pursuant to Reorganization Plan Number 4 of 1978. Employers should note that plan amendments pursuant to this regulation may necessitate reporting and disclosure under that Act, including requirements relating to summary plan descriptions and summaries of material modifications.

SPECIAL ANALYSES

 It has been determined that these rules are not major rules as defined in Executive Order 12291. Therefore, a Regulatory Impact Analysis is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply to these regulations, and, therefore, a Regulatory Flexibility Analysis is not required. Pursuant to section 7805(f) of the Internal Revenue Code, the notice of proposed rulemaking was submitted to the Small Business Administration for comment on its impact on small business.

DRAFTING INFORMATION

 The principal authors of these regulations are Nancy J. Marks, David Munroe, Marjorie Hoffman, and Patricia McDermott of the Office of the Associate Chief Counsel (Employee Benefits and Exempt Organizations), Internal Revenue Service. However, personnel from other offices of the Service and Treasury Department participated in their development.

LIST OF SUBJECTS IN 26 CFR PART 1

 Income taxes, Reporting and recordkeeping requirements.

ADOPTION OF AMENDMENTS TO THE REGULATIONS

Accordingly, 26 CFR part 1 is amended as follows:

PART 1 -- INCOME TAXES

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

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

Par. 2. Section 1.401-4 is amended by revising the section heading and paragraph (d) to read as follows:

SECTION 1.401-4 DISCRIMINATION AS TO CONTRIBUTIONS OR BENEFITS (BEFORE 1994).

* * * * *

(d)(1) Except as provided in paragraph (d)(2) of this section, the provisions of this section do not apply to plan years beginning on or after January 1, 1994. For rules applicable to plan years beginning on or after January 1, 1994, see sections 1.401(a)(4)-1 through 1.401(a)(4)-13.

(2) In the case of plans maintained by organizations exempt from income taxation under section 501(a), including plans subject to section 403(b)(12)(A)(i) (nonelective plans), the provisions of this section do not apply to plan years beginning on or after January 1, 1996. For rules applicable to plan years beginning on or after January 1, 1996, see sections 1.401(a)(4)-1 through 1.401(a)(4)-13.

Par. 3. Section 1.401(a)-4 is amended by revising the section heading and paragraph A-6(a) to read as follows:

SECTION 1.401(a)-4 OPTIONAL FORMS OF BENEFIT (BEFORE 1994).

* * * * *

A-6: (a) GENERAL EFFECTIVE DATE -- (1) IN GENERAL. Except as otherwise provided in this section, the provisions of this section are effective January 30, 1986, and do not apply to plan years beginning on or after January 1, 1994. For rules applicable to plan years beginning on or after January 1, 1994, see sections 1.401(a)(4)-1 through 1.401(a)(4)-13.

(2) PLANS OF TAX-EXEMPT ORGANIZATIONS. In the case of plans maintained by organizations exempt from income taxation under section 501(a), including plans subject to section 403(b)(12)(A)(i) (nonelective plans), except as otherwise provided in this section, the provisions of this section are effective January 30, 1986, and do not apply to plan years beginning on or after January 1, 1996. For rules applicable to plan years beginning on or after January 1, 1996, see sections 1.401(a)(4)-1 through 1.401(a)(4)-13.

* * * * *

Paragraph 4. Sections 1.401(a)(4)-0 through 1.401(a)(4)- 8(c)(2)(iii) and sections 1.401(a)(4)-8(d) through 1.401(a)(4)-13(e) are revised and section 1.401(a)(4)-8(c)(2)(iv) is added to read as follows:

SECTION 1.401(a)(4)-0 TABLE OF CONTENTS.

This section contains a listing of the major headings of sections 1.401(a)(4)-1 through 1.401(a)(4)-13.

SECTION 1.401(a)(4)-1 NONDISCRIMINATION REQUIREMENTS OF SECTION 401(a)(4).

(a) In general.

(b) Requirements a plan must satisfy.

(1) In general.

(2) Nondiscriminatory amount of contributions or benefits.

(3) Nondiscriminatory availability of benefits, rights, and features.

(4) Nondiscriminatory effect of plan amendments and terminations.

(c) Application of requirements.

(1) In general.

(2) Interpretation.

(3) Plan-year basis of testing.

(4) Application of section 410(b) rules.

(5) Collectively-bargained plans.

(6) Former employees.

(7) Employee-provided contributions and benefits.

(8) Allocation of earnings.

(9) Rollovers, transfers, and buybacks.

(10) Vesting.

(11) Crediting service.

(12) Governmental plans.

(13) Employee stock ownership plans.

(14) Section 401(h) benefits.

(15) Definitions.

(16) Effective dates and fresh-start rules.

(d) Additional guidance.

SECTION 1.401(a)(4)-2 NONDISCRIMINATION IN AMOUNT OF EMPLOYER CONTRIBUTIONS UNDER A DEFINED CONTRIBUTION PLAN.

(a) Introduction.

(1) Overview.

(2) Alternative methods of satisfying nondiscriminatory amount requirement.

(b) Safe harbors.

(1) In general.

(2) Safe harbor for plans with uniform allocation formula.

(3) Safe harbor for plans with uniform points allocation formula.

(4) Use of safe harbors not precluded by certain plan provisions.

(c) General test for nondiscrimination in amount of contributions.

(1) General rule.

(2) Determination of allocation rates.

(3) Satisfaction of section 410(b) by a rate group.

(4) Examples.

SECTION 1.401(a)(4)-3 NONDISCRIMINATION IN AMOUNT OF EMPLOYER- PROVIDED BENEFITS UNDER A DEFINED BENEFIT PLAN.

(a) Introduction.

(1) Overview.

(2) Alternative methods of satisfying nondiscriminatory amount requirement.

(b) Safe harbors.

(1) In general.

(2) Uniformity requirements.

(3) Safe harbor for unit credit plans.

(4) Safe harbor for plans using fractional accrual rule.

(5) Safe harbor for insurance contract plans.

(6) Use of safe harbors not precluded by certain plan provisions.

(c) General test for nondiscrimination in amount of benefits.

(1) General rule.

(2) Satisfaction of section 410(b) by a rate group.

(3) Certain violations disregarded.

(4) Examples.

(d) Determination of accrual rates.

(1) Definitions.

(2) Rules of application.

(3) Optional rules.

(4) Examples.

(e) Compensation rules.

(1) In general.

(2) Average annual compensation.

(3) Examples.

(f) Special rules.

(1) In general.

(2) Certain qualified disability benefits.

(3) Accruals after normal retirement age.

(4) Early retirement window benefits.

(5) Unpredictable contingent event benefits.

(6) Determination of benefits on other than plan-year basis.

(7) Adjustments for certain plan distributions.

(8) Adjustment for certain QPSA charges.

(9) Disregard of certain offsets.

(10) Special rule for multiemployer plans.

SECTION 1.401(a)(4)-4 NONDISCRIMINATORY AVAILABILITY OF BENEFITS, RIGHTS, AND FEATURES.

(a) Introduction.

(b) Current availability.

(1) General rule.

(2) Determination of current availability.

(3) Benefits, rights, and features that are eliminated prospectively.

(c) Effective availability.

(1) General rule.

(2) Examples.

(d) Special rules.

(1) Mergers and acquisitions.

(2) Frozen participants.

(3) Early retirement window benefits.

(4) Permissive aggregation of certain benefits, rights, or features.

(5) Certain spousal benefits.

(6) Special ESOP rules.

(7) Special testing rule for unpredictable contingent event benefits.

(e) Definitions.

(1) Optional form of benefit.

(2) Ancillary benefit.

(3) Other right or feature.

SECTION 1.401(a)(4)-5 PLAN AMENDMENTS AND PLAN TERMINATIONS.

(a) Introduction.

(1) Overview.

(2) Facts-and-circumstances determination.

(3) Safe harbor for certain grants of benefits for past periods.

(4) Examples.

(b) Pre-termination restrictions.

(1) Required provisions in defined benefit plans.

(2) Restriction of benefits upon plan termination.

(3) Restrictions on distributions.

(4) Operational restrictions on certain money purchase pension plans.

SECTION 1.401(a)(4)-6 TRIBUTORY DEFINED BENEFIT PLANS.

(a) Introduction.

(b) Determination of employer-provided benefit.

(1) General rule.

(2) Composition-of-work-force method.

(3) Minimum-benefit method.

(4) Grandfather rules for plans in existence on May 14, 1990.

(5) Government-plan method.

(6) Cessation of employee contributions.

(c) Rules applicable in determining whether employee-provided benefits are nondiscruniratory in amount.

(1) In general.

(2) Same note of contributions.

(3) Total-benefits method.

(4) Grandfather rule for plans in existence on May 14, 1990.

SECTION 1.401(a)(4)-7 IMPUTATION OF PERMITTED DISPARITY.

(a) Introduction.

(b) Adjusting allocation notes.

(1) In general.

(2) Employees whose plan year compensation does not exceed taxable wage base.

(3) Employees whose plan year compensation exceeds taxable wage base.

(4) Definitions.

(5) Example.

(c) Adjusting accrual rates.

(1) In general.

(2) Employees whose average annual compensation does not exceed covered compensation.

(3) Employees whose average annual compensation exceeds covered compensation.

(4) Definitions.

(5) Employees with negative unadjusted accrual rates.

(6) Example.

(d) Rules of general application.

(1) Eligible plans.

(2) Exceptions from consistency requirements.

(3) Overall permitted disparity.

SECTION 1.401(a)(4)-8 CROSS-TESTING.

(a) Introduction.

(b) Nondiscrimination in amount of benefits provided under a defined contribution plan.

(1) General rule.

(2) Determination of equivalent accrual rates.

(3) Safe-harbor testing method for target benefit plans.

(c) Nondiscrimination in amount of contributions under a defined benefit plan.

(1) General rule.

(2) Determination of equivalent allocation rates.

(3) Safe harbor testing method for cash balance plans.

(d) Safe-harbor testing method for defined benefit plans that are part of a floor-offset arrangement.

(1) General rule.

(2) Application of safe-harbor testing method to qualified offset arrangements.

SECTION 1.401(a)(4)-9 PLAN AGGREGATION AND RESTRUCTURING.

(a) Introduction.

(b) Application of nondiscrimination requirements to DB/DC plans.

(1) General rule.

(2) Special rules for demonstrating nondiscrimination in amount of contributions or benefits.

(3) Optional rules for demonstrating nondiscrimination in availability of certain benefits, rights, and features.

(c) Plan restructuring.

(1) General rule.

(2) Identification of component plans.

(3) Satisfaction of section 401(a)(4) by a component plan.

(4) Satisfaction of section 410(b) by a component plan.

(5) Effect of restructuring under other sections.

(6) Examples.

SECTION 1.401(a)(4)-10 TESTING OF FORMER EMPLOYEES.

(a) Introduction.

(b) Nondiscrimination in amount of contributions or benefits.

(1) General rule.

(2) Permitted disparity.

(3) Examples.

(c) Nondiscrimination in availability of benefits, rights, or features.

SECTION 1.401(a)(4)-11 ADDITIONAL RULES.

(a) Introduction.

(b) Rollovers, transfers, and buybacks.

(1) Rollovers and elective transfers.

(2) Other transfers. [Reserved]

(3) Employee buybacks.

(c) Vesting.

(1) General rule.

(2) Deemed equivalence of statutory vesting schedules.

(3) Safe harbor for vesting schedules.

(4) Examples.

(d) Service-crediting rules.

(1) Overview.

(2) Manner of crediting service.

(3) Service-crediting period.

(e) Family aggregation rules. [Reserved]

(f) Governmental plans. [Reserved]

(g) Corrective amendments.

(1) In general.

(2) Scope of corrective amendments.

(3) Conditions for corrective amendments.

(4) Corrective amendments must have substance.

(5) Effect under other statutory requirements.

(6) Examples.

SECTION 1.401(a)(4)-12 DEFINITIONS.

SECTION 1.401(a)(4)-13 EFFECTIVE DATES AND FRESH-START RULES.

(a) General effective dates.

(1) In general.

(2) plans of tax-exempt organizations.

(3) Compliance during transition period.

(b) Effective date for governmental plans.

(c) Fresh-start rules for defined benefit plans.

(1) Introduction.

(2) General rule.

(3) Definition of frozen.

(4) Fresh-start formulas.

(5) Rules of application.

(6) Examples.

(d) Compensation adjustments to frozen accrued benefits.

(1) Introduction.

(2) In general.

(3) Plan requirements.

(4) Meaningful coverage as of fresh-start date.

(5) Meaningful ongoing coverage.

(6) Meaningful current benefit accruals.

(7) Minimum benefit adjustment.

(8) Adjusted accrued benefit.

(9) Examples.

(e) Determination of initial theoretical reserve for target benefit plans.

(1) General rule.

(2) Example.

(f) Special fresh-start rules for cash balance plans.

(1) In general.

(2) Alternative formula.

(3) Limitations on formulas.

SECTION 1.401(a)(4)-1 NONDISCRIMINATION REQUIREMENTS OF SECTION 401(a)(4).

(a) IN GENERAL. Section 401(a)(4) provides that a plan is a qualified plan only if the contributions or the benefits provided under the plan do not discriminate in favor of HCEs. Whether a plan satisfies this requirement depends on the form of the plan and on its effect in operation. In making this determination, intent is irrelevant. This section sets forth the exclusive rules for determining whether a plan satisfies section 401(a)(4). A plan that complies in form and operation with the rules in this section therefore satisfies section 401(a)(4).

(b) REQUIREMENTS A PLAN MUST SATISFY -- (1) IN GENERAL. In order to satisfy section 401(a)(4), a plan must satisfy each of the requirements of this paragraph (b).

(2) NONDISCRIMINATORY AMOUNT OF CONTRIBUTIONS OR BENEFITS -- (i) GENERAL RULE. Either the contributions or the benefits provided under the plan must be nondiscriminatory in amount. It need not be shown that both the contributions and the benefits provided are nondiscriminatory in amount, but only that either the contributions alone or the benefits alone are nondiscriminatory in amount.

(ii) DEFINED CONTRIBUTION PLANS -- (A) GENERAL RULE. A defined contribution plan satisfies this paragraph (b)(2) if the contributions allocated under the plan (including forfeitures) are nondiscriminatory in amount under section 1.401(a)(4)-2. Alternatively, a defined contribution plan (other than an ESOP) satisfies this paragraph (b)(2) if the equivalent benefits provided under the plan are nondiscriminatory in amount under section 1.401(a)(4)-8(b). Section 1.401(a)(4)-8(b) includes a safe-harbor testing method for contributions provided under a target benefit plan.

(B) SECTION 401(k) PLANS AND SECTION 401(m) PLANS. A section 401(k) plan is deemed to satisfy this paragraph (b)(2) because section 1.410(b)-9 defines a section 401(k) plan as a plan consisting of elective contributions under a qualified cash or deferred arrangement (i.e., one that satisfies section 401(k)(3), the nondiscriminatory amount requirement applicable to qualified cash or deferred arrangements). A section 401(m) plan satisfies this paragraph (b)(2) only if the plan satisfies sections 1.401(m)-1(b) and 1.401(m)-2. Contributions under a nonqualified cash or deferred arrangement, elective contributions described in section 1.401(k)- 1(b)(4)(iv) that fail to satisfy the allocation and compensation requirements of section 1.401(k)-1(b)(4)(i), matching contributions that fail to satisfy section 1.401(m)-1(b)(4)(ii)(A), and qualified nonelective contributions treated as elective or matching contributions for certain purposes under sections 1.401(k)-1(b)(5) and 1.401(m)-1(b)(5), respectively, are not subject to the special rule in this paragraph (b)(2)(ii)(B), because they are not treated as part of a section 401(k) plan or section 401(m) plan as those terms are defined in section 1.410(b)-9. The contributions described in the preceding sentence must satisfy paragraph (b)(2)(ii)(A) of this section.

(iii) DEFINED BENEFIT PLANS. A defined benefit plan satisfies this paragraph (b)(2) if the benefits provided under the plan are nondiscriminatory in amount under section 1.401(a)(4)-3. Alternatively, a defined benefit plan satisfies this paragraph (b)(2) if the equivalent allocations provided under the plan are nondiscriminatory in amount under section 1.401(a)(4)-8(c). Section 1.401(a)(4)-8(c) includes a safe-harbor testing method for benefits provided under a cash balance plan. In addition, section 1.401(a)(4)- 8(d) provides a safe-harbor testing method for benefits provided under a defined benefit plan that is part of a floor-offset arrangement.

(3) NONDISCRIMINATORY AVAILABILITY OF BENEFITS, RIGHTS, AND FEATURES. All benefits, rights, and features provided under the plan must be made available in the plan in a nondiscriminatory manner. Rules for determining whether this requirement is satisfied are set forth in section 1.401(a)(4)-4.

(4) NONDISCRIMINATORY EFFECT OF PLAN AMENDMENTS AND TERMINATIONS. The timing of plan amendments must not have the effect of discriminating significantly in favor of HCEs. Rules for determining whether this requirement is satisfied are set forth in section 1.401(a)(4)-5(a). Section 1.401(a)(4)-5(b) provides additional requirements regarding plan terminations.

(c) APPLICATION OF REQUIREMENTS -- (1) IN GENERAL. The requirements of paragraph (b) of this section must be applied in accordance with the rules set forth in this paragraph (c).

(2) INTERPRETATION. The provisions of sections 1.401(a)(4)-1 through 1.401(a)(4)-13 must be interpreted in a reasonable manner consistent with the purpose of preventing discrimination in favor of HCEs.

(3) PLAN-YEAR BASIS OF TESTING. The requirements of paragraph (b) of this section are generally applied on the basis of the plan year and on the basis of the terms of the plan in effect during the plan year. Thus, unless otherwise provided, the compensation, contributions, benefit accruals, and other items used to apply these requirements must be determined with respect to the plan year being tested. However, section 1.401(a)(4)-11(g) provides rules allowing for corrective amendments made after the close of the plan year to be taken into account in satisfying certain requirements under paragraph (b) of this section.

(4) APPLICATION OF SECTION 410(b) RULES -- (i) RELATIONSHIP BETWEEN SECTIONS 401(a)(4) AND 410(b). To be a qualified plan, a plan must satisfy both sections 410(b) and 401(a)(4). Section 410(b) requires that a plan benefit a nondiscriminatory group of employees, and section 401(a)(4) requires that the contributions or benefits provided to employees benefiting under the plan not discriminate in favor of HCEs. Consistent with this requirement, the definition of a plan subject to testing under section 401(a)(4) is the same as the definition of a plan subject to testing under section 410(b), i.e., the plan determined after applying the mandatory disaggregation rules of section 1.410(b)-7(c) and the permissive aggregation rules of section 1.410(b)-7(d). In addition, whichever testing option is used for the plan year under section 1.410(b)-8(a) (e.g., quarterly testing) must also be used for purposes of determining whether the plan satisfies section 401(a)(4) for the plan year.

(ii) SPECIAL RULES FOR CERTAIN AGGREGATED PLANS. Special rules are set forth in section 1.401(a)(4)-9(b) for applying the nondiscriminatory amount and availability requirements of paragraphs (b)(2) and (b)(3) of this section to a plan that includes one or more defined benefit plans and one or more defined contribution plans that have been permissively aggregated under section 1.410(b)-7(d).

(iii) RESTRUCTURING. In certain circumstances, a plan may be restructured on the basis of employee groups and treated as comprising two or more plans, each of which is treated as a separate plan that must independently satisfy sections 401(a)(4) and 410(b). Rules relating to restructuring plans for purposes of applying the requirements of paragraph (b) of this section are set forth in section 1.401(a)(4)-9(c).

(iv) REFERENCES TO SECTION 410(b). Except as otherwise specifically provided, references to satisfying section 410(b) in sections 1.401(a)(4)-1 through 1.401(a)(4)-13 mean satisfying section 1.410(b)-2 (taking into account any special rules available in satisfying that section, other than the permissive aggregation rules of section 1.410(b)-7(d)). In the case of a plan described in section 410(c)(1) that has not made the election described in section 410(d) and is not subject to section 403(b)(12)(A)(i), references in sections 1.401(a)(4)-1 through 1.401(a)(4)-13 to satisfying section 410(b) mean satisfying section 410(c)(2).

(5) COLLECTIVELY-BARGAINED PLANS. The requirements of paragraph (b) of this section are treated as satisfied by a collectively- bargained plan that automatically satisfies section 410(b) under section 1.410(b)-2(b)(7).

(6) FORMER EMPLOYEES. In applying the nondiscriminatory amount and availability requirements of paragraphs (b)(2) and (b)(3) of this section, former employees are tested separately from active employees, unless otherwise provided. Rules for applying paragraphs (b)(2) and (b)(3) of this section to former employees are set forth in section 1.401(a)(4)-10.

(7) EMPLOYEE-PROVIDED CONTRIBUTIONS AND BENEFITS. In applying the nondiscriminatory amount requirement of paragraph (b)(2) of this section, employee-provided contributions and benefits are tested separately from employer-provided contributions and benefits, unless otherwise provided. Rules for determining the amount of employer- provided benefits under a defined benefit plan that include employee contributions not allocated to separate accounts are set forth in section 1.401(a)(4)-6(b), and rules for applying paragraph (b)(2) of this section to employee contributions under such a plan are set forth in section 1.401(a)(4)-6(c). See paragraph (b)(2)(ii)(B) of this section for rules applicable to employee contributions allocated to separate accounts.

(8) ALLOCATION OF EARNINGS. Notwithstanding any other provision in sections 1.401(a)(4)-1 through 1.401(a)(4)-13, a defined contribution plan does not satisfy paragraph (b)(2) of this section if the manner in which income, expenses, gains, or losses are allocated to accounts under the plan discriminates in favor of HCEs or former HCEs.

(9) ROLLOVERS, TRANSFERS, AND BUYBACKS. In applying the requirements of paragraph (b) of this section, rollover (including direct rollover) contributions described in section 402(c), 402(e)(6), 403(a)(4), 403(a)(5), or 408(d)(3), elective transfers described in section 1.411(d)-4, Q&A-3(b), transfers of assets and liabilities described in section 414(1), and employee buybacks are treated in accordance with the rules set forth in section 1.401(a)(4)-11(b).

(10) VESTING. A plan does not satisfy the nondiscriminatory amount requirement of paragraph (b)(2) of this section unless it satisfies section 1.401(a)(4)-11(c) with respect to the manner in which employees vest in their accrued benefits.

(11) CREDITING SERVICE. A plan does not satisfy paragraphs (b)(2) and (b)(3) of this section unless it satisfies section 1.401(a)(4)-11(d) with respect to the manner in which employees' service is credited under the plan. Service other than actual service with the employer may not be taken into account in determining whether the plan satisfies paragraphs (b) (2) and (b)(3) of this section except as provided in section 1.401(a)(4)-11(d).

(12) GOVERNMENTAL PLANS. The rules of this section apply to a governmental plan within the meaning of section 414(d), except as provided in sections 1.401(a)(4)-11(f) and 1.401(a)(4)-13(b).

(13) EMPLOYEE STOCK OWNERSHIP PLANS. [Reserved]

(14) SECTION 401(h) BENEFITS. In applying the requirements of paragraph (b) of this section, the portion of a plan providing benefits described in section 401(h) is tested separately from the portion of the same plan providing retirement benefits, and thus is not required to satisfy this section. Rules applicable to section 401(h) benefits are set forth in section 1.401-14(b)(2).

(15) DEFINITIONS. In applying the requirements of this section, the definitions in section 1.401(a)(4)-12 govern.

(16) EFFECTIVE DATES AND FRESH-START RULES. In applying the requirements of this section, the effective dates set forth in section 1.401(a)(4)-13 govern. Section 1.401(a)(4)-13 also provides certain transition and fresh-start rules that apply for purposes of this section.

(d) ADDITIONAL GUIDANCE. The Commissioner may, in revenue rulings, notices, and other guidance, published in the Internal Revenue Bulletin, provide any additional guidance that may be necessary or appropriate in applying the nondiscrimination requirements of section 401(a)(4), including additional safe harbors and alternative methods and procedures for satisfying those requirements. See section 601.601(d)(2)(ii)(b) of this chapter.

SECTION 1.401(a)(4)-2 NONDISCRIMINATION IN AMOUNT OF EMPLOYER CONTRIBUTIONS UNDER A DEFINED CONTRIBUTION PLAN.

(a) INTRODUCTION -- (1) OVERVIEW. This section provides rules for determining whether the employer contributions allocated under a defined contribution plan are nondiscriminatory in amount as required by section 1.401(a)(4)-1(b)(2)(ii)(A). Certain defined contribution plans that provide uniform allocations are permitted to satisfy this requirement by meeting one of the safe harbors in paragraph (b) of this section. Plans that do not provide uniform allocations may satisfy this requirement by satisfying the general test in paragraph (c) of this section. See section 1.401(a)(4)-1(b)(2)(ii)(B) for the exclusive tests applicable to section 401(k) plans and section 401(m) plans.

(2) ALTERNATIVE METHODS OF SATISFYING NONDISCRIMINATORY AMOUNT REQUIREMENT. A defined contribution plan is permitted to satisfy paragraph (b)(2) or (c) of this section on a restructured basis pursuant to section 1.401(a)(4)-9(c). Alternatively, a defined contribution plan (other than an ESOP) is permitted to satisfy the nondiscriminatory amount requirement of section 1.401(a)(4)- 1(b)(2)(ii)(A) on the basis of equivalent benefits pursuant to section 1.401(a)(4)-8(b).

(b) SAFE HARBORS -- (1) IN GENERAL. The employer contributions allocated under a defined contribution plan are nondiscriminatory in amount for a plan year if the plan satisfies either of the safe harbors in paragraph (b)(2) or (b)(3) of this section. Paragraph (b)(4) of this section provides exceptions for certain plan provisions that do not cause a plan to fail to satisfy this paragraph (b).

(2) SAFE HARBOR FOR PLANS WITH UNIFORM ALLOCATION FORMULA -- (i) GENERAL RULE. A defined contribution plan satisfies the safe harbor in this paragraph (b)(2) for a plan year if the plan allocates all amounts taken into account under paragraph (c)(2)(ii) of this section for the plan year under an allocation formula that allocates to each employee the same percentage of plan year compensation, the same dollar amount, or the same dollar amount for each uniform unit of service (not to exceed one week) performed by the employee during the plan year.

(ii) PERMITTED DISPARITY. If a plan satisfies section 401(l) in form, differences in employees' allocations under the plan attributable to uniform disparities permitted under section 1.401(l)- 2 (including differences in disparities that are deemed uniform under section 1.401(l)-2(c)(2)) do not cause the plan to fail to satisfy this paragraph (b)(2).

(3) SAFE HARBOR FOR PLANS WITH UNIFORM POINTS ALLOCATION FORMULA -- (i) GENERAL RULE. A defined contribution plan (other than an ESOP) satisfies the safe harbor in this paragraph (b)(3) for a plan year if it satisfies both of the following requirements:

(A) The plan must allocate amounts under a uniform points allocation formula. A uniform points allocation formula defines each employee's allocation for the plan year as the product of the total of all amounts taken into account under paragraph (c)(2)(ii) of this section and a fraction, the numerator of which is the employee's points for the plan year and the denominator of which is the sum of the points of all employees in the plan for the plan year. For this purpose, an employee's points for a plan year equal the sum of the employee's points for age, service, and units of plan year compensation for the plan year. Under a uniform points allocation formula, each employee must receive the same number of points for each year of age, the same number of points for each year of service, and the same number of points for each unit of plan year compensation. (See section 1.401(a)(4)-11(d)(3) regarding service that may be taken into account as years of service.) A uniform points allocation formula need not grant points for both age and service, but it must grant points for at least one of them. If the allocation formula grants points for years of service, the plan is permitted to limit the number of years of service taken into account to a single maximum number of years of service. A uniform points allocation formula need not grant points for units of plan year compensation, but if it does, the unit used must be a single dollar amount for all employees that does not exceed $200.

(B) For the plan year, the average of the allocation rates for the HCEs in the plan must not exceed the average of the allocation rates for the NHCEs in the plan. For this purpose, allocation rates are determined in accordance with paragraph (c)(2) of this section, without imputing permitted disparity and without grouping allocation rates under paragraphs (c)(2)(iv) and (v) of this section, respectively.

(ii) EXAMPLE. The following example illustrates the safe harbor in this paragraph (b)(3):

EXAMPLE. (a) Plan A has a single allocation formula that applies to all employees, under which each employee's allocation for the plan year equals the product of the total of all amounts taken into account for all employees for the plan year under paragraph (c)(2)(ii) of this section and a fraction, the numerator of which is the employee's points for the plan year and the denominator of which is the sum of the points of all employees for the plan year. Plan A grants each employee 10 points for each year of service (including pre-participation service and imputed service credited under Plan A that satisfies section 1.401(a)(4)-11(d)(3)) and one point for each $100 of plan year compensation. For the 1994 plan year, the total allocations are $71,200, and the total points for all employees are 7,120. Each employee's allocation for the 1994 plan year is set forth in the table below.

 Employee  Years of  Plan Year     Points      Amount of    Allocation

(c) For the 1994 plan year, the average allocation rate for the HCEs (H1 through H4) is 11.3 percent, and the average allocation rate for NHCEs (N1 through N4) is 11.3 percent. Because the average of the allocation rates for the HCEs does not exceed the average of the allocation rates for the NHCEs, Plan A satisfies paragraph (b)(3)(i)(B) of this section and, thus, the safe harbor in this paragraph (b)(3) for the 1994 plan year.

(4) USE OF SAFE HARBORS NOT PRECLUDED BY CERTAIN PLAN PROVISIONS -- (i) IN GENERAL. A plan does not fail to satisfy this paragraph (b) merely because the plan contains one or more of the provisions described in this paragraph (b)(4). Unless otherwise provided, any such provision must apply uniformly to all employees.

(ii) ENTRY DATES. The plan provides one or more entry dates during the plan year as permitted by section 410(a)(4).

(iii) CERTAIN CONDITIONS ON ALLOCATIONS. The plan provides that an employee's allocation for the plan year is conditioned on either the employee's employment on the last day of the plan year or the employee's completion of a minimum number of hours of service during the plan year (not to exceed 1,000), or both. Such a provision may include an exception from this condition for all employees whose employment terminates during the plan year or only for those employees whose employment terminates during the plan year on account of one or more of the following circumstances: retirement, disability, death, or military service.

(iv) CERTAIN LIMITS ON ALLOCATIONS. The plan limits allocations otherwise provided under the allocation formula to a maximum dollar amount or a maximum percentage of plan year compensation, limits the dollar amount of plan year compensation taken into account in determining the amount of allocations, or applies the restrictions of section 409(n) or the limits of section 415.

(v) LOWER ALLOCATIONS FOR HCEs. The allocations provided to one or more HCEs under the plan are less than the allocations that would otherwise be provided to those employees if the plan satisfied this paragraph (b) (without regard to this paragraph (b)(4)(v)).

(vi) MULTIPLE FORMULAS -- (A) GENERAL RULE. The plan provides that an employee's allocation under the plan is the greater of the allocations determined under two or more formulas, or is the sum of the allocations determined under two or more formulas. This paragraph (b)(4)(vi) does not apply to a plan unless each of the formulas under the plan satisfies the requirements of paragraph (b)(4)(vi)(B) through (D) of this section.

(B) SOLE FORMULAS. The formulas must be the only formulas under the plan.

(C) SEPARATE TESTING. Each of the formulas must separately satisfy this paragraph (b). A formula that is available solely to some or all NHCEs is deemed to satisfy this paragraph (b)(4)(vi)(C).

(D) AVAILABILITY -- (1) GENERAL RULE. All of the formulas must be available on the same terms to all employees.

(2) FORMULAS FOR NHCEs. A formula does not fail to be available on the same terms to all employees merely because the formula is not available to any HCEs, but is available to some or all NHCEs on the same terms as all of the other formulas in the plan.

(3) TOP-HEAVY FORMULAS. In the case of a plan that provides the greater of the allocations under two or more formulas, one of which is a top-heavy formula, the top-heavy formula does not fail to be available on the same terms to all employees merely because it is available solely to all non-key employees on the same terms as all the other formulas under the plan. Furthermore, the top-heavy formula does not fail to be available on the same terms as the other formulas under the plan merely because it is conditioned on the plan's being top-heavy within the meaning of section 416(g). Finally, the top- heavy formula does not fail to be available on the same terms as the other formulas under the plan merely because it is available to all employees described in section 1.416-1, Q&A M-10 (i.e., all non-key employees who have not separated from service as of the last day of the plan year). The preceding sentence does not apply, however, unless the plan would satisfy section 410(b) if all employees who are benefiting under the plan solely as a result of receiving allocations under the top-heavy formula were treated as not currently benefiting under the plan. For purposes of this paragraph (b)(4)(vi)(D)(3), a top-heavy formula is a formula that provides the minimum benefit described in section 416(c)(2) (taking into account, if applicable, the modification in section 416(h)(2)(A)(ii)(II)).

(E) PROVISIONS MAY BE APPLIED MORE THAN ONCE. The provisions of this paragraph (b)(4)(vi) may be applied more than once. For example, a plan satisfies this paragraph (b) if an employee's allocation under the plan is the greater of the allocations under two or more formulas, and one or more of those formulas is the sum of the allocations under two or more other formulas, provided that each of the formulas under the plan satisfies the requirements of paragraph (b)(4)(vi)(B) through (D) of this section.

(F) EXAMPLES. The following examples illustrate the rules in this paragraph (b)(4)(vi):

EXAMPLE 1. Under Plan A, each employee's allocation equals the sum of the allocations determined under two formulas. The first formula provides an allocation of five percent of plan year compensation. The second formula provides an allocation of $100. Plan A satisfies this paragraph (b)(4)(vi).

EXAMPLE 2. Under Plan B, each employee's allocation equals the greater of the allocations determined under two formulas. The first formula provides an allocation of seven percent of plan year compensation and is available to all employees who complete at least 1,000 hours of service during the plan year and who have not separated from service as of the last day of the plan year. The second formula is a top-heavy formula that provides an allocation of three percent of plan year compensation and that is available to all employees described in section 1.416-1, Q&A M-10. Plan B does not satisfy the general rule in paragraph (b)(4)(vi)(D)(1) of this section because the two formulas are not available on the same terms to all employees (i.e., an employee is required to complete 1,000 hours of service during the plan year to receive an allocation under the first formula, but not under the second formula). Nonetheless, because the second formula is a top-heavy formula, the special availability rules for top-heavy formulas in paragraph (b)(4)(vi)(D)(3) of this section apply. Thus, the second formula does not fail to be available on the same terms as the first formula merely because the second formula is available to all employees described in section 1.416-1, Q&A M- 10, as long as the plan would satisfy section 410(b) if all employees who are benefiting under the plan solely as a result of receiving allocations under the top-heavy formula were treated as not currently benefiting under the plan. This is true even if the plan conditions the availability of the second formula on the plan's being top-heavy for the plan year.

EXAMPLE 3. The facts are the same as in Example 2, except that the first formula is available to all employees who have not separated from service as of the last day of the plan year, regardless of whether they complete at least 1,000 hours of service during the plan year. Plan B still does not satisfy the general rule in paragraph (b)(4)(vi)(D)(1) of this section because the two formulas are not available on the same terms to all employees (i.e., the second formula is only available to all non-key employees). Nonetheless, because the second formula is a top-heavy formula, the special availability rules for top-heavy formulas in paragraph (b)(4)(vi)(D)(3) of this section apply. Thus, the second formula does not fail to be available on the same terms as the first formula merely because the second formula is available solely to all non-key employees.

(c) GENERAL TEST FOR NONDISCRIMINATION IN AMOUNT OF CONTRIBUTIONS -- (i) GENERAL RULE. The employer contributions allocated under a defined contribution plan are nondiscriminatory in amount for a plan year if each rate group under the plan satisfies section 410(b). For purposes of this paragraph (c), a rate group exists under a plan for each HCE and consists of the HCE and all other employees in the plan (both HCEs and NHCEs) who have an allocation rate greater than or equal to the HCE's allocation rate. Thus, an employee is in the rate group for each HCE who has an allocation rate less than or equal to the employee's allocation rate.

(2) DETERMINATION OF ALLOCATION RATES -- (i) GENERAL RULE. The allocation rate for an employee for a plan year equals the sum of the allocations to the employee's account for the plan year, expressed either as a percentage of plan year compensation or as a dollar amount.

(ii) ALLOCATIONS TAKEN INTO ACCOUNT. The amounts taken into account in determining allocation rates for a plan year include all employer contributions and forfeitures that are allocated or treated as allocated to the account of an employee under the plan for the plan year, other than amounts described in paragraph (c)(2)(iii) of this section. For this purpose, employer contributions include annual additions described in section 1.415-6(b)(2)(i) (regarding amounts arising from certain transactions between the plan and the employer). In the case of a deemed contribution plan subject to section 412, an employer contribution is taken into account in the plan year for which it is required to be contributed and allocated to employees' accounts under the plan, even if all or part of the required contribution is not actually made.

(iii) ALLOCATIONS NOT TAKEN INTO ACCOUNT. Allocations of income, expenses, gains, and losses attributable to the balance in an employee's account are not taken into account in determining allocation rates.

(iv) IMPUTATION OF PERMITTED DISPARITY. The disparity permitted under section 401(l) may be imputed in accordance with the rules of section 1.401(a)(4)-7.

(v) GROUPING OF ALLOCATION RATES -- (A) GENERAL RULE. An employer may treat all employees who have allocation rates within a specified range above and below a midpoint rate chosen by the employer as having an allocation rate equal to the midpoint rate within that range. Allocation rates within a given range may not be grouped under this paragraph (c)(2)(v) if the allocation rates of HCEs within the range generally are significantly higher than the allocation rates of NHCEs in the range. The specified ranges within which all employees are treated as having the same allocation rate may not overlap and may be no larger than provided in paragraph (c)(2)(v)(B) of this section. Allocation rates of employees that are not within any of these specified ranges are determined without regard to this paragraph (c)(2)(v).

(B) SIZE OF SPECIFIED RANGES. The lowest and highest allocation rates in the range must be within five percent (not five percentage points) of the midpoint rate. If allocation rates are determined as a percentage of plan year compensation, the lowest and highest allocation rates need not be within five percent of the midpoint rate, if they are no more than one quarter of a percentage point above or below the midpoint rate.

(vi) CONSISTENCY REQUIREMENT. Allocation rates must be determined in a consistent manner for all employees for the plan year.

(3) SATISFACTION OF SECTION 410(b) BY A RATE GROUP -- (i) GENERAL RULE. For purposes of determining whether a rate group satisfies section 410(b), the rate group is treated as if it were a separate plan that benefits only the employees included in the rate group for the plan year. Thus, for example, under section 1.401(a)(4)-1(c)(4)(iv), the ratio percentage of the rate group is determined taking into account all nonexcludable employees regardless of whether they benefit under the plan. Paragraph (c)(3)(ii) and (iii) of this section provide additional special rules for determining whether a rate group satisfies section 410(b).

(ii) APPLICATION OF NONDISCRIMINATORY CLASSIFICATION TEST. A rate group satisfies the nondiscriminatory classification test of section 1.410(b)-4 (including the reasonable classification requirement of section 1.410(b)-4(b)) if and only if the ratio percentage of the rate group is greater than or equal to the lesser of --

(A) The midpoint between the safe and the unsafe harbor percentages applicable to the plan; and

(B) The ratio percentage of the plan.

(iii) APPLICATION OF AVERAGE BENEFIT PERCENTAGE TEST. A rate group satisfies the average benefit percentage test of section 1.410(b)-5 if the plan of which it is a part satisfies section 1.410(b)-5 (without regard to section 1.410(b)-5(f)). In the case of a plan that relies on section 1.410(b)-5(f) to satisfy the average benefit percentage test, each rate group under the plan satisfies the average benefit percentage test (if applicable) only if the rate group separately satisfies section 1.410(b)-5(f).

(4) EXAMPLES. The following examples illustrate the general test in this paragraph (c):

EXAMPLE 1. Employer X maintains two defined contribution plans, Plan A and Plan B, that are aggregated and treated as a single plan for purposes of sections 410(b) and 401(a)(4) pursuant to section 1.410(b)-7(d). For the 1994 plan year, Employee M has plan year compensation of $10,000 and receives an allocation of $200 under Plan A and an allocation of $800 under Plan B. Employee M's allocation rate under the aggregated plan for the 1994 plan year is 10 percent (i.e., $1,000 divided by $10,000).

EXAMPLE 2. The employees in Plan C have the following allocation rates (expressed as a percentage of plan year compensation): 2.75 percent, 2.80 percent, 2.85 percent, 3.25 percent, 6.65 percent, 7.33 percent, 7.34 percent, and 7.35 percent. Because the first four rates are within a range of no more than one quarter of a percentage point above and below 3.0 percent (a midpoint rate chosen by the employer), under paragraph (c)(2)(v) of this section the employer may treat the employees who have those rates as having an allocation rate of 3.0 percent (provided that the allocation rates of HCEs within the range generally are not significantly higher than the allocation rates of NHCEs within the range). Because the last four rates are within a range of no more than five percent above and below 7.0 percent (a midpoint rate chosen by the employer), the employer may treat the employees who have those rates as having an allocation rate of 7.0 percent (provided that the allocation rates of HCEs within the range generally are not significantly higher than the allocation rates of NHCEs within the range).

EXAMPLE 3. (a) Employer Y has only six nonexcludable employees, all of whom benefit under Plan D. The HCEs are H1 and H2, and the NHCEs are N1 through N4. For the 1994 plan year, H1 and N1 through N4 have an allocation rate of 5.0 percent of plan year compensation. For the same plan year, H2 has an allocation rate of 7.5 percent of plan year compensation.

(b) There are two rate groups under Plan D. Rate group 1 consists of H1 and all those employees who have an allocation rate greater than or equal to H1's allocation rate (5.0 percent). Thus, rate group 1 consists of H1, H2, and N1 through N4. Rate group 2 consists only of H2 because no other employee has an allocation rate greater than or equal to H2's allocation rate (7.5 percent).

(c) The ratio percentage for rate group 2 is zero percent -- i.e., zero percent (the percentage of all nonhighly compensated nonexcludable employees who are in the rate group) divided by 50 percent (the percentage of all highly compensated nonexcludable employees who are in the rate group). Therefore rate group 2 does not satisfy the ratio percentage test under section 1.410(b)-2(b)(2). Rate group 2 also does not satisfy the nondiscriminatory classification test of section 1.410(b)-4 (as modified by paragraph (c)(3) of this section). Rate group 2 therefore does not satisfy section 410(b) and, as a result, Plan D does not satisfy the general test in paragraph (c)(1) of this section. This is true regardless of whether rate group 1 satisfies section 1.410(b)-2(b)(2).

EXAMPLE 4. (a) The facts are the same as in EXAMPLE 3, except that N4 has an allocation rate of 8.0 percent.

(b) There are two rate groups in Plan D. Rate group 1 consists of H1 and all those employees who have an allocation rate greater than or equal to H1's allocation rate (5.0 percent). Thus, rate group 1 consists of H1, H2 and N1 through N4. Rate group 2 consists of H2, and all those employees who have an allocation rate greater than or equal to H2's allocation rate (7.5 percent). Thus, rate group 2 consists of H2 and N4.

(c) Rate group 1 satisfies the ratio percentage test under section 1.410(b)-2(b)(2) because the ratio percentage of the rate group is 100 percent -- i.e., 100 percent (the percentage of all nonhighly compensated nonexcludable employees who are in the rate group) divided by 100 percent (the percentage of all highly compensated nonexcludable employees who are in the rate group).

(d) Rate group 2 does not satisfy the ratio percentage test of section 1.410(b)-2(b)(2) because the ratio percentage of the rate group is 50 percent -- i.e., 25 percent (the percentage of all nonhighly compensated nonexcludable employees who are in the rate group) divided by 50 percent (the percentage of all highly compensated nonexcludable employees who are in the rate group).

(e) However, rate group 2 does satisfy the nondiscriminatory classification test of section 1.410(b)-4 because the ratio percentage of the rate group (50 percent) is greater than the safe harbor percentage applicable to the plan under section 1.410(b)-4(c)(4) (45.5 percent).

(f) Under paragraph (c)(3)(iii) of this section, rate group 2 satisfies the average benefit percentage test, if Plan D satisfies the average benefit percentage test. (The requirement that Plan D satisfy the average benefit percentage test applies even though Plan D satisfies the ratio percentage test and would ordinarily not need to run the average benefit percentage test.) If Plan D satisfies the average benefit percentage test, then rate group 2 satisfies section 410(b) and thus, Plan D satisfies the general test in paragraph (c)(1) of this section, because each rate group under the plan satisfies section 410(b).

EXAMPLE 5. (a) Plan E satisfies section 410(b) by satisfying the nondiscriminatory classification test of section 1.410(b)-4 and the average benefit percentage test of section 1.410(b)-5 (without regard to section 1.410(b)-5(f)). See section 1.410(b)-2(b)(3). Plan E uses the facts-and- circumstances requirements of section 1.410(b)-4(c)(3) to satisfy the nondiscriminatory classification test of section 1.410(b)-4. The safe and unsafe harbor percentages applicable to the plan under section 1.410(b)-4(c)(4) are 29 and 20 percent, respectively. Plan E has a ratio percentage of 22 percent.

(b) Rate group 1 under Plan E has a ratio percentage of 23 percent. Under paragraph (c)(3)(ii) of this section, the rate group satisfies the nondiscriminatory classification requirement of section 1.410(b)-4, because the ratio percentage of the rate group (23 percent) is greater than the lesser of --

(1) The ratio percentage for the plan as a whole (22 percent); and

(2) The midpoint between the safe and unsafe harbor percentages (24.5 percent).

(c) Under paragraph (c)(3)(iii) of this section, the rate group satisfies section 410(b) because the plan satisfies the average benefit percentage test of section 1.410(b)-5.

SECTION 1.401(a)(4)-3 NONDISCRIMINATION IN AMOUNT OF EMPLOYER- PROVIDED BENEFITS UNDER A DEFINED BENEFIT PLAN.

(a) INTRODUCTION -- (1) OVERVIEW. This section provides rules for determining whether the employer-provided benefits under a defined benefit plan are nondiscriminatory in amount as required by section 1.401(a)(4)-1(b)(2)(iii). Certain defined benefit plans that provide uniform benefits are permitted to satisfy this requirement by meeting one of the safe harbors in paragraph (b) of this section. Plans that do not provide uniform benefits may satisfy this requirement by satisfying the general test in paragraph (c) of this section. Paragraph (d) of this section provides rules for determining the individual benefit accrual rates needed for the general test. Paragraph (e) of this section provides rules for determining compensation for purposes of applying the requirements of this section. Paragraph (f) of this section provides additional rules that apply generally for purposes of both the safe harbors in paragraph (b) of this section and the general test in paragraph (c) of this section. See section 1.401(a)(4)-6 for rules for determining the amount of employer-provided benefits under a contributory DB plan, and for determining whether the employee-provided benefits under such a plan are nondiscriminatory in amount.

(2) ALTERNATIVE METHODS OF SATISFYING NONDISCRIMINATORY AMOUNT REQUIREMENT. A defined benefit plan is permitted to satisfy paragraph (b) or (c) of this section on a restructured basis pursuant to section 1.401(a)(4)-9(c). Alternatively, a defined benefit plan is permitted to satisfy the nondiscriminatory amount requirement of section 1.401(a)(4)-1(b)(2)(iii) on the basis of equivalent allocations pursuant to section 1.401(a)(4)-8(c). In addition, a defined benefit plan that is part of a floor-offset arrangement is permitted to satisfy this section pursuant to section 1.401(a)(4)- 8(d).

(b) SAFE HARBORS -- (1) IN GENERAL. The employer-provided benefits under a defined benefit plan are nondiscriminatory in amount for a plan year if the plan satisfies each of the uniformity requirements of paragraph (b)(2) of this section and any one of the safe harbors in paragraphs (b)(3) (unit credit plans), (b)(4) (fractional accrual plans), and (b)(5) (insurance contract plans) of this section. Paragraph (b)(6) of this section provides exceptions for certain plan provisions that do not cause a plan to fail to satisfy this paragraph (b). Paragraph (f) of this section provides additional rules that apply in determining whether a plan satisfies this paragraph (b).

(2) UNIFORMITY REQUIREMENTS -- (i) UNIFORM NORMAL RETIREMENT BENEFIT. The same benefit formula must apply to all employees. The benefit formula must provide all employees with an annual benefit payable in the same form commencing at the same uniform normal retirement age. The annual benefit must be the same percentage of average annual compensation or the same dollar amount for all employees who will have the same number of years of service at normal retirement age. (See section 1.401(a)(4)-11(d)(3) regarding service that may be taken into account as years of service.) The annual benefit must equal the employee's accrued benefit at normal retirement age (within the meaning of section 411(a)(7)(A)(i)) and must be the normal retirement benefit under the plan (within the meaning of section 411(a)(9)).

(ii) UNIFORM POST-NORMAL RETIREMENT BENEFIT. With respect to an employee with a given number of years of service at any age after normal retirement age, the annual benefit commencing at that employee's age must be the same percentage of average annual compensation or the same dollar amount that would be payable commencing at normal retirement age to an employee who had that same number of years of service at normal retirement age.

(iii) UNIFORM SUBSIDIES. Each subsidized optional form of benefit available under the plan must be currently available (within the meaning of section 1.401(a)(4)-4(b)(2)) to substantially all employees. Whether an optional form of benefit is considered subsidized for this purpose may be determined using any reasonable actuarial assumptions.

(iv) NO EMPLOYEE CONTRIBUTIONS. The plan must not be a contributory DB plan.

(v) PERIOD OF ACCRUAL. Each employee's benefit must be accrued over the same years of service that are taken into account in applying the benefit formula under the plan to that employee. For this purpose, any year in which the employee benefits under the plan (within the meaning of section 1.410(b)-3(a)) is included as a year of service in which a benefit accrues. Thus, for example, a plan does not satisfy the safe harbor in paragraph (b)(4) of this section unless the plan uses the same years of service to determine both the normal retirement benefit under the plan's benefit formula and the fraction by which an employee's fractional rule benefit is multiplied to derive the employee's accrued benefit as of any plan year.

(vi) EXAMPLES. The following examples illustrate the rules in this paragraph (b)(2):

EXAMPLE 1. Plan A provides a normal retirement benefit equal to two percent of average annual compensation times each year of service commencing at age 65 for all employees. Plan A provides that employees of Division S receive their benefit in the form of a straight life annuity and that employees of Division T receive their benefit in the form of a life annuity with an automatic cost-of-living increase. Plan A does not provide a uniform normal retirement benefit within the meaning of paragraph (b)(2)(i) of this section because the annual benefit is not payable in the same form to all employees.

EXAMPLE 2. Plan B provides a normal retirement benefit equal to 1.5 percent of average annual compensation times each year of service at normal retirement age for all employees. The normal retirement age under the plan is the earlier of age 65 or the age at which the employee completes 10 years of service, but in no event earlier than age 62. Plan B does not provide a uniform normal retirement benefit within the meaning of paragraph (b)(2)(i) of this section because the same uniform normal retirement age does not apply to all employees.

EXAMPLE 3. Plan C is an accumulation plan under which the benefit for each year of service equals one percent of plan year compensation payable in the same form to all employees commencing at the same uniform normal retirement age. Under paragraph (e)(2) of this section, an accumulation plan may substitute plan year compensation for average annual compensation. Plan C provides a uniform normal retirement benefit within the meaning of paragraph (b)(2)(i) of this section, because all employees with the same number of years of service at normal retirement age will receive an annual benefit that is treated as the same percentage of average annual compensation.

EXAMPLE 4. The facts are the same as in EXAMPLE 3, except that the benefit for each year of service equals one percent of plan year compensation increased by reference to the increase in the cost of living from the year of service to normal retirement age. Plan C does not provide a uniform normal retirement benefit, because the annual benefit defined by the benefit formula can vary for employees with the same number of years of service at normal retirement age, depending on the age at which those years of service were credited to the employee under the plan.

EXAMPLE 5. Plan D provides a normal retirement benefit of 50 percent of average annual compensation at normal retirement age (age 65) for employees with 30 years of service at normal retirement age. Plan D provides that, in the case of an employee with less than 30 years of service at normal retirement age, the normal retirement benefit is reduced on a pro rata basis for each year of service less than 30. However, if an employee with less than 30 years of service at normal retirement age continues to work past normal retirement age, Plan D provides that the additional years of service worked past normal retirement age are taken into account for purposes of the 30 years of service requirement. Thus, an employee who has 26 years of service at age 65 but who does not retire until age 69 with 30 years of service will receive a benefit of 50 percent of average annual compensation. Plan D provides uniform post-normal retirement benefits within the meaning of paragraph (b)(2)(ii) of this section.

EXAMPLE 6. (a) Plan E is amended on February 14, 1994, to provide an early retirement window benefit that consists of an unreduced early retirement benefit to employees who terminate employment after attainment of age 55 with 10 years of service and between June 1, 1994, and November 30, 1994. The early retirement window benefit is a single subsidized optional form of benefit. Paragraph (b)(2)(iii) of this section requires that the subsidized optional form of benefit be currently available (within the meaning of section 1.401(a)(4)-4(b)(2)) to substantially all employees. Section 1.401(a)(4)-4(b)(2)(ii)(A)(2) provides that age and service requirements are not disregarded in determining the current availability of an optional form of benefit if those requirements must be satisfied within a specified period of time. Thus, the early retirement window benefit is not currently available to an employee unless the employee will satisfy the eligibility requirements for the early retirement window benefit by the close of the early retirement window benefit period. Plan E will fail to satisfy paragraph (b)(2)(iii) of this section unless substantially all of the employees satisfy the eligibility requirements for the early retirement window benefit by November 30, 1994. However, see section 1.401(a)(4)-9(c)(6), EXAMPLE 2 for an example of how a plan with an early retirement window benefit may be restructured into two component plans, each of which satisfies the safe harbors of this paragraph (b).

(b) A similar analysis would apply if, instead of an unreduced early retirement benefit, the early retirement window benefit consisted of a special schedule of early retirement factors, defined by starting with the plan's usual schedule and then treating each employee eligible for the early retirement window benefit as being five years older than the employee actually is, but not older than the employee's normal retirement age.

EXAMPLE 7. Plan F generally provides a normal retirement benefit of 1.5 percent of an employee's average annual compensation multiplied by the employee's years of service with the employer. For employees transferred outside of the group of employees covered by the plan, the plan's benefit formula takes into account only years of service prior to the transfer, but determines average annual compensation taking into account section 414(s) compensation both before and after the transfer. Plan F does not satisfy the requirements of paragraph (b)(2)(v) of this section with respect to transferred employees, because their benefits are accrued over years of service (i.e., after transfer) that are not taken into account in applying the plan's benefit formula to them. However, see EXAMPLE 2 of paragraph (b)(6)(x)(B) of this section for an example of how a plan that continues to take transferred employees' section 414(s) compensation into account after their transfer may still satisfy this paragraph (b).

(3) SAFE HARBOR FOR UNIT CREDIT PLANS -- (i) GENERAL RULE. A plan satisfies the safe harbor in this paragraph (b)(3) for a plan year if it satisfies both of the following requirements:

(A) The plan must satisfy the 133 1/3 percent accrual rule of section 411(b)(1)(B).

(B) Each employee's accrued benefit under the plan as of any plan year must be determined by applying the plan's benefit formula to the employee's years of service and (if applicable) average annual compensation, both determined as of that plan year.

(ii) EXAMPLE. The following example illustrates the rules in this paragraph (b)(3):

EXAMPLE. Plan A provides that the accrued benefit of each employee as of any plan year equals the employee's average annual compensation times a percentage that depends on the employee's years of service determined as of that plan year. The percentage is two percent for each of the first 10 years of service, plus 1.5 percent for each of the next 10 years of service, plus two percent for all additional years of service. Plan A satisfies this paragraph (b)(3).

(4) SAFE HARBOR FOR PLANS USING FRACTIONAL ACCRUAL RULE -- (i) GENERAL RULE. A plan satisfies the safe harbor in this paragraph (b)(4) for a plan year if it satisfies each of the following requirements:

(A) The plan must satisfy the fractional accrual rule of section 411(b)(1)(C).

(B) Each employee's accrued benefit under the plan as of any plan year before the employee reaches normal retirement age must be determined by multiplying the employee's fractional rule benefit (within the meaning of section 1.411(b)-1(b)(3)(ii)(A)) by a fraction, the numerator of which is the employee's years of service determined as of the plan year, and the denominator of which is the employee's projected years of service as of normal retirement age.

(C) The plan must satisfy one of the following requirements:

(1) Under the plan, it must be impossible for any employee to accrue in a plan year a portion of the normal retirement benefit described in paragraph (b)(2)(i) of this section that is more than one third larger than the portion of the same benefit accrued in that or any other plan year by any other employee, when each portion of the benefit is expressed as a percentage of each employee's average annual compensation or as a dollar amount. In making this determination, actual and potential employees in the plan with any amount of service at normal retirement must be taken into account (other than employees with more than 33 years of service at normal retirement age). In addition, in the case of a plan that satisfies section 401(l) in form, an employee is treated as accruing benefits at a rate equal to the excess benefit percentage in the case of a defined benefit excess plan or at a rate equal to the gross benefit percentage in the case of an offset plan.

(2) The normal retirement benefit under the plan must be a flat benefit that requires a minimum of 25 years of service at normal retirement age for an employee to receive the unreduced flat benefit, determined without regard to section 415. For this purpose, a flat benefit is a benefit that is the same percentage of average annual compensation or the same dollar amount for all employees who have a minimum number of years of service at normal retirement age (e.g., 50 percent of average annual compensation), with a pro rata reduction in the flat benefit for employees who have less than the minimum number of years of service at normal retirement age. An employee is permitted to accrue the maximum benefit permitted under section 415 over a period of less than 25 years, provided that the flat benefit under the plan, determined without regard to section 415, can accrue over no less than 25 years.

(3) The plan must satisfy the requirements of paragraph (b)(4)(i)(C)(2) of this section (other than the requirement that the minimum number of years of service for receiving the unreduced flat benefit is at least 25 years), and, for the plan year, the average of the normal accrual rates for all nonhighly compensated nonexcludable employees must be at least 70 percent of the average of the normal accrual rates for all highly compensated nonexcludable employees. The averages in the preceding sentence are determined taking into account all nonexcludable employees (regardless of whether they benefit under the plan). In addition, contributions and benefits under other plans of the employer are disregarded. For purposes of this paragraph (b)(4)(i)(C)(3), normal accrual rates are determined under paragraph (d) of this section.

(ii) EXAMPLES. The following examples illustrate the rules in this paragraph (b)(4). In each example, it is assumed that the plan has never permitted employee contributions.

EXAMPLE 1. Plan A provides a normal retirement benefit equal to 1.6 percent of average annual compensation times each year of service up to 25. Plan A further provides that an employee's accrued benefit as of any plan year equals the employee's fractional rule benefit multiplied by a fraction, the numerator of which is the employee's years of service as of the plan year, and the denominator of which is the employee's projected years of service as of normal retirement age. The greatest benefit that an employee could accrue in any plan year is 1.6 percent of average annual compensation (this is the case for an employee with 25 or fewer years of projected service at normal retirement age). Among potential employees with 33 or fewer years of projected service at normal retirement age, the lowest benefit that an employee could accrue in any plan year is 1.212 percent of average annual compensation (this is the case for an employee with 33 years of projected service at normal retirement age). Plan A satisfies paragraph (b)(4)(i)(C)(1) of this section because 1.6 percent is not more than one third larger than 1.212 percent.

EXAMPLE 2. Plan B provides a normal retirement benefit equal to 1.0 percent of average annual compensation up to the integration level, and 1.6 percent of average annual compensation above the integration level, times each year of service up to 35. Plan B further provides that an employee's accrued benefit as of any plan year equals the employee's fractional rule benefit multiplied by a fraction, the numerator of which is the employee's years of service as of the plan year and the denominator of which is the employee's projected years of service as of normal retirement age. For purposes of satisfying the one third larger rule in paragraph (b)(4)(i)(C)(1) of this section, because Plan B satisfies section 401(l) in form, all employees with less than 35 projected years of service are assumed to accrue benefits at the rate of 1.6 percent of average annual compensation (the excess benefit percentage under the plan). Plan B satisfies paragraph (b)(4)(i)(C) of this section because all employees with 33 or fewer years of projected service at normal retirement age accrue in each plan year a benefit of 1.6 percent of average annual compensation.

EXAMPLE 3. Plan C provides a normal retirement benefit equal to four percent of average annual compensation times each year of service up to 10 and one percent of average annual compensation times each year of service in excess of 10 and not in excess of 30. Plan C further provides that an employee's accrued benefit as of any plan year equals the employee's fractional rule benefit multiplied by a fraction, the numerator of which is the employee's years of service as of the plan year, and the denominator of which is the employee's projected years of service as of normal retirement age. The greatest benefit that an employee could accrue in any plan year is four percent of average annual compensation (this is the case for an employee with 10 or fewer years of projected service at normal retirement age). Among employees with 33 or fewer years of projected service at normal retirement age, the lowest benefit that an employee could accrue in a plan year is 1.82 percent of average annual compensation (this is the case of an employee with 33 years of projected service at normal retirement age). Plan C fails to satisfy this paragraph (b)(4) because four percent is more than one third larger than 1.82 percent. See also section 1.401(a)(4)-9(c)(6), EXAMPLE 3.

EXAMPLE 4. Plan D provides a normal retirement benefit of 100 percent of average annual compensation, reduced by four percentage points for each year of service below 25 the employee has at normal retirement age. Plan D further provides that an employee's accrued benefit as of any plan year is equal to the employee's fractional rule benefit multiplied by a fraction, the numerator of which is the employee's years of service as of the plan year, and the denominator of which is the employee's projected years of service at normal retirement age. In the case of an employee who has five years of service as of the current plan year, and who is projected to have 10 years of service at normal retirement age, the employee's fractional rule benefit would be 40 percent of average annual compensation, and the employee's accrued benefit as of the current plan year would be 20 percent of average annual compensation (the fractional rule benefit multiplied by a fraction of five years over 10 years). Plan D satisfies this paragraph (b)(4).

EXAMPLE 5. The facts are the same as in EXAMPLE 4, except that the normal retirement benefit is 125 percent of average annual compensation, reduced by five percentage points for each year of service below 25 that the employee has at normal retirement age. Plan D satisfies this paragraph (b)(4), even though an employee may accrue the maximum benefit allowed under section 415 (i.e., 100 percent of the participant's average compensation for the high three years of service) in less than 25 years.

EXAMPLE 6. The facts are the same as in EXAMPLE 1, except that the plan determines each employee's accrued benefit by multiplying the employee's projected normal retirement benefit (rather than the fractional rule benefit) by the fraction described in EXAMPLE 1. In determining an employee's projected normal retirement benefit, the plan defines each employee's average annual compensation as the average annual compensation the employee would have at normal retirement age if the employee's annual section 414(s) compensation in future plan years equaled the employee's plan year compensation for the prior plan year. Under these facts, Plan A does not satisfy paragraph (b)(4)(i)(B) of this section because the employee's accrued benefit is determined on the basis of a projected normal retirement benefit that is not the same as the employee's fractional rule benefit determined in accordance with section 1.411(b)-1(b)(3)(ii)(A).

EXAMPLE 7. Plan E provides a normal retirement benefit of 50 percent of average annual compensation, with a pro rata reduction for employees with less than 30 years of service at normal retirement age. Plan E further provides that an employee's accrued benefit as of any plan year is equal to the employee's fractional rule benefit multiplied by a fraction, the numerator of which is the employee's years of service as of the plan year, and the denominator of which is the employee's projected years of service at normal retirement age. For purposes of determining this fraction, the plan limits the years of service taken into account for an employee to the number of years the employee has participated in the plan. However, all years of service (including years of service before the employee commenced participation in the plan) are taken into account in determining an employee's normal retirement benefit under the plan's benefit formula. Plan E fails to satisfy this paragraph (b)(4) because the years of service over which benefits accrue differ from the years of service used in applying the benefit formula under the plan. See paragraph (b)(2)(v) of this section.

EXAMPLE 8. (a) Plan F provides a normal retirement benefit equal to 2.0 percent of average annual compensation, plus 0.65 percent of average annual compensation above covered compensation, for each year of service up to 25. Plan F further provides that an employee's accrued benefit as of any plan year equals the sum of --

(1) The employee's fractional rule benefit (determined as if the normal retirement benefit under the plan equaled 2.0 percent of average annual compensation for each year of service up to 25) multiplied by a fraction, the numerator of which is the employee's years of service as of the plan year and the denominator of which is the employee's projected years of service as of normal retirement age; plus

(2) 0.65 percent of the employee's average annual compensation above covered compensation multiplied by the employee's years of service (up to 25) as of the current plan year.

(b) Although Plan F satisfies the fractional accrual rule of section 411(b)(1)(C), the plan fails to satisfy this paragraph (b)(4) because the plan does not determine employees' accrued benefits in accordance with paragraph (b)(4)(i)(B) of this section.

(5) SAFE HARBOR FOR INSURANCE CONTRACT PLANS. A plan satisfies the safe harbor in this paragraph (b)(5) if it satisfies each of the following requirements:

(i) The plan must satisfy the accrual rule of section 411(b)(1)(F).

(ii) The plan must be an insurance contract plan within the meaning of section 412(i).

(iii) The benefit formula under the plan must be one that would satisfy the requirements of paragraph (b)(4) of this section if the stated normal retirement benefit under the formula accrued ratably over each employee's period of plan participation through normal retirement age in accordance with paragraph (b)(4)(i)(B) of this section. Thus, the benefit formula may not recognize years of service before an employee commenced participation in the plan because, otherwise, the definition of years of service for determining the normal retirement benefit would differ from the definition of years of service for determining the accrued benefit under paragraph (b)(4)(i)(B) of this section. See paragraph (b)(4)(ii), EXAMPLE 7, of this section. Notwithstanding the foregoing, an insurance contract plan adopted and in effect on September 19, 1991, may continue to recognize years of service prior to an employee's participation in the plan for an employee who is a participant in the plan on that date to the extent provided by the benefit formula in the plan on such date.

(iv) The scheduled premium payments under an individual or group insurance contract used to fund an employee's normal retirement benefit must be level annual payments to normal retirement age. Thus, payments may not be scheduled to cease before normal retirement age.

(v) The premium payments for an employee who continues benefiting after normal retirement age must be equal to the amount necessary to fund additional benefits that accrue under the plan's benefit formula for the plan year.

(vi) Experience gains, dividends, forfeitures, and similar items must be used solely to reduce future premiums.

(vii) All benefits must be funded through contracts of the same series. Among other requirements, contracts of the same series must have cash values based on the same terms (including interest and mortality assumptions) and the same conversion rights. A plan does not fail to satisfy this requirement, however, if any change in the contract series or insurer applies on the same terms to all employees. But see section 1.401(a)(4)-5(a)(4), EXAMPLE 12 (change in insurer considered a plan amendment subject to section 1.401(a)(4)- 5(a)).

(viii) If permitted disparity is taken into account, the normal retirement benefit stated under the plan's benefit formula must satisfy section 1.401(l)-3. For this purpose, the 0.75-percent factor in the maximum excess or offset allowance in section 1.401(l)- 3(b)(2)(i) or (b)(3)(i), respectively, adjusted in accordance with section 1.401(l)-3(d)(9) and (e), is reduced by multiplying the factor by 0.80.

(6) USE OF SAFE HARBORS NOT PRECLUDED BY CERTAIN PLAN PROVISIONS -- (i) IN GENERAL. A plan does not fail to satisfy this paragraph (b) merely because the plan contains one or more of the provisions described in this paragraph (b)(6). Unless otherwise provided, any such provision must apply uniformly to all employees.

(ii) SECTION 401(l) PERMITTED DISPARITY. The plan takes permitted disparity into account in a manner that satisfies section 401(l) in form. Thus, differences in employees' benefits under the plan attributable to uniform disparities permitted under section 1.401(l)-3 (including differences in disparities that are deemed uniform under section 1.401(l)-3(c)(2)) do not cause a plan to fail to satisfy this paragraph (b).

(iii) DIFFERENT ENTRY DATES. The plan provides one or more entry dates during the plan year as permitted by section 410(a)(4).

(iv) CERTAIN CONDITIONS ON ACCRUALS. The plan provides that an employee's accrual for the plan year is less than a full accrual (including a zero accrual) because of a plan provision permitted by the year-of-participation rules of section 411(b)(4).

(v) CERTAIN LIMITS ON ACCRUALS. The plan limits benefits otherwise provided under the benefit formula or accrual method to a maximum dollar amount or to a maximum percentage of average annual compensation (e.g., by limiting service taken into account in the benefit formula) or in accordance with section 401(a)(5)(D), applies the limits of section 415, or limits the dollar amount of compensation taken into account in determining benefits.

(vi) DOLLAR ACCRUAL PER UNIFORM UNIT OF SERVICE. The plan determines accruals based on the same dollar amount for each uniform unit of service (not to exceed one week) performed by each employee with the same number of years of service under the plan during the plan year. The preceding sentence applies solely for purposes of the unit credit safe harbor in paragraph (b)(3) of this section.

(vii) PRIOR BENEFITS ACCRUED UNDER A DIFFERENT FORMULA. The plan determines benefits for years of service after a fresh-start date for all employees under a benefit formula and accrual method that differ from the benefit formula and accrual method previously used to determine benefit accruals for employees in a fresh-start group for years of service before the fresh-start date. This paragraph (b)(6)(vii) applies solely to plans that satisfy section 1.401(a)(4)- 13(c) with respect to the fresh start.

(viii) EMPLOYEE CONTRIBUTIONS. The plan is a contributory DB plan that would satisfy the requirements of paragraph (b) of this section if the plan's benefit formula provided benefits at employees' employer-provided benefit rates determined under section 1.401(a)(4)- 6(b). This paragraph (b)(6)(viii) does not apply to a plan tested under paragraph (b)(4) or (b)(5) of this section unless the plan satisfies one of the methods in section 1.401(a)(4)-6(b)(4) through (b)(6). A minimum benefit added to the plan solely to satisfy section 1.401(a)(4)-6(b)(3) is not taken into account in determining whether this paragraph (b)(6)(viii) is satisfied.

(ix) CERTAIN SUBSIDIZED OPTIONAL FORMS. The plan provides a subsidized optional form of benefit that is available to fewer than substantially all employees because the optional form of benefit has been eliminated prospectively as provided in section 1.401(a)(4)-4(b)(3).

(x) LOWER BENEFITS FOR HCES -- (A) GENERAL RULE. The benefits (including any subsidized optional form of benefit) provided to one or more HCEs under the plan are inherently less valuable to those HCEs (determined by applying the principles of section 1.401(a)(4)-4(d)(4)) than the benefits that would otherwise be provided to those HCEs if the plan satisfied this paragraph (b) (determined without regard to this paragraph (b)(6)(x)). These inherently less valuable benefits are deemed to satisfy this paragraph (b).

(B) EXAMPLES. The following examples illustrate the rules in this paragraph (b)(6)(x):

EXAMPLE 1. Plan A would satisfy this paragraph (b)(determined without regard to this paragraph (b)(6)(x)), except for the fact that it fails to satisfy the requirement of paragraph (b)(2)(iii) of this section (i.e., a subsidized optional form must be available to substantially all employees on similar terms). Each subsidized optional form in the plan is available to all the NHCEs on similar terms, but one of the subsidized optional forms of benefit is not available to any of the HCEs. Plan A satisfies this paragraph (b), because Plan A is a safe harbor plan with respect to the NHCEs and provides inherently less valuable benefits to the HCEs.

EXAMPLE 2. (a) Plan B would satisfy this paragraph (b) (determined without regard to this paragraph (b)(6)(x)), except for the fact that some employees are not being credited with years of service under the plan, but are continuing to accrue benefits as a result of compensation increases. These are employees who have been transferred from the employer that sponsors Plan B to another member of the controlled group whose employees are not covered by Plan B. For these employees, Plan B fails to satisfy the requirement of paragraph (b)(2)(v) of this section (i.e., each employee's benefit must accrue over the same years of service used in applying the benefit formula).

(b) Plan B is restructured into two component plans under the provisions of section 1.401(a)(4)-9(c). One component plan (Component Plan B1) consists of all NHCEs who are not being credited with years of service under the plan's benefit formula but are continuing to accrue benefits as a result of compensation increases, and the other component plan (Component Plan B2) consists of the balance of the employees.

(c) Component Plan B1 satisfies this section and section 410(b), because it benefits only NHCEs.

(d) Component Plan B2 is treated as satisfying this paragraph (b), because Plan B would satisfy this paragraph (b) (determined without regard to this paragraph (b)(6)(x)) with respect to the employees in Component Plan B2 but for the fact that it provides inherently less valuable benefits to some HCEs in that component plan (i.e., the employees who are credited only with compensation increases rather than both years of service and compensation increases).

(e) Under section 1.401(a)(4)-9(c), if Component Plan B2 satisfies section 410(b), then Plan B satisfies this section.

(xi) MULTIPLE FORMULAS -- (A) GENERAL RULE. The plan provides that an employee's benefit under the plan is the greater of the benefits determined under two or more formulas, or is the sum of the benefits determined under two or more formulas. This paragraph (b)(6)(xi) does not apply to a plan unless each of the formulas under the plan satisfies the requirements of paragraph (b)(6)(xi)(B) through (D) of this section.

(B) SOLE FORMULAS. The formulas must be the only formulas under the plan.

(C) SEPARATE TESTING. Each of the formulas must separately satisfy the uniformity requirements of paragraph (b)(2) of this section and also separately satisfy one of the safe harbors in paragraphs (b)(3) through (b)(5) of this section. A formula that is available solely to some or all NHCEs is deemed to satisfy this paragraph (b)(6)(xi)(C).

(D) AVAILABILITY -- (1) GENERAL RULE. All of the formulas must be available on the same terms to all employees.

(2) FORMULAS FOR NHCES. A formula does not fail to be available on the same terms to all employees merely because the formula is not available to any HCEs, but is available to some or all NHCEs on the same terms as all of the other formulas in the plan.

(3) TOP-HEAVY FORMULAS. Rules parallel to those in section 1.401(a)(4)-2(b)(4)(vi)(D)(3) apply in the case of a plan that provides the greater of the benefits under two or more formulas, one of which is a top-heavy formula. For purposes of this paragraph (b)(6)(xi)(D)(3), a top-heavy formula is a formula that provides a benefit equal to the minimum benefit described in section 416(c)(1) (taking into account, if applicable, the modification in section 416(h)(2)(A)(ii)(I)).

(E) PROVISIONS MAY BE APPLIED MORE THAN ONCE. The provisions of this paragraph (b)(6)(xi) may be applied more than once. See section 1.401(a)(4)-2(b)(4)(vi)(E) for an example of the application of these provisions more than once.

(F) EXAMPLES. The following examples illustrate the rules in this paragraph (b)(6)(xi):

EXAMPLE 1. Under Plan A, each employee's benefit equals the sum of the benefits determined under two formulas. The first formula provides one percent of average annual compensation per year of service. The second formula provides $10 per year of service. Plan A is eligible to apply the rules in this paragraph (b)(6)(xi).

EXAMPLE 2. Under Plan B, each employee's benefit equals the greater of the benefits determined under two formulas. The first formula provides $15 per year of service and is available to all employees who complete at least 500 hours of service during the plan year. The second formula provides 1.5 percent of average annual compensation per year of service and is available to all employees who complete at least 1,000 hours of service during the plan year. Plan B does not satisfy this paragraph (b)(6)(xi) because the two formulas are not available on the same terms to all employees.

EXAMPLE 3. Under Plan C, each employee's benefit equals the greater of the benefits determined under two formulas. The first formula provides $15 per year of service and is available to all employees who complete at least 1,000 hours of service during the plan year. The second formula provides the minimum benefit described in section 416(c)(1) and is available to all non-key employees who complete at least 1,000 hours of service during the plan year. Plan C does not satisfy the general rule in paragraph (b)(6)(xi)(D)(1) of this section because the two formulas are not available on the same terms to all employees (i.e., the second formula is only available to all non-key employees). Nonetheless, because the second formula is a top- heavy formula, the special availability rules for top-heavy formulas in paragraph (b)(6)(xi)(D)(3) of this section apply. Thus, the second formula does not fail to be available on the same terms as the first formula merely because the second formula is available solely to all non-key employees on the same terms. This is true even if the plan conditions the availability of the second formula on the plan's being top-heavy for the plan year.

EXAMPLE 4. Under Plan D, each employee's benefit equals the greater of the benefits determined under two formulas. The first formula is available to all employees and provides a benefit equal to 1.5 percent of average annual compensation per year of service. The second formula is only available to NHCEs and provides a benefit equal to two percent of average annual compensation per year of service, minus two percent of the primary insurance amount per year of service. The amount of the offset is not limited to the maximum permitted offset under section 1.401(l)-3(b). Under paragraph (b)(6)(xi)(D)(2) of this section, both formulas are treated as available to all employees on the same terms. Furthermore, even though the second formula does not satisfy any of the safe harbors in this paragraph (b), the formula is deemed to satisfy the separate testing requirement under paragraph (b)(6)(xi)(C) of this section, because the formula is available solely to some or all NHCEs.

EXAMPLE 5. Plan E is a unit credit plan that provides a benefit of one percent of average annual compensation per year of service to all employees. In 1994, the plan is amended to provide a benefit of two percent of average annual compensation per year of service after 1993, while continuing to provide a benefit of one percent of average annual compensation per year of service for all years of service before 1994. Thus, the plan's amended benefit formula provides a benefit equal to the sum of the benefits determined under two benefit formulas: one percent of average annual compensation per year of service, plus one percent of average annual compensation per year of service after 1993. Plan E satisfies this paragraph (b)(6)(xi).

EXAMPLE 6. The facts are the same as in Example 5, except that the plan amendment in 1994 decreases the benefit to 0.75 percent of average annual compensation per year of service after 1993, while retaining the one-percent formula for all years of service before 1994. Thus, the plan's amended benefit formula provides a benefit equal to the sum of the benefits determined under two benefit formulas: 0.75 percent of average annual compensation per year of service, plus 0.25 percent of average annual compensation per year of service before 1994. Under these facts, the second formula does not separately satisfy any of the safe harbors in this paragraph (b) because the years of service over which each employee's benefit accrues under the second formula (i.e., all years of service) are not the same years of service that are taken into account in applying the benefit formula under the plan to that employee (i.e., years of service before 1994). See paragraph (b)(2)(v) of this section. But see paragraph (b)(6)(vii) of this section and section 1.401(a)(4)- 13, which provide rules under which Plan E, as amended, may be able to satisfy this paragraph (b).

EXAMPLE 7. Plan F provides a benefit to all employees of one percent of average annual compensation per year of service. Employee M was hired as the president of the employer in December 1994 and was not a HCE under section 414(q) during the 1994 calendar plan year. In 1994, Plan F is amended to provide a benefit that is the greater of the benefit determined under the pre-existing formula in the plan and a new formula that is available solely to some NHCEs (including Employee M). The new formula does not satisfy the uniformity requirements of paragraph (b)(2) of this section, because it provides a different benefit for some NHCEs than for other NHCEs. As a result of this change, Employee M receives a higher accrual in 1994 than the NHCEs who are not eligible for the new formula. In 1995, when Employee M first becomes a HCE, the second formula no longer applies to Employee M. It would be inconsistent with the purpose of preventing discrimination in favor of HCEs for Plan F to use the special rule for a formula that is available solely to some or all NHCEs to satisfy the separate testing requirement of paragraph (b)(6)(xi)(C) of this section for the 1994 calendar plan year. See section 1.401(a)(4)-1(c)(2).

(c) GENERAL TEST FOR NONDISCRIMINATION IN AMOUNT OF BENEFITS -- (1) GENERAL RULE. The employer-provided benefits under a defined benefit plan are nondiscriminatory in amount for a plan year if each rate group under the plan satisfies section 410(b). For purposes of this paragraph (c)(1), a rate group exists under a plan for each HCE and consists of the HCE and all other employees (both HCEs and NHCEs) who have a normal accrual rate greater than or equal to the HCE's normal accrual rate, and who also have a most valuable accrual rate greater than or equal to the HCE's most valuable accrual rate. Thus, an employee is in the rate group for each HCE who has a normal accrual rate less than or equal to the employee's normal accrual rate, and who also has a most valuable accrual rate less than or equal to the employee's most valuable accrual rate.

(2) SATISFACTION OF SECTION 410(b) BY A RATE GROUP. For purposes of determining whether a rate group satisfies section 410(b), the same rules apply as in section 1.401(a)(4)-2(c)(3). See paragraph (c)(4) of this section and section 1.401(a)(4)-2(c)(4), Example 3 through Example 5, for examples of this rule.

(3) CERTAIN VIOLATIONS DISREGARDED. A plan is deemed to satisfy paragraph (c)(1) of this section if the plan would satisfy that paragraph by treating as not benefiting no more than five percent of the HCEs in the plan, and the Commissioner determines that, on the basis of all of the relevant facts and circumstances, the plan does not discriminate with respect to the amount of employer-provided benefits. For this purpose, five percent of the number of HCEs may be determined by rounding to the nearest whole number (e.g., 1.4 rounds to 1 and 1.5 rounds to 2). Among the relevant factors that the Commissioner may consider in making this determination are --

(i) The extent to which the plan has failed the test in paragraph (c)(1) of this section;

(ii) The extent to which the failure is for reasons other than the design of the plan;

(iii) Whether the HCEs causing the failure are five-percent owners or are among the highest paid nonexcludable employees;

(iv) Whether the failure is attributable to an event that is not expected to recur (e.g., a plant closing); and

(v) The extent to which the failure is attributable to benefits accrued under a prior benefit structure or to benefits accrued when a participant was not a HCE.

(4) EXAMPLES. The following examples illustrate the rules in this paragraph (c):

EXAMPLE 1. (a) Employer X has 1100 nonexcludable employees, N1 through N1000, who are NHCEs, and HI through H100, who are HCEs. Employer X maintains Plan A, a defined benefit plan that benefits all of these nonexcludable employees. The normal and most valuable accrual rates (determined as a percentage of average annual compensation) for the employees in Plan A for the 1994 plan year are listed in the following table.

 Normal              Most Valuable

(c) Rate group 1 consists of H1 and all those employees who have a normal accrual rate greater than or equal to H1's normal accrual rate (1.5 percent) and who also have a most valuable accrual rate greater than or equal to H1's most valuable accrual rate (2.0 percent). Thus, rate group 1 consists of HI through H100 and N101 through N1000.

(d) Rate group 1 satisfies the ratio percentage test of section 1.410(b)-2(b)(2) because the ratio percentage of the rate group is 90 percent, i.e., 90 percent (the percentage of all nonhighly compensated nonexcludable employees who are in the rate group) divided by 100 percent (the percentage of all highly compensated nonexcludable employees who are in the rate group).

(e) Because H1 through H50 have the same normal accrual rates and the same most valuable accrual rates, the rate group with respect to each of them is identical. Thus, because rate group 1 satisfies section 410(b), rate groups 2 through 50 also satisfy section 410(b).

(f) Rate group 51 consists of H51 and all those employees who have a normal accrual rate greater than or equal to H51's normal accrual rate (2.0 percent) and who also have a most valuable accrual rate greater than or equal to H51's most valuable accrual rate (2.65 percent). Thus, rate group 51 consists of H51 through H100 and N501 through N1000. (Even though N101 through N500 have a most valuable accrual rate (3.0 percent) greater than H51's most valuable accrual rate (2.65 percent), they are not included in this rate group because their normal accrual rate (1.5 percent) is less than H51's normal accrual rate (2.0 percent).)

(g) Rate group 51 satisfies the ratio percentage test of section 1.410(b)-2(b)(2) because the ratio percentage of the rate group is 100 percent, i.e., 50 percent (the percentage of all nonhighly compensated nonexcludable employees who are in the rate group) divided by 50 percent (the percentage of all highly compensated nonexcludable employees who are in the rate group).

(h) Because H51 through H100 have the same normal accrual rates and the same most valuable accrual rates, the rate group with respect to each of them is identical. Thus, because rate group 51 satisfies section 410(b), rate groups 52 through 100 also satisfy section 410(b).

(i) The employer-provided benefits under Plan A are nondiscriminatory in amount because each rate group under the plan satisfies section 410(b).

EXAMPLE 2. The facts are the same as in EXAMPLE 1, except that H96 has a most valuable accrual rate of 3.5. Each of the rate groups is the same as in EXAMPLE 1, except that rate group 96 consists solely of H96 because no other employee has a most valuable accrual rate greater than 3.5. Because the plan would satisfy the test in paragraph (c)(1) of this section by treating H96 (who constitutes less than five percent of the HCEs in the plan) as not benefiting, the Commissioner may determine under paragraph (c)(3) of this section that, on the basis of all of the relevant facts and circumstances, the plan does not discriminate with respect to the amount of benefits.

(d) DETERMINATION OF ACCRUAL RATES -- (1) DEFINITIONS -- (i) NORMAL ACCRUAL RATE. The normal accrual rate for an employee for a plan year is the increase in the employee's accrued benefit (within the meaning of section 411(a)(7)(A)(i)) during the measurement period, divided by the employee's testing service during the measurement period, and expressed either as a dollar amount or as a percentage of the employee's average annual compensation.

(ii) MOST VALUABLE ACCRUAL RATE. The most valuable accrual rate for an employee for a plan year is the increase in the employee's most valuable optional form of payment of the accrued benefit during the measurement period, divided by the employee's testing service during the measurement period, and expressed either as a dollar amount or as a percentage of the employee's average annual compensation. The employee's most valuable optional form of payment of the accrued benefit is determined by calculating for the employee the normalized QJSA associated with the accrued benefit that is potentially payable in the current or any future plan year at any age under the plan and selecting the largest (per year of testing service). If the plan provides a QSUPP, the most valuable accrual rate also takes into account the QSUPP payable in conjunction with the QJSA at each age under the plan. Thus, the most valuable accrual rate reflects the value of all benefits accrued or treated as accrued under section 411(d)(6) that are payable in any form and at any time under the plan, including early retirement benefits, retirement-type subsidies, early retirement window benefits, and QSUPPs. In addition, the most valuable accrual rate must take into account any such benefits that are available during a plan year, even if the benefits cease to be available before the end of the current or any future plan year.

(iii) MEASUREMENT PERIOD. The measurement period can be --

(A) The current plan year;

(B) The current plan year and all prior years; or

(C) The current plan year and all prior and future years.

(iv) TESTING SERVICE -- (A) GENERAL RULE. Testing service means an employee's years of service as defined in the plan for purposes of applying the benefit formula under the plan, subject to the requirements of paragraph (d)(1)(iv)(B) of this section. Alternatively, testing service means service determined for all employees in a reasonable manner that satisfies the requirements of paragraph (d)(1)(iv)(B) of this section. For example, the number of plan years that an employee has benefited under the plan within the meaning of section 1.410(b)-3(a) is an acceptable definition of testing service because it determines service in a reasonable manner and satisfies paragraph (d)(1)(iv)(B) of this section. See also section 1.401(a)(4)-11(d)(3) (additional limits on service that may be taken into account as testing service).

(B) REQUIREMENTS FOR TESTING SERVICE -- (1) EMPLOYEES NOT CREDITED WITH YEARS OF SERVICE UNDER THE BENEFIT FORMULA. An employee must be credited with testing service for any year in which the employee benefits under the plan (within the meaning of section 1.410(b)-3(a)), unless that year is part of a period of service that may not be taken into account under section 1.401(a)(4)-11(d)(3). This rule applies even if the employee does not receive service credit under the benefit formula for that year (e.g., because of a service cap in the benefit formula or because of a transfer out of the group of employees covered by the plan).

(2) CURRENT YEAR TESTING SERVICE. In the case of a measurement period that is the current plan year, testing service for the plan year equals one (1).

(2) RULES OF APPLICATION -- (i) CONSISTENCY REQUIREMENT. Both normal and most valuable accrual rates must be determined in a consistent manner for all employees for the plan year. Thus, for example, the same measurement periods must be used, and the rules of this paragraph (d)(2) and any available options described in paragraph (d)(3) of this section must be applied consistently. If plan benefits are not expressed as straight life annuities beginning at employees testing ages, they must be normalized.

(ii) DETERMINING PLAN BENEFITS SERVICE AND COMPENSATION -- (A) IN GENERAL. Potential plan benefits, testing service, and average annual compensation must be determined in a reasonable manner, reflecting actual or projected service and compensation only through the end of the measurement period. The determination of potential plan benefits is not reasonable if it incorporates an assumption that, in future years, an employee's compensation will increase or the employee will terminate employment before the employee's testing age (other than the assumptions under paragraph (d)(1)(ii) of this section that the employee's service will end in connection with the payment of each potential QJSA in future years).

(B) SECTION 415 LIMITS. For purposes of determining accrual rates under this paragraph (d), plan benefits are generally determined without regard to whether those benefits are permitted to be paid under section 415. However, plan provisions implementing any of the limits of section 415 may be taken into account in applying this paragraph (d) if the plan does not provide for benefit increases resulting from section 415(d)(1) adjustments for former employees who were employees in a plan year in which such plan provisions were taken into account in applying this paragraph (d). If the limits of section 415 are taken into account under this paragraph (d)(2)(ii)(B) as of the end of the measurement period, they must also be taken into account as of the beginning of the measurement period. If the limits of section 415 are not taken into account in testing the plan for the current plan year, but were taken into account in testing the plan for the preceding plan year, any resulting increase in the accrued benefits taken into account in testing the plan is treated as an increase in accrued benefits during the current plan year.

(iii) REQUIREMENTS FOR MEASUREMENT PERIOD THAT INCLUDES FUTURE YEARS -- (A) DISCRIMINATORY PATTERN OF ACCRUALS. A measurement period that includes future years (as described in paragraph (d)(1)(iii)(C) of this section) may not be used if the pattern of accruals under the plan discriminates in favor of HCEs (i.e., if projected benefits for HCEs are relatively front-loaded when compared to the degree of frontloading or backloading for NHCEs). This determination is made based on all of the relevant facts and circumstances.

(B) FUTURE-PERIOD LIMITATION. Future years beginning after an employee's attainment of the employee's testing age (or after the employee's assumed termination in the case of most valuable accrual rates) may not be included in the measurement period.

(3) OPTIONAL RULES -- (i) IMPUTATION OF PERMITTED DISPARITY. The disparity permitted under section 401(l) may be imputed in accordance with the rules of section 1.401(a)(4)-7.

(ii) GROUPING OF ACCRUAL RATES -- (A) GENERAL RULE. An employer may treat all employees who have accrual rates within a specified range above and below a midpoint rate chosen by the employer as having an accrual rate equal to the midpoint rate within that range. Accrual rates within a given range may not be grouped under this paragraph (d)(3)(ii) if the accrual rates of HCEs within the range generally are significantly higher than the accrual rates of NHCEs in the range. The specified ranges within which all employees are treated as having the same accrual rate may not overlap and may be no larger than provided in paragraph (d)(3)(ii)(B) of this section. Accrual rates of employees that are not within any of these specified ranges are determined without regard to this paragraph (d)(3)(ii).

(B) SIZE OF SPECIFIED RANGES. In the case of normal accrual rates, the lowest and highest accrual rates in the range must be within five percent (not five percentage points) of the midpoint rate. In the case of most valuable accrual rates, the lowest and highest accrual rates in the range must be within 15 percent (not 15 percentage points) of the midpoint rate. If accrual rates are determined as a percentage of average annual compensation, the lowest and highest accrual rates need not be within five percent (or 15 percent) of the midpoint rate, if they are no more than one twentieth of a percentage point above or below the midpoint rate.

(iii) FRESH-START ALTERNATIVE -- (A) GENERAL RULE. Notwithstanding the definition of measurement period provided in paragraph (d)(1)(iii) of this section, a measurement period for a fresh-start group is permitted to be limited to the period beginning after the fresh-start date with respect to that group if the plan makes a fresh start that satisfies section 1.401(a)(4)-13(c) (without regard to section 1.401(a)(4)-13(c)(2)(i) and (ii)). If the measurement period is so limited or the measurement period is the plan year (whether or not so limited), any compensation adjustments during the measurement period to the frozen accrued benefit as of the fresh-start date that are permitted under the rules of section 1.401(a)(4)-13(d) may be disregarded in determining the increase in accrued benefits during the measurement period, but only if --

(1) The plan makes a fresh start as of the fresh-start date that satisfies section 1.401(a)(4)-13(c) (without regard to section 1.401(a)(4)-13(c)(2)(ii)) in conjunction with a bona fide amendment to the benefit formula or accrual method under the plan; and

(2) The amendment provides for adjustments to employees' frozen accrued benefits as of the fresh-start date in accordance with the rules of section 1.401(a)(4)-13(d).

(B) APPLICATION OF CONSISTENCY REQUIREMENTS. Limiting the application of the fresh-start alternative in this paragraph (d)(3)(iii) to a fresh-start group that consists of fewer than all employees does not violate the consistency requirement of paragraph (d)(2)(i) of this section.

(iv) FLOOR ON MOST VALUABLE ACCRUAL RATE. In lieu of determining an employee's most valuable accrual rate in accordance with the definition in paragraph (d)(1)(ii) of this section, an employer may determine an employee's most valuable accrual rate for the current plan year as the employee's highest most valuable accrual rate determined for any prior plan year. This option may be used only if the employee's normal accrual rate has not changed significantly from the normal accrual rate for the relevant prior plan year and, there have been no plan amendments in the interim period since that prior plan year that affect the determination of most valuable accrual rate.

(4) EXAMPLES. The following examples illustrate the rules in this paragraph (d):

EXAMPLE 1. The employees in Plan A have the following normal accrual rates (expressed as percentage of average annual compensation): 0.8 percent, 0.83 percent, 0.9 percent, 1.9 percent, 2.0 percent, and 2.1 percent. Because the first three rates are within a range of no more than one twentieth of a percentage point above or below 0.85 percent (a midpoint rate chosen by the employer), the employer may treat the employees who have those rates as having an accrual rate of 0.85 percent (provided that the accrual rates of HCEs within the range are not significantly higher than the accrual rates for NHCEs within the range). Because the last three rates are within a range of no more than five percent above or below 2.0 percent (a midpoint rate chosen by the employer), the employer may treat the employees who have those rates as having an accrual rate of 2.0 percent (provided that the accrual rates of HCEs within the range are not significantly higher than the accrual rates for NHCEs within the range).

EXAMPLE 2. Employer X maintains a plan under which headquarters employees accrue a benefit of 1.25 percent of average compensation for the first 10 years of service and 0.75 percent of average compensation for subsequent years of service, while all other employees accrue a benefit of one percent of compensation for all years of service. Assume that the group of headquarters employees does not satisfy section 410(b). Under these facts, the pattern of accruals under the plan discriminates in favor of HCEs, and, therefore, under paragraph (d)(2)(iii)(A) of this section, the measurement period for determining accrual rates under the plan may not include future service.

(e) COMPENSATION RULES -- (1) IN GENERAL. This paragraph (e) provides rules for determining average annual compensation. Safe harbor plans that satisfy paragraph (b) of this section must determine benefits either as a dollar amount unrelated to employees' compensation or as a percentage of each employee's average annual compensation. In contrast, plans that must satisfy the general test of paragraph (c) of this section are not required under this section to determine benefits under any particular definition of compensation or in any particular manner, but the accrual rates used in testing these plans must be expressed either as a dollar amount or determined as a percentage of each employee's average annual compensation.

(2) AVERAGE ANNUAL COMPENSATION -- (i) GENERAL RULE. An employee's average annual compensation is the average of the employee's annual section 414(s) compensation determined over the averaging period in the employee's compensation history during which the average of the employee's annual section 414(s) compensation is the highest. For this purpose, an averaging period must consist of three or more consecutive 12-month periods, but need not be longer than the employee's period of employment. An employee's compensation history may begin at any time, but must be continuous, be no shorter than the averaging period, and end in the current plan year.

(ii) CERTAIN PERMITTED MODIFICATIONS TO AVERAGE ANNUAL COMPENSATION -- (A) USE OF PLAN YEAR COMPENSATION. If the measurement period for determination of accrual rates is the current plan year, or the plan is an accumulation plan that satisfies paragraph (b) of this section, then plan year compensation may be substituted for average annual compensation.

(B) DROP-OUT YEARS. Any of the following types of 12-month periods in an employee's compensation history may be disregarded in determining the employee's average annual compensation (including for purposes of the requirement to average section 414(s) compensation over consecutive 12-month periods), but only if the plan disregards the employee's compensation for those periods in determining benefits --

(1) The 12-month period in which the employee terminates employment;

(2) All 12-month periods in which the employee performs no services; or

(3) All 12-month periods in which the employee performs services for less than a specified number of hours or specified period of time in the 12-month period. The specified number of hours or specified period of time may be selected by the employer, but may not exceed three quarters of the time that an employee in the same job category working on a full-time basis would perform services during that 12-month period.

(C) DROP-OUT MONTHS WITHIN 12-MONTH PERIODS. If a plan determines an employee's average annual compensation using 12-month periods that do not end on a fixed date (e.g., average annual compensation as of a date is defined as the average of the employee's section 414(s) compensation for the 60 consecutive months within the compensation history in which the average is highest), then, for purposes of determining a 12-month period, any of the following type of months may be disregarded (including for purposes of the requirement to average section 414(s) compensation over consecutive 12-month periods), but only if the plan disregards the employee's compensation for those months in determining benefits --

(1) The month in which the employee terminates employment;

(2) All months in which the employee performs no services; or

(3) All months in which the employee performs services for less than a specified number of hours or specified period of time in the month. The specified number of hours or specified period of time may be selected by the employer, but may not exceed three quarters of the time that an employee in the same job category working on a full-time basis would perform services during that month.

(D) EMPLOYEES WORKING LESS THAN FULL-TIME. In the case of an employee who normally works less than full-time, the rules in paragraphs (e)(2)(ii)(B)(3) and (e)(2)(ii)(C)(3) of this section may be applied in relation to that employee's normal work schedule (instead of a full-time employee's work schedule) by prorating the specified number of hours or specified period of time, based on the employee's normal work schedule as a fraction of a full-time schedule.

(E) EXCEPTION FROM CONSECUTIVE-PERIODS REQUIREMENT FOR CERTAIN PLANS. The requirement that the periods taken into account under paragraph (e)(2)(i) of this section be consecutive does not apply in the case of a plan that is not a section 401(l) plan, provided that it does not take permitted disparity into account under section 1.401(a)(4)-7. This paragraph (e)(2)(ii)(E) applies only if the plan does not take into account whether 12-month periods of compensation are consecutive in determining average compensation for purposes of calculating benefits.

(iii) CONSISTENCY REQUIREMENTS. Average annual compensation must be determined in a consistent manner for all employees.

(3) EXAMPLES. The following examples illustrate the rules in this paragraph (e):

EXAMPLE 1. Plan A is a defined benefit plan. Plan A determines benefits on the basis of the average of each employee's annual compensation for the five consecutive plan years (or the employee's period of employment, if shorter) during the employee's compensation history in which the average of the employee's annual compensation is the highest. The compensation history used for this purpose is the last 10 plan years, plus the current plan year. In determining compensation for each plan year in the compensation history, Plan A defines compensation using a single definition that satisfies section 414(s) as a safe harbor definition under section 1.414(s)-1(c). Plan A determines benefits on the basis of average annual compensation.

EXAMPLE 2. Plan B is a defined benefit plan. Plan B determines benefits on the basis of the average of each employee's compensation for the five consecutive 12-month periods (or the employee's period of employment, if shorter) during the employee's compensation history in which the average of the employee's annual compensation is the highest. The compensation history used for this purpose is the 10 consecutive 12-month periods ending on the employee's termination date. In determining the average, Plan B disregards all months in which the employee performs services for less than 100 hours (60 percent of a full-time work schedule of 173 hours). In the case of an employee whose normal work schedule is less than a full- time schedule, Plan B disregards all months in which that employee performs services for less than 60 percent of the employee's normal work schedule. Plan B defines compensation for each 12-month period using a single definition that satisfies section 1.414(s)-1. Plan B determines benefits on the basis of average annual compensation.

EXAMPLE 3. (a) The facts are the same as in Example 1, except that, for plan years prior to 1996, the compensation for a plan year was determined under a rate of pay definition of compensation that satisfies section 414(s), while, for plan years after 1995, the compensation for a plan year is determined using a definition that satisfies section 414(s) as a safe harbor definition under section 1.414(s)-1(c).

(b) The underlying definition of compensation for each plan year in the employee's compensation history is section 414(s) compensation, because for each plan year the definition satisfies the requirements for section 414(s) compensation under section 1.401(a)(4)-12. Therefore, Plan A determines benefits on the basis of average annual compensation, even though the underlying definition used to measure the amount of compensation for each plan year in an employee's compensation history is not the same for all plan years.

EXAMPLE 4. The facts are the same as in Example 1, except that Plan A determines benefits on the basis of the average of the employee's annual section 414(s) compensation for the five consecutive 12-month periods ending on June 30 during the employee's compensation history in which the average is highest. An employee's compensation history begins when the employee commences participation in the plan and ends in the current plan year. In the case of an employee with less than five consecutive years of plan participation as of June 30, the compensation history is extended prior to the employee's commencement of participation to include the five consecutive 12-month periods ending on June 30 of the current plan year (or the employee's total period of employment, if shorter). Plan A determines benefits on the basis of average annual compensation.

EXAMPLE 5. The facts are the same as in Example 4, except that Plan A determines benefits on the basis of the average of each employee's compensation for the employee's entire compensation history. Plan A determines benefits on the basis of average annual compensation.

(f) SPECIAL RULES -- (1) IN GENERAL. The special rules in this paragraph (f) apply for purposes of applying the provisions of this section to a defined benefit plan. Any special rule provided in this paragraph (f) that is optional must, if used, apply uniformly to all employees.

(2) CERTAIN QUALIFIED DISABILITY BENEFITS. In general, qualified disability benefits (within the meaning of section 411(a)(9)) are not taken into account under this section. However, a qualified disability benefit that results from the crediting of compensation or service for a period of disability in the same manner as actual compensation or service is credited under a plan's benefit formula is permitted to be taken into account under this section as an accrued benefit upon the employee's return to service with the employer following the period of disability, provided that the qualified disability benefit is then treated in the same manner as an accrued benefit for all purposes under the plan.

(3) ACCRUALS AFTER NORMAL RETIREMENT AGE -- (i) GENERAL RULE. An employee's accruals for any plan year after the plan year in which the employee attains normal retirement age are taken into account for purposes of this section. However, any plan provision that provides for increases in an employee's accrued benefit solely because the employee has delayed commencing benefits beyond the normal retirement age applicable to the employee under the plan may be disregarded, but only if --

(A) The same uniform normal retirement age applies to all employees; and

(B) The percentage factor used to increase the employee's accrued benefit is no greater than the largest percentage factor that could be applied to increase actuarially the employee's accrued benefit using any standard mortality table and any standard interest rate.

(ii) EXAMPLES. The following examples illustrate the rules of this paragraph (f)(3). In each example, it is assumed that the plan satisfies the requirements of paragraph (f)(3)(i)(A) and (B) of this section.

EXAMPLE 1. Plan A provides a benefit of two percent of average annual compensation per year of service for all employees. In addition, Plan A provides an actuarial increase in an employee's accrued benefit of six percent for each year that an employee defers commencement of benefits beyond normal retirement age. For employees who continue in service beyond normal retirement age, the employee's two-percent accrual for the current plan year is offset by the six-percent actuarial increase, as permitted under section 411(b)(1)(H)(iii)(II). For purposes of this section, the actuarial increase (and hence the offset) may be disregarded, and thus all employees may be treated as if they were accruing at the rate of two percent of average annual compensation per year.

EXAMPLE 2. The facts are the same as in Example 1, except that the employee's two-percent accrual for the current plan year is not offset by the six-percent actuarial increase. The employer may disregard the actuarial increase and thus may treat all employees as if they were accruing at the rate of two percent of average annual compensation per year.

(4) EARLY RETIREMENT WINDOW BENEFITS -- (i) GENERAL RULE. In applying the requirements of this section, all early retirement benefits, retirement-type subsidies, QSUPPs, and other optional forms of benefit under a plan, and changes in the plan's benefit formula, are taken into account regardless of whether they are permanent features of the plan or are offered only to employees whose employment terminates within a limited period of time. Additional rules and examples relevant to the testing of early retirement window benefits are found in Example 6 of paragraph (b)(2)(vi) of this section; paragraph (b)(2)(ii)(A)(2), Example 2 of paragraph (c)(2), paragraph (d)(3), and Example 3 of paragraph (e)(1)(iii) of section 1.401(a)(4)-4; paragraph (c)(4)(i) and Example 2 of paragraph (c)(6) of section 1.401(a)(4)-9; and the definition of benefit formula in section 1.401(a)(4)-12.

(ii) SPECIAL RULES -- (A) YEAR IN WHICH EARLY RETIREMENT WINDOW BENEFIT TAKEN INTO ACCOUNT. Notwithstanding paragraph (f)(4)(i) of this section, an early retirement window benefit is disregarded for purposes of determining whether a plan satisfies this section with respect to an employee for all plan years other than the first plan year in which the benefit is currently available (within the meaning of section 1.401(a)(4)-4(b)(2)) to the employee. For purposes of this paragraph (f)(4)(ii)(A), in determining which plan years the benefit is currently available, an early retirement window benefit that consists of a temporary change in the plan's benefit formula is treated as an optional form of benefit.

(B) TREATMENT OF EARLY RETIREMENT WINDOW BENEFIT THAT CONSISTS OF TEMPORARY CHANGE IN BENEFIT FORMULA. An early retirement window benefit is disregarded for purposes of determining an employee's normal accrual rate, even if the early retirement window benefit consists of a temporary change in a plan's benefit formula. However, if an early retirement window benefit consists of a temporary change in a plan's benefit formula, the plan does not satisfy paragraph (b) of this section during the period for which the change is effective unless the plan satisfies paragraph (b) of this section both reflecting the temporary change in the benefit formula and disregarding that change.

(C) EFFECT OF EARLY RETIREMENT WINDOW BENEFIT ON MOST VALUABLE ACCRUAL RATE. In determining an employee's most valuable optional form of payment of the accrued benefit (which is used in determining the employee's most valuable accrual rate under paragraphs (d)(1)(ii) and (f)(4)(i) of this section), an early retirement window benefit that is currently available to the employee (within the meaning of paragraph (f)(4)(ii)(A) of this section) and that is not disregarded for a plan year under paragraph (f)(4)(ii)(A) of this section is taken into account in that plan year with respect to the employee's accrued benefit as of the earliest of the employee's date of termination, the close of the early retirement window, or the last day of that plan year.

(D) EFFECT OF EARLY RETIREMENT WINDOW BENEFIT ON AVERAGE BENEFIT PERCENTAGE TEST. Notwithstanding paragraph (c)(2) of this section, a rate group under a plan that provides an early retirement window benefit is deemed to satisfy the average benefit percentage test of section 1.410(b)-5 if --

(1) All rate groups under the plan would satisfy the ratio percentage test of section 1.410(b)-2(b)(2) if the early retirement window benefit were disregarded; and

(2) The group of employees to whom the early retirement window benefit is currently available (within the meaning of paragraph (f)(4)(ii)(A) of this section) satisfies section 410(b) without regard to the average benefit percentage test of section 1.410(b)-5.

(iii) EARLY RETIREMENT WINDOW BENEFIT DEFINED. For purposes of this paragraph (f)(4), an early retirement window benefit is an early retirement benefit, retirement-type subsidy, QSUPP, or other optional form of benefit under a plan that is available, or a change in the plan's benefit formula that is applicable, only to employees who terminate employment within a limited period specified by the plan (not to exceed one year) under circumstances specified by the plan. A benefit does not fail to be described in the preceding sentence merely because the plan contains provisions under which certain employees may receive the benefit even though, for bona fide business reasons, they terminate employment within a reasonable period after the end of the limited period. An amendment to an early retirement window benefit that merely extends the periods in the preceding sentences is not treated as a separate early retirement window benefit, provided that the periods, as extended, satisfy the preceding sentences. However, any other amendment to an early retirement window benefit creates a separate early retirement window benefit.

(iv) EXAMPLES. The following examples illustrate the rules of this paragraph (f)(4):

EXAMPLE 1. (a) Plan A provides a benefit of one percent of average annual compensation per year of service and satisfies the requirements of paragraph (b)(2) of this section. Thus, the plan provides the same benefit to all employees with the same years of service under the Plan. Plan A is amended to treat all employees with ten or more years of service who terminate employment after attainment of age 55 and between March 1, 1999, and January 31, 2000, as if they had an additional five years of service under the benefit formula. However, in order to ensure the orderly implementation of the early retirement window, the plan amendment provides that designated employees in the human resources department who would otherwise be eligible for the early retirement window benefit are eligible to be treated as having the additional five years of service only if they terminate between January 1, 2000, and April 30, 2000.

(b) The additional benefits provided under this amendment are tested as benefits provided to employees rather than former employees. The effect of this amendment is temporarily to change the benefit formula for employees who are eligible for the early retirement window benefit because the amendment changes (albeit temporarily) the amount of the benefit payable to those employees at normal retirement age. See the definition of benefit formula in section 1.401(a)(4)-12. Assume that the additional years of service credited to employees eligible for the window benefit do not represent past service (within the meaning of section 1.401(a)(4)-11(d)(3)(i)(B)) or pre- participation or imputed service (within the meaning of section 1.401(a)(4)-11(d)(3)(ii)(A) or (B), respectively) and thus may not be taken into account as years of service. See section 1.401(a)(4)-11(d)(3)(i)(A) (regarding years of service that may not be taken into account under section 1.401(a)(4)-1(b)(2)). Thus, the window-eligible employees are entitled to a larger benefit (as a percentage of average annual compensation) than other employees with the same number of years of service, and the plan does not satisfy the uniform normal retirement benefit requirement of paragraph (b)(2)(i) of this section.

(c) Plan A is restructured under the provisions of section 1.401(a)(4)-9(c) into two component plans: Component Plan A1, consisting of all employees who are not eligible for the early retirement window benefit and all of their accruals and benefits, rights, and features under the plan, and Component Plan A2, consisting of all employees who are eligible for the early retirement window benefit (including the designated employees in the human resource department) and all of their accruals and benefits, rights, and features under the plan.

(d) Component Plan A1 still satisfies paragraph (b) of this section, because there has been no change for the employees in that component plan. Similarly, Component Plan A2 satisfies paragraph (b) of this section disregarding the change in the benefit formula.

(e) Because the early retirement window benefit consists of a temporary change in the benefit formula, paragraph (f)(4)(ii)(B) of this section requires that the plan satisfy the requirements of paragraph (b) of this section reflecting the change in order to remain a safe harbor plan. After reflecting the change, Component Plan A2 still provides the same benefit (albeit higher than under the regular benefit formula) to all employees with the same years of service that may be taken into account in testing the plan, and thus the benefit formula (as temporarily amended) satisfies the requirements of paragraphs (b)(2)(i) and (ii) of this section.

(f) Since Component Plan A2 also satisfies all of the other requirements of paragraph (b)(2) of this section and the safe harbor of paragraph (b)(3) of this section reflecting the change in the benefit formula, Component Plan A2 satisfies this paragraph (b) both reflecting and disregarding the change in the benefit formula. Thus, Component Plan A2 satisfies paragraph (b) of this section.

EXAMPLE 2. The facts are the same as in Example 1, except that Plan A's benefit formula used the maximum amount of permitted disparity under section 401(l) prior to the amendment. The analysis is the same as in paragraphs (a) through the first sentence of paragraph (e) of Example 1. In order to satisfy the requirements of paragraph (b)(2) of this section, a plan that uses permitted disparity must satisfy the requirements of section 401(l) after reflecting the change in the benefit formula. Because, as stated in Example 1, the additional five years of service may not be taken into account for purposes of satisfying paragraph (b) of this section, the disparity that results from crediting that service exceeds the maximum permitted disparity under section 401(l). Thus, Component Plan A2 does not satisfy the requirements of paragraph (b) of this section.

EXAMPLE 3. The facts are the same as in Example 1, except that Plan A is tested under the general test in paragraph (c) of this section. The early retirement window benefit is disregarded for purposes of determining the normal accrual rates, but is taken into account in 1999 for purposes of determining the most valuable accrual rates, of employees who were eligible for the early retirement window benefit (regardless of whether they elected to receive it). As stated in Example 1, the additional five years of service do not represent past service, pre- participation service, or imputed service, and thus under section 1.401(a)(4)-11(d)(3)(i)(A) may not be taken into account as testing service.

(5) UNPREDICTABLE CONTINGENT EVENT BENEFITS -- (i) GENERAL RULE. In general, an unpredictable contingent event benefit (within the meaning of section 412(l)(7)(B)(ii)) is not taken into account under this section until the occurrence of the contingent event. Thus, the special rule in section 1.401(a)(4)-4(d)(7) (treating the contingent event as having occurred) does not apply for purposes of this section. In the case of an unpredictable contingent event that is expected to result in the termination from employment of certain employees within a period of time consistent with the rules for defining an early retirement window benefit in paragraph (f)(4)(iii) of this section, the unpredictable contingent event benefit available to those employees is permitted to be treated as an early retirement window benefit, thus permitting the rules of paragraph (f)(4) of this section to be applied to it.

(ii) EXAMPLE. The following example illustrates the rules of this paragraph (f)(5):

EXAMPLE. (a) Employer X operates various manufacturing plants and maintains Plan A, a defined benefit plan that covers all of its nonexcludable employees. Plan A provides an early retirement benefit under which employees who retire after age 55 but before normal retirement age and who have at least 10 years of service receive a benefit equal to their normal retirement benefit reduced by four percent per year for each year prior to normal retirement age. Plan A also provides a plant-closing benefit under which employees who satisfy the conditions for receiving the early retirement benefit and who work at a plant where operations have ceased and whose employment has been terminated will receive an unreduced normal retirement benefit. The plant-losing benefit is an unpredictable contingent event benefit.

(b) During the 1997 plan year, Employer X had no plant closings. Therefore, the plant-closing benefit is not taken into account for the 1997 plan year in determining accrual rates or in applying the safe harbors in paragraph (b) of this section.

(c) During the 1998 plan year, Employer X begins to close one plant. Employees M through Z, who are employees at the plant that is closing, are expected to terminate employment with Employer X during the plan year and will satisfy the conditions for the plant-closing benefit. Therefore, in testing Plan A under this section for the 1998 plan year, the availability of the plant-losing benefit to Employees M through Z must be taken into account in determining their accrual rates or in determining whether the plan satisfies one of the safe harbors under paragraph (b) of this section.

(d) Because the employees eligible for the unpredictable contingent event benefit are expected to terminate employment with Employer X during a period consistent with the rules for defining an early retirement window benefit, in testing Plan A under this section for the 1998 plan year, the special rules in paragraph (f)(4)(ii) of this section may be applied. Thus, for example, normal accrual rates may be determined without reference to the unpredictable contingent event benefit.

(e) Despite the closing of the plant, Employee Q remains an employee into the 1999 plan year. Under paragraph (f)(4)(ii)(A) of this section, the availability of the plant-closing benefit to Employee Q may be disregarded in the 1999 plan year.

(6) DETERMINATION OF BENEFITS ON OTHER THAN PLAN-YEAR BASIS. For purposes of this section, accruals are generally determined based on the plan year. Nevertheless, an employer may determine accruals on the basis of any period ending within the plan year as long as the period is at least 12 months in duration. For example, accruals for all employees may be determined based on accrual computation periods ending within the plan year.

(7) ADJUSTMENTS FOR CERTAIN CLAN DISTRIBUTIONS. For purposes of this section, an employee's accrued benefit includes the actuarial equivalent of prior distributions of accrued benefits from the plan to the employee if the years of service taken into account in determining the accrued benefits that were distributed continue to be taken into account under the plan for purposes of determining the employee's current accrued benefit. For purposes of this paragraph (f)(7), actuarial equivalence must be determined in a uniform manner for all employees using reasonable actuarial assumptions. A standard interest rate and a standard mortality table are among the assumptions considered reasonable for this purpose. Thus, for example, if an employee has commenced receipt of benefits in accordance with the minimum distribution requirements of section 401(a)(9), and the plan reduces the employee's accrued benefit to take into account the amount of the distributions, the employee's accrued benefit for purposes of this section is restored to the value it would have had if the distributions had not occurred.

(8) ADJUSTMENT FOR CERTAIN QPSA CHARGES. For purposes of this section, an employee's accrued benefit includes the cost of a qualified preretirement survivor annuity (QPSA) that reduces the employee's accrued benefit otherwise determined under the plan, as permitted under section 1.401(a)-20, Q&A-21. Thus, an employee's accrued benefit for purposes of this section is determined as if the cost of the QPSA had not been charged against the accrued benefit. This paragraph (f)(8) applies only if the QPSA charges apply uniformly to all employees.

(9) DISREGARD OF CERTAIN OFFSETS -- (i) GENERAL RULE. For purposes of this section, an employee's accrued benefit under a plan includes that portion of the benefit that is offset under an offset provision described in section 1.401(a)(4)-11(d)(3)(i)(D). The rule in the preceding sentence applies only to the extent that the benefit by which the benefit under the plan being tested is offset is attributable to periods for which the plan being tested credits pre- participation service (within the meaning of section 1.401(a)(4)- 11(d)(3)(ii)(A)) that satisfies section 1.401(a)(4)-11(d)(3)(iii) or past service (within the meaning of section 1.401(a)(4)- 11(d)(3)(i)(B)), and only if --

(A) The benefit under the plan being tested is offset by either --

(1) Benefits under a qualified defined benefit plan or defined contribution plan (whether or not terminated); or

(2) Benefits under a foreign plan that are reasonably expected to be paid; and,

(B) If any portion of the benefit that is offset is nonforfeitable (within the meaning of section 411), that portion is offset by a benefit (or portion of a benefit) that is also nonforfeitable (or vested, in the case of a foreign plan).

(ii) EXAMPLES. The following examples illustrate the rules in this paragraph (f)(9):

EXAMPLE 1. (a) Employer X maintains two qualified defined benefit plans, Plan A and Plan B. Plan B provides that, whenever an employee transfers to Plan B from Plan A, the service that was credited under Plan A is credited in determining benefits under Plan B. The Plan A service credited under Plan B is pre- participation service that satisfies section 1.401(a)(4)- 11(d)(3)(iii). Plan B offsets the benefits determined under Plan B by the employee's vested benefits under Plan A. Plan A does not credit additional benefit service or accrual service after employees transfer to Plan B.

(b) The Plan B provision providing for an offset of benefits under Plan A satisfies section 1.401(a)(4)- 11(d)(3)(i)(D). This is because the provision applies to similarly-situated employees and the benefits under Plan A that are offset against the Plan B benefits are attributable to pre- participation service taken into account under Plan B.

(c) This paragraph (f)(9) applies in determining the benefits that are taken into account under this section for employees in Plan B who are transferred from Plan A. This is because the offset provision is described in section 1.401(a)(4)-11(d)(3)(i)(D), the benefits under the other plan by which the benefits under the plan being tested are offset are attributable solely to pre-participation service that satisfies section 1.401(a)(4)-11(d)(3)(iii), and the benefits are offset solely by vested benefits under another qualified plan. Thus, for example, the accrual rates of employees in Plan B are determined as if there were no offset, i.e., by adding back the benefits that are offset to the net benefits under Plan B.

(d) The result would be the same even if Plan A continued to recognize compensation paid after the transfer in the determination of benefits under Plan A. However, if Plan A continued to credit benefit or accrual service after the transfer, then, to the extent that Plan B's offset of benefits under Plan A increased as a result, the additional benefits offset under Plan B would not be added back in determining the benefits under Plan B that are taken into account under this section.

EXAMPLE 2. The facts are the same as in Example 1, except that Plan A is not a plan described in paragraph (f)(9)(i)(A) of this section. None of the benefits under Plan B that are offset by benefits under Plan A may be added back in determining the benefits under Plan B that are taken into account under this section. Thus, benefits under Plan B are tested on a net basis.

(10) SPECIAL RULE FOR MULTIEMPLOYER PLANS. For purposes of this section, if a multiemployer plan increases benefits for service prior to a specific date subject to a plan provision requiring employees to complete a specified amount of service (not to exceed five years) after that date, then benefits are permitted to be determined disregarding the service condition, provided that the condition is applicable to all employees in the multiemployer plan (including collectively bargained employees).

SECTION 1.401(a)(4)-4 NONDISCRIMINATORY AVAILABILITY OF BENEFITS, RIGHTS, AND FEATURES.

(a) INTRODUCTION. This section provides rules for determining whether the benefits, rights, and features provided under a plan (i.e., all optional forms of benefit, ancillary benefits, and other rights and features available to any employee under the plan) are made available in a nondiscriminatory manner. Benefits, rights, and features provided under a plan are made available to employees in a nondiscriminatory manner only if each benefit, right, or feature satisfies the current availability requirement of paragraph (b) of this section and the effective availability requirement of paragraph (c) of this section. Paragraph (d) of this section provides special rules for applying these requirements. Paragraph (e) of this section defines optional form of benefit, ancillary benefit, and other right or feature.

(b) CURRENT AVAILABILITY -- (1) GENERAL RULE. The current availability requirement of this paragraph (b) is satisfied if the group of employees to whom a benefit, right, or feature is currently available during the plan year satisfies section 410(b) (without regard to the average benefit percentage test of section 1.410(b)-5). In determining whether the group of employees satisfies section 410(b), an employee is treated as benefiting only if the benefit, right, or feature is currently available to the employee.

(2) DETERMINATION OF CURRENT AVAILABILITY -- (i) GENERAL RULE. Whether a benefit, right, or feature that is subject to specified eligibility conditions is currently available to an employee generally is determined based on the current facts and circumstances with respect to the employee (e.g., current compensation, accrued benefit, position, or net worth).

(ii) CERTAIN CONDITIONS DISREGARDED -- (A) CERTAIN AGE AND SERVICE CONDITIONS -- (i) GENERAL RULE. Notwithstanding paragraph (b)(2)(i) of this section, any specified age or service condition with respect to an optional form of benefit or a social security supplement is disregarded in determining whether the optional form of benefit or the social security supplement is currently available to an employee. Thus, for example, an optional form of benefit that is available to all employees who terminate employment on or after age 55 with at least 10 years of service is treated as currently available to an employee, without regard to the employee's current age or years of service, and without regard to whether the employee could potentially meet the age and service conditions prior to attaining the plan's normal retirement age.

(2) TIME-LIMITED AGE OR SERVICE CONDITIONS NOT DISREGARDED. Notwithstanding paragraph (b)(2)(ii)(A)(i) of this section, an age or service condition is not disregarded in determining the current availability of an optional form of benefit or social security supplement if the condition must be satisfied within a limited period of time. However, in determining the current availability of an optional form of benefit or a social security supplement subject to such an age or service condition, the age and service of employees may be projected to the last date by which the age condition or service condition must be satisfied in order to he eligible for the optional form of benefit or social security supplement under the plan. Thus, for example, an optional form of benefit that is available only to employees who terminate employment between July 1, 1995, and December 31, 1995, after attainment of age 55 with at least 10 years of service is treated as currently available to an employee only if the employee could satisfy those age and service conditions by December 31, 1995.

(B) CERTAIN OTHER CONDITIONS. Specified conditions on the availability of a benefit, right, or feature requiring a specified percentage of the employee's accrued benefit to be nonforfeitable, termination of employment, death, satisfaction of a specified health condition (or failure to meet such condition), disability, hardship, family status, default on a plan loan secured by a participant's account balance, execution of a covenant not to compete, application for benefits or similar ministerial or mechanical acts, election of a benefit form, execution of a waiver of rights under the Age Discrimination in Employment Act or other federal or state law, or absence from service, are disregarded in determining the employees to whom the benefit, right, or feature is currently available. In addition, if a multiemployer plan includes a reasonable condition that limits eligibility for an ancillary benefit, or other right or feature, to those employees who have recent service under the plan (e.g., a condition on a death benefit that requires an employee to have a minimum number of hours credited during the last two years) and the condition applies to all employees in the multiemployer plan (including the collectively bargained employees) to whom the ancillary benefit, or other right or feature, is otherwise currently available, then the condition is disregarded in determining the employees to whom the ancillary benefit, or other right or feature, is currently available.

(C) CERTAIN CONDITIONS RELATING TO MANDATORY CASH-OUTS. In the case of a plan that provides for mandatory cash-outs of all terminated employees who have a vested accrued benefit with an actuarial present value less than or equal to a specified dollar amount (not to exceed $3,500) as permitted by sections 411(a)(11) and 417(e), the implicit condition on any benefit, right, or feature (other than the mandatory cash-out) that requires the employee to have a vested accrued benefit with an actuarial present value in excess of the specified dollar amount is disregarded in determining the employees to whom the benefit, right, or feature is currently available.

(D) OTHER DOLLAR LIMITS. A condition that the amount of an employee's vested accrued benefit or the actuarial present value of that benefit be less than or equal to a specified dollar amount is disregarded in determining the employees to whom the benefit, right, or feature is currently available.

(E) CERTAIN CONDITIONS ON PLAN LOANS. In the case of an employee's right to a loan from the plan, the condition that an employee must have an account balance sufficient to be eligible to receive a minimum loan amount specified in the plan (not to exceed $1,000) is disregarded in determining the employees to whom the right is currently available.

(3) BENEFITS, RIGHTS, AND FEATURES THAT ARE ELIMINATED PROSPECTIVELY -- (i) SPECIAL TESTING RULE. Notwithstanding paragraph (b)(1) of this section, a benefit, right, or feature that is eliminated with respect to benefits accrued after the later of the eliminating amendment's adoption or effective date (the elimination date), but is retained with respect to benefits accrued as of the elimination date, and that satisfies this paragraph (b) as of the elimination date, is treated as satisfying this paragraph (b) for all subsequent periods. This rule does not apply if the terms of the benefit, right, or feature (including the employees to whom it is available) are changed after the elimination date.

(ii) ELIMINATION OF A BENEFIT, RIGHT, OR FEATURE -- (A) GENERAL RULE. For purposes of this paragraph (b)(3), a benefit, right, or feature provided to an employee is eliminated with respect to benefits accrued after the elimination date if the amount or value of the benefit, right, or feature depends solely on the amount of the employee's accrued benefit (within the meaning of section 411(a)(7)) as of the elimination date, including subsequent income, expenses, gains, and losses with respect to that benefit in the case of a defined contribution plan.

(B) SPECIAL RULE FOR BENEFITS, RIGHTS, AND FEATURES THAT ARE NOT SECTION 411(D)(6)-PROTECTED BENEFITS. Notwithstanding paragraph (b)(3)(ii)(A) of this section, in the case of a benefit, right, or feature under a defined contribution plan that is not a section 411(d)(6)-protected benefit (within the meaning of section 1.411(d)- 4, Q&A-1), e.g., the availability of plan loans, for purposes of this paragraph (b)(3)(ii) each employee's accrued benefit as of the elimination date may be treated, on a uniform basis, as consisting exclusively of the dollar amount of the employee's account balance as of the elimination date.

(C) SPECIAL RULE FOR BENEFITS, RIGHTS, AND FEATURES THAT DEPEND ON ADJUSTED ACCRUED BENEFITS. For purposes of this paragraph (b)(3), a benefit, right, or feature provided to an employee under a plan that has made a fresh start does not fail to be eliminated as of an elimination date that is the fresh-start date merely because it depends solely on the amount of the employee's adjusted accrued benefit (within the meaning of section 1.401(a)(4)-13(d)(8)).

(c) EFFECTIVE AVAILABILITY -- (1) GENERAL RULE. Based on all of the relevant facts and circumstances, the group of employees to whom a benefit, right, or feature is effectively available must not substantially favor HCEs.

(2) EXAMPLES. The following examples illustrate the rules of this paragraph (c):

EXAMPLE 1. Employer X maintains Plan A, a defined benefit plan that covers both of its highly compensated nonexcludable employees and nine of its 12 nonhighly compensated nonexcludable employees. Plan A provides for a normal retirement benefit payable as an annuity and based on a normal retirement age of 65, and an early retirement benefit payable upon termination in the form of an annuity to employees who terminate from service with the employer on or after age 55 with 30 or more years of service. Both HCEs of Employer X currently meet the age and service requirement, or will have 30 years of service by the time they reach age 55. All but two of the nine NHCEs of Employer X who are covered by Plan A were hired on or after age 35 and, thus, cannot qualify for the early retirement benefit. Even though the group of employees to whom the early retirement benefit is currently available satisfies the ratio percentage test of section 1.410(b)-2(b)(2) when age and service are disregarded pursuant to paragraph (b)(2)(ii)(A) of this section, absent other facts, the group of employees to whom the early retirement benefit is effectively available substantially favors HCEs.

EXAMPLE 2. Employer Y maintains Plan B, a defined benefit plan that provides for a normal retirement benefit payable as an annuity and based on a normal retirement age of 65. By a plan amendment first adopted and effective December 1, 1998, Employer Y amends Plan B to provide an early retirement benefit that is available only to employees who terminate employment by December 15, 1998, and who are at least age 55 with 30 or more years of service. Assume that all employees were hired prior to attaining age 25 and that the group of employees who have, or will have, attained age 55 with 30 years of service by December 15, 1998, satisfies the ratio percentage test of section 1.410(b)-2(b)(2). Assume, further, that the employer takes no steps to inform all eligible employees of the early retirement option on a timely basis and that the only employees who terminate from employment with the employer during the two-week period in which the early retirement benefit is available are HCEs. Under these facts, the group of employees to whom this early retirement window benefit is effectively available substantially favors HCEs.

EXAMPLE 3. Employer Z amends Plan C on June 30, 1999, to provide for a single sum optional form of benefit for employees who terminate from employment with Employer Z after June 30, 1999, and before January 1, 2000. The availability of this single sum optional form of benefit is conditioned on the employee's having a particular disability at the time of termination of employment. The only employee of the employer who meets this disability requirement at the time of the amendment and thereafter through December 31, 1999, is a HCE. Under paragraph (b)(2)(ii)(B) of this section, the disability condition is disregarded in determining the current availability of the single sum optional form of benefit. Nevertheless, under these facts, the group of employees to whom the single sum optional form of benefit is effectively available substantially favors HCEs.

(d) SPECIAL RULES -- (1) MERGERS AND ACQUISITIONS -- (i) SPECIAL TESTING RULE. A benefit, right, or feature available under a plan solely to an acquired group of employees is treated as satisfying paragraphs (b) and (c) of this section during the period that each of the following requirements is satisfied:

(A) The benefit, right, or feature must satisfy paragraphs (b) and (c) of this section (determined without regard to the special rule in section 410(b)(6)(C)) on the date that is selected by the employer as the latest date by which an employee must be hired or transferred into the acquired trade or business for an employee to be included in the acquired group of employees. This determination is made with reference to the plan of the current employer and its nonexcludable employees.

(B) The benefit, right, or feature must be available under the plan of the current employer after the transaction on the same terms as it was available under the plan of the prior employer before the transaction. This requirement is not violated merely because of a change made to the benefit, right, or feature that is permitted by section 411(d)(6), provided that --

(1) The change is a replacement of the benefit, right, or feature with another benefit, right, or feature that is available to the same employees as the original benefit, right, or feature, and the original benefit, right, or feature is of inherently equal or greater value (within the meaning of paragraph (d)(4)(i)(A) of this section) than the benefit, right, or feature that replaces it; or

(2) The change is made before January 12, 1993.

(ii) SCOPE OF SPECIAL TESTING RULE. This paragraph (d)(1) applies only to benefits, rights, and features with respect to benefits accruing under the plan of the current employer, and not to benefits, rights, and features with respect to benefits accrued under the plan of the prior employer (unless, pursuant to the transaction, the plan of the prior employer becomes the plan of the current employer, or the assets and liabilities with respect to the acquired group of employees under the plan of the prior employer are transferred to the plan of the current employer in a plan merger, consolidation, or other transfer described in section 414(l)).

(iii) EXAMPLE. The following example illustrates the rules of this paragraph (d)(1):

EXAMPLE. Employer X maintains Plan A, a defined benefit plan with a single sum optional form of benefit for all employees. Employer Y acquires Employer X and merges Plan A into Plan B, a defined benefit plan maintained by Employer Y that does not otherwise provide a single sum optional form of benefit. Employer Y continues to provide the single sum optional form of benefit under Plan B on the same terms as it was offered under Plan A to all employees who were acquired in the transaction with Employer X (and to no other employees). The optional form of benefit satisfies paragraphs (b) and (c) of this section immediately following the transaction (determined without taking into account section 410(b)(6)(C)) when tested with reference to Plan B and Employer Y's nonexcludable employees. Under these facts, Plan B is treated as satisfying this section with respect to the single sum optional form of benefit for the plan year of the transaction and all subsequent plan years.

(2) FROZEN PARTICIPANTS. A plan must satisfy the nondiscriminatory availability requirement of this section not only with respect to benefits, rights, and features provided to employees who are currently benefiting under the plan, but also separately with respect to benefits, rights, and features provided to nonexcludable employees with accrued benefits who are not currently benefiting under the plan (frozen participants). Thus, each benefit, right, and feature available to any frozen participant under the plan is separately subject to the requirements of this section. A plan satisfies paragraphs (b) and (c) of this section with respect to a benefit, right, or feature available to any frozen participant under the plan only if one or more of the following requirements is satisfied:

(i) The benefit, right, or feature must be one that would satisfy paragraphs (b) and (c) of this section if it were not available to any employee currently benefiting under the plan.

(ii) The benefit, right, or feature must be one that would satisfy paragraphs (b) and (c) of this section if all frozen participants were treated as employees currently benefiting under the plan.

(iii) No change in the availability of the benefit, right, or feature may have been made that is first effective in the current plan year with respect to a frozen participant.

(iv) Any change in the availability of the benefit, right, or feature that is first effective in the current plan year with respect to a frozen participant must be made in a nondiscriminatory manner. Thus, any expansion in the availability of the benefit, right, or feature to any highly compensated frozen participant must be applied on a consistent basis to all nonhighly compensated frozen participants. Similarly, any contraction in the availability of the benefit, right, or feature that affects any nonhighly compensated frozen participant must be applied on a consistent basis to all highly compensated frozen participants.

(3) EARLY RETIREMENT WINDOW BENEFITS. If a benefit, right, or feature meets the definition of an early retirement window benefit in section 1.401(a)(4)-3(f)(4)(iii) (or would meet that definition if the definition applied to all benefits, rights, and features), the benefit, right, or feature is disregarded for purposes of applying this section with respect to an employee for all plan years other than the first plan year in which the benefit is currently available to the employee.

(4) PERMISSIVE AGGREGATION OF CERTAIN BENEFITS, RIGHTS, OR FEATURES -- (i) GENERAL RULE. An optional form of benefit, ancillary benefit, or other right or feature may be aggregated with another optional form of benefit, ancillary benefit, or other right or feature, respectively, and the two may be treated as a single optional form of benefit, ancillary benefit, or other right or feature, if both of the following requirements are satisfied:

(A) One of the two optional forms of benefit, ancillary benefit, or other rights or features must in all cases be of inherently equal or greater value than the other. For this purpose, one benefit, right, or feature is of inherently equal or greater value than another benefit, right, or feature only if, at any time and under any conditions, it is impossible for any employee to receive a smaller amount or a less valuable right under the first benefit, right, or feature than under the second benefit, right, or feature.

(B) The optional form of benefit, ancillary benefit, or other right or feature of inherently equal or greater value must separately satisfy paragraphs (b) and (c) of this section (without regard to this paragraph (d)(4)).

(ii) AGGREGATION MAY BE APPLIED MORE THAN ONCE. The aggregation rule in this paragraph (d)(4) may be applied more than once. Thus, for example, an optional form of benefit may be aggregated with another optional form of benefit that itself constitutes two separate optional forms of benefit that are aggregated and treated as a single optional form of benefit under this paragraph (d)(4).

(iii) EXAMPLES. The following examples illustrate the rules in this paragraph (d)(4):

EXAMPLE 1. Plan A is a defined benefit plan that provides a single sum optional form of benefit to all employees. The single sum optional form of benefit is available on the same terms to all employees, except that, for employees in Division S, a five- percent discount factor is applied and, for employees of Division T, a seven-percent discount factor is applied. Under paragraph (e)(1) of this section, the single sum optional form of benefit constitutes two separate optional forms of benefit. Assume that the single sum optional form of benefit available to employees of Division S separately satisfies paragraphs (b) and (c) of this section without taking into account this paragraph (d)(4). Because a lower discount factor is applied in determining the single sum optional form of benefit available to employees of Division S than is applied in determining the single sum optional form of benefit available to employees of Division T, the first single sum optional form of benefit is of inherently greater value than the second single sum optional form of benefit. Under these facts, these two single sum optional forms of benefit may be aggregated and treated as a single optional form of benefit for purposes of this section.

EXAMPLE 2. The facts are the same as in Example 1, except that, in order to receive the single sum optional form of benefit, employees of Division S (but not employees of Division T) must have completed at least 20 years of service. The single sum optional form of benefit available to employees of Division S is not of inherently equal or greater value than the single sum optional form of benefit available to employees of Division T, because an employee of Division S who terminates employment with less than 20 years of service would receive a smaller single sum amount (i.e., zero) than a similarly-situated employee of Division T who terminates employment with less than 20 years of service. Under these facts, the two single sum optional forms of benefit may not be aggregated and treated as a single optional form of benefit for purposes of this section.

(5) CERTAIN SPOUSAL BENEFITS. In the case of a plan that includes two or more plans that have been permissively aggregated under section 1.410(b)-7(d), the aggregated plan satisfies this section with respect to the availability of any nonsubsidized qualified joint and survivor annuities, qualified preretirement survivor annuities, or spousal death benefits described in section 401(a)(11), if each plan that is part of the aggregated plan satisfies section 401(a)(11) Whether a benefit is considered subsidized for this purpose may be determined using any reasonable actuarial assumptions. For purposes of this paragraph (d)(5), a qualified joint and survivor annuity, qualified preretirement survivor annuity, or spousal death benefit is deemed to be nonsubsidized if it is provided under a defined contribution plan.

(6) SPECIAL ESOP RULES. An ESOP does not fail to satisfy paragraphs (b) and (c) of this section merely because it makes an investment diversification right or feature or a distribution option available solely to all qualified participants (within the meaning of section 401(a)(28)(B)(iii)), or merely because the restrictions of section 409(n) apply to certain individuals.

(7) SPECIAL TESTING RULE FOR UNPREDICTABLE CONTINGENT EVENT BENEFITS. A benefit, right, or feature that is contingent on the occurrence of an unpredictable contingent event (within the meaning of section 412(l)(7)(B)(ii)) is tested under this section as if the event had occurred. Thus, the current availability of a benefit that becomes an optional form of benefit upon the occurrence of an unpredictable contingent event is tested by deeming the event to have occurred and by disregarding age and service conditions on the eligibility for that benefit to the extent permitted for optional forms of benefit under paragraph (b)(2) of this section.

(e) DEFINITIONS -- (1) OPTIONAL FORM OF BENEFIT -- (i) GENERAL RULE. The term optional form of benefit means a distribution alternative (including the normal form of benefit) that is available under a plan with respect to benefits described in section 411(d)(6)(A) or a distribution alternative that is an early retirement benefit or retirement-type subsidy described in section 411(d)(6)(B)(i), including a QSUPP. Except as provided in paragraph (e)(1)(ii) of this section, different optional forms of benefit exist if a distribution alternative is not payable on substantially the same terms as another distribution alternative. The relevant terms include all terms affecting the value of the optional form, such as the method of benefit calculation and the actuarial assumptions used to determine the amount distributed. Thus, for example, different optional forms of benefit may result from differences in terms relating to the payment schedule, timing, commencement, medium of distribution (e.g., in cash or in kind), election rights, differences in eligibility requirements, or the portion of the benefit to which the distribution alternative applies.

(ii) EXCEPTIONS -- (A) DIFFERENCES IN BENEFIT FORMULA OR ACCRUAL METHOD. A distribution alternative available under a defined benefit plan does not fail to be a single optional form of benefit merely because the benefit formulas, accrual methods, or other factors (including service-computation methods and definitions of compensation) underlying, or the manner in which employees vest in, the accrued benefit that is paid in the form of the distribution alternative are different for different employees to whom the distribution alternative is available. Notwithstanding the foregoing, differences in the normal retirement ages of employees or in the form in which the accrued benefit of employees is payable at normal retirement age under a plan are taken into account in determining whether a distribution alternative constitutes one or more optional forms of benefit.

(B) DIFFERENCES IN ALLOCATION FORMULA. A distribution alternative available under a defined contribution plan does not fail to be a single optional form of benefit merely because the allocation formula or other factors (including service-computation methods, definitions of compensation, and the manner in which amounts described in section 1.401(a)(4)-2(c)(2)(iii) are allocated) underlying, or the manner in which employees vest in, the accrued benefit that is paid in the form of the distribution alternative are different for different employees to whom the distribution alternative is available.

(C) DISTRIBUTIONS SUBJECT TO SECTION 417(e). A distribution alternative available under a defined benefit plan does not fail to be a single optional form of benefit merely because, in determining the amount of a distribution, the plan applies a lower interest rate to determine the distribution for employees with a vested accrued benefit having an actuarial present value not in excess of $25,000, as required by section 417(e)(3) and section 1.417(e)-1.

(D) DIFFERENCES ATTRIBUTABLE TO UNIFORM NORMAL RETIREMENT AGE. A distribution alternative available under a defined benefit plan does not fail to be a single optional form of benefit, to the extent that the differences are attributable to differences in normal retirement dates among employees, provided that the differences do not prevent the employees from having the same uniform normal retirement age under the definition of uniform normal retirement age in section 1.401(a)(4)-12.

(iii) EXAMPLES. The following examples illustrate the rules in this paragraph (e)(1):

EXAMPLE 1. Plan A is a defined benefit plan that benefits all employees of Divisions S and T. The plan offers a qualified joint and 50-percent survivor annuity at normal retirement age, calculated by multiplying an employee's single life annuity payment by a factor. For an employee of Division S whose benefit commences at age 65, the plan provides a factor of 0.90, but for a similarly-situated employee of Division T the plan provides a factor of 0.85. The qualified joint and survivor annuity is not available to employees of Divisions S and T on substantially the same terms, and thus it constitutes two separate optional forms of benefit.

EXAMPLE 2. Plan B is a defined benefit plan that benefits all employees of Divisions U and V. The plan offers a single sum distribution alternative available on the same terms and determined using the same actuarial assumptions, to all employees. However, different benefit formulas apply to employees of each division. Under the exception provided in paragraph (e)(1)(ii)(A) of this section, the single sum optional form of benefit available to employees of Division U is not a separate optional form of benefit from the single sum optional form of benefit available to employees of Division V.

EXAMPLE 3. Defined benefit Plan C provides an early retirement benefit based on a schedule of early retirement factors that is a single optional form of benefit. Plan C is amended to provide an early retirement window benefit that consists of a temporary change in the plan's benefit formula (e.g., the addition of five years of service to an employee's actual service under the benefit formula) applicable in determining the benefits for certain employees who terminate employment within a limited period of time. Under the exception provided in paragraph (e)(1)(ii)(A) of this section, the early retirement optional form of benefit available to window-eligible employees is not a separate optional form of benefit from the early retirement optional form of benefit available to the other employees.

(2) ANCILLARY BENEFIT. The term ancillary benefit means social security supplements (other than QSUPPs), disability benefits not in excess of a qualified disability benefit described in section 411(a)(9), ancillary life insurance and health insurance benefits, death benefits under a defined contribution plan, preretirement death benefits under a defined benefit plan, shut-down benefits not protected under section 411(d)(6), and other similar benefits. Different ancillary benefits exist if an ancillary benefit is not available on substantially the same terms as another ancillary benefit. Principles similar to those in paragraph (e)(1)(ii) of this section apply in making this determination.

(3) OTHER RIGHT OR FEATURE -- (i) GENERAL RULE. The term other right or feature generally means any right or feature applicable to employees under the plan. Different rights or features exist if a right or feature is not available on substantially the same terms as another right or feature.

(ii) EXCEPTIONS TO DEFINITION OF OTHER RIGHT OR FEATURE. Notwithstanding paragraph (e)(3)(i) of this section, a right or feature is not considered an other right or feature if it --

(A) Is an optional form of benefit or an ancillary benefit under the plan;

(B) Is one of the terms that are taken into account in determining whether separate optional forms of benefit or ancillary benefits exist, or that would be taken into account but for paragraph (e)(1)(ii) of this section (e.g., benefit formulas or the manner in which benefits vest); or

(C) Cannot reasonably be expected to be of meaningful value to an employee (e.g., administrative details).

(iii) EXAMPLES. Other rights and features include, but are not limited to --

(A) Plan loan provisions (other than those relating to a distribution of an employee's accrued benefit upon default under a loan);

(B) The right to direct investments;

(C) The right to a particular form of investment, including, for example, a particular class or type of employer securities (taking into account, in determining whether different forms of investment exist, any differences in conversion, dividend, voting, liquidation preference, or other rights conferred under the security);

(D) The right to make each rate of elective contributions described in section 1.401(k)-1(g)(3) (determining the rate based on the plan's definition of the compensation out of which the elective contributions are made (regardless of whether that definition satisfies section 414(s)), but also treating different rates as existing if they are based on definitions of compensation or other requirements or formulas that are not substantially the same);

(E) The right to make after-tax employee contributions to a defined benefit plan that are not allocated to separate accounts;

(F) The right to make each rate of after-tax employee contributions described in section 1.401(m)-1(f)(6) (determining the rate based on the plan's definition of the compensation out of which the after-tax employee contributions are made (regardless of whether that definition satisfies section 414(s)), but also treating different rates as existing if they are based on definitions of compensation or other requirements or formulas that are not substantially the same);

(G) The right to each rate of allocation of matching contributions described in section 1.401(m)-1(f)(12) (determining the rate using the amount of matching, elective, and after-tax employee contributions determined after any corrections under sections 1.401(k)-1(f)(1)(i), 1.401(m)-1(e)(1)(i), and 1.401(m)-2(c), but also treating different rates as existing if they are based on definitions of compensation or other requirements or formulas that are not substantially the same);

(H) The right to purchase additional retirement or ancillary benefits under the plan; and

(I) The right to make rollover contributions and transfers to and from the plan.

SECTION 1.401(a)(4)-5 PLAN AMENDMENTS AND PLAN TERMINATIONS.

(a) INTRODUCTION -- (1) OVERVIEW. This paragraph (a) provides rules for determining whether the timing of a plan amendment or series of amendments has the effect of discriminating significantly in favor of HCEs or former HCEs. For purposes of this section, a plan amendment includes, for example, the establishment or termination of the plan, and any change in the benefits, rights, or features, benefit formulas, or allocation formulas under the plan. Paragraph (b) of this section sets forth additional requirements that must be satisfied in the case of a plan termination.

(2) FACTS-AND-CIRCUMSTANCES DETERMINATION. Whether the timing of a plan amendment or series of plan amendments has the effect of discriminating significantly in favor of HCEs or former HCEs is determined at the time the plan amendment first becomes effective for purposes of section 401(a), based on all of the relevant facts and circumstances. These include, for example, the relative numbers of current and former HCEs and NHCEs affected by the plan amendment, the relative length of service of current and former HCEs and NHCEs, the length of time the plan or plan provision being amended has been in effect, and the turnover of employees prior to the plan amendment. In addition, the relevant facts and circumstances include the relative accrued benefits of current and former HCEs and NHCEs before and after the plan amendment and any additional benefits provided to current and former HCEs and NHCEs under other plans (including plans of other employers, if relevant). In the case of a plan amendment that provides additional benefits based on an employee's service prior to the amendment, the relevant facts and circumstances also include the benefits that employees and former employees who do not benefit under the amendment would have received had the plan, as amended, been in effect throughout the period on which the additional benefits are based.

(3) SAFE HARBOR FOR CERTAIN GRANTS OF BENEFITS FOR PAST PERIODS. The timing of a plan amendment that credits (or increases benefits attributable to) years of service for a period in the past is deemed not to have the effect of discriminating significantly in favor of HCEs or former HCEs if the period for which the service credit (or benefit increase) is granted does not exceed the five years immediately preceding the year in which the amendment first becomes effective, the service credit (or benefit increase) is granted on a reasonably uniform basis to all employees, benefits attributable to the period are determined by applying the current plan formula, and the service credited is service (including pre-participation or imputed service) with the employer or a previous employer that may be taken into account under section 1.401(a)(4)-11(d)(3) (without regard to section 1.401(a)(4)-11(d)(3)(i)(B)). However, this safe harbor is not available if the plan amendment granting the service credit (or increasing benefits) is part of a pattern of amendments that has the effect of discriminating significantly in favor of HCEs or former HCEs.

(4) EXAMPLES. The following examples illustrate the rules in this paragraph (a):

EXAMPLE 1. Plan A is a defined benefit plan that covered both HCEs and NHCEs for most of its existence. The employer decides to wind up its business. In the process of ceasing operations, but at a time when the plan covers only HCEs, Plan A is amended to increase benefits and thereafter is terminated. The timing of this plan amendment has the effect of discriminating significantly in favor of HCEs.

EXAMPLE 2. Plan B is a defined benefit plan that provides a social security supplement that is not a QSUPP. After substantially all of the HCEs of the employer have benefited from the supplement, but before a substantial number of NHCEs have become eligible for the supplement, Plan B is amended to reduce significantly the amount of the supplement. The timing of this plan amendment has the effect of discriminating significantly in favor of HCEs.

EXAMPLE 3. Plan C is a defined benefit plan that contains an ancillary life insurance benefit available to all employees. The plan is amended to eliminate this benefit at a time when life insurance payments have been made only to beneficiaries of HCEs. Because all employees received the benefit of life insurance coverage before Plan C was amended, the timing of this plan amendment does not have the effect of discriminating significantly in favor of HCEs or former HCEs.

EXAMPLE 4. Plan D provides for a benefit of one percent of average annual compensation per year of service. Ten years after Plan D is adopted, it is amended to provide a benefit of two percent of average annual compensation per year of service, including years of service prior to the amendment. The amendment is effective only for employees currently employed at the time of the amendment. The ratio of HCEs to former HCEs is significantly higher than the ratio of NHCEs to former NHCEs. In the absence of any additional factors, the timing of this plan amendment has the effect of discriminating significantly in favor of HCEs.

EXAMPLE 5. The facts are the same as in Example 4, except that, in addition, the years of prior service are equivalent between HCEs and NHCEs who are current employees, and the group of current employees with prior service would satisfy the nondiscriminatory classification test of section 1.410(b)-4 in the current and all prior plan years for which past service credit is granted. The timing of this plan amendment does not have the effect of discriminating significantly in favor of HCEs or former HCEs.

EXAMPLE 6. Employer V maintains Plan E, an accumulation plan. In 1994, Employer V amends Plan E to provide that the compensation used to determine an employee's benefit for all preceding plan years shall not be less than the employee's average annual compensation as of the close of the 1994 plan year. The years of service and percentage increases in compensation for HCEs are reasonably comparable to those of NHCEs. In addition, the ratio of HCEs to former HCEs is reasonably comparable to the ratio of NHCEs to former NHCEs. The timing of this plan amendment does not have the effect of discriminating significantly in favor of HCEs or former HCEs.

EXAMPLE 7. Employer W currently has six nonexcludable employees, two of whom, H1 and H2, are HCEs, and the remaining four of whom, N1 through N4, are NHCEs. The ratio of HCEs to former HCEs is significantly higher than the ratio of NHCEs to former NHCEs. Employer W establishes Plan F, a defined benefit plan providing a benefit of one percent of average annual compensation per year of service, including years of service prior to the establishment of the plan. H1 and H2 each have 15 years of prior service, N1 has nine years of past service, N2 has five years, N3 has three years, and N4 has one year. The timing of this plan establishment has the effect of discriminating significantly in favor of HCEs.

EXAMPLE 8. Assume the same facts as in Example 7, except that N1 through N4 were hired in the current year, and Employer W never employed any NHCEs prior to the current year. Thus, no NHCEs would have received additional benefits had Plan F been in existence during the preceding 15 years. The timing of this plan establishment does not have the effect of discriminating significantly in favor of HCEs or former HCEs.

EXAMPLE 9. The facts are the same as in Example 7, except that Plan F limits the grant of past service credit to five years, and the grant of past service otherwise satisfies the safe harbor in paragraph (a)(3) of this section. The timing of this plan establishment is deemed not to have the effect of discriminating significantly in favor of HCEs or former HCEs.

EXAMPLE 10. The facts are the same as in Example 9, except that, five years after the establishment of Plan F, Employer W amends the plan to provide a benefit equal to two percent of average annual compensation per year of service, taking into account all years of service since the establishment of the plan. The ratio of HCEs to former HCEs who terminated employment during the five-year period since the establishment of the plan is significantly higher than the ratio of NHCEs to former NHCEs who terminated employment during the five-year period since the establishment of the plan. Although the amendment described in this example might separately satisfy the safe harbor in paragraph (a)(3) of this section, the safe harbor is not available with respect to the amendment because, under these facts, the amendment is part of a pattern of amendments that has the effect of discriminating significantly in favor of HCEs.

EXAMPLE 11. Employer Y maintains Plan G, a defined benefit plan, covering all its employees. In 1995, Employer Y acquires Division S from Employer Z. Some of the employees of Division S had been covered under a defined benefit plan maintained by Employer Z. Soon after the acquisition, Employer Y amends Plan G to cover all employees of Division S and to credit those who were in Division S's defined benefit plan with years of service for years of employment with Employer Z. Because the timing of the plan amendment was determined by the timing of the transaction, the timing of this plan amendment does not have the effect of discriminating significantly in favor of HCEs or former HCEs. See also section 1.401(a)(4)-11(d)(3) for other rules regarding the crediting of pre-participation service.

EXAMPLE 12. Plan H is an insurance contract plan within the meaning of section 412(i). For all plan years before 1999, Plan H purchases insurance contracts from Insurance Company J. In 1999, Plan H shifts future purchases of insurance contracts to Insurance Company K. The shift in insurance companies is a plan amendment subject to this paragraph (a).

(b) PRE-TERMINATION RESTRICTIONS -- (1) REQUIRED PROVISIONS IN DEFINED BENEFIT PLANS. A defined benefit plan has the effect of discriminating significantly in favor of HCEs or former HCEs unless it incorporates provisions restricting benefits and distributions as described in paragraph (b)(2) and (3) of this section at the time the plan is established or, if later, as of the first plan year to which sections 1.401(a)(4)-1 through 1.401(a)(4)-13 apply to the plan under section 1.401(a)(4)-13(a) or (b). This paragraph (b) does not apply if the Commissioner determines that such provisions are not necessary to prevent the prohibited discrimination that may occur in the event of an early termination of the plan. The restrictions in this paragraph (b) apply to a plan within the meaning of section 1.410(b)-7(b) (i.e., a section 414(l) plan). Any plan containing a provision described in this paragraph (b) satisfies section 411(d)(2) and does not fail to satisfy section 411(a) or (d)(3) merely because of the provision.

(2) RESTRICTION OF BENEFITS UPON PLAN TERMINATION. A plan must provide that, in the event of plan termination, the benefit of any HCE (and any former HCE) is limited to a benefit that is nondiscriminatory under section 401(a)(4).

(3) RESTRICTIONS ON DISTRIBUTIONS -- (i) GENERAL RULE. A plan must provide that, in any year, the payment of benefits to or on behalf of a restricted employee shall not exceed an amount equal to the payments that would be made to or on behalf of the restricted employee in that year under --

(A) A straight life annuity that is the actuarial equivalent of the accrued benefit and other benefits to which the restricted employee is entitled under the plan (other than a social security supplement); and

(B) A social security supplement, if any, that the restricted employee is entitled to receive.

(ii) RESTRICTED EMPLOYEE DEFINED. For purposes of this paragraph (b), the term restricted employee generally means any HCE or former HCE. However, an HCE or former HCE need not be treated as a restricted employee in the current year if the HCE or former HCE is not one of the 25 (or a larger number chosen by the employer) nonexcludable employees and former employees of the employer with the largest amount of compensation in the current or any prior year. Plan provisions defining or altering this group can be amended at any time without violating section 411(d)(6).

(iii) BENEFIT DEFINED. For purposes of this paragraph (b), the term benefit includes, among other benefits, loans in excess of the amounts set forth in section 72(p)(2)(A), any periodic income, any withdrawal values payable to a living employee or former employee, and any death benefits not provided for by insurance on the employee's or former employee's life.

(iv) NONAPPLICABILITY IN CERTAIN CASES. The restrictions in this paragraph (b)(3) do not apply, however, if any one of the following requirements is satisfied:

(A) After taking into account payment to or on behalf of the restricted employee of all benefits payable to or on behalf of that restricted employee under the plan, the value of plan assets must equal or exceed 110 percent of the value of current liabilities, as defined in section 412(l)(7).

(B) The value of the benefits payable to or on behalf of the restricted employee must be less than one percent of the value of current liabilities before distribution.

(C) The value of the benefits payable to or on behalf of the restricted employee must not exceed the amount described in section 411(a)(11)(A) (restrictions on certain mandatory distributions).

(v) DETERMINATION OF CURRENT LIABILITIES. For purposes of this paragraph (b), any reasonable and consistent method may be used for determining the value of current liabilities and the value of plan assets.

(4) OPERATIONAL RESTRICTIONS ON CERTAIN MONEY PURCHASE PENSION PLANS. A money purchase pension plan that has an accumulated funding deficiency, within the meaning of section 412(a), or an unamortized funding waiver, within the meaning of section 412(d), must comply in operation with the restrictions on benefits and distributions as described in paragraphs (b)(2) and (b)(3) of this section. Such a plan does not fail to satisfy section 411(d)(6) merely because of restrictions imposed by the requirements of this paragraph (b)(4).

SECTION 1.401(a)(4)-6 CONTRIBUTORY DEFINED BENEFIT PLANS.

(a) INTRODUCTION. This section provides rules necessary for determining whether a contributory DB plan satisfies the nondiscriminatory amount requirement of section 1.401(a)(4)-1(b)(2). Paragraph (b) of this section provides rules for determining the amount of benefits derived from employer contributions (employer- provided benefits) under a contributory DB plan for purposes of determining whether the plan satisfies section 1.401(a)(4)-1(b)(2) with respect to such amounts. Paragraph (c) of this section provides the exclusive rules for determining whether a contributory DB plan satisfies section 1.401(a)(4)-1(b)(2) with respect to the amount of benefits derived from employee contributions not allocated to separate accounts (employee-provided benefits). See section 1.401(a)(4)-1(b)(2)(ii)(B) for the exclusive tests applicable to employee contributions allocated to separate accounts under a section 401(m) plan.

(b) DETERMINATION OF EMPLOYER-PROVIDED BENEFIT -- (1) GENERAL RULE. An employee's employer-provided benefit under a contributory DB plan for purposes of section 401(a)(4) equals the difference between the employee's total benefit and the employee's employee-provided benefit under the plan. The rules of section 411(c) generally must be used to determine the employee's employer-provided benefit for this purpose. However, paragraphs (b)(2) through (b)(6) of this section provide alternative methods for determining the employee's employer- provided benefit.

(2) COMPOSITION-OF-WORKFORCE METHOD -- (i) GENERAL RULE. A contributory DB plan that satisfies paragraph (b)(2)(ii)(A) and (B) of this section may determine employees' employer-provided benefit rates under the rules of paragraph (b)(2)(iii) of this section.

(ii) ELIGIBILITY REQUIREMENTS -- (A) UNIFORM RATE OF EMPLOYEE CONTRIBUTIONS. A contributory DB plan satisfies this paragraph (b)(2)(ii)(A) if all employees make employee contributions at the same rate, expressed as a percentage of plan year compensation (the employee contribution rate). A plan does not fail to satisfy this paragraph (b)(2)(ii)(A) merely because it eliminates employee contributions for all employees with plan year compensation below a specified contribution breakpoint that is either a stated dollar amount or a stated percentage of covered compensation (within the meaning of section 1.401(l)-1(c)(7)); or merely because all employees make employee contributions at the same rate (expressed as a percentage of plan year compensation) with respect to plan year compensation up to the contribution breakpoint (base employee contribution rate) and at a higher rate (expressed as a percentage of plan year compensation) that is the same for all employees with respect to plan year compensation above the contribution breakpoint (excess employee contribution rate). A plan described in paragraph (c)(4)(i) of this section that satisfies paragraph (c)(4)(iii) of this section is deemed to satisfy this paragraph.

(B) DEMOGRAPHIC REQUIREMENTS -- (1) IN GENERAL. A contributory DB plan satisfies this paragraph (b)(2)(ii)(B) if it satisfies either of the demographic tests in paragraph (b)(2)(ii)(B)(2) or (3) of this section.

(2) MINIMUM PERCENTAGE TEST. This test is satisfied only if more than 40 percent of the NHCEs in the plan have attained ages at least equal to the plan's target age, and more than 20 percent of the NHCEs in the plan have attained ages at least equal to the average attained age of the HCEs in the plan. For this purpose, a plan's target age is the lower of age 50 or the average attained age of the HCEs in the plan minus X years, where X equals 20 minus the product of five times the employee contribution rate under the plan. In no case, however, may X years be fewer than zero (0) years. Thus, for example, if the average attained age of the HCEs in the plan is 53 and the employee contribution rate is two percent of plan year compensation, the plan's target age is 43 years (i.e., 53 - (20 - (5 x 2))).

(3) RATIO TEST. This test is satisfied only if the percentage of all nonhighly compensated nonexcludable employees, who are in the plan and who have attained ages at least equal to the average attained age of the HCEs in the plan, is at least 70 percent of the percentage of all highly compensated nonexcludable employees, who are in the plan and who have attained ages at least equal to the average attained age of the HCEs in the plan. Attained ages must be determined as of the beginning of the plan year. In lieu of determining the actual distribution of the attained ages of the HCEs, an employer may assume that 50 percent of all HCEs have attained ages at least equal to the average attained age of the HCEs.

(iii) DETERMINATION OF EMPLOYER-PROVIDED BENEFIT -- (A) SAFE HARBOR PLANS OTHER THAN SECTION 401(l) PLANS. For purposes of applying the exception to the safe harbor in section 1.401(a)(4)- 3(b)(6)(viii) with respect to employer-provided benefits under a plan other than a section 401(l) plan, the employee's entire accrued benefit is treated as employer-provided.

(B) SECTION 401(l) PLANS -- (1) GENERAL RULE. For purposes of applying the exception to the safe harbor in section 1.401(a)(4)- 3(b)(6)(viii) with respect to employer-provided benefits under a section 401(l) plan, an employee's base benefit percentage and excess benefit percentage are reduced, or an employee's gross benefit percentage is reduced, by subtracting the product of the employee contribution rate and the factor determined under paragraph (b)(2)(iv) of this section from the respective percentages for the plan year. For this purpose, the employee contribution rate is the highest rate of employee contributions applicable to any potential level of plan year compensation for that plan year under the plan.

(2) EXCESS PLANS WITH VARYING CONTRIBUTION RATES. In the case of a defined benefit excess plan described in the second sentence of paragraph (b)(2)(ii)(A) of this section, solely for purposes of reducing an employee's base benefit percentage as required under paragraph (b)(2)(iii)(B)(i) of this section, it may be assumed that the employee's employee contribution rate equals the weighted average of the base employee contribution rate and the excess employee contribution rate. In determining this weighted average, the weight of the base employee contribution rate is equal to a fraction, the numerator of which is the lesser of the integration level and the contribution breakpoint and the denominator of which is the integration level. The weight of the excess employee contribution rate is equal to the difference between one and the weight of the base employee contribution rate.

(3) OFFSET PLANS WITH VARYING CONTRIBUTION RATES. In the case of an offset plan described in the second sentence of paragraph (b)(2)(ii)(A) of this section, an equivalent adjustment to the alternative method in paragraph (b)(2)(iii)(B)(2) of this section may be made to the offset percentage.

(C) EMPLOYER-PROVIDED BENEFITS UNDER THE GENERAL TEST. For purposes of applying the general test of section 1.401(a)(4)-3(c) with respect to employer-provided benefits, an employee's normal and most valuable accrual rates otherwise determined under section 1.401(a)(4)-3(d) (without applying any of the options under section 1.401(a)(4)-3(d)(3) other than the fresh-start alternative of section 1.401(a)(4)-3(d)(3)(iii)) are each reduced by subtracting the product of the employee's contributions (expressed as a percentage of plan year compensation) and the factor determined under paragraph (b)(2)(iv) of this section from the respective accrual rates. A plan may then apply the optional rules in section 1.401(a)(4)-3(d)(3)(i) and (ii) to this resulting accrual rate.

(D) ADDITIONAL LIMITATION. A plan may not use the composition- of-workforce method provided in this paragraph (b)(2) to determine an employee's base benefit percentage, excess benefit percentage, gross benefit percentage, offset percentage, or accrual rates unless employee contributions have been made at the same rate (or rates) throughout the period after the fresh-start date or throughout the measurement period used to determine accrual rates.

(iv) DETERMINATION OF PLAN FACTOR. The factor for a plan is determined under the following table based on the average entry age of the employees in the plan and on whether the plan determines benefits based on average compensation. For this purpose, average entry age equals the average attained age of all employees in the plan, minus the average years of participation of all employees in the plan. A plan is treated as determining benefits based on average compensation if it determines benefits based on compensation averaged over a specified period not exceeding five consecutive years (or the employee's entire period of employment with the employer, if shorter).

                              TABLE OF FACTORS

EXAMPLE 1. Plan A is a contributory DB plan that is a defined benefit excess plan providing a benefit equal to 2.0 percent of employees' average annual compensation at or below covered compensation, plus 2.5 percent of average annual compensation above covered compensation, times years of service up to 35. Under the plan, average annual compensation is determined using a five-consecutive-year period for purposes of section 1.401(a)(4)-3(e)(2). The plan requires employee contributions at a rate of four percent of plan year compensation for all employees. Assume that the plan satisfies the demographic requirements of paragraph (b)(2)(ii)(B) of this section. Under these facts, the plan satisfies the eligibility requirements of paragraph (b)(2)(ii) of this section. Assume, further, that the average attained age for all employees in the plan is 55, and that the average years of participation of all employees in the plan is 10. The average entry age for the plan is therefore 45, and, accordingly, the appropriate factor under the table is 0.2. Thus, in applying the safe harbor requirements of section 1.401(a)(4)-3(b) to this plan for the plan year (including the requirements of section 1.401(l)-3), the employee's base benefit percentage and excess benefit percentage are each reduced by 0.8 percent (4 percent x 0.2) and equal 1.2 percent and 1.7 percent, respectively.

EXAMPLE 2. The facts are the same as in EXAMPLE 1, except that the employee contribution rate is two percent of plan year compensation up to the covered compensation level, and four percent for plan year compensation at or above that contribution breakpoint. The employer elects to apply the alternative method in paragraph (b)(2)(iii)(B)(2) of this section to determine the reduction in the base benefit percentage. Because the contribution breakpoint is equal to the integration level, the weight of the employee contribution rate below the contribution breakpoint is 100 percent, and the weight of the employee contribution rate above the contribution breakpoint is zero. Thus, the weighted average of employee contribution rates is two percent. Under the alternative method in paragraph (b)(2)(iii)(B)(2) of this section, the reduction in the employee's base benefit percentage is 0.4. In applying the safe harbor requirements of section 1.401(a)(4)-3(b) to this plan (including the requirements of section 1.401(l)-3), the employee's base benefit percentage is 1.6 percent, and the employee's excess benefit percentage is 1.7.

EXAMPLE 3. The facts are the same as in Example 1, except that the employee contribution rate is two percent of plan year compensation up to 50 percent of the covered compensation level, and four percent for plan year compensation at or above that contribution breakpoint. Because the contribution breakpoint is equal to 50 percent of the integration level, the weight of the employee contribution rate below the contribution breakpoint is 50 percent, and the weight of the employee contribution rate above the contribution breakpoint is 50 percent. Thus, the weighted average of employee contribution rates is three percent. Under the alternative method in paragraph (b)(2)(iii)(B)(2) of this section, the reduction in the employee's base benefit percentage is 0.6. In applying the safe harbor requirements of section 1.401(a)(4)-3(b) to this plan (including the requirements of section 1.401(l)-3), the employee's base benefit percentage is 1.4 percent, and the employee's excess benefit percentage is 1.7.

EXAMPLE 4. The facts are the same as in Example 1, except that the plan is tested using the general test in section 1.401(a)(4)-3(c). Assume Employee M benefits under Plan A and has a normal accrual rate for the plan year (calculated with respect to Employee M's total accrued benefit) of 2.2 percent of average annual compensation. In applying the general test in section 1.401(a)(4)-3(c) with respect to employer-provided benefits, this rate is reduced by 0.8 to yield a normal accrual rate of 1.4 percent. This rate may then be adjusted using either of the optional rules in section 1.401(a)(4)-3(d)(3)(i) or (ii).

(3) MINIMUM-BENEFIT METHOD -- (i) APPLICATION OF UNIFORM FACTORS. A contributory DB plan that satisfies the uniform rate requirement of paragraph (b)(2)(ii)(A) of this section and the minimum benefit requirement of paragraph (b)(3)(ii) of this section may apply the adjustments provided in paragraph (b)(2)(iii) of this section as if the average entry age of employees in the plan were within the range of 30 to 40, without regard to the actual demographics of the employees in the plan.

(ii) MINIMUM BENEFIT REQUIREMENT. This requirement is satisfied if the plan provides that, in plan years beginning on or after the effective date of these regulations, as set forth in section 1.401(a)(4)-13(a) and (b), each employee will accrue a benefit that equals or exceeds the sum of--

(A) The accrued benefit derived from employee contributions made for plan years beginning on or after the effective date of these regulations, determined in accordance with section 411(c); and

(B) Fifty percent of the total benefit accrued in plan years beginning on or after the effective date of these regulations, as determined under the plan benefit formula without regard to that portion of the formula designed to satisfy the minimum benefit requirement of this paragraph (b)(3)(ii).

(iii) EXAMPLE. The following example illustrates the minimum- benefit method of this paragraph (b)(3):

EXAMPLE. Plan A is contributory DB plan. For the plan year beginning in 1994, Employee M participates in Plan A and accrues a benefit under the terms of the plan (without regard to the minimum benefit requirement of paragraph (b)(3)(ii) of this section) of $3,000. The portion of Employee M's benefit accrual for the plan year beginning in 1994 derived from employee contributions is $2,000, determined by applying the rules of section 411(c) to such contributions. The requirement of paragraph (b)(3)(ii) of this section is not satisfied for the plan year beginning in 1994 unless the plan provides that Employee M's benefit accrual for the plan year beginning in 1994 is equal to $3,500 ($2,000 + (50 percent x $3,000)).

(4) GRANDFATHER RULE FOR PLANS IN EXISTENCE ON MAY 14, 1990. A contributory DB plan that satisfies paragraph (c)(4) of this section may determine an employee's employer-provided benefit by subtracting from the employee's total benefit the employee-provided benefits determined using any reasonable method set forth in the plan, provided that it is the same method used in determining whether the plan satisfies paragraph (c)(4)(ii)(D) of this section.

(5) GOVERNMENT-PLAN METHOD. A contributory DB plan that is established and maintained for its employees by the government of any state or political subdivision or by any agency or instrumentality thereof may treat an employee's total benefit as entirely employer- provided.

(6) CESSATION OF EMPLOYEE CONTRIBUTIONS. If a contributory DB plan provides that no employee contributions may be made to the plan after the last day of the first plan year beginning on or after the effective date of these regulations, as set forth in section 1.401(a)(4)-13(a) and (b), the plan may treat an employee's total benefit as entirely employer-provided.

(c) RULES APPLICABLE IN DETERMINING WHETHER EMPLOYEE-PROVIDED BENEFITS ARE NONDISCRIMINATORY IN AMOUNT -- (1) IN GENERAL. A contributory DB plan satisfies section 1.401(a)(4)-1(b)(2) with respect to the amount of employee-provided benefits for a plan year only if the plan satisfies the requirements of paragraph (c)(2), (c)(3), or (c)(4) of this section for the plan year. This requirement applies regardless of the method used to determine the amount of employer-provided benefits under paragraph (b) of this section.

(2) SAME RATE OF CONTRIBUTIONS. This requirement is satisfied for a plan year if the employee contribution rate (within the meaning of paragraph (b)(2)(ii)(A) of this section) is the same for all employees for the plan year.

(3) TOTAL-BENEFITS METHOD. This requirement is satisfied for a plan year if --

(i) The total benefits (i.e., the sum of employer-provided and employee-provided benefits) under the plan would satisfy section 1.401(a)(4)-3 if all benefits were treated as employer-provided benefits; and

(ii) The plan's contribution requirements satisfy paragraph (b)(2)(ii)(A) of this section.

(4) GRANDFATHER RULES FOR PLANS IN EXISTENCE ON MAY 14, 1990 -- (i) IN GENERAL. This requirement is satisfied for a plan year if the plan contained provisions as of May 14, 1990, that meet the requirements of paragraph (c)(4)(ii) or (c)(4)(iii) of this section.

(ii) GRADED CONTRIBUTION RATES. The plan's provisions meet the requirements of this paragraph (c)(4)(ii) if all the following requirements are met:

(A) The provisions require employee contributions at a greater rate (expressed as a percentage of compensation) at higher levels of compensation than at lower levels of compensation.

(B) The required rate of employee contributions is not increased after May 14, 1990, although the level of compensation at which employee contributions are required may be increased or decreased.

(C) All employees are permitted to make employee contributions under the plan at a uniform rate with respect to all compensation, beginning no later than the last day of the first plan year to which these regulations apply, as set forth in section 1.401(a)(4)-13(a) and (b).

(D) The benefits provided on account of employee contributions at lower levels of compensation are comparable to those provided on account of employee contributions at higher levels of compensation.

(iii) PRIOR YEAR COMPENSATION. The plan's provisions meet the requirements of this paragraph (c)(4)(iii) if they are part of a plan maintained by more than one employer that requires employee contributions and the rate of required employee contributions, expressed as a percentage of compensation for the last calendar year ending before the beginning of the plan year, is the same for all employees.

SECTION 1.401(a)(4)-7 IMPUTATION OF PERMITTED DISPARITY.

(a) INTRODUCTION. In determining whether a plan satisfies section 401(a)(4) with respect to the amount of contributions or benefits, section 401(a)(5)(C) allows the disparities permitted under section 401(l) to be taken into account. For purposes of satisfying the safe harbors of sections 1.401(a)(4)-2(b)(2) and 1.401(a)(4)- 3(b), permitted disparity may be taken into account only by satisfying section 401(l) in form in accordance with section 1.401(l)-2 or 1.401(l)-3, respectively. For purposes of the general tests of sections 1.401(a)(4)-2(c) and 1.401(a)(4)-3(c), permitted disparity may be taken into account only in accordance with the rules of this section. In general, this section allows permitted disparity to be arithmetically imputed with respect to employer-provided contributions or benefits by determining an adjusted allocation or accrual rate that appropriately accounts for the permitted disparity with respect to each employee. Paragraph (b) of this section provides rules for imputing permitted disparity with respect to employer- provided contributions by adjusting each employee's unadjusted allocation rate. Paragraph (c) of this section provides rules for imputing permitted disparity with respect to employer-provided benefits by adjusting each employee's unadjusted accrual rate. Paragraph (d) of this section provides rules of general application.

(b) ADJUSTING ALLOCATION RATES -- (1) IN GENERAL. The rules in this paragraph (b) produce an adjusted allocation rate for each employee by determining the excess contribution percentage under the hypothetical formula that would yield the allocation actually received by the employee, if the plan took into account the full disparity permitted under section 401(l)(2) and used the taxable wage base as the integration level. This adjusted allocation rate is used to determine whether the amount of contributions under the plan satisfies the general test of section 1.401(a)(4)-2(c) and to apply the average benefit percentage test on the basis of contributions under section 1.410(b)-5(d). Paragraphs (b)(2) and (b)(3) of this section apply to employees whose plan year compensation does not exceed and does exceed, respectively, the taxable wage base, and paragraph (b)(4) of this section provides definitions.

(2) EMPLOYEES WHOSE PLAN YEAR COMPENSATION DOES NOT EXCEED TAXABLE WAGE BASE. If an employee's plan year compensation does not exceed the taxable wage base, the employee's adjusted allocation rate is the lesser of the A rate and the B rate determined under the formulas below, where the permitted disparity rate and the unadjusted allocation rate are determined under paragraph (b)(4)(ii) and (iv) of this section, respectively.

 A Rate = 2 x unadjusted allocation rate

 C Rate =       allocations

(i) ALLOCATIONS. Allocations means the amount determined by multiplying the employee's plan year compensation by the employee's unadjusted allocation rate.

(ii) PERMITTED DISPARITY RATE -- (A) GENERAL RULE. Permitted disparity rate means the rate in effect as of the beginning of the plan year under section 401(l)(2)(A)(ii) (e.g., 5.7 percent for plan years beginning in 1990).

(B) CUMULATIVE PERMITTED DISPARITY LIMIT. Notwithstanding paragraph (b)(4)(ii)(A) of this section, the permitted disparity rate is zero for an employee who has benefited under a defined benefit plan taken into account under section 1.401(l)-5(a)(3) for a plan year that begins on or after one year from the first day of the first plan year to which these regulations apply, as set forth in section 1.401(a)(4)-13(a) and (b), if imputing permitted disparity would result in a cumulative disparity fraction for the employee, as defined in section 1.401(l)-5(c)(2), that exceeds 35. See section 1.401(l)-5(c)(1) for special rules for determining whether an employee has benefited under a defined benefit plan for this purpose.

(iii) TAXABLE WAGE BASE. Taxable wage base means the taxable wage base, as defined in section 1.401(l)-1(c)(32), in effect as of the beginning of the plan year.

(iv) UNADJUSTED ALLOCATION RATE. Unadjusted allocation rate means the employee's allocation rate determined under section 1.401(a)(4)-2(c)(2)(i) for the plan year (expressed as a percentage of plan year compensation), without imputing permitted disparity under this section.

(5) EXAMPLE. The following example illustrates the rules in this paragraph (b):

EXAMPLE. (a) Employees M and N participate in a defined contribution plan maintained by Employer X. Employee M has plan year compensation of $30,000 in the 1990 plan year and has an unadjusted allocation rate of five percent. Employee N has plan year compensation of $100,000 in the 1990 plan year and has an unadjusted allocation rate of eight percent. The taxable wage base in 1990 is $51,300.

(b) Because Employee M's plan year compensation does not exceed the taxable wage base, Employee M's A rate is 10 percent (2 x 5 percent), and Employee M's B rate is 10.7 percent (5 percent + 5.7 percent). Thus, Employee M's adjusted allocation rate is 10 percent, the lesser of the A rate and the B rate.

(c) Employee N's allocations are $8,000 (8 percent x $100,000). Because Employee N's plan year compensation exceeds the taxable wage base, Employee N's C rate is 10.76 percent ($8,000 divided by ($100,000 - (1/2 x $51,300))), and Employee N's D rate is 10.92 percent (($8,000 + (5.7 percent x $51,300)) divided by $100,000). Thus, Employee N's adjusted allocation rate is 10.76 percent, the lesser of the C rate and the D rate.

(c) ADJUSTING ACCRUAL RATES -- (1) IN GENERAL. The rules in this paragraph (c) produce an adjusted accrual rate for each employee by determining the excess benefit percentage under the hypothetical plan formula that would yield the employer-provided accrual actually received by the employee, if the plan took into account the full permitted disparity under section 401(l)(3)(A) in each of the first 35 years of an employee's testing service under the plan and used the employee's covered compensation as the integration level. This adjusted accrual rate is used to determine whether the amount of employer-provided benefits under the plan satisfies the alternative safe harbor for flat benefit plans under section 1.401(a)(4)- 3(b)(4)(i)(C)(3) or the general test of section 1.401(a)(4)-3(c), and to apply the average benefit percentage test on the basis of benefits under section 1.410(b)-5. Paragraphs (c)(2) and (c)(3) of this section apply to employees whose average annual compensation does not exceed and does exceed, respectively, covered compensation, and paragraph (c)(4) of this section provides definitions. Paragraph (c)(5) of this section provides a special rule for employees with negative unadjusted accrual rates.

(2) EMPLOYEES WHOSE AVERAGE ANNUAL COMPENSATION DOES NOT EXCEED COVERED COMPENSATION. If an employee's average annual compensation does not exceed the employee's covered compensation, the employee's adjusted accrual rate is the lesser of the A rate and the B rate determined under the formulas below, where the permitted disparity factor and the unadjusted accrual rate are determined under paragraph (c)(4)(iii) and (v) of this section, respectively.

 A Rate = 2 x unadjusted accrual rate

 C Rate = employer-provided accrual

(i) COVERED COMPENSATION. Covered compensation means covered compensation as defined in section 1.401(1)-1(c)(7). Notwithstanding section 1.401(l)-1(c)(7)(iii), an employee's covered compensation must be automatically adjusted each plan year for purposes of applying this paragraph (c).

(ii) EMPLOYER-PROVIDED ACCRUAL. Employer-provided accrual means the amount determined by multiplying the employee's average annual compensation by the employee's unadjusted accrual rate.

(iii) PERMITTED DISPARITY FACTOR -- (A) GENERAL RULE. Permitted disparity factor for an employee means the sum of the employee's annual permitted disparity factors determined under paragraph (c)(4)(iii)(B) of this section for each of the years in the measurement period used for determining the employee's accrual rate in section 1.401(a)(4)-3(d)(1), divided by the employee's testing service during that measurement period.

(B) ANNUAL PERMITTED DISPARITY FACTOR -- (1) DEFINITION. An employee's annual permitted disparity factor is generally 0.75 percent adjusted, pursuant to section 1.401(l)-3(e), using as the age at which benefits commence the lesser of age 65 or the employee's testing age. No adjustments are made in the annual permitted disparity factor unless an employee's testing age is different from the employee's social security retirement age. An annual permitted disparity factor that is less than the annual permitted disparity factor described in the first sentence of this paragraph (c)(4)(iii)(B)(1) may be used if it is a uniform percentage of that factor (e.g., 50 percent of the annual permitted disparity factor) or a fixed percentage (e.g., 0.65 percent) for all employees.

(2) ANNUAL PERMITTED DISPARITY FACTOR AFTER 35 YEARS. For purposes of determining the sum described in paragraph (c)(4)(iii)(A) of this section, the annual permitted disparity factor for each of the employee's first 35 years of testing service is the amount described in paragraph (c)(4)(iii)(B)(i) of this section, and the annual permitted disparity factor in any subsequent year equals zero. This rule applies regardless of whether the end of the measurement period extends beyond an employee's first 35 years of testing service. Thus, for example, if the measurement period is the current plan year and the employee completed 35 years of testing service prior to the beginning of the current plan year, under this paragraph (c)(4)(iii)(B)(2) the annual permitted disparity factor in the current plan year (and hence the sum of the annual permitted disparity factors for each year in the measurement period) is zero.

(3) CUMULATIVE PERMITTED DISPARITY LIMIT. The 35 years used in paragraph (c)(4)(iii)(B)(2) of this section must be reduced by the employee's cumulative disparity fraction, as defined in section 1.401(l)-5(c)(2), but determined solely with respect to the employee's total years of service under all plans taken into account under section 1.401(l)-5(a)(3) during the measurement period, other than the plan being tested.

(iv) SOCIAL SECURITY RETIREMENT AGE. Social security retirement age means social security retirement age as defined in section 415(b)(8).

(v) UNADJUSTED ACCRUAL RATE. Unadjusted accrual rate means the normal or most valuable accrual rate, whichever is being determined for the employee under section 1.401(a)(4)-3(d), expressed as a percentage of average annual compensation, without imputing permitted disparity under this section.

(5) EMPLOYEES WITH NEGATIVE UNADJUSTED ACCRUAL RATES. Notwithstanding the formulas in paragraph (c)(2) and (c)(3) of this section, if an employee's unadjusted accrual rate is less than zero, the employee's adjusted accrual rate is deemed to be the employee's unadjusted accrual rate.

(6) EXAMPLE. The following example illustrates the rules in this paragraph (c):

EXAMPLE. (a) Employees M and N participate in a defined benefit plan that uses a normal retirement age of 65. The plan is being tested for the plan year under section 1.401(a)(4)- 3(c), using unadjusted accrual rates determined using a plan year measurement period under section 1.401(a)(4)- 3(d)(1)(iii)(A). Employee M has an unadjusted normal accrual rate of 1.48 percent, average annual compensation of $21,000, and an employer-provided accrual of $311 (1.48 percent x $21,000). Employee N has an unadjusted normal accrual rate of 1.7 percent, average annual compensation of $106,000, and an employer-provided accrual of $1,802 (1.7 percent x $106,000). The covered compensation of both Employees M and N is $25,000, and social security retirement age for both employees is 65. Neither employee has testing service of more than 35 years and neither has ever participated in another plan.

(b) Because Employee M's average annual compensation does not exceed covered compensation, Employee M's A rate is 2.96 percent (2.0 x 1.48 percent), and Employee M's B rate is 2.23 percent (1.48 percent + 0.75 percent). Thus, Employee M's adjusted accrual rate is 2.23 percent, the lesser of the A rate and the B rate.

(c) Because Employee N's average annual compensation exceeds covered compensation, Employee N's C rate is 1.93 percent ($1,802/($106,000 - (0.5 x $25,000))), and Employee N's D rate is 1.88 percent (($1,802 + (0.75 percent x $25,000))/$106,000). Thus, Employee N's adjusted accrual rate is 1.88 percent, the lesser of the C rate and the D rate.

(d) RULES OF GENERAL APPLICATION -- (1) ELIGIBLE PLANS. The rules in this section may be used only for those plans to which the permitted disparity rules of section 401(l) are available. See section 1.401(l)-1(a)(3).

(2) EXCEPTIONS FROM CONSISTENCY REQUIREMENTS. A plan does not fail to satisfy the consistency requirements of section 1.401(a)(4)- 2(c)(2)(vi) or section 1.401(a)(4)-3(d)(2)(i) merely because the plan does not impute disparity for some employees to the extent required to comply with paragraph (d)(3) of this section, or because the plan does not impute disparity for any employees (including self-employed individuals within the meaning of section 401(c)(1)) who are not covered by any of the taxes under section 3111(a), section 3221, or section 1401.

(3) OVERALL PERMITTED DISPARITY. The annual overall permitted disparity limits of section 1.401(l)-5(b) apply to the employer- provided contributions and benefits for an employee under all plans taken into account under section 1.401(l)-5(a)(3). Thus, if an employee who benefits under the plan for the current plan year also benefits under a section 401(l) plan for the plan year ending with or within the current plan year, permitted disparity may not be imputed for that employee for the plan year. See section 1.401(l)-5(b)(9), Example 4. Similarly, if an employee who benefits under the plan for the current plan year also benefits under another plan of the employer for the plan year ending with or within the current plan year, disparity may be imputed for that employee under only one of the plans.

SECTION 1.401(a)(4)-8 CROSS-TESTING.

(a) INTRODUCTION. This section provides rules for testing defined benefit plans on the basis of equivalent employer-provided contributions and defined contribution plans on the basis of equivalent employer-provided benefits under section 1.401(a)(4)- 1(b)(2). Paragraphs (b)(1) and (c)(1) of this section provide general tests for nondiscrimination based on individual equivalent accrual or allocation rates determined under paragraphs (b)(2) and (c)(2) of this section, respectively. Paragraphs (b)(3), (c)(3), and (d) of this section provide additional safe-harbor testing methods for target benefit plans, cash balance plans, and defined benefit plans that are part of floor-offset arrangements, respectively, that generally may be satisfied on a design basis.

(b) NONDISCRIMINATION IN AMOUNT OF BENEFITS PROVIDED UNDER A DEFINED CONTRIBUTION PLAN -- (1) GENERAL RULE. Equivalent benefits under a defined contribution plan (other than an ESOP) are nondiscriminatory in amount for a plan year if the plan would satisfy section 1.401(a)(4)-2(c)(1) for the plan year if an equivalent accrual rate, as determined under paragraph (b)(2) of this section, were substituted for each employee's allocation rate in the determination of rate groups. A plan does not fail to satisfy this paragraph (b)(1) merely because allocations are made at the same rate for employees who are older than their testing age (determined without regard to the current-age rule in paragraph (4) of the definition of Testing age in section 1.401(a)(4)-12) as they are made for employees who are at that age.

(2) DETERMINATION OF EQUIVALENT ACCRUAL RATES -- (i) BASIC DEFINITION. An employee's equivalent accrual rate for a plan year is the annual benefit that is the result of normalizing the increase in the employee's account balance during the measurement period, divided by the number of years in which the employee benefited under the plan during the measurement period, and expressed either as a dollar amount or as a percentage of the employee's average annual compensation. A measurement period that includes future years may not be used for this purpose.

(ii) RULES OF APPLICATION -- (A) DETERMINATION OF ACCOUNT BALANCE. The increase in the account balance during the measurement period taken into account under paragraph (b)(2)(i) of this section does not include income, expenses, gains, or losses allocated during the measurement period that are attributable to the account balance as of the beginning of the measurement period, but does include any additional amounts that would have been included in the increase in the account balance but for the fact that they were previously distributed (including a reasonable adjustment for interest). In the case of a measurement period that is the current plan year, an employer may also elect to disregard the income, expenses, gains, and losses allocated during the current plan year that are attributable to the increase in account balance since the beginning of the year, and thus, determine the increase in account balance during the plan year taking into account only the allocations described in section 1.401(a)(4)-2(c)(2)(ii). In addition, an employer may disregard distributions made to a NHCE as well as distributions made to any employee in plan years beginning before a selected date no later than January 1, 1986.

(B) NORMALIZATION. The account balances determined under paragraph (b)(2)(ii)(A) of this section are normalized by treating them as single-sum benefits that are immediately and unconditionally payable to the employee. A standard interest rate, and a straight life annuity factor that is based on the same or a different standard interest rate and on a standard mortality table, must be used in normalizing these benefits. In addition, no mortality may be assumed prior to the employee's testing age.

(iii) OPTIONS. Any of the optional rules in section 1.401(a)(4)- 3(d)(3) (e.g., imputation of permitted disparity) may be applied in determining an employee's equivalent accrual rate by substituting the employee's equivalent accrual rate (determined without regard to the option) for the employee's normal accrual rate (i.e., not most valuable accrual rate) in that section where appropriate. For this purpose, however, the last sentence of the fresh-start alternative in section 1.401(a)(4)-3(d)(3)(iii)(A) (dealing with compensation adjustments to the frozen accrued benefit) is not applicable. No other options are available in determining an employee's equivalent accrual rate except those (e.g., selection of alternative measurement periods) specifically provided in this paragraph (b)(2). Thus, for example, none of the optional special rules in section 1.401(a)(4)- 3(f) (e.g., determination of benefits on other than a plan year basis under section 1.401(a)(4)-3(f)(6)) is available.

(iv) CONSISTENCY RULE. Equivalent accrual rates must be determined in a consistent manner for all employees for the plan year. Thus, for example, the same measurement periods and standard interest rates must be used, and any available options must be applied consistently if at all.

(3) SAFE-HARBOR TESTING METHOD FOR TARGET BENEFIT PLANS -- (i) GENERAL RULE. A target benefit plan is a money purchase pension plan under which contributions to an employee's account are determined by reference to the amounts necessary to fund the employee's stated benefit under the plan. Whether a target benefit plan satisfies section 401(a)(4) with respect to an equivalent amount of benefits is generally determined under paragraphs (b)(1) and (b)(2) of this section. A target benefit plan is deemed to satisfy section 401(a)(4) with respect to an equivalent amount of benefits, however, if each of the following requirements is satisfied:

(A) STATED BENEFIT FORMULA. Each employee's stated benefit must be determined as the straight life annuity commencing at the employee's normal retirement age under a formula that would satisfy the requirements of section 1.401(a)(4)-3(b)(4)(i)(C)(1) or (2), and that would satisfy each of the uniformity requirements in section 1.401(a)(4)-3(b)(2) (taking into account the relevant exceptions provided in section 1.401(a)(4)-3(b)(6)), if the plan were a defined benefit plan with the same benefit formula. In determining whether these requirements are satisfied, the rules of section 1.401(a)(4)- 3(f) do not apply, and, in addition, except as provided in paragraph (b)(3)(vii) of this section, an employee's stated benefit at normal retirement age under the stated benefit formula is deemed to accrue ratably over the period ending with the plan year in which the employee is projected to reach normal retirement age and beginning with the latest of: the first plan year in which the employee benefited under the plan, the first plan year taken into account in the stated benefit formula, and any plan year immediately following a plan year in which the plan did not satisfy this paragraph (b)(3). Thus, except as provided in paragraph (b)(3)(vii) of this section, under section 1.401(a)(4)-3(b)(2)(v) an employee's stated benefit may not take into account service in years prior to the first plan year that the employee benefited under the plan, and an employee's stated benefit may not take into account service in plan years prior to the current plan year unless the plan satisfied this paragraph (b)(3) in all of those prior plan years.

(B) EMPLOYER AND EMPLOYEE CONTRIBUTIONS. Employer contributions with respect to each employee must be based exclusively on the employee's stated benefit using the method provided in paragraph (b)(3)(iv) of this section, and forfeitures and any other amounts under the plan taken into account under section 1.401(a)(4)- 2(c)(2)(ii) (other than employer contributions) are used exclusively to reduce employer contributions. Employee contributions (if any) may not be used to fund the stated benefit.

(C) PERMITTED DISPARITY. If permitted disparity is taken into account, the stated benefit formula must satisfy section 1.401(l)-3. For this purpose, the 0.75-percent factor in the maximum excess or offset allowance in section 1.401(l)-3(b)(2)(i) or (b)(3)(i), respectively, as adjusted in accordance with section 1.401(l)-3(d)(9) (and, if the employee's normal retirement age is not the employee's social security retirement age, section 1.401(l)-3(e)), is further reduced by multiplying the factor by 0.80.

(ii) CHANGES IN STATED BENEFIT FORMULA. A plan does not fail to satisfy paragraph (b)(3)(i) of this section merely because the plan determines each employee's stated benefit in the current plan year under a stated benefit formula that differs from the stated benefit formula used to determine the employee's stated benefit in prior plan years.

(iii) STATED BENEFITS AFTER NORMAL RETIREMENT AGE. A target benefit plan may limit increases in the stated benefit after normal retirement age consistent with the requirements applicable to defined benefit plans under section 411(b)(1)(H) (without regard to section 411(b)(1)(H)(iii)), provided that the limitation applies on the same terms to all employees. Thus, post-normal retirement benefits required under section 1.401(a)(4)-3(b)(2)(ii) must be provided under the stated benefit formula, subject to any uniformly applicable service cap under the formula.

(iv) METHOD FOR DETERMINING REQUIRED EMPLOYER CONTRIBUTIONS -- (A) GENERAL RULE. An employer's required contribution to the account of an employee for a plan year is determined based on the employee's stated benefit and the amount of the employee's theoretical reserve as of the date the employer's required contribution is determined for the plan year (the determination date). Paragraph (b)(3)(iv)(B) of this section provides rules for determining an employee's theoretical reserve. Paragraph (b)(3)(iv)(C) and (D) of this section provides rules for determining an employer's required contributions.

(B) THEORETICAL RESERVE -- (1) INITIAL THEORETICAL RESERVE. An employee's theoretical reserve as of the determination date for the first plan year in which the employee benefits under the plan, the first plan year taken into account under the stated benefit formula (if that is the current plan year), or the first plan year immediately following any plan year in which the plan did not satisfy this paragraph (b)(3), is zero.

(2) THEORETICAL RESERVE IN SUBSEQUENT PLAN YEARS. An employee's theoretical reserve as of the determination date for a plan year (other than a plan year described in paragraph (b)(3)(iv)(B)(1) of this section) is the employee's theoretical reserve as of the determination date for the prior plan year, plus the employer's required contribution for the prior plan year (as limited by section 415, but without regard to the additional contributions described in paragraph (b)(3)(v) of this section) both increased by interest from the determination date for the prior plan year through the determination date for the current plan year, but not beyond the determination date for the plan year that includes the employee's normal retirement date. (Thus, an employee's theoretical reserve as of the determination date for a plan year does not include the amount of the employer's required contribution for the plan year.) The interest rate for determining employer contributions that was in effect on the determination date in the prior plan year must be applied to determine the required interest adjustment for this period. For plan years beginning after the effective date applicable to the plan under section 1.401(a)(4)-13(a) or (b), a standard interest rate must be used, and may not be changed except on the determination date for a plan year.

(C) REQUIRED CONTRIBUTIONS FOR EMPLOYEES UNDER NORMAL RETIREMENT AGE. The required employer contributions with respect to an employee whose attained age is less than the employee's normal retirement age must be determined for each plan year as follows:

(1) Determine the employee's fractional rule benefit (within the meaning of section 1.411(b)-1(b)(3)(ii)(A)) under the plan's stated benefit formula as if the plan were a defined benefit plan with the same benefit formula.

(2) Determine the actuarial present value of the fractional rule benefit determined in paragraph (b)(3)(iv)(C)(1) of this section as of the determination date for the current plan year, using a standard interest rate and a standard mortality table that are set forth in the plan and that are the same for all employees, and assuming no mortality before the employee's normal retirement age.

(3) Determine the excess, if any, of the amount determined in paragraph (b)(3)(iv)(C)(2) of this section over the employee's theoretical reserve for the current plan year determined under paragraph (b)(3)(iv)(B) of this section.

(4) Determine the required employer contribution for the current plan year by amortizing on a level annual basis, using the same interest rate used for paragraph (b)(3)(iv)(C)(2) of this section, the result in paragraph (b)(3)(iv)(C)(3) of this section over the period beginning with the determination date for the current plan year and ending with the determination date for the plan year in which the employee is projected to reach normal retirement age.

(D) REQUIRED CONTRIBUTIONS FOR EMPLOYEES OVER NORMAL RETIREMENT AGE. The required employer contributions with respect to an employee whose attained age equals or exceeds the employee's normal retirement age is the excess, if any, of the actuarial present value, as of the determination date for the current plan year, of the employee's stated benefit for the current plan year (determined using an immediate straight life annuity factor based on a standard interest rate and a standard mortality table, for an employee whose attained age equals the employee's normal retirement age) over the employee's theoretical reserve as of the determination date.

(v) EFFECT OF SECTION 415 AND 416 REQUIREMENTS. A target benefit plan does not fail to satisfy this paragraph (b)(3) merely because required contributions under the plan are limited by section 415 in a plan year. Similarly, a target benefit plan does not fail to satisfy this paragraph (b)(3) merely because additional contributions are made consistent with the requirements of section 416(c)(2) (regardless of whether the plan is top-heavy).

(vi) CERTAIN CONDITIONS ON ALLOCATIONS. A target benefit plan does not fail to satisfy this paragraph (b)(3) merely because required contributions under the plan are subject to the conditions on allocations permitted under section 1.401(a)(4)-2(b)(4)(iii).

(vii) SPECIAL RULES FOR TARGET BENEFIT PLANS QUALIFIED UNDER PRIOR LAW -- (A) SERVICE TAKEN INTO ACCOUNT PRIOR TO SATISFACTION OF THIS PARAGRAPH. For purposes of determining whether the stated benefit formula satisfies paragraph (b)(3)(i)(A) of this section (e.g., whether the period over which an employee's stated benefit is deemed to accrue is the same as the period taken into account under the stated benefit formula as required by paragraph (b)(3)(i)(A) of this section), a target benefit plan that was adopted and in effect on September 19, 1991, is deemed to have satisfied this paragraph (b)(3), and an employee is treated as benefiting under the plan, in any year prior to the effective date applicable to the plan under section 1.401(a)(4)-13(a) or (b) that was taken into account in the stated benefit formula under the plan on September 19, 1991, if the plan satisfied the applicable nondiscrimination requirements for target benefit plans for that prior year.

(B) INITIAL THEORETICAL RESERVE. Notwithstanding paragraph (b)(3)(iv)(B)(1) of this section, a target benefit plan under which the stated benefit formula takes into account service for an employee for plan years prior to the first plan year in which the plan satisfied this paragraph (b)(3), as permitted under paragraph (b)(3)(vii)(A) of this section, must determine an initial theoretical reserve for the employee as of the determination date for the last plan year beginning before such plan year under the rules of section 1.401(a)(4)-13(e).

(C) SATISFACTION OF PRIOR LAW. In determining whether a plan satisfied the applicable nondiscrimination requirements for target benefit plans for any period prior to the effective date applicable to the plan under section 1.401(a)(4)-13(a) or (b), no amendments after September 19, 1991, other than amendments necessary to satisfy section 401(l), are taken into account.

(viii) EXAMPLES. The following examples illustrate the rules in this paragraph (b)(3):

EXAMPLE 1. (a) Employer X maintains a target benefit plan with a calendar plan year that bases contributions on a stated benefit equal to 40 percent of each employee's average annual compensation, reduced pro rata for years of participation less than 25, payable annually as a straight life annuity commencing at normal retirement age. The UP-84 mortality table and an interest rate of 7.5 percent are used to calculate the contributions necessary to fund the stated benefit. Required contributions are determined on the last day of each plan year. The normal retirement age under the plan is 65. Employee M is 39 years old in 1994, has participated in the plan for six years, and has average annual compensation equal to $60,000 for the 1994 plan year. Assume that Employee M's theoretical reserve as of the last day of the 1993 plan year is $13,909, determined under section 1.401(a)(4)-13(e), and that required employer contributions for 1993 were determined using an interest rate of six percent.

(b) Under these facts, Employer X's 1994 required contribution to fund Employee M's stated benefit is $1,318, calculated as follows:

(1) Employee M's fractional rule benefit is $24,000 (40 percent of Employee M's average annual compensation of $60,000).

(2) The actuarial present value of Employee M's fractional rule benefit as of the last day of the 1994 plan year is $30,960 (Employee M's fractional rule benefit of $24,000 multiplied by 1.290, the actuarial present value factor for an annual straight life annuity commencing at age 65 applicable to a 39-year-old employee, determined using the stated interest rate of 7.5 percent and the UP-84 mortality table, and assuming no mortality before normal retirement age).

(3) The actuarial present value of Employee M's fractional rule benefit ($30,960) is reduced by Employee M's theoretical reserve as of the last day of the 1994 plan year. The theoretical reserve on that day is $14,744 -- the $13,909 theoretical reserve as of the last day of the 1993 plan year, increased by interest for one year at the rate of six percent. Because the required contribution for the 1993 plan year is taken into account under section 1.401(a)(4)-13(e)(2) in determining the theoretical reserve as of the last day of the 1993 plan year, it is not added to the theoretical reserve again in this paragraph (b)(3) of this Example 1. The resulting difference is $16,216 ($30,960 - $14,744).

(4) The $16,216 excess of the actuarial present value of Employee M's fractional rule benefit over Employee M's theoretical reserve is multiplied by 0.0813, the amortization factor applicable to a 39-year-old employee determined using the stated interest rate of 7.5 percent. The product of $1,318 is the amount of the required employer contribution for Employee M for the 1994 plan year.

EXAMPLE 2. (a) The facts are the same as in Example 1, except that as of January 1, 1995, the plan's stated benefit formula is amended to provide for a stated benefit equal to 45 percent of average annual compensation, reduced pro rata for years of participation less than 25, payable annually as a straight life annuity commencing at normal retirement age. For the 1995 plan year, Employee M's average annual compensation continues to be $60,000. The mortality table used for the calculation of the employer's required contributions remains the same as in the prior plan year, but the plan's stated interest rate is changed to 8.0 percent effective as of December 31, 1995.

(b) Under these facts, Employer X's required contribution for Employee M is $1,290, calculated as follows:

(1) Employee M's fractional rule benefit is $27,000 (45 percent of $60,000).

(2) The actuarial present value of Employee M's fractional rule benefit as of the last day of the 1995 plan year is $32,319 ($27,000 multiplied by 1.197, the actuarial present value factor for an annuity commencing at age 65 applicable to a 40-year-old employee, determined using the stated interest rate of 8.0 percent and the UP-84 mortality table, and assuming no mortality before normal retirement age).

(3) The actuarial present value of Employee M's fractional rule benefit ($32,319) is reduced by Employee M's theoretical reserve as of the last day of the 1995 plan year. The theoretical reserve as of that day is $17,267 -- the $14,744 theoretical reserve as of the last day of the 1994 plan year plus the $1,318 required contribution for the 1994 plan year, both increased by interest for one year at the rate of 7.5 percent. The resulting difference is $15,052 ($32,319 - $17,267).

(4) The result in paragraph (b)(3) of this Example 2 is multiplied by 0.0857, the amortization factor applicable to a 40-year-old employee determined using the stated interest rate of 8.0 percent. The product, $1,290, is the amount of the required employer contribution for Employee M for the 1995 plan year.

(c) NONDISCRIMINATION IN AMOUNT OF CONTRIBUTIONS UNDER A DEFINED BENEFIT PLAN -- (1) GENERAL RULE. Equivalent allocations under a defined benefit plan are nondiscriminatory in amount for a plan year if the plan would satisfy section 1.401(a)(4)-3(c)(1) (taking into account section 1.401(a)(4)-3(c)(3)) for the plan year if an equivalent normal and most valuable allocation rate, as determined under paragraph (c)(2) of this section, were substituted for each employee's normal and most valuable accrual rate, respectively, in the determination of rate groups.

(2) DETERMINATION OF EQUIVALENT ALLOCATION RATES -- (i) BASIC DEFINITIONS. An employee's equivalent normal and most valuable allocation rates for a plan year are, respectively, the actuarial present value of the increase over the plan year in the benefit that would be taken into account in determining the employee's normal and most valuable accrual rates for the plan year, expressed either as a dollar amount or as a percentage of the employee's plan year compensation. In the case of a contributory DB plan, the rules in section 1.401(a)(4)-6(b)(1), (b)(5), or (b)(6) must be used to determine the amount of each employee's employer-provided benefit that would be taken into account for this purpose.

(ii) RULES FOR DETERMINING ACTUARIAL PRESENT VALUE. The actuarial present value of the increase in an employee's benefit must be determined using a standard interest rate and a standard mortality table, and no mortality may be assumed prior to the employee's testing age.

(iii) OPTIONS. The optional rules in section 1.401(a)(4)- 2(c)(2)(iv) (imputation of permitted disparity) and (v) (grouping of rates) may be applied to determine an employee's equivalent normal and most valuable allocation rates by substituting those rates (determined without regard to the option) for the employee's allocation rate in that section where appropriate. In addition, the limitations under section 415 may be taken into account under section 1.401(a)(4)-3(d)(2)(ii)(B), and qualified disability benefits may be taken into account as accrued benefits under section 1.401(a)(4)- 3(f)(2), in determining the increase in an employee's accrued benefit during a plan year for purposes of paragraph (c)(2)(i) of this section, if those rules would otherwise be available. No other options are available in determining an employee's equivalent normal and most valuable allocations rate except those (e.g., selection of alternative standard interest rates) specifically provided in this paragraph (c)(2). Thus, while all of the mandatory rules in section 1.401(a)(4)-3(d) and (f) for determining the amount of benefits used to determine an employee's normal and most valuable accrual rates (e.g., the treatment of early retirement window benefits in section 1.401(a)(4)-3(f)(4)) are applicable in determining an employee's equivalent normal and most valuable allocation rates, none of the optional rules under section 1.401(a)(4)-3 is available (except the options relating to the section 415 limits and qualified disability benefits noted above).

(iv) CONSISTENCY RULE. Equivalent allocation rates must be determined in a consistent manner for all employees for the plan year. Thus, for example, the same standard interest rates must be used, and any available options must be applied consistently if at all.

* * * * *

(d) SAFE-HARBOR TESTING METHOD FOR DEFINED BENEFIT PLANS THAT ARE PART OF A FLOOR-OFFSET ARRANGEMENT -- (1) GENERAL RULE. A defined benefit plan that is part of a floor-offset arrangement is deemed to satisfy the nondiscriminatory amount requirement of section 1.401(a)(4)-1(b)(2) if all of the following requirements are satisfied:

(i) Under the floor-offset arrangement, the accrued benefit (as defined in section 411(a)(7)(A)(i)) that would otherwise be provided to an employee under the defined benefit plan must be reduced solely by the actuarial equivalent of all or part of the employee's account balance attributable to employer contributions under a defined contribution plan maintained by the same employer (plus the actuarial equivalent of all or part of any prior distributions from that portion of the account balance). If any portion of the benefit that is being offset is nonforfeitable, that portion may be offset only by a benefit (or portion of a benefit) that is also nonforfeitable. In determining the actuarial equivalent of amounts provided under the defined contribution plan, an interest rate no higher than the highest standard interest rate must be used, and no mortality may be assumed in determining the actuarial equivalent of any prior distributions from the defined contribution plan or for periods prior to the benefit commencement date under the defined benefit plan.

(ii) The defined benefit plan may not be a contributory DB plan (unless it satisfies section 1.401(a)(4)-6(b)(6)), and benefits under the defined benefit plan may not be reduced by any portion of the employee's account balance under the defined contribution plan (or prior distributions from that account) that are attributable to employee contributions.

(iii) The defined benefit plan and the defined contribution plan must benefit the same employees.

(iv) The offset under the defined benefit plan must be applied to all employees on the same terms.

(v) All employees must have available to them under the defined contribution plan the same investment options and the same options with respect to the timing of preretirement distributions.

(vi) The defined benefit plan must satisfy the uniformity requirements of section 1.401(a)(4)-3(b)(2) and the unit credit safe harbor in section 1.401(a)(4)-3(b)(3) without taking into account the offset described in paragraph (d)(1)(i) of this section (i.e., on a gross-benefit basis), and the defined contribution plan must satisfy any of the tests in section 1.401(a)(4)-2(b) or (c). Alternatively, the defined benefit plan must satisfy any of the tests in section 1.401(a)(4)-3(b) or (c) without taking into account the offset described in paragraph (d)(1)(i) of this section, and the defined contribution plan must satisfy the uniform allocation safe harbor in section 1.401(a)(4)-2(b)(2).

(vii) The defined contribution plan may not be a section 401(k) plan or a section 401(m) plan.

(2) APPLICATION OF SAFE-HARBOR TESTING METHOD TO QUALIFIED OFFSET ARRANGEMENTS. A defined benefit plan that is part of a qualified offset arrangement as defined in section 1116(f)(5) of the Tax Reform Act of 1986, Pub. L. No. 99-514, is deemed to satisfy the requirements of paragraph (d)(1)(vi) and (vii) of this section, if the only defined contribution plans included in the qualified offset arrangement are section 401(k) plans, section 401(m) plans, or both, and the defined benefit plan would satisfy the requirements of paragraph (d)(1)(vi) of this section assuming the elective contributions for each employee under the defined contribution plan were the same (either as a dollar amount or as a percentage of compensation) for all plan years since the establishment of the plan.

SECTION 1.401(a)(4)-9 PLAN AGGREGATION AND RESTRUCTURING.

(a) INTRODUCTION. Two or more plans that are permissively aggregated and treated as a single plan under sections 1.410(b)-7(d) must also be treated as a single plan for purposes of section 401(a)(4). See section 1.401(a)(4)-12 (definition of plan). An aggregated plan is generally tested under the same rules applicable to single plans. Paragraph (b) of this section, however, provides special rules for determining whether a plan that consists of one or more defined contribution plans and one or more defined benefit plans (a DB/DC plan) satisfies section 401(a)(4) with respect to the amount of employer-provided benefits and the availability of benefits, rights, and features. Paragraph (c) of this section provides rules allowing a plan to be treated as consisting of separate component plans and allowing the component plans to be tested separately under section 401(a)(4).

(b) APPLICATION OF NONDISCRIMINATION REQUIREMENTS TO DB/DC PLANS -- (1) General rule. Except as provided in paragraph (b)(2) of this section, whether a DB/DC plan satisfies section 401(a)(4) is determined using the same rules applicable to a single plan. In addition, paragraph (b)(3) of this section provides an optional rule for demonstrating nondiscrimination in availability of benefits, rights, and features provided under a DB/DC plan.

(2) SPECIAL RULES FOR DEMONSTRATING NONDISCRIMINATION IN AMOUNT OF CONTRIBUTIONS OR BENEFITS -- (i) APPLICATION OF GENERAL TESTS. A DB/DC plan satisfies section 401(a)(4) with respect to the amount of contributions or benefits for a plan year if it would satisfy section 1.401(a)(4)-3(c)(1) (without regard to the special rule in section 1.401(a)(4)-3(c)(3)) for the plan year if an employee's aggregate normal and most valuable allocation rates, as determined under paragraph (b)(2)(ii)(A) of this section, or an employee's aggregate normal and most valuable accrual rates, as determined under paragraph (b)(2)(ii)(B) of this section, were substituted for each employee's normal and most valuable accrual rates, respectively, in the determination of rate groups.

(ii) DETERMINATION OF AGGREGATE RATES -- (A) AGGREGATE ALLOCATION RATES. An employee's aggregate normal and most valuable allocation rates are determined by treating all defined contribution plans that are part of the DB/DC plan as a single plan, and all defined benefit plans that are part of the DB/DC plan as a separate single plan; and determining an allocation rate and equivalent normal and most valuable allocation rates for the employee under each plan under sections 1.401(a)(4)-2(c)(2) and 1.401(a)(4)-8(c)(2), respectively. The employee's aggregate normal allocation rate is the sum of the employee's allocation rate and equivalent normal allocation rate determined in this manner, and the employee's aggregate most valuable allocation rate is the sum of the employee's allocation rate and equivalent most valuable allocation rate determined in this manner.

(B) AGGREGATE ACCRUAL RATES. An employee's aggregate normal and most valuable accrual rates are determined by treating all defined contribution plans that are part of the DB/DC plan as a single plan, and all defined benefit plans that are part of the DB/DC plan as a separate single plan; and determining an equivalent accrual rate and normal and most valuable accrual rates for the employee under each plan under sections 1.401(a)(4)-8(b)(2) and 1.401(a)(4)-3(d), respectively. The employee's aggregate normal accrual rate is the sum of the employee's equivalent accrual rate and the normal accrual rate determined in this manner, and the employee's aggregate most valuable accrual rate is the sum of the employee's equivalent accrual rate and most valuable accrual rate determined in this manner.

(iii) OPTIONS APPLIED ON AN AGGREGATE BASIS. The optional rules in section 1.401(a)(4)-2(c)(2)(iv) (imputation of permitted disparity) and (v) (grouping of rates) may not be used to determine an employee's allocation or equivalent allocation rate, but may be applied to determine an employee's aggregate normal and most valuable allocation rates by substituting those rates (determined without regard to the option) for the employee's allocation rate in that section where appropriate. The optional rules in section 1.401(a)(4)- 3(d)(3) (e.g., imputation of permitted disparity) may not be used to determine an employee's accrual or equivalent accrual rate, but may be applied to determine an employee's aggregate normal and most valuable accrual rate by substituting those rates (determined without regard to the option) for the employee's normal and most valuable accrual rates, respectively, in that section where appropriate.

(iv) CONSISTENCY RULE -- (A) GENERAL RULE. Aggregate normal and most valuable allocation rates and aggregate normal and most valuable accrual rates must be determined in a consistent manner for all employees for the plan year. Thus, for example, the same measurement periods and interest rates must be used, and any available options must be applied consistently, if at all, for the entire DB/DC plan. Consequently, options that are not permitted to be used under section 1.401(a)(4)-8 in cross-testing a defined contribution plan or a defined benefit plan (such as measurement periods that include future periods, non-standard interest rates, the option to disregard compensation adjustments described in section 1.401(a)(4)-13(d), or the option to disregard plan provisions providing for actuarial increases after normal retirement age under section 1.401(a)(4)- 3(f)(3)) may not be used in testing a DB/DC plan on either a benefits or contributions basis, because their use would inevitably result in inconsistent determinations under the defined contribution and defined benefit portions of the plan.

(B) EXCEPTION FOR SECTION 415 ALTERNATIVE. A DB/DC plan does not fail to satisfy the consistency rule in paragraph (b)(2)(iv)(A) of this section merely because the limitations under section 415 are not taken into account, or may not be taken into account, under section 1.401(a)(4)-3(d)(2)(ii)(B) in determining employees' accrual or equivalent allocation rates under the defined benefit portion of the plan, even though those limitations are applied in determining employees' allocation and equivalent accrual rates under the defined contribution portion of the plan.

(3) OPTIONAL RULES FOR DEMONSTRATING NONDISCRIMINATION IN AVAILABILITY OF CERTAIN BENEFITS, RIGHTS, AND FEATURES -- (i) CURRENT AVAILABILITY. A DB/DC plan is deemed to satisfy section 1.401(a)(4)- 4(b)(1) with respect to the current availability of a benefit, right, or feature other than a single sum benefit, loan, ancillary benefit, or benefit commencement date (including the availability of in- service withdrawals), that is provided under only one type of plan (defined benefit or defined contribution) included in the DB/DC plan, if the benefit, right, or feature is currently available to all NHCEs in all plans of the same type as the plan under which it is provided.

(ii) EFFECTIVE AVAILABILITY. The fact that it may be difficult or impossible to provide a benefit, right, or feature described in paragraph (b)(3)(i) of this section under a plan of a different type than the plan or plans under which it is provided is one of the factors taken into account in determining whether the plan satisfies the effective availability requirement of section 1.401(a)(4)- 4(c)(1).

(c) PLAN RESTRUCTURING --(1) GENERAL RULE. A plan may be treated, in accordance with this paragraph (c), as consisting of two or more component plans for purposes of determining whether the plan satisfies section 401(a)(4). If each of the component plans of a plan satisfies all of the requirements of sections 401(a)(4) and 410(b) as if it were a separate plan, then the plan is treated as satisfying section 401(a)(4).

(2) IDENTIFICATION OF COMPONENT PLANS. A plan may be restructured into component plans, each consisting of all the allocations, accruals, and other benefits, rights, and features provided to a selected group of employees. The employer may select the group of employees used for this purpose in any manner, and the composition of the groups may be changed from plan year to plan year. Every employee must be included in one and only one component plan under the same plan for a plan year.

(3) SATISFACTION OF SECTION 401(a)(4) BY A COMPONENT PLAN -- (i) GENERAL RULE. The rules applicable in determining whether a component plan satisfies section 401(a)(4) are the same as those applicable to a plan. Thus, for this purpose, any reference to a plan in section 401(a)(4) and the regulations thereunder (other than this paragraph (c)) is interpreted as a reference to a component plan. As is true for a plan, whether a component plan satisfies the uniformity and other requirements applicable to safe harbor plans under sections 1.401(a)(4)-2(b) and 1.401(a)(4)-3(b) is determined on a design basis. Thus, for example, plan provisions are not disregarded merely because they do not currently apply to employees in the component plan if they will apply to those employees as a result of the mere passage of time.

(ii) CERTAIN TESTING RULES INVOLVING AVERAGING. The safe harbor in section 1.401(a)(4)-2(b)(3) for plans with uniform points allocation formulas are not available in testing (and thus cannot be satisfied by) contributions under a component plan. See sections 1.401(k)-1(b)(3)(iii) and 1.401(m)-1(b)(3)(iii) for rules regarding the inapplicability of restructuring to section 401(k) plans and section 401(m) plans.

(4) SATISFACTION OF SECTION 410(b) BY A COMPONENT PLAN -- (i) GENERAL RULE. The rules applicable in determining whether a component plan satisfies section 410(b) are generally the same as those applicable to a plan. However, a component plan is deemed to satisfy the average benefit percentage test of section 1.410(b)-5 if the plan of which it is a part satisfies section 1.410(b)-5 (without regard to section 1.410(b)-5(f)). In the case of a component plan that is part of a plan that relies on section 1.410(b)-5(f) to satisfy the average benefit percentage test, the component plan is deemed to satisfy the average benefit percentage test only if the component plan separately satisfies section 1.410(b)-5(f). In addition, all component plans of a plan are deemed to satisfy the average benefit percentage test if the plan makes an early retirement window benefit (within the meaning of section 1.401(a)(4)-3(f)(4)(iii)) currently available (within the meaning of section 1.401(a)(4)-3(f)(4)(ii)(A)) to a group of employees that satisfies section 410(b) (without regard to the average benefit percentage test), and if it would not be necessary for the plan or any rate group or component plan of the plan to satisfy that test in order for the plan to satisfy sections 401(a)(4) and 410(b) in the absence of the early retirement window benefit.

(ii) RELATIONSHIP TO SATISFACTION OF SECTION 410(b) BY THE PLAN. Satisfaction of section 410(b) by a component plan is relevant solely for purposes of determining whether the plan of which it is a part satisfies section 401(a)(4), and not for purposes of determining whether the plan satisfies section 410(b) itself. The plan must still independently satisfy section 410(b) in order to be a qualified plan. Similarly, satisfaction of section 410(b) by a plan is relevant solely for purposes of determining whether the plan, and not the component plan, satisfies section 410(b). Thus, for example, a component plan that does not satisfy the ratio percentage test of section 1.410(b)-2(b)(2) must still satisfy the average benefit test of section 1.410(b)-2(b)(3), even though the plan of which it is a part satisfies the ratio percentage test.

(5) EFFECT OF RESTRUCTURING UNDER OTHER SECTIONS. The restructuring rules provided in this paragraph (c) apply solely for purposes of sections 401(a)(4) and 401(l), and those portions of sections 410(b), 414(s), and any other provisions that are specifically applicable in determining whether the requirements of section 401(a)(4) are satisfied. Thus, for example, a component plan is not treated as a separate plan under section 401(a)(26).

(6) EXAMPLES. The following examples illustrate the rules in this paragraph (c):

EXAMPLE 1. Employer X maintains a defined benefit plan. The plan provides a normal retirement benefit equal to 1.0 percent of average annual compensation times years of service to employees at Plant S, and 1.5 percent of average annual compensation times years of service to employees at Plant T. Under paragraph (c)(2) of this section, the plan may be treated as consisting of two component defined benefit plans, one providing retirement benefits equal to 1.0 percent of average annual compensation times years of service to the employees at Plant S, and another providing benefits equal to 1.5 percent of average annual compensation times years of service to employees at Plant T. If each component plan satisfies sections 401(a)(4) and 410(b) as if it were a separate plan under the rules of this paragraph (c), then the entire plan satisfies section 401(a)(4).

EXAMPLE 2. (a) Employer Y maintains Plan A, a defined benefit plan, for its Employees M, N, O, P, Q, and R. Plan A provides benefits under a uniform formula that satisfies the requirements of section 1.401(a)(4)-3(b)(2) and (b)(3) before it is amended on February 14, 1994. The amendment provides an early retirement window benefit that is a subsidized optional form of benefit under section 1.401(a)(4)-3(b)(2)(iii) and that is available on the same terms to all employees who satisfy the eligibility requirements for the window. The early retirement window benefit is available only to employees who retire between June 1, 1994, and November 30, 1994.

(b) Assume that Employees M, N, and O will be eligible to receive the window benefit by the end of the window period and Employees P, Q, and R will not. Because substantially all employees will not satisfy the eligibility requirements for the early retirement window benefit by the close of the early retirement window benefit period, Plan A fails to satisfy the uniform subsidies requirement of section 1.401(a)(4)- 3(b)(2)(iii). See section 1.401(a)(4)-3(b)(2)(vi), Example 6.

(c) Under paragraph (c)(2) of this section, Employees M, N, O, P, Q, and R may be grouped into two component plans, one consisting of Employees M, N, and O and all their accruals and other benefits, rights, and features under the plan (including the early retirement window benefit), and another consisting of Employees P, Q, and R, and all their accruals and other benefits, rights, and features under the plan. Each of the component plans identified in this manner satisfies the uniform subsidies requirement of section 1.401(a)(4)-3(b)(2)(iii), and thus satisfies section 1.401(a)(4)-3(b). The entire plan satisfies section 401(a)(4) under the rules of this paragraph (c), if each of these component plans also satisfies section 410(b) as if it were a separate plan (including, if applicable, the reasonable classification requirement of section 1.410(b)- 4(b), and taking into account the special rule of paragraph (c)(4)(i) of this section that forgives the average benefit percentage test in certain situations in which the average benefit percentage test would be required solely as a result of the early retirement window benefit).

EXAMPLE 3. (a) Employer Z maintains Plan B, a defined benefit plan with a benefit formula that provides two percent of average annual compensation for each year of service up to 20 to each employee. Assume that Plan B would satisfy the fractional accrual rule safe harbor in section 1.401(a)(4)-3(b)(4), except that some employees accrue a portion of their normal retirement benefit in the current plan year that is more than one third larger than the portion of the same benefit accrued by other employees for the current plan year, and the plan therefore fails to satisfy the one-third-larger-requirement of section 1.401(a)(4)-3(b)(4)(i)(C)(1).

(b) Employer Z restructures Plan B into two plans, one covering employees with 30 years or less of service at normal retirement age, and the other covering all other employees. Each component plan would separately satisfy the one-third-larger requirement of section 1.401(a)(4)-3(b)(4)(i)(C)(1) if the only employees taken into account were those employees included in the component plan in the current plan year. Under paragraph (c)(3)(i) of this section and section 1.401(a)(4)- 3(b)(4)(i)(C)(1), however, the component plans do not satisfy the one-third-larger requirement because the safe harbor determination is made taking into account the effect of the plan benefit formula on any potential employee in the component plan (other than employees with more than 33 years of service at normal retirement age), and not just those employees included in the component plan in the current plan year.

SECTION 1.401(a)(4)-10 TESTING OF FORMER EMPLOYEES.

(a) INTRODUCTION. This section provides rules for determining whether a plan satisfies the nondiscriminatory amount and nondiscriminatory availability requirements of section 1.401(a)(4)- 1(b)(2) and (3), respectively, with respect to former employees. Generally, this section is relevant only in the case of benefits provided through an amendment to the plan effective in the current plan year. See the definitions of employee and former employee in section 1.401(a)(4)-12.

(b) NONDISCRIMINATION IN AMOUNT OF CONTRIBUTIONS OR BENEFITS -- (1) GENERAL RULE. A plan satisfies section 1.401(a)(4)-1(b)(2) with respect to the amount of contributions or benefits provided to former employees if, under all of the relevant facts and circumstances, the amount of contributions or benefits provided to former employees does not discriminate significantly in favor of former HCEs. For this purpose, contributions or benefits provided to former employees includes all contributions or benefits provided to former employees or, at the employer's option, only those contributions or benefits arising out of the amendment providing the contributions or benefits. A plan under which no former employee currently benefits (within the meaning of section 1.410(b)-3(b)) is deemed to satisfy this paragraph (b).

(2) PERMITTED DISPARITY. Section 401(l) and section 1.401(a)(4)- 7 generally apply to benefits provided to former employees in the same manner as those provisions apply to employees. Thus, for example, for purposes of determining a former employee's cumulative permitted disparity limit, the sum of the former employee's total annual disparity fractions (within the meaning of section 1.401(l)-5) as an employee continues to be taken into account. However, the permitted disparity rate applicable to a former employee is determined under section 1.401(l)-3(e) as of the age the former employee commenced receipt of benefits, not as of the date the employee receives the accrual for the current plan year.

(3) EXAMPLES. The following examples illustrate the rules in this paragraph (b):

EXAMPLE 1. Employer X maintains a section 401(l) plan, Plan A, that uses maximum permitted disparity. Plan A is amended to increase the benefits of all former employees in pay status. The percentage increase for each former employee is reasonably comparable to the adjustment in social security benefits under section 215(i)(2)(A) of the Social Security Act since the former employee commenced receipt of benefits. Plan A does not fail to satisfy this paragraph (b) merely because of the amendment.

EXAMPLE 2. The facts are the same as in Example 1, except that the amendment provides an across-the-board 20 percent increase in benefits for all former employees in pay status. The cost of living has increased at an average rate of three percent in the two years preceding the amendment, and some HCEs have retired and become former HCEs during that period. Because this amendment increases the disparity in the plan formula beyond the maximum permitted disparity adjusted for any reasonable approximation of the increase in the cost of living since the HCEs retired, Plan A discriminates significantly in favor of former HCEs, and thus does not satisfy this paragraph (b).

EXAMPLE 3. The facts are the same as an Example 1, except that Plan A is only amended to increase the benefits of former employees in pay status who terminated employment with Employer X after attaining early retirement age. The determination of whether the amendment causes Plan A to fail to satisfy this paragraph (b) must take into account the relative numbers of former HCEs and former NHCEs who have terminated employment with Employer X after attaining early retirement age.

(c) NONDISCRIMINATION IN AVAILABILITY OF BENEFITS, RIGHTS, OR FEATURES. A plan satisfies section 401(a)(4) with respect to the availability of benefits, rights, and features provided to former employees if any change in the availability of any benefit, right, or feature to any former employee is applied in a manner that, under all of the relevant facts and circumstances, does not discriminate significantly in favor of former HCEs. For purposes of demonstrating that a plan satisfies section 401(a)(4) with respect to the availability of loans provided to former employees, an employer may treat former employees who are parties in interest within the meaning of section 3(14) of the Employee Retirement Income Security Act of 1974 as employees.

SECTION 1.401(a)(4)-11 ADDITIONAL RULES.

(a) INTRODUCTION. This section provides additional rules for determining whether a plan satisfies section 401(a)(4). Paragraph (b) of this section provides rules for the treatment of the portion of an employee's accrued benefit or account balance that is attributable to rollovers, transfers between plans, and employee buybacks. Paragraph (c) of this section provides rules regarding vesting. Paragraph (d) of this section provides rules regarding service crediting. Paragraph (e) of this section, regarding family aggregation, and paragraph (f) of this section, regarding governmental plans, are reserved. Paragraph (g) of this section provides rules regarding the extent to which corrective amendments may be made for purposes of section 401(a).

(b) ROLLOVERS, TRANSFERS, AND BUYBACKS -- (1) ROLLOVERS AND ELECTIVE TRANSFERS. The portion of an employee's accrued benefit or account balance under a plan that is attributable to rollover (including direct rollover) contributions to the plan that are described in section 402(c), 402(e)(6), 403(a)(4), 403(a)(5), or 408(d)(3), or elective transfers to the plan that are described in section 1.411(d)-4, Q&A-3(b), is not taken into account in determining whether the plan satisfies the nondiscriminatory amount requirement of section 1.401(a)(4)-1(b)(2).

(2) OTHER TRANSFERS. [Reserved]

(3) EMPLOYEE BUYBACKS -- (i) REHIRED EMPLOYEE BUYBACK OF PREVIOUS SERVICE. An employee's repayment to a plan of a prior distribution from the plan (including reasonable interest from the time of the distribution) that results in the restoration of the employee's accrued benefit under the plan (or the service associated with that accrued benefit) that would otherwise be disregarded in determining the employee's accrued benefit in accordance with section 411 on account of the distribution is not treated as an employee contribution for purposes of sections 1.401(a)(4)-1 through 1.401(a)(4)-13.

(ii) MAKE-UP OF MISSED EMPLOYEE CONTRIBUTIONS. If a contributory DB plan gives all employees who did not make employee contributions for a prior period the right to make the missed contributions at a later date (including reasonable interest from the time of the missed contributions) and, once the contributions have been made, determines benefits under the plan by treating the employee contributions (excluding the interest) as if they were actually made during that prior period, then those contributions must satisfy section 1.401(a)(4)-6(c) as if they were employee contributions actually made during that prior period. Thus, for example, section 1.401(a)(4)- 6(c)(2) is not satisfied for the current plan year if the employee contribution rate (within the meaning of section 1.401(a)(4)- 6(b)(2)(ii)(A) but determined without regard to the interest) for the employees making up missed contributions is different than the employee contribution rate applicable to other employees during the prior period. The rule in this paragraph (b)(3)(ii) may be extended to employees who did not make employee contributions for a period of service that is or would otherwise have been credited under the plan and that preceded their participation in the plan.

(c) VESTING -- (1) GENERAL RULE. A plan satisfies this paragraph (c) if the manner in which employees vest in their accrued benefits under the plan does not discriminate in favor of HCEs. Whether the manner in which employees vest in their accrued benefits under a plan discriminates in favor of HCEs is determined under this paragraph (c) based on all of the relevant facts and circumstances, taking into account any relevant provisions of sections 401(a)(5)(E), 411(a)(10), 411(d)(1), 411(d)(2), 411(d)(3), 411(e), and 420(c)(2), and taking into account any plan provisions that affect the nonforfeitability of employees' accrued benefits (e.g., plan provisions regarding suspension of benefits permitted under section 411(a)(3)(B)), other than the method of crediting years of service for purposes of applying the vesting schedule provided in the plan.

(2) DEEMED EQUIVALENCE OF STATUTORY VESTING SCHEDULES. For purposes of this paragraph (c), the manner in which employees vest in their accrued benefits under the vesting schedules in section 411(a)(2)(A) and (B) are treated as equivalent to one another, and the manner in which employees vest in their accrued benefits under the vesting schedules in section 416(b)(1)(A) and (B) are treated as equivalent to one another.

(3) SAFE HARBOR FOR VESTING SCHEDULES. The manner in which employees vest in their accrued benefits under a plan is deemed not to discriminate in favor of HCEs if each combination of plan provisions that affect the nonforfeitability of any employee's accrued benefit would satisfy the nondiscriminatory availability requirements of section 1.401(a)(4)-4 if that combination were an other right or feature.

(4) EXAMPLES. The following examples illustrate the rules in this paragraph (c):

EXAMPLE 1. Plan A provides the six-year graded vesting schedule described in section 416(b)(1)(B). In 1996, Plan A is amended to provide the five-year vesting schedule described in section 411(a)(2)(A). To comply with section 411(a)(10)(B), the plan amendment also provides that all employees with at least three years of service may elect to retain the prior vesting schedule. The manner in which employees vest in their accrued benefits under Plan A does not discriminate in favor of HCEs merely because the prior vesting schedule continues to apply to the accrued benefits of electing employees, even if, at the time of the election or in future years, the prior vesting schedule applies only to a group of employees that does not satisfy section 410(b).

EXAMPLE 2. The facts are the same as in EXAMPLE 1, except that, for administrative convenience in complying with section 411(a)(10)(B), the plan amendment automatically provides all employees employed on the date of the amendment with the higher of the nonforteitable percentages determined under either schedule. The manner in which employees vest in their accrued benefits under Plan A does not discriminate in favor of HCEs merely because, for administrative convenience in complying with section 411(a)(10), the amendment exceeds the requirements of section 411(a)(10). The result would be the same if the plan amendment automatically provided the higher of the nonforteitable percentages only to those employees with at least three years of service.

EXAMPLE 3. (a) Employer Y maintains Plan B covering all of its employees. On January 1, 1996, Employer Y sells Division M to Employer Z, and all of the employees in Division M become employees of Employer Z. Employer Y obtains a determination letter that the resulting cessation of participation by these employees in Plan B constitutes a partial termination. Therefore, in order to satisfy section 411(d)(3), Plan B fully vests the accrued benefit of each of the employees of Division M whose participation in Plan B ceased as a result of the sale on January 1, 1996.

(b) The manner in which employees vest in their accrued benefits under Plan B does not discriminate in favor of HCEs merely because, in order to satisfy section 411(d)(3), the accrued benefits of all employees affected by the partial termination become fully vested. This is true even if the affected group of employees does not satisfy section 410(b).

EXAMPLE 4. (a) The facts are the same as in EXAMPLE 3, except that Employer Y does not obtain a determination letter that the sale of Division M to Employer Z will cause a partial termination. Instead, based on its reasonable belief that the sale will cause a partial termination, and in order to ensure that Plan B will satisfy section 411(d)(3), Employer Y amends Plan B to vest fully the accrued benefit on January 1, 1996 of each of the employees it reasonably believes to be an affected employee.

(b) The manner in which employees vest in their accrued benefits under Plan B does not discriminate in favor of HCEs merely because, based on Employer Y's reasonable belief that the sale will cause a partial termination, Plan B is amended to vest fully the accrued benefits of each of the employees it reasonably believes to be an affected employee.

(d) SERVICE-CREDITING RULES -- (1) OVERVIEW -- (i) IN GENERAL. A defined benefit plan or a defined contribution plan does not satisfy this paragraph (d) with respect to the manner in which service is credited under the plan unless the plan satisfies paragraph (d)(2) of this section. Paragraph (d)(3) of this section provides rules for determining whether service other than actual service with the employer may be taken into account in determining whether a defined benefit plan or a defined contribution plan satisfies section 1.401 (a)(4)-1(b)(2) or (b)(3). (However, for purposes of cross-testing a defined contribution plan, only years in which the employee benefited under the plan may be taken into account in determining equivalent accrual rates. See section 1.401(a)(4)-8(b)(2)(i).) The rules of this paragraph (d) apply separately to service credited under a plan for each different purpose under the plan, including, but not limited to: application of the benefit formula (benefit service), application of the accrual method (accrual service), application of the vesting schedule (vesting service), entitlement to benefits, rights, and features (entitlement service), application of the requirements for eligibility to participate in the plan (eligibility service).

(ii) SPECIAL RULE FOR PRE-EFFECTIVE DATE SERVICE. A plan is deemed to satisfy this paragraph (d) with respect to service credited for periods prior to the effective date applicable to the plan under section 1.401(a)(4)-13(a) or (b) under a plan provision adopted and in effect as of February 11, 1993 (and any such service may be taken into account for purposes of satisfying section 1.401(a)(4)-1(b)(2) or (b)(3)), if the plan satisfied the applicable nondiscrimination requirements with respect to the service that were in effect for all relevant periods prior to the applicable effective date.

(2) MANNER OF CREDITING SERVICE -- (i) GENERAL RULE. A plan satisfies this paragraph (d)(2) if, on the basis of all of the relevant facts and circumstances, the manner in which employees' service is credited for all purposes under the plan does not discriminate in favor of HCEs.

(ii) EQUIVALENT SERVICE-CREDITING METHODS. For purposes of this paragraph (d)(2), a service-crediting method used for a specified purpose that is based on hours of service, as provided in 29 CFR 2530.200b-2, and a service-crediting method used for the same purpose that is based on one of the equivalencies set forth in 29 CFR 2530.200b-3, are treated as equivalent if the service-crediting methods are otherwise the same.

(iii) SAFE HARBOR FOR SERVICE-CREDITING. The manner in which service is credited under a plan for a specified purpose is deemed to satisfy this paragraph (d)(2) if each combination of service- crediting provisions applied for that purpose would satisfy the nondiscriminatory availability requirements of section 1.401(a)(4)-4 if that combination were an other right or feature.

(iv) EXAMPLES. The following examples illustrate the rules in this paragraph (d)(2):

EXAMPLE 1. (a) Plan A covers both salaried employees and hourly employees. All of the HCEs in Plan A are salaried employees. For administrative convenience, salaried employees in Plan A (none of whom are part-time) have their years of service calculated in accordance with the elapsed time provisions in section 1.410(a)-7. Hourly employees in Plan A (most of whom are scheduled to work 2,000 hours in a year) have their hours of service calculated in accordance with 29 CFR 2530.200b-2 and are credited with a year of service for each plan year in which they complete 1,000 hours of service.

(b) Plan A does not fail to satisfy this paragraph (d)(2) merely because different service-crediting provisions are applied to salaried and hourly employees for administrative convenience. The service-crediting provisions for hourly employees in Plan A are reasonably comparable to the service- crediting provisions for salaried employees. This is because the amount of service credited to hourly employees who complete fewer than 1,000 hours of service before termination of employment (i.e., quit, retirement, discharge, or death) during the plan year (and are treated less favorably than the salaried employees with the same period of employment during the plan year) is balanced by the amount of service credited to hourly employees who complete more than 1,000 hours of service before termination of employment during the plan year (who are treated more favorably than the salaried employees with the same period of employment during the plan year).

EXAMPLE 2. (a) The facts are the same as in EXAMPLE 1, except Plan A requires hourly employees to complete 2,000 hours of service in order to be credited with a full year of service, with a pro rata reduction for hourly employees who complete fewer than 2,000 hours of service.

(b) Plan A does not fail to satisfy this paragraph (d)(2) merely because different service-crediting provisions are applied to salaried and hourly employees for administrative convenience. The service-crediting provisions for hourly employees in Plan A are reasonably comparable to the service- crediting provisions for salaried employees. This is because the amount of service credited to hourly employees whose employment terminates (i.e., quit, retire, are discharged, or die) during the plan year is reasonably comparable to the amount of service credited to salaried employees whose employment is terminated during the plan year with the same period of employment during the plan year.

(3) SERVICE-CREDITING PERIOD -- (i) LIMITATION ON SERVICE TAKEN INTO ACCOUNT -- (A) General rule. Except as otherwise provided in this paragraph (d)(3), service for periods in which an employee does not perform services as an employee of the employer or in which the employee did not participate in the plan may not be taken into account in determining whether the plan satisfies section 1.401(a)(4)-1(b)(2) and (b)(3). In addition, in determining whether a plan satisfies section 1.401(a)(4)-1(b)(2) and (b)(3), no more than one year of service may be taken into account with respect to any 12-consecutive-month period (with adjustments for shorter periods, if appropriate) unless the additional service is required to be credited under section 410 or 411, whichever is applicable.

(B) PAST SERVICE. Notwithstanding paragraph (d)(3)(i)(A) of this section, service for periods in which an employee performed services as an employee of the employer and did not participate in a plan, but in which the employee would have participated in the plan but for the fact that the plan (or the plan amendment extending coverage to the employee) was not in existence during that period, may be taken into account in determining whether the plan satisfies section 1.401(a)(4)-1(b)(2) and (b)(3). This is because service for such periods generally would have been credited for the employee but for the timing of the plan establishment or amendment, and the timing of the plan establishment or amendment must satisfy section 1.401(a)(4)- 5(a).

(C) PRE-PARTICIPATION AND IMPUTED SERVICE. Notwithstanding paragraph (d)(3)(i)(A) of this section, to the extent that a plan treats pre-participation service and imputed service as actual service with the employer, such service may be taken into account in determining whether the plan satisfies section 1.401(a)(4)-1(b)(2) and (b)(3) if the service satisfies each of the requirements in paragraph (d)(3)(iii) of this section taking into account, in the case of imputed service, the additional rules in paragraph (d)(3)(iv) of this section.

(D) ADDITIONAL LIMITATIONS ON SERVICE-CREDITING IN THE CASE OF CERTAIN OFFSETS. Notwithstanding paragraphs (d)(3)(i)(B) and (C) of this section, if a plan credits benefit service or accrual service under paragraph (d)(3)(i)(B) or (C) of this section for a period before an employee becomes a participant in the plan, but offsets the benefits determined under the plan by benefits under another plan (whether or not qualified or terminated) that are attributable to the same period for which that service is credited, then that service may not be taken into account for purposes of determining whether the first plan satisfies section 1.401(a)(4)-1(b)(2) or (b)(3) unless the offset provision applies on the same basis to all similarly-situated employees (within the meaning of paragraph (d)(3)(iii)(A) of this section).

(ii) DEFINITIONS -- (A) PRE-PARTICIPATION SERVICE. For purposes of this section, pre-participation service includes all years of service credited under a plan for years of service with the employer or a prior employer for periods before the employee commenced or recommenced participation in the plan (other than past service described in paragraph (d)(3)(i)(B) of this section).

(B) IMPUTED SERVICE. For purposes of this section, imputed service includes any service credited for periods after an employee has commenced participation in a plan while the employee is not performing services as an employee for the employer (including a period in which the employee performs services for another employer, e.g., a joint venture), or while the employee has a reduced work schedule and would not otherwise be credited with service at the level being credited under the general terms of the plan.

(iii) REQUIREMENTS FOR PRE-PARTICIPATION AND IMPUTED SERVICE -- (A) PROVISION APPLIED TO ALL SIMILARLY-SITUATED EMPLOYEES -- (1) GENERAL RULE. A plan provision crediting pre-participation service or imputed service to any HCE must apply on the same terms to all similarly-situated NHCEs. Whether two employees are similarly situated for this purpose must be determined based on reasonable business criteria, generally taking into account only the circumstances resulting in the employees being covered under the plan or being granted imputed service and on the situation of the employees (e.g., the plan in which the employees benefit or the employer by which they are employed) during the period for which the pre-participation service or imputed service is credited. For example, employees who enter a plan as a result of a particular merger and who participated in the same plan of a prior employer are generally similarly situated. As another example, employees who are transferred to different joint ventures or different spun-off divisions are generally not similarly situated.

(2) EXAMPLES. The following examples illustrate the rules in this paragraph (d)(3)(iii)(A):

EXAMPLE 1. Employer X maintains defined benefit Plans A and B and defined contribution Plan C. Plan A covers all employees who work at the headquarters of Employer X. Plan B covers some employees in Division M of Employer X, and Plan C covers the other employees of Division M. Plans B and C have not been aggregated for purposes of satisfying section 401(a)(4) or 410(b) for the period for which service is being credited. Plan A provides that, whenever an employee covered by Plan B transfers from Division M to the headquarters, the employee's service credited under Plan B is credited under Plan A, and the employee's benefit under Plan A is offset by the employee's benefit under Plan B. However, Plan A provides for no similar recognition of service or offset for employees covered by Plan C who transfer from Division M to the headquarters. Plan A does not fail to satisfy this paragraph (d)(3)(iii)(A) merely because it credits service for employees transferring from Plan B but not from Plan C, because it is reasonable to treat employees participating in different plans that have not been aggregated as not being similarly situated.

EXAMPLE 2. The facts are the same as in EXAMPLE 1, except that Employer X acquires two trades or businesses from different employers. Employees of the acquired trades or businesses become employees of Division M and become covered by Plan B. In addition, Plan B is amended to credit service with one of the trades or businesses but not the other. Plan B does not fail to satisfy this paragraph (d)(3)(iii)(A) merely because it credits service for one acquired trade or business but not another, because it is reasonable to treat employees of one acquired trade or business as not similarly situated to employees of another acquired trade or business.

(B) LEGITIMATE BUSINESS REASON -- (1) GENERAL RULE. There must be a legitimate business reason, based on all of the relevant facts and circumstances, for a plan to credit imputed service or for a plan to credit pre-participation service for a period of service with another employer.

(2) RELEVANT FACTS AND CIRCUMSTANCES WHEN CREDITING SERVICE WITH ANOTHER EMPLOYER. The following are examples of relevant facts and circumstances for determining whether a legitimate business reason exists for a plan to credit pre-participation or imputed service for a period of service with another employer as service with the employer: whether one employer has a significant ownership, control, or similar interest in, or relationship with, the other employer (though not enough to cause the two employers to be treated as a single employer under section 414); whether the two employers share interrelated business operations; whether the employers maintain the same multiple employer plan; whether the employers share similar attributes, such as operation in the same industry or the same geographic area; and whether the employees are an acquired group of employees or the employees became employed by the other employer in a transaction between the two employers that was a stock or asset acquisition, merger, or other similar transaction involving a change in the employer of the employees of a trade or business. Other factors may also be relevant for this purpose, such as the plan's treatment of service with other employers with which the employer has a similar relationship and the type of service being credited (e.g., vesting service as compared to benefit service or accrual service). A legitimate business reason is deemed to exist for a plan to credit military service as service with the employer.

(3) EXAMPLES. The following examples illustrate the rules in this paragraph (d)(3)(iii)(B):

EXAMPLE 1. Twenty unrelated employers jointly sponsor a multiple-employer plan that covers all employees of the employers. From time to time, employees transfer employment among the employers. There is a legitimate business reason for a disaggregated portion of the plan that benefits the employees of one of the employers to treat service with any of the other employers as service with the employer.

EXAMPLE 2. Employer X owns 20 percent of the outstanding stock of Employer Y. From time to time, employees transfer from Employer X to Employer Y at the request of Employer X. Employer X maintains defined benefit Plan A. Plan A provides that years of service include an employee's years of service with Employer Y. There is a legitimate business reason for Plan A to credit service with Employer Y because Employer X, through its 20- percent ownership interest, benefits from the service that the transferred employees provide to Employer Y.

EXAMPLE 3. Employer Z manufactures widgets and belongs to the National Widget Manufacturers' Association. From time to time, Employer Z hires employees from other widget manufacturers. Employer Z maintains a defined benefit plan, Plan B, which credits pre-participation service for periods of service with all other members of the Association located in the western half of the United States as service with Employer Z. There is a legitimate business reason for Plan B to treat service with other members of the Association as service with Employer Z.

(C) NO SIGNIFICANT DISCRIMINATION -- (1) GENERAL RULE. Based on all of the relevant facts and circumstances, a plan provision crediting pre-participation or imputed service must not by design or in operation discriminate significantly in favor of HCEs.

(2) RELEVANT FACTS AND CIRCUMSTANCES. The following are examples of relevant facts and circumstances for determining whether a plan provision crediting pre-participation service or imputed service discriminates significantly in favor of HCEs: whether the service credit does not duplicate benefits but merely makes an employee whole (i.e., prevents the employee from being disadvantaged with respect to benefits by a change in job or employer or provides the employee with benefits comparable to those of other employees); the degree of business ties between the current employer and the prior employer, such as the degree of ownership interest or other affiliation; the degree of excess coverage under section 410(b) of NHCEs for the plan crediting the service, taking into account employees who are credited with pre-participation service; whether the other employer maintains a qualified plan for its employees; the existence of reciprocal service credit under other plans of the employer or the prior employer; the circumstances underlying the employee's transfer into the group of employees covered by the plan; the type of service being credited; and the relative number of employees other than five- percent owners or the most highly-paid HCEs of the employer (determined without regard to the one officer rule of section 414(q)(5)(B)) who are being credited with pre-participation service or imputed service. The relative number referred to in the last factor is determined taking into account all employees who have been over time, or are reasonably expected to be in the future, credited with such service.

(3) EXAMPLES. The following examples illustrate the rules in this paragraph (d)(3)(iii)(C). It is assumed that facts not described in an example do not, in the aggregate, suggest that the relevant plan provision either does or does not discriminate significantly in favor of HCEs.

EXAMPLE 1. (a) Employer U maintains defined benefit Plans A and B. Plan A covers all employees who work at the headquarters of Employer U. Plan B covers all employees of Division M of Employer U. Plan A provides that, whenever an employee transfers from Division M to the headquarters, the employee's service credited under Plan B is credited under Plan A, and the employee's benefit under Plan A is offset by the employee's benefit under Plan B. Employees, including a meaningful number of NHCEs, are periodically transferred from Division M to the headquarters of Employer U for bona fide business reasons.

(b) The Plan A provision crediting service under Plan B does not discriminate significantly in favor of HCEs. The provision is designed only to prevent employees from being disadvantaged by being transferred from Division M to the headquarters, and a meaningful number of NHCEs can be expected to benefit from it.

EXAMPLE 2. (a) The facts are the same as in EXAMPLE 1, except that the only employees transferred from Division M to the headquarters of Employer U are HCEs (but not the most highly-paid HCEs of Employer U).

(b) Employer U determines that Plan A would have satisfied sections 401(a)(4) and 410(b) for the period for which the transferred employees are being credited with pre-participation service had the employees participated in Plan A during that period. This determination is based on test results under sections 401(a)(4) and 410(b) for the current year, taking into account significant demographic changes over this period.

(c) The Plan A provision crediting service under Plan B does not significantly discriminate in favor of HCEs in the current year. This conclusion is based on the fact that the circumstances underlying the transfers indicate that they were made for bona fide business reasons, that Plan A would have satisfied sections 401(a)(4) and 410(b) had the transferred employees participated in Plan A during the period for which the pre-participation service is credited, and that the transferred employees are not the most highly-paid HCEs of Employer U.

EXAMPLE 3. (a) The facts are the same as in EXAMPLE 1, except that the only employee who is transferred from Division M to the headquarters of Employer U is Employee P, who is among the most highly-paid HCEs of Employer U. Plan A provides an unreduced early retirement benefit at age 55 for employees with 20 years of service, but Plan B's early retirement benefits are not subsidized. Employee P is transferred to the headquarters with 20 years of service credited under Plan B and shortly before attainment of age 55. Employee P is expected to retire upon reaching age 55.

(b) The Plan A provision crediting service under Plan B discriminates significantly in favor of HCEs in the year of the transfer. This is because the circumstances underlying this transfer (i.e., its occurrence shortly before Employee P's expected retirement and the fact that the transfer significantly increased Employee P's early retirement benefits) indicate that Employee P was transferred to the headquarters primarily to obtain the higher pension benefits provided under Plan A.

(c) Because of this conclusion, the pre-participation service credited to Employee P cannot be taken into account in determining whether Plan A satisfies section 1.401(a)(4)-1(b)(2) and (b)(3). Thus, if Plan A credits the service, it cannot be a safe harbor plan because the benefit formula will take into account service that may not be taken into account under this paragraph (d)(3). In addition, Employee P's accrual rates under the general test in section 1.401(a)(4)-3(c) are likely to be higher than those of other employees because, while the pre- participation service may be used to determine Employee P's benefits under Plan A, the service must be disregarded in determining Employee P's testing service. Also, if Employee P's pre-participation service is used in determining Employee P's entitlement to a benefit, right, or feature under Plan A, the fact that the service must be disregarded in determining Employee P's entitlement service for purposes of section 1.401(a)(4)-4 may cause the benefit, right, or feature to be treated as a separate benefit, right, or feature that is currently available only to Employee P.

EXAMPLE 4. (a) Employer V manufactures widgets and belongs to the National Widget Manufacturers' Association. Each member of the Association maintains a defined benefit plan that credits pre-participation service for periods of service with other members and offsets benefits under the plan by benefits under the plans of the other members. Employer V maintains defined benefit Plan C. Employer V periodically hires employees from other widget manufacturers who are not among its most highly- paid HCEs. In 1997, however, the only employee hired by Employer V from another member of the Association is Employee Q, who is among Employer V's most highly-paid HCEs. Employee Q receives pre-participation service credit in accordance with the terms of Plan C. Some of the plans maintained by other members of the Association credited pre-participation service to NHCEs for the same period for which the pre-participation service is credited to Employee Q.

(b) The provision of Plan C crediting pre-participation service with other members of the Association does not discriminate significantly in 1997, despite the fact that the only employee who received pre-participation service credit under the provision in that year was among the most highly-paid HCEs of Employer V. This conclusion is based on the relative number of employees other than Employer V's most highly-paid HCEs who have been credited in the past, or are reasonably expected to be credited in the future, with pre-participation service for periods of service with other members of the Association, and the fact that other employees who are NHCEs are being credited with pre-participation service under a reciprocal agreement.

EXAMPLE 5. Employer W owns 79 percent of the outstanding stock of Employer X. From time to time, employees transfer from Employer W to Employer X at the request of Employer W. The only employees who have ever been transferred are HCEs. Employer W maintains a defined benefit plan, Plan D, which credits employees transferred to Employer X with imputed benefit and accrual service while employed by Employer X. Employer X maintains no qualified plan. Plan D would fail either section 401(a)(4) or section 410(b) in the current plan year if the individuals employed by Employer X were treated as employed by Employer W. In addition, Plan D would fail either section 401(a)(4) or section 410(b) in the current plan year if the portion of Plan D covering the transferred employees were treated as maintained by Employer X. The Plan D provision crediting imputed benefit and accrual service to employees transferred to Employer X significantly discriminates in favor of HCEs in the current plan year.

EXAMPLE 6. The facts are the same as in EXAMPLE 5, except that Plan D credits the individuals who transfer to Employer X only with imputed vesting and entitlement service. The Plan D provision crediting imputed vesting and entitlement service to individuals transferred to Employer X does not significantly discriminate in favor of HCEs in the current plan year, because there is less potential for discrimination when the only types of service being imputed are vesting and entitlement service.

(iv) ADDITIONAL RULES FOR IMPUTED SERVICE -- (A) LEGITIMATE BUSINESS REASONS FOR CREDITING IMPUTED SERVICE -- (1) GENERAL RULE. A legitimate business reason does not exist for a plan to impute service after an individual has permanently ceased to perform services as an employee (within the meaning of section 1.410(b)-9) for the employer maintaining the plan, i.e., is not expected to resume performing services as an employee for the employer. The preceding sentence does not apply in the case of an individual who is not performing services for the employer because of disability or is performing services for another employer under an arrangement (such as a transfer of the employee to another employer) that provides some ongoing business benefit to the original employer. The first sentence in this paragraph (d)(3)(iv)(A)(1) also does not apply in the case of vesting and entitlement service if the employee is performing services for another employer that is being treated under the plan as actual service with the original employer.

(2) CERTAIN PRESUMPTIONS APPLICABLE. Whether an individual has permanently ceased to perform services as an employee for an employer is determined taking into account all of the relevant facts and circumstances. There is a rebuttable presumption for a period of up to two years that an individual who has ceased to perform services as an employee for an employer is nonetheless expected to resume performing services as an employee for the employer, if the employer continues to treat the individual as an employee for significant purposes unrelated to the plan. After two years, there is a rebuttable presumption that an individual who has ceased to perform services as an employee for the employer is not expected to resume performing services as an employee for the employer. The fact that an individual is absent to perform jury duty or military service automatically rebuts the latter presumption. Other evidence, such as the employer's layoff policy, the terms of an employment contract, or specific leave to pursue a degree requiring more than two years of study, may also rebut this presumption.

(3) IMPUTED SERVICE FOR PART-TIME EMPLOYEES. Rules similar to the rules in paragraph (d)(3)(iv)(A)(1) and (2) of this section apply in the case of an employee whose work hours are temporarily reduced and who therefore would normally be credited with service at a reduced rate, but who continues to be credited with service at the same rate as before the reduction (e.g., an employee who continues to be credited with service as if the employee were a full-time employee during a temporary change from a full-time to a part-time work schedule).

(B) ADDITIONAL FACTORS FOR DETERMINING WHETHER A PROVISION CREDITING IMPUTED SERVICE DISCRIMINATES SIGNIFICANTLY. In addition to the factors described in paragraph (d)(3)(iii)(C)(2) of this section, relevant facts and circumstances for determining whether a plan provision crediting imputed service during a leave of absence or a period of reduced services discriminates significantly include any employer policies or practices that restrict the ability of employees to take leaves of absence or work temporarily on a part-time basis, respectively.

(v) SATISFACTION OF OTHER SERVICE-CREDITING RULES. A plan does not fail to satisfy this paragraph (d)(3) merely because it credits service to the extent necessary to satisfy the service-crediting rules in section 410(a), 411(a), 413, or 414(a), section 1.410(a)-7 (elapsed-time method of service-crediting) or 29 CFR 2530.200b-2 (regarding hours of service to be credited), whichever is applicable, or 29 CFR section 2530.204-2(d) (regarding double proration of service and compensation).

(e) FAMILY AGGREGATION RULES. [Reserved]

(f) GOVERNMENTAL PLANS. [Reserved]

(g) CORRECTIVE AMENDMENTS -- (1) IN GENERAL. A corrective amendment that satisfies the rules of this paragraph (g) is taken into account for purposes of satisfying certain section 401(a) requirements for a plan year, by treating the corrective amendment as if it were adopted and effective as of the first day of the plan year. These rules apply in addition to the rules of section 401(b). Paragraph (g)(2) of this section describes the scope of the corrective amendments that are permitted to be made. Paragraph (g)(3) of this section specifies the conditions under which a corrective amendment may be made. Paragraph (g)(4) of this section provides a rule prohibiting a corrective amendment from being taken into account to the extent that it does not have substance. Paragraph (g)(5) of this section discusses the effect of the corrective amendments permitted under this paragraph (g) under provisions other than section 401(a).

(2) SCOPE OF CORRECTIVE AMENDMENTS. For purposes of satisfying the minimum coverage requirements of section 410(b), the nondiscriminatory amount requirement of section 1.401(a)(4)-1(b)(2), or the nondiscriminatory plan amendment requirement of section 1.401(a)(4)-1(b)(4), a corrective amendment may retroactively increase accruals or allocations for employees who benefited under the plan during the plan year being corrected, or may grant accruals or allocations to individuals who did not benefit under the plan during the plan year being corrected. In addition, for purposes of satisfying the nondiscriminatory current availability requirement of section 1.401(a)(4)(b) for benefits, rights, or features, a corrective amendment may make a benefit, right, or feature available to employees to whom it was previously not available. A corrective amendment may not, however, correct for a failure to incorporate the pre-termination restrictions of section 1.401(a)(4)-5(b).

(3) CONDITIONS FOR CORRECTIVE AMENDMENTS -- (i) IN GENERAL. A corrective amendment is not taken into account prior to its adoption under this paragraph (g) unless it satisfies each of the requirements of paragraph (g)(3)(ii) through (vii) of this section, whichever are applicable. Thus, for example, if any of the applicable requirements are not satisfied, any additional accruals arising from an amendment adopted after the end of a plan year are not given retroactive effect and, thus, are tested in the plan year in which the amendment is adopted.

(ii) BENEFITS NOT REDUCED. Except as permitted under paragraph (g)(3)(vi)(C)(2) of this section, the corrective amendment may not result in a reduction of an employee's benefits (including any benefit, right, or feature), determined based on the terms of the plan in effect immediately before the amendment.

(iii) AMENDMENT EFFECTIVE FOR ALL PURPOSES. For purposes of determining an employee's rights and benefits under the plan, the corrective amendment must generally be effective as if the amendment had been made on the first day of the plan year being corrected. Thus, if the corrective amendment is made after the close of the plan year being corrected, an employee's allocations or accruals, along with the associated benefits, rights, and features, must be increased to the level at which they would have been had the amendment been in effect for the entire preceding plan year. Accordingly, such increases are taken into account for testing purposes as if the increases had actually occurred in the prior plan year. However, to the extent that an amendment makes a benefit, right, or feature available to a group of employees, the amendment does not fail to satisfy this paragraph (g)(3)(iii) merely because it is not effective prior to the date of adoption and, therefore, the benefit, right, or feature is not made currently available to those employees before that date.

(iv) TIME WHEN AMENDMENT MUST BE ADOPTED AND PUT INTO EFFECT -- (A) GENERAL RULE. Any corrective amendment intended to apply to the preceding plan year must be adopted and implemented on or before the 15th day of the 10th month after the close of the plan year in order to be taken into account for the preceding plan year.

(B) DETERMINATION LETTER REQUESTED BY EMPLOYER OR PLAN ADMINISTRATOR. If, on or before the end of the period set forth in paragraph (g)(3)(iv)(A) of this section, the employer or plan administrator files a request pursuant to section 601.201(o) of this chapter (Statement of Procedural Rules) for a determination letter on the amendment, the initial or continuing qualification of the plan, or the trust that is part of the plan, the period set forth in paragraph (g)(3)(iv)(A) of this section is extended in the same manner as provided for an extension of the remedial amendment period under section 1.401(b)-1(d)(3).

(v) CORRECTIVE AMENDMENT FOR COVERAGE OR AMOUNTS TESTING -- (A) RETROACTIVE BENEFITS MUST BE PROVIDED TO NONDISCRIMINATORY GROUP. Except as provided in paragraph (g)(3)(v)(B) of this section, if the corrective amendment is adopted after the close of the plan year, the additional allocations or accruals for the preceding year resulting from the corrective amendment must separately satisfy section 401(a)(4) for the preceding plan year and must benefit a group of employees that separately satisfies section 410(b) (determined by applying the same rules as are applied in determining whether a component plan separately satisfies section 410(b) under section 1.401(a)(4)-9(c)(4)). Thus, for example, in applying the rules of this paragraph (g)(3)(v), an employer may not aggregate the additional accruals or allocations for the preceding plan year resulting from the corrective amendment with the other accruals or allocations already provided under the terms of the plan as in effect during the preceding plan year without regard to the corrective amendment.

(B) CORRECTIVE AMENDMENT TO CONFORM TO SAFE HARBOR. The requirements of paragraph (g)(3)(v)(A) of this section need not be met if the corrective amendment is for purposes of conforming the plan to one of the safe harbors in section 1.401(a)(4)-2(b) or section 1.401(a)(4)-3(b) (including for purposes of applying the requirements of those safe harbors under the optional testing methods in section 1.401(a)(4)-8(b)(3) or (c)(3)), or ensuring that the plan continues to meet one of those safe harbors.

(vi) CONDITIONS FOR CORRECTIVE AMENDMENT OF THE AVAILABILITY OF BENEFITS, RIGHTS, AND FEATURES. A corrective amendment may not he taken into account under this paragraph (g) for purposes of satisfying section 1.401(a)(4)-4(b) for a given plan year unless --

(A) The corrective amendment is not part of a pattern of amendments being used to correct repeated failures with respect to a particular benefit, right, or feature;

(B) The relevant provisions of the plan immediately after the corrective amendment with respect to the benefit, right, or feature (including a corrective amendment eliminating the benefit, right, or feature) remain in effect until the end of the first plan year beginning after the date of the amendment; and

(C) The corrective amendment either --

(1) Expands the group of employees to whom the benefit, right, or feature is currently available so that for each plan year in which the corrective amendment is taken into account in determining whether the plan satisfies section 1.401(a)(4)-4(b), the group of employees to whom the benefit, right, or feature is currently available, after taking into account the amendment, satisfies the nondiscriminatory classification requirement of section 1.410(b)-4 (and thus the current availability requirement of section 1.401(a)(4)-4(b)) with a ratio percentage greater than or equal to the lesser of --

(i) The safe harbor percentage applicable to the plan; and

(ii) The ratio percentage of the plan; or

(2) Eliminates the benefit, right, or feature (to the extent permitted under section 411(d)(6)) on or before the last day of the plan year for which the corrective amendment is taken into account.

(vii) SPECIAL RULES FOR SECTION 401(k) CLANS AND SECTION 401(m) PLANS -- (A) MINIMUM COVERAGE REQUIREMENTS. In the case of a section 401(k) plan, a corrective amendment may only be taken into account for purposes of satisfying section 1.410(b)-3(a)(2)(i) under this paragraph (g) for a given plan year to the extent that the corrective amendment grants qualified nonelective contributions within the meaning of section 1.401(k)-1(g)(13)(ii) (QNECs) to nonhighly compensated nonexcludable employees who were not eligible employees within the meaning of section 1.401(k)-1(g)(4) for the given plan year, and the amount of the QNECs granted to each nonhighly compensated nonexcludable employee equals the product of the nonhighly compensated nonexcludable employee's plan year compensation and the actual deferral percentage (within the meaning of section 401(k)(3)(B)) for the given plan year for the group of NHCEs who are eligible employees. Similarly, in the case of a section 401(m) plan, a corrective amendment may only be taken into account for purposes of satisfying section 1.410(b)-3(a)(2)(i) under this paragraph (g) for a given plan year to the extent that the corrective amendment grants qualified nonelective contributions (QNECs) to nonhighly compensated nonexcludable employees who were not eligible employees within the meaning of section 1.401(m)-1(f)(4) for the given plan year, and the amount of the QNECs granted to each nonhighly compensated nonexcludable employee equals the product of the nonhighly compensated nonexcludable employee's plan year compensation and the actual contribution percentage (within the meaning of section 401(m)(3)) for the given plan year for the group of NHCEs who are eligible employees.

(B) CORRECTION OF RATE OF MATCH. In the case of a section 401(m) plan, allocations for a given plan year granted under a corrective amendment to NHCEs who made contributions for the plan year eligible for a matching contribution may be treated as matching contributions. These allocations treated as matching contributions may be taken into account for purposes of satisfying the current availability requirement of section 1.401(a)(4)-4(b) with respect to the right to a rate of match, but may not be taken into account for satisfying other amounts testing.

(4) CORRECTIVE AMENDMENTS MUST HAVE SUBSTANCE. A corrective amendment is not taken into account in determining whether a plan satisfies section 401(a)(4) or 410(b) to the extent the amendment affects nonvested employees whose employment with the employer terminated on or before the close of the preceding year, and who therefore would not have received any economic benefit from the amendment if it had been made in the prior year. Similarly, in determining whether the requirements of paragraph (g)(3)(vi)(C)(1) of this section are satisfied, a corrective amendment making a benefit, right, or feature available to employees is not taken into account to the extent the benefit, right, or feature is not currently available to any of those employees immediately after the amendment. However, a plan will not fail to satisfy the requirements of paragraph (g)(3)(vi)(C)(1) of this section by operation of the provisions in this paragraph (g)(4) if the benefit, right, or feature is made available to all employees in the plan as of the date of the amendment.

(5) EFFECT UNDER OTHER STATUTORY REQUIREMENTS. A corrective amendment under this paragraph (g) is treated as if it were adopted and effective as of the first day of the plan year only for the specific purposes described in this paragraph (g). Thus, for example, the corrective amendment is taken into account not only for purposes of sections 401(a)(4) and 410(b), but also for purposes of determining whether the plan satisfies sections 401(l). By contrast, the amendment is not given retroactive effect for purposes of section 404 (deductions for employer contributions) or section 412 (minimum funding standards), unless otherwise provided for in rules applicable to those sections.

(6) EXAMPLES. The following examples illustrate the rules in this paragraph (g):

EXAMPLE 1. Employer U maintains a calendar year defined benefit plan that in 1994 is tested using the safe harbor for flat benefit plans in section 1.401(a)(4)-3(b)(4). In 1996, Employer U is concerned that the plan will not satisfy the demographic requirement in section 1.401(a)(4)-3(b)(4)(i)(C)(3) for the 1995 plan year because the average of the normal accrual rates for all NHCEs is less than 70 percent of the average of the normal accrual rates for all HCEs. Provided the corrective amendment would otherwise satisfy this paragraph (g), Employer U may make a corrective amendment to the plan to increase the number of NHCEs so that the amended plan satisfies the safe harbor for the 1995 plan year. The corrective amendment need not satisfy paragraph (g)(3)(v)(A) of this section because Employer U is retroactively amending the plan to conform to a safe harbor in section 1.401(a)(4)-3(b). See paragraph (g)(3)(v)(B) of this section.

EXAMPLE 2. (a) Employer V maintains a calendar year defined contribution plan covering all the employees in Division M and Division N. Under the plan, only employees in Division M have the right to direct the investments in their account. For plan years prior to 1996, the plan met the current availability requirement of section 1.401(a)(4)-4(b) because the employees in Division M were a group of employees that satisfied the nondiscriminatory classification test of section 1.410(b)-4. Because of attrition in the employee population in Division M in 1996, the group of employees to whom the right to direct investments is available during that plan year no longer meets the nondiscriminatory classification test of section 1.410(b)-4. Thus, the right to direct investments under the plan does not meet the current availability requirement of section 1.401(a)(4)-4(b) during the 1996 plan year.

(b) Employer V may amend the plan in 1997 (but on or before October 15) to make the right to direct investments available from the date of the corrective amendment to a larger group of employees and the corrective amendment may be taken into account for purposes of satisfying the current availability requirement of section 1.401(a)(4)-4(b) for 1996 if the amendment satisfies this paragraph (g). Thus, for example, the group of employees to whom the right to direct investments is currently available, after taking into account the corrective amendment, must satisfy the nondiscriminatory classification test of section 1.410(b)-4 for 1996 using a safe harbor percentage (or if lower, the ratio percentage of the plan for 1996). In addition, the corrective amendment making the right to direct investments available to a larger group of employees must remain in effect through the end of the 1998 plan year.

(c) In order for Employer V to take the corrective amendment into account for purposes of satisfying the current availability requirement of section 1.401(a)(4)-4(b) for the portion of the 1997 plan year before the amendment, the group of employees to whom the right to direct investments is currently available, taking into account the amendment, must satisfy the nondiscriminatory classification test of section 1.410(b)-4 for 1997 using a safe harbor percentage (or if lower, the ratio percentage of the plan for 1997).

(d) Alternatively, if Employer V adopts the corrective amendment before the end of the 1996 plan year, the corrective amendment need only remain in force through the end of the 1997 plan year, or the corrective amendment may eliminate the right to direct investments (provided that the elimination remains in effect through the end of the 1997 plan year).

EXAMPLE 3. The facts are the same as in Example 2. In 1997, Employer V makes a corrective amendment to extend the plan to employees of Division O as well as Divisions M and N. Assume that the corrective amendment satisfies paragraph (g)(3)(v)(A) of this section, and thus, may be taken into account for purposes of satisfying the nondiscriminatory amounts requirement of section 1.401(a)(4)-1(b)(2) or the minimum coverage requirements of section 410(b). However, the employees in Division O will not be taken into account in determining whether the right to direct investments meets the current availability requirements of section 1.401(a)(4)-4(b) unless the corrective amendment meets the requirements of paragraph (g)(3)(vi) of this section. Thus, for example, the group of employees to whom the right to direct investments is made available as a result of the expansion of coverage, after taking into account the corrective amendment, must satisfy the nondiscriminatory clarification test of section 1.410(b)-4 for 1996 using a safe harbor percentage (or if lower, the ratio percentage of the plan for 1996). In addition, the amendment making the right to direct investments available to a larger group of employees must remain in effect through the end of the 1998 plan year.

EXAMPLE 4. Employer W maintains a defined benefit plan that covers all employees and that offsets an employee's benefit by the employee's projected primary insurance amount. The plan is not eligible to use the safe harbors under section 1.401(a)(4)- 3(b) because the plan does not satisfy section 401(l). Under the plan, the accrual rates for all HCEs (determined under the general test of section 1.401(a)(4)-3(c)) for 1998 are less than 1.5 percent of average annual compensation, and the accrual rates for all NHCEs (determined under the general test of section 1.401(a)(4)-3(c)) for 1998 are two percent of average annual compensation. If Employer W adopts a corrective amendment adopted in 1999 that retroactively increases HCEs' benefits under the plan so that their accrual rates equal those of the NHCEs, the corrective amendment may not be taken into account in testing the 1998 plan year (i.e., the accruals that result from the corrective amendment are treated as 1999 accruals), because the accruals for the 1998 plan year resulting from the corrective amendment would not separately satisfy sections 410(b) and 401(a)(4). This is the case even if, after taking the amendment into account, the plan would satisfy sections 410(b) and 401(a)(4) for the 1998 plan year.

EXAMPLE 5. Employer X maintains two plans -- Plan A and Plan B. Plan A satisfies the ratio percentage test of section 1.410(b)-2(b)(2), but Plan B does not. Thus, in order to satisfy section 410(b), Plan B must satisfy the average benefits test of section 1.410(b)-2(b)(3). The average benefit percentage of Plan B is 60 percent. Employer X may take into account a corrective amendment that increases the accruals under either Plan A or Plan B so that the average benefit percentage meets the 70 percent requirement of the average benefits test, if the amendment satisfies paragraph (g)(3)(v) of this section.

EXAMPLE 6. Employer Y maintains Plan C, which does not satisfy section 401(a)(4) in a plan year. Under the terms of paragraph (g)(2) of this section, Employer Y amends Plan C to increase the benefits of certain employees retroactively. In designing the amendment, Employer Y identifies those employees who have terminated without vested benefits during the period after the end of the prior plan year and before the adoption date of the amendment, and the amendment provides increases in benefits primarily to those employees. It would be inconsistent with the purpose of preventing discrimination in favor of HCEs for Plan C to treat the amendment as retroactively effective under this paragraph (g). See section 1.401(a)(4)-1(c)(2).

EXAMPLE 7. Employer Z maintains both a section 401(k) plan and a section 401(m) plan that provides matching contributions at a rate of 50 percent with respect to elective contributions under the section 401(k) plan. In plan year 1995, the section 401(k) plan fails to satisfy the actual deferral percentage test of section 401(k)(3). In order to satisfy section 401(k)(3), Employer Z makes corrective distributions to HCEs H1 through H10 of their excess contributions as provided under section 1.401(k)-1(f). The matching contributions that H1 through H10 had received on account of their excess contributions are not forfeited, however. Thus, the effective rate of matching contributions provided to H1 through H10 is increased as a result of the corrective distributions. See section 1.401(a)(4)-4(e)(3)(iii)(G). Since no NHCE in the section 401(m) plan is provided with an equivalent rate of matching contributions, the rate of matching contributions provided to H1 through H10 does not satisfy the nondiscriminatory availability requirement of section 1.401(a)(4)-4 in plan year 1995. Employer Z makes a corrective amendment by October 15, 1996, that grants allocations to NHCEs who made contributions for the 1995 plan year eligible for a matching contribution. Employer Z may treat the allocations granted under the corrective amendment to those NHCEs as matching contributions for the 1995 plan year and, as a result, take them into account in determining whether the availability of the rate of matching contributions provided to H1 through H10 satisfies the current availability requirement of section 1.401(a)(4)-4(b) for the 1995 plan year.

SECTION 1.401(a)(4)-12 DEFINITIONS.

Unless otherwise provided, the definitions in this section govern in applying the provisions of sections 1.401(a)(4)-1 through 1.401(a)(4)-13.

ACCUMULATION PLAN. Accumulation plan means a defined benefit plan under which the benefit of every employee for each plan year is separately determined, using plan year compensation (if benefits are determined as a percentage of compensation rather as than a dollar amount) separately calculated for the plan year, and each employee's total accrued benefit as of the end of a plan year is the sum of the separately determined benefit for that plan year and the total accrued benefit as of the end of the preceding plan year.

ACQUIRED GROUP OF EMPLOYEES. Acquired group of employees means employees of a prior employer who become employed by the employer in a transaction between the employer and the prior employer that is a stock or asset acquisition, merger, or other similar transaction involving a change in the employer of the employees of a trade or business, plus employees hired by or transferred into the acquired trade or business on or before a date selected by the employer that is within the transition period defined in section 410(b)(6)(C)(ii). In addition, in the case of a transaction prior to the effective date of these regulations, the date by which employees must be hired by or transferred into the acquired trade or business in order to be included in the acquired group of employees may be any date prior to February 11, 1993, without regard to whether it is later than the end of the transition period defined in section 410(b)(6)(C)(ii).

ACTUARIAL EQUIVALENT. An amount or benefit is the actuarial equivalent of, or is actuarially equivalent to, another amount or benefit at a given time if the actuarial present value of the two amounts or benefits (calculated using the same actuarial assumptions) at that time is the same.

ACTUARIAL PRESENT VALUE. Actuarial present value means the value as of a specified date of an amount or series of amounts due thereafter, where each amount is --

(1) Multiplied by the probability that the condition or conditions on which payment of the amount is contingent will be satisfied; and

(2) Discounted according to an assumed rate of interest to reflect the time value of money.

ANCILLARY BENEFIT. Ancillary benefit is defined in section 1.401(a)(4)-4(e)(2).

AVERAGE ANNUAL COMPENSATION. Average annual compensation is defined in section 1.401(a)(4)-3(e)(2).

BASE BENEFIT PERCENTAGE. Base benefit percentage is defined in section 1.401(l)-1(c)(3).

BENEFIT FORMULA. Benefit formula means the formula a defined benefit plan applies to determine the accrued benefit (within the meaning of section 411(a)(7)(A)(i)) in the form of an annual benefit commencing at normal retirement age of an employee who continues in service until normal retirement age. Thus, for example, the benefit formula does not include the accrual method the plan applies (in conjunction with the benefit formula) to determine the accrued benefit of an employee who terminates employment before normal retirement age. For purposes of this definition, a change in plan provisions that applies only to certain employees who terminate within a limited period of time (e.g., an early retirement window benefit) is treated as a change in the plan's benefit formula for the employees to whom the change is potentially applicable during the period that the change is potentially applicable to them. The preceding sentence applies only to the extent that the change in plan provisions would result in a change in the benefit formula if it were permanent and applied without regard to when the employees' employment was terminated.

BENEFIT RIGHT, OR FEATURE. Benefit, right, or feature means an optional form of benefit, an ancillary benefit, or an other right or feature within the meaning of section 1.401(a)(4)-4(e).

CONTRIBUTORY DB PLAN. Contributory DB plan means a defined benefit plan that includes employee contributions not allocated to separate accounts.

DEFINED BENEFIT EXCESS PLAN. Defined benefit excess plan is defined in section 1.401(l)-1(c)(16)(i).

DEFINED BENEFIT PLAN. Defined benefit plan is defined in section 1.410(b)-9.

DEFINED CONTRIBUTION PLAN. Defined contribution plan is defined in section 1.410(b)-9.

DETERMINATION DATE. Determination date is defined in section 1.401(a)(4)-8(b)(3)(iv)(A).

EMPLOYEE. With respect to a plan for a given plan year, employee means an employee (within the meaning of section 1.410(b)-9) who benefits as an employee under the plan for the plan year (within the meaning of section 1.410(b)-3).

EMPLOYER. Employer is defined in section 1.410(b)-9.

ESOP. ESOP is defined in section 1.410(b)-9.

EXCESS BENEFIT PERCENTAGE. Excess benefit percentage is defined in section 1.401(l)-1(c)(14).

FORMER EMPLOYEE. With respect to a plan for a given plan year, former employee means a former employee (within the meaning of section 1.410(b)-9).

FORMER HCE. Former HCE means a highly compensated former employee as defined in section 1.410(b)-9.

FORMER NHCE. Former NHCE means a former employee who is not a former HCE.

FRESH-START DATE. Fresh-start date is defined in section 1.401(a)(4)-13(c)(5)(iii).

FRESH-START GROUP. Fresh-start group is defined in section 1.401(a)(4)-13(c)(5)(ii).

GROSS BENEFIT PERCENTAGE. Gross benefit percentage is defined in section 1.401(l)-1(c)(18).

HCE. HCE means a highly compensated employee as defined in section 1.410(b)-9 who benefits under the plan for the plan year (within the meaning of section 1.410(b)-3).

INTEGRATION LEVEL. Integration level is defined in section 1.401(l)-1(c)(20).

MEASUREMENT PERIOD. Measurement period is defined in section 1.401(a)(4)-3(d)(1)(iii).

MULTIEMPLOYER PLAN. Multiemployer plan is defined in section 1.410(b)-9.

NHCE. NHCE means an employee who is not a HCE.

NONEXCLUDABLE EMPLOYEE. Nonexcludable employee means an employee within the meaning of section 1.410(b)-9, other than an excludable employee with respect to the plan as determined under section 1.410(b)-6. A nonexcludable employee may be either a highly or nonhighly compensated nonexcludable employee, depending on the nonexcludable employee's status under section 414(q).

NORMALIZE. With respect to a benefit payable to an employee in a particular form, normalize means to convert the benefit to an actuarially equivalent straight life annuity commencing at the employee's testing age. The actuarial assumptions used in normalizing a benefit must be reasonable and must be applied on a gender-neutral basis. A standard interest rate and a standard mortality table are among the assumptions considered reasonable for this purpose.

OFFSET PLAN. Offset plan is defined in section 1.401(l)- 1(c)(24).

OPTIONAL FORM OF BENEFIT. Optional form of benefit is defined in section 1.401(a)(4)-4(e)(1).

OTHER RIGHT OR FEATURE. Other right or feature is defined in section 1.401(a)(4)A(e)(3).

PLAN. Plan means a plan within the meaning of section 1.410(b)- 7(a) and (b), after application of the mandatory disaggregation rules of section 1.410(b)-7(c) and the permissive aggregation rules of section 1.410(b)-7(d).

PLAN YEAR. Plan year is defined in section 1.410(b)-9.

PLAN YEAR COMPENSATION -- (1) IN GENERAL. Plan year compensation means section 414(s) compensation for the plan year determined by measuring section 414(s) compensation during one of the periods described in paragraphs (2) through (4) of this definition. Whichever period is selected must be applied uniformly to determine the plan year compensation of every employee.

(2) PLAN YEAR. This period consists of the plan year.

(3) TWELVE-MONTH PERIOD ENDING IN THE PLAN YEAR. This period consists of a specified 12-month period ending with or within the plan year, such as the calendar year or the period for determining benefit accruals described in section 1.401(a)(4)-3(f)(6).

(4) PERIOD OF PLAN PARTICIPATION DURING THE PLAN YEAR. This period consists of the portion of the plan year during which the employee is a participant in the plan. This period may be used to determine plan year compensation for the plan year in which participation begins, the plan year in which participation ends, or both. This period may be used to determine plan year compensation when substituted for average annual compensation in section 1.401(a)(4)-3(e)(2)(ii)(A) only if the plan year is also the period for determining benefit accruals under the plan rather than another period as permitted under section 1.401(a)(4)-3(f)(6). Further, selection of this period must be made on a reasonably consistent basis from plan year to plan year in a manner that does not discriminate in favor of HCEs.

(5) SPECIAL RULE FOR NEW EMPLOYEES. Notwithstanding the uniformity requirement of paragraph (1) of this definition, if employees' plan year compensation for a plan year is determined based on a 12-month period ending within the plan year under paragraph (3) of this definition, then the plan year compensation of any employees whose date of hire was less than 12 months before the end of that 12-month period must be determined uniformly based either on the plan year or on the employees' periods of participation during the plan year, as provided in paragraphs (2) and (4), respectively, of this definition.

QJSA. QJSA means a qualified joint and survivor annuity as defined in section 417(b).

QSUPP -- (1) IN GENERAL. QSUPP or qualified social security supplement means a social security supplement that meets each of the requirements in paragraphs (2) through (6) of this definition.

(2) ACCRUAL -- (i) GENERAL RULE. The amount of the social security supplement payable at any age for which the employee is eligible for the social security supplement must be equal to the lesser of --

(A) The employee's old-age insurance benefit, unreduced on account of age, under title II of the Social Security Act; and

(B) The accrued social security supplement, determined under one of the methods in paragraph (2)(ii) through (iv) of this definition.

(ii) SECTION 401(l) PLANS. In the case of a section 401(l) plan that is a defined benefit excess plan, each employee's accrued social security supplement equals the employee's average annual compensation up to the integration level, multiplied by the disparity provided by the plan for the employee's years of service used in determining the employee's accrued benefit under the plan. In the case of a section 401(l) plan that is an offset plan, each employee's accrued social security supplement equals the dollar amount of the offset accrued for the employee under the plan.

(iii) PIA OFFSET PLAN. In the case of a PIA offset plan, each employee's accrued social security supplement equals the dollar amount of the offset accrued for the employee under the plan. For this purpose, a PIA offset plan is a plan that reduces an employee's benefit by an offset based on a stated percentage of the employee's primary insurance amount under the Social Security Act.

(iv) OTHER PLANS. In the case of any other plan, each employee's social security supplement accrues ratably over the period beginning with the later of the employee's commencement of participation in the plan or the effective date of the social security supplement and ending with the earliest age at which the social security supplement is payable to the employee. The effective date of the social security supplement is the later of the effective date of the amendment adding the social security supplement or the effective date of the amendment modifying an existing social security supplement to comply with the requirements of this definition. If, by the end of the first plan year to which these regulations apply, as set forth in section 1.401(a)(4)-13(a) and (b), an amendment is made to a social security supplement in existence on September 19, 1991, the employer may treat the accrued portion of the social security supplement, as determined under the plan without regard to amendments made after September 19, 1991, as included in the employee's accrued social security supplement, provided that the remainder of the social security supplement is accrued under the otherwise-applicable method.

(3) VESTING. The plan must provide that an employee's right to the accrued social security supplement becomes nonforfeitable within the meaning of section 411 as if it were an early retirement benefit.

(4) ELIGIBILITY. The plan must impose the same eligibility conditions on receipt of the social security supplement as on receipt of the early retirement benefit in conjunction with which the social security supplement is payable. Furthermore, if the service required for an employee to become eligible for the social security supplement exceeds 15 years, then the ratio percentage of the group of employees who actually satisfy the eligibility conditions on receipt of the QSUPP in the current plan year must equal or exceed the unsafe harbor percentage applicable to the plan under section 1.410(b)A(c)(4)(ii).

(5) QJSA. At each age, the most valuable QSUPP commencing at that age must be payable in conjunction with the QJSA commencing at that age. In addition, the plan must provide that, in the case of a social security supplement payable in conjunction with a QJSA, the social security supplement will be paid after the employee's death on the same terms as the QJSA, but in no event for a period longer than the period for which the social security supplement would have been paid to the employee had the employee not died. For example, if the QJSA is in the form of a joint annuity with a 50-percent survivor's benefit, the social security supplement must provide a 50-percent survivor's benefit. When section 417(c) requires the determination of a QJSA for purposes of determining a qualified pre-retirement survivor's annuity as defined in section 417(c) (QPSA), the social security supplement payable in conjunction with that QJSA must be paid in conjunction with the QPSA.

(6) PROTECTION. The plan must specifically provide that the social security supplement is treated as an early retirement benefit that is protected under section 411(d)(6) (other than for purposes of sections 401(a)(11) and 417). Thus, the accrued social security supplement must continue to be payable notwithstanding subsequent amendment of the plan (including the plan's termination), and an employee may meet the eligibility requirements for the social security supplement after plan termination.

QUALIFIED PLAN. Qualified plan means a plan that satisfies section 401(a). For this purpose, a qualified plan includes an annuity plan described in section 403(a).

RATE GROUP. Rate group is defined in section 1.401(a)(4)-2(c)(1) or is defined in section 1.401(a)(4)-3(c)(1).

RATIO PERCENTAGE. Ratio percentage is defined in section 1.410(b)-9.

SECTION 401(a)(17) EMPLOYEE. Section 401(a)(17) employee is defined in section 1.401(a)(17)-1(e)(2)(ii).

SECTION 401(k) PLAN. Section 401(k) plan is defined in section 1.410(b)-9.

SECTION 401(l) PLAN. Section 401(l) plan is defined in section 1.410(b)-9.

SECTION 401(m) PLAN. Section 401(m) plan is defined in section 1.410(b)-9.

SECTION 414(s) COMPENSATION -- (1) GENERAL RULE. When used with reference to compensation for a plan year, 12-month period, or other specified period, section 414(s) compensation means compensation measured using an underlying definition that satisfies section 414(s) for the applicable plan year. Whether an underlying definition of compensation satisfies section 414(s) is determined on a year-by-year basis, based on the provisions of section 414(s) in effect for the applicable plan year and, if relevant, the employer's HCEs and NHCEs for that plan year. See section 1.414(s)-1(i) for transition rules for plan years beginning before the effective date applicable to the plan under section 1.401(a)(4)-13(a) or (b). For a plan year or 12-month period beginning before January 1, 1988, any underlying definition of compensation may be used to measure the amount of employees' compensation for purposes of this definition, provided that the definition was nondiscriminatory based on the facts and circumstances in existence for that plan year or for the plan year in which that 12-month period ends.

(2) DETERMINATION PERIOD FOR SECTION 414(s) NONDISCRIMINATION REQUIREMENT -- (i) GENERAL RULE. If an underlying definition of compensation must satisfy the nondiscrimination requirement in section 1.414(s)-1(d)(3) in order to satisfy section 414(s) for a plan year, any one of the following determination periods may be used to satisfy the nondiscrimination requirement --

(A) The plan year;

(B) The calendar year ending in the plan year; or

(C) The 12-month period ending in the plan year that is used to determine the underlying definition of compensation.

(ii) EXCEPTION FOR PARTIAL PLAN YEAR COMPENSATION. Notwithstanding the general rule in paragraph (2)(i) of this definition, if the period for measuring the underlying compensation is the portion of the plan year during which each employee is a participant in the plan (as provided in paragraph (4) of the definition of plan year compensation in this section), that period must be used as the determination period.

(3) PLANS USING PERMITTED DISPARITY. In the case of a section 401(l) plan or a plan that imputes permitted disparity in accordance with section 1.401(a)(4)-7, an underlying definition of compensation is not section 414(s) compensation if the definition results in significant under inclusion of compensation for employees.

(4) DOUBLE PRORATION OF SERVICE AND COMPENSATION. If a defined benefit plan prorates benefit accruals as permitted under section 411(b)(4)(B) by crediting less than full years of participation, then compensation for a plan year, 12-month period, or other specified period that is used to determine the amount of an employee's benefits under the plan wi11 not fail to be section 414(s) compensation, merely because the amount of compensation for that period is adjusted to reflect the equivalent of full-time compensation to the extent necessary to satisfy the requirements of 29 CFR 2530.204-2(d) (regarding double proration of service and compensation). This adjustment is disregarded in determining whether the underlying definition of compensation used satisfies the requirements of section 414(s). Thus, for example, if the underlying definition of compensation is an alternative definition that must satisfy the nondiscrimination requirement of section 1.414(s)-1(d)(3), in determining whether that requirement is satisfied with regard to the underlying definition, the compensation included for any employee is determined without any adjustment to reflect the equivalent of full- time compensation required by 29 CFR 2530.204-2(d).

SOCIAL SECURITY SUPPLEMENT. Social security supplement is defined in section 1.411(a)-7(c)(4)(ii).

STANDARD INTEREST RATE. Standard interest rate means an interest rate that is neither less than 7.5 percent nor greater than 8.5 percent, compounded annually. The Commissioner may, in revenue rulings, notices, and other guidance of general applicability, change the definition of standard interest rate.

STANDARD MORTALITY TABLE. Standard mortality table means one of the following tables: the UP-1984 Mortality Table (Unisex); the 1983 Group Annuity Mortality Table (1983 GAM) (Female); the 1983 Group Annuity Mortality Table (1983 GAM) (Male); the 1983 Individual Annuity Mortality Table (1983 IAM) (Female); the 1983 Individual Annuity Modality Table (1983 IAM) (Male); the 1971 Group Annuity Mortality Table (1971 GAM) (Female); the 1971 Group Annuity Mortality Table (1971 GAM) (Male); the 1971 Individual Annuity Mortality Table (1971 IAM) (Female); or the 1971 Individual Annuity Mortality Table (1971 IAM) (Male). These standard mortality tables are available from the Society of Actuaries, 475 N. Martingale Road, Suite 800, Schaumberg, Illinois 60173. The Commissioner may, in revenue rulings, notices, and other guidance of general applicability, change the definition of standard mortality table. See section 601.601(d)(2)(ii)(b) of this Chapter.

STRAIGHT LIFE ANNUITY. Straight life annuity means an annuity payable in equal installments for the life of the employee that terminates upon the employee's death.

TESTING AGE. With respect to an employee, testing age means the age determined for the employee under the following rules:

(1) If the plan provides the same uniform normal retirement age for all employees, the employee's testing age is the employee's normal retirement age under the plan.

(2) If a plan provides different uniform normal retirement ages for different employees or different groups of employees, the employee's testing age is the employee's latest normal retirement age under any uniform normal retirement age under the plan, regardless of whether that particular uniform normal retirement age actually applies to the employee under the plan.

(3) If the plan does not provide a uniform normal retirement age, the employee's testing age is 65.

(4) If an employee is beyond the testing age otherwise determined for the employee under paragraphs (1) through (3) of this definition, the employee's testing age is the employee's current age. The rule in the preceding sentence does not apply in the case of a defined benefit plan that fails to satisfy the requirements of section 1.401(a)(4)-3(f)(3)(i) (permitting certain increases in benefits that commence after normal retirement age to be disregarded).

TESTING SERVICE. Testing service is defined in section 1.401(a)(4)-3(d)(1)(iv).

UNIFORM NORMAL RETIREMENT AGE -- (1) GENERAL RULE. Uniform normal retirement age means a single normal retirement age under the plan that does not exceed the maximum age in paragraph (2) of this definition and that is the same for all of the employees in a given group. A group of employees does not fail to have a uniform normal retirement age merely because the plan contains provisions described in paragraphs (3) and (4) of this definition.

(2) MAXIMUM AGE. The maximum age is generally 65. However, if all employees have the same social security retirement age (within the meaning of section 415(b)(8)), the maximum age is the employees' social security retirement age. Thus, for example, a component plan has a uniform normal retirement age of 67 if it defines normal retirement age as social security retirement age and all employees in the component plan have a social security retirement age of 67.

(3) STATED ANNIVERSARY DATE -- (i) GENERAL RULE. A group of employees does not fail to have a uniform normal retirement age merely because the plan provides that the normal retirement age of all employees in the group is the later of a stated age (not exceeding the maximum age in paragraph (2) of this definition) or a stated anniversary no later than the fifth anniversary of the time each employee commenced participation in the plan. For employees who commenced participation in the plan before the first plan year beginning on or after January 1, 1988, the stated anniversary date may be later than the anniversary described in the preceding sentence if it is no later than the earlier of the tenth anniversary of the date the employee commenced participation in the plan (or such earlier anniversary selected by the employer, if less than 10) or the fifth anniversary of the first day of the first plan year beginning on or after January 1, 1988.

(ii) USE OF SERVICE OTHER THAN ANNIVERSARY OF COMMENCEMENT OF PARTICIPATION. In lieu of using a stated anniversary date as permitted under paragraph (3)(i) of this definition, a plan may use a stated number of years of service measured on another basis, provided that the determination is made on a basis that satisfies section 411(a)(8) and that the stated number of years of service does not exceed the number of anniversaries permitted under paragraph (3)(i) of this definition. For example, a uniform normal retirement age could be based on the earlier of the fifth anniversary of the commencement of participation and the completion of five years of vesting service.

(4) CONVERSION OF NORMAL RETIREMENT AGE TO NORMAL RETIREMENT DATE. A group of employees does not fail to have a uniform normal retirement age merely because a defined benefit plan provides for the commencement of normal retirement benefits on different retirement dates for different employees if each employee's normal retirement date is determined on a reasonable basis with reference to an otherwise uniform normal retirement age and the difference between the normal retirement date and the uniform normal retirement age cannot exceed six months for any employee. Thus, for example, benefits under a plan do not fail to commence at a uniform normal retirement age of age 62 for purposes of section 1.401(a)(4)- 3(b)(2)(i), merely because the plan's normal retirement date is defined as the last day of the plan year nearest attainment of age 62.

YEAR OF SERVICE. Year of service means a year of service as defined in the plan for a specific purpose, including the method of crediting service for that purpose under the plan.

SECTION 1.401(a)(4)-13 EFFECTIVE DATES AND FRESH-START RULES.

(a) GENERAL EFFECTIVE DATES -- (1) IN GENERAL. Except as otherwise provided in this section, sections 1.401(a)(4)-1 through 1.401(a)(4)-13 apply to plan years beginning on or after January 1, 1994.

(2) PLANS OF TAX-EXEMPT ORGANIZATIONS. In the case of plans maintained by organizations exempt from income taxation under section 501(a), including plans subject to section 403(b)(12)(A)(i) (nonelective plans), sections 1.401(a)(4)-1 through 1.401(a)(4)-13 apply to plan years beginning on or after January 1, 1996.

(3) COMPLIANCE DURING TRANSITION PERIOD. For plan years beginning before the effective date of these regulations, as set forth in paragraph (a)(1) and (2) of this section, and on or after the first day of the first plan year to which the amendments made to section 410(b) by section 1112(a) of the Tax Reform Act of 1986 (TRA '86) apply, a plan must be operated in accordance with a reasonable, good faith interpretation of section 401(a)(4), taking into account pre-existing guidance and the amendments made by TRA '86 to related provisions of the Code (including, for example, sections 401(l), 401(a)(17), and 410(b)). Whether a plan is operated in accordance with a reasonable, good faith interpretation of section 401(a)(4) will generally be determined on the basis of all the relevant facts and circumstances, including the extent to which an employer has resolved unclear issues in its favor. A plan will be deemed to be operated in accordance with a reasonable, good faith interpretation of section 401(a)(4) if it is operated in accordance with the terms of sections 1.401(a)(4)-1 through 1.401(a)(4)-13.

(b) EFFECTIVE DATE FOR GOVERNMENTAL PLANS. In the case of governmental plans described in section 414(d), including plans subject to section 403(b)(12)(A)(i) (nonelective plans), sections 1.401(a)(4)-1 through 1.401(a)(4)-13 apply to plan years beginning on or after the later of January 1, 1996, or 90 days after the opening of the first legislative session beginning on or after January 1, 1996, of the governing body with authority to amend the plan, if that body does not meet continuously. Such plans are deemed to satisfy section 401(a)(4) for plan years before that effective date. For purposes of this paragraph (b), the governing body with authority to amend the plan is the legislature, board, commission, council, or other governing body with authority to amend the plan.

(c) FRESH-START RULES FOR DEFINED BENEFIT PLANS -- (1) INTRODUCTION. This paragraph (c) provides rules that must be satisfied in order to use the fresh-start testing options for defined benefit plans in section 1.401(a)(4)-3(b)(6)(vii) and (d)(3)(iii), relating to the safe harbors and the general test, respectively. Those fresh- start options are designed to allow a plan to be tested without regard to benefits accrued before a selected fresh-start date. To the extent provided in paragraph (d) of this section, those options also may be used to disregard certain increases in benefits attributable to compensation increases after a fresh-start date. Although this paragraph (c) generally requires a plan to be amended to freeze employees' accrued benefits as of a fresh-start date and to provide any additional accrued benefits after the fresh-start date solely in accordance with certain specified formulas, certain of these requirements do not apply to a plan that is tested under the general test of section 1.401(a)(4)-3(c). See section 1.401(a)(4)- 3(b)(6)(vii) and (d)(3)(iii).

(2) GENERAL RULE. A defined benefit plan satisfies this paragraph (c) if --

(i) Accrued benefits of employees in the fresh-start group are frozen as of the fresh-start date in accordance with paragraph (c)(3) of this section;

(ii) Accrued benefits after the fresh-start date for employees in the fresh-start group are determined under one of the fresh-start formulas in paragraph (c)(4) of this section; and

(iii) paragraph (c)(5) of this section is satisfied.

(3) DEFINITION OF FROZEN -- (i) GENERAL RULE. An employee's accrued benefit under a plan is frozen as of the fresh-start date if it is determined as if the employee terminated employment with the employer as of the fresh-start date (or the date the employee actually terminated employment with the employer, if earlier), and without regard to any amendment to the plan adopted after that date, other than amendments recognized as effective as of or before that date under section 401(b) or section 1.401(a)(4)-11(g). The assumption that an employee has terminated employment applies solely for purposes of this paragraph (c)(3). Thus, for example, the fresh start has no effect on the service taken into account for purposes of determining vesting and eligibility for benefits, rights, and features under the plan.

(ii) PERMITTED COMPENSATION ADJUSTMENTS. An employee's accrued benefit under a plan that satisfies paragraph (d) of this section does not fail to be frozen as of the fresh-start date merely because the plan makes the adjustments described in paragraph (d)(7) and (8) of this section with regard to the fresh-start date. In addition, if the frozen accrued benefit of an employee under the plan includes top-heavy minimum benefits, an employee's accrued benefit under a plan does not fail to be frozen as of the fresh-start date merely because the plan increases the frozen accrued benefit of each employee in the fresh-start group solely to the extent necessary to comply with the average compensation requirement of section 416(c)(1)(D)(i).

(iii) PERMITTED CHANGES IN OPTIONAL FORMS. An employee's accrued benefit under a plan does not fail to be frozen as of the fresh-start date merely because the plan provides a new optional form of benefit with respect to the frozen accrued benefit, if --

(A) The optional form is provided with respect to each employee's entire accrued benefit (i.e., accrued both before and after the fresh-start date);

(B) The plan provided meaningful coverage as of the fresh-start date, as described in paragraph (d)(4) of this section; and

(C) The plan provides meaningful current benefit accruals as described in paragraph (d)(6) of this section.

(iv) FLOOR-OFFSET PLANS. In the case of a plan that was a floor- offset plan described in section 1.401(a)(4)-8(d) prior to the fresh- start date, an employee's accrued benefit as of the fresh-start date does not fail to be frozen merely because the actuarial equivalent of the account balance in the defined contribution plan that is offset against the defined benefit plan varies as a result of investment return that is different from the assumed interest rate used to determine the actuarial equivalent of the account balance.

(4) FRESH-START FORMULAS -- (i) FORMULA WITHOUT WEAR-AWAY. An employee's accrued benefit under the plan is equal to the sum of --

(A) The employee's frozen accrued benefit; and

(B) The employee's accrued benefit determined under the formula applicable to benefit accruals in the current plan year (current formula) as applied to the employee's years of service after the fresh-start date.

(ii) FORMULA WITH WEAR-AWAY. An employee's accrued benefit under the plan is equal to the greater of --

(A) The employee's frozen accrued benefit; or

(B) The employee's accrued benefit determined under the current formula as applied to the employee's total years of service (before and after the fresh-start date) taken into account under the current formula.

(iii) FORMULA WITH EXTENDED WEAR-AWAY. An employee's accrued benefit under the plan is equal to the greater of --

(A) The amount determined under paragraph (c)(4)(i) of this section; or

(B) The amount determined under paragraph (c)(4)(ii)(B) of this section.

(5) RULES OF APPLICATION -- (i) CONSISTENCY REQUIREMENT. This paragraph (c)(5) is not satisfied unless the fresh-start rules in this paragraph (c) (and paragraph (d) of this section, if applicable) are applied consistently to all employees in the fresh-start group. Thus, for example, the same fresh-start date and fresh-start formula (within the meaning of paragraph (c)(4) of this section) must apply to all employees in the fresh-start group. Similarly, if a plan makes a fresh start for all employees with accrued benefits on the fresh- start date and, for a later plan year, is aggregated for purposes of section 401(a)(4) with another plan that did not make the same fresh start, the aggregated plan must make a new fresh start in order to use the fresh-start rules for that later plan year or any subsequent plan year.

(ii) DEFINITION OF FRESH-START GROUP. Generally, the fresh-start group with respect to a fresh start consists of all employees who have accrued benefits as of the fresh-start date and have at least one hour of service with the employer after that date. However, a fresh-start group with respect to a fresh start may consist exclusively of all employees who have accrued benefits as of the fresh-start date, have at least one hour of service with the employer after that date, and are --

(A) Section 401(a)(17) employees;

(B) Members of an acquired group of employees (provided the fresh-start date is the date determined under paragraph (c)(5)(iii)(B) of this section); or

(C) Employees with a frozen accrued benefit that is attributable to assets and liabilities transferred to the plan as of a fresh-start date in connection with the transfer (provided the fresh-start date is the date determined under paragraph (c)(5)(iii)(C) of this section) and for whom the current formula is different from the formula used to determine the frozen accrued benefit.

(iii) DEFINITION OF FRESH-START DATE. Generally, the fresh-start date is the last day of a plan year. However, a plan may use a fresh- start date other than the last day of the plan year if --

(A) The plan satisfied the safe harbor rules of section 1.401(a)(4)-3(b) for the period from the beginning of the plan year through the fresh-start date;

(B) The fresh-start group is an acquired group of employees, and the fresh-start date is the latest date of hire or transfer into an acquired trade or business selected by the employer for any employees to be included in the acquired group of employees; or

(C) The fresh-start group is the group of employees with a frozen accrued benefit that is attributable to assets and liabilities transferred to the plan and the fresh-start date is the date as of which the employees begin accruing benefits under the plan.

(6) EXAMPLES. The following examples illustrate the rules in this paragraph (c):

EXAMPLE 1. (a) Employer X maintains a defined benefit plan with a calendar plan year. The plan formula provides an employee with a normal retirement benefit at age 65 of one percent of average annual compensation up to covered compensation multiplied by the employee's years of service for Employer X, plus 1.5 percent of average annual compensation in excess of covered compensation, multiplied by the employee's years of service for Employer X up to 40.

(b) For plan years beginning after 1994, Employer X amends the plan formula to provide a normal retirement benefit of 0.75 percent of average annual compensation up to covered compensation multiplied by the employee's total years of service for Employer X up to 35, plus 1.4 percent of average annual compensation in excess of covered compensation multiplied by the employee's years of service for Employer X up to 35. For plan years after 1994, each employee's accrued benefit is determined under the fresh-start formula in paragraph (c)(4)(iii) of this section (formula with extended wear-away), using December 31, 1994, as the fresh-start date.

(c) As of December 31, 1994, Employee M has 10 years of service for Employer X, has average annual compensation of $38,000, and has covered compensation of $30,000. Employee M's accrued benefit as of December 31, 1994, is therefore $4,200 ((1 percent x $30,000 x 10 years) + (1.5 percent x $8,000 x 10 years)). As of December 31, 1995, Employee M has 11 years of service for Employer X, has average annual compensation of $40,000 (determined by taking into account compensation before and after the fresh-start date), and has covered compensation of $32,000. Employee M's accrued benefit as of December 31, 1995, is $4,552, the greater of --

(1) $4,552, the sum of Employee M's accrued benefit frozen as of December 31, 1994, ($4,200) and the amended formula applied to Employee M's years of service after 1994 ((0.75 percent x $32,000 x 1 year) + (1.4 percent x $8,000 x 1 year), or $352); or

(2) $3,872, the amended formula applied to Employee M's total years of service ((0.75 percent x $32,000 x 11 years) + (1.4 percent x $8,000 x 11 years)).

EXAMPLE 2. (a) Employer Y maintains a defined benefit plan, Plan A, that has a calendar plan year. For the 1995 plan year, Plan A satisfies the requirements for a safe harbor plan in section 1.401(a)(4)-3(b). Employer Y selects a date in 1995 for all the employees, freezes the employees' accrued benefits as of that date under the rules of paragraph (c)(3) of this section, and, in accordance with the rules of this paragraph (c), amends Plan A to determine benefits for a11 employees after that date using the formula with wear-away described in paragraph (c)(4)(ii) of this section. The new benefit formula would satisfy the requirements for a safe harbor plan in section 1.401(a)(4)-3(b) if all accrued benefits were determined under it.

(b) Because Plan A satisfied the requirements for a safe harbor plan for the period from the beginning of the plan year through the selected date, paragraph (c)(5)(iii)(A) of this section permits the selected date to be a fresh-start date, even if it is not the last day of the plan year. Thus, Plan A satisfies the requirements in this paragraph (c) for a fresh start as of the fresh-start date.

(c) Under section 1.401(a)(4)-3(b)(6)(vii), a plan does not fail to satisfy the requirements of section 1.401(a)(4)-3(b), merely because of benefits accrued under a different formula prior to a fresh-start date. Thus, Plan A still satisfies the safe harbor requirements of section 1.401(a)(4)-3(b) after the amendment to the benefit formula. Because Plan A satisfied the requirements for a safe harbor plan for the period from the beginning of the plan year, taking the amendment into account, Employer Y may select any date within the plan year (which may be the same date as the first fresh-start date) and apply the fresh-start rules in this paragraph (c) a second time as of that date.

(d) COMPENSATION ADJUSTMENTS TO FROZEN ACCRUED BENEFITS -- (1) INTRODUCTION. In addition to the fresh-start rules in paragraph (c) of this section, this paragraph (d) sets forth requirements that must be satisfied in order for a plan to disregard increases in benefits accrued as of a fresh-start date that are attributable to increases in employees' compensation after the fresh-start date.

(2) IN GENERAL. In the case of a defined benefit plan that is tested under the safe harbors in section 1.401(a)(4)-3(b) or section 1.401(a)(4)-8(c)(3), an employee's adjusted accrued benefit (determined under the rules in paragraph (d)(8) of this section) may be substituted for the employee's frozen accrued benefit in applying the formulas in paragraph (c)(4) of this section (or paragraph (f)(2) of this section, if applicable) if paragraphs (d)(3) through (d)(7) of this section are satisfied. Thus, for example, in determining whether such a plan satisfies section 1.401(a)(4)-3(b), any compensation adjustments to the employee's frozen accrued benefit described in paragraph (d)(8) of this section are disregarded. Similarly, in the case of a defined benefit plan tested under the general test in section 1.401(a)(4)-3(c), the compensation adjustments described in paragraph (d)(8) of this section may be disregarded under the rules of section 1.401(a)(4)-3(d)(3)(iii) if paragraphs (d)(3) through (d)(7) of this section are satisfied. Of course, any increases in accrued benefits exceeding these adjustments must be taken into account under the general test, and a plan providing such excess increases generally will fail to satisfy the safe harbor requirements of section 1.401(a)(4)-3(b). Where paragraphs (d)(3) through (d)(7) of this section are satisfied with respect to a plan as of the fresh-start date, but one or more of those paragraphs fail to be satisfied for a later plan year, further compensation adjustments described in paragraph (d)(8) of this section may not be disregarded in testing the plan under section 1.401(a)(4)-3.

(3) PLAN REQUIREMENTS -- (i) PRE-FRESH-START DATE. As of the fresh-start date, the plan must have contained a benefit formula under which benefits of each employee in the fresh-start group that are accrued as of the fresh-start date and are attributable to service before the fresh-start date would be affected by the employee's compensation after the fresh-start date. A plan satisfies this requirement, for example, if it based benefits on an employee's highest average pay over a fixed period of years or on an employee's average pay over the employee's entire career with the employer. A plan does not satisfy this paragraph (d)(3)(i) if the Commissioner determines, based on all of the relevant facts and circumstances, that the plan provision described in the first sentence of this paragraph (d)(3) was added primarily in order to provide additional benefits to HCEs that are disregarded under the special testing rules described in this paragraph (d).

(ii) POST-FRESH-START DATE. The plan by its terms must provide that the accrued benefits of each employee in the fresh-start group after the fresh-start date be at least equal to the employee's adjusted accrued benefit (i.e., the frozen accrued benefit as of the fresh-start date, adjusted as provided under paragraph (d)(7) of this section, plus the compensation adjustments described in paragraph (d)(8) of this section).

(4) MEANINGFUL COVERAGE AS OF FRESH-START DATE. The plan must have provided meaningful coverage as of the fresh-start date. A plan provided meaningful coverage as of the fresh-start date if the group of employees with accrued benefits under the plan as of the fresh- start date satisfied the minimum coverage requirements of section 410(b) as in effect on that date (determined without regard to section 410(b)(6)(C)). In order to satisfy the requirement in the preceding sentence, an employer may amend the plan to grant past service credit under the formula in effect as of the fresh-start date to NHCEs, if the amount of past service granted them is reasonably comparable, on average, to the amount of past service HCEs have under the plan. Any benefit increase that results from the grant of past service credit to a NHCE under this paragraph (d)(4) is included in the employee's frozen accrued benefit.

(5) MEANINGFUL ONGOING COVERAGE -- (i) GENERAL RULE. The fresh- start group must have satisfied the minimum coverage requirements of section 410(b) for all plan years from the first plan year beginning after the fresh-start date through the current plan year. Thus, if a fresh-start group fails to satisfy the minimum coverage requirements of section 410(b) for any plan year, this paragraph (d)(5) is not satisfied for that plan year or any subsequent plan year; however, such a failure is not taken into account in determining whether this paragraph (d)(5) is satisfied for any previous plan year.

(ii) ALTERNATIVE RULES. Notwithstanding paragraph (d)(5)(i) of this section, a fresh-start group is deemed to satisfy this paragraph (d)(5) for all plan years following the fresh-start date if any one of the following requirements is satisfied:

(A) SECTION 410(b) COVERAGE FOR FIRST FIVE YEARS. The fresh- start group must have satisfied the minimum coverage requirements of section 410(b) for the first five plan years beginning after the fresh-start date.

(B) RATIO PERCENTAGE COVERAGE AS OF FRESH-START DATE. The fresh- start group must have satisfied the ratio percentage test of section 1.410(b)-2(b)(2) as of the fresh-start date.

(C) FRESH START FOR ACQUIRED GROUP OF EMPLOYEES. The fresh-start group must consist of an acquired group of employees that satisfied the minimum coverage requirements of section 410(b) (determined without regard to section 410(b)(6)(C)) as of the fresh-start date.

(D) FRESH START BEFORE APPLICABLE EFFECTIVE DATE. The fresh- start date with respect to the fresh-start group must have been on or before the effective date applicable to the plan under paragraph (a) or (b) of this section.

(6) MEANINGFUL CURRENT BENEFIT ACCRUALS. The benefit formula and accrual method under the plan that apply to the fresh-start group in the aggregate must provide benefit accruals in the current plan year (other than increases in benefits accrued as of the fresh-start date) at a rate that is meaningful in comparison to the rate at which benefits accrued for the fresh-start group in plan years beginning before the fresh-start date. Whether this requirement is satisfied with respect to a fresh-start group that does not include all employees in the plan with an hour of service after the fresh-start date may be determined taking into account the rate at which benefits are provided to other employees in the plan.

(7) MINIMUM BENEFIT ADJUSTMENT -- (i) IN GENERAL. In the case of a section 401(l) plan or a plan that imputes disparity under section 1.401(a)(4)-7, the plan must make the minimum benefit adjustment described in paragraph (d)(7)(ii) or (iii) of this section.

(ii) EXCESS OR OFFSET CLANS. In the case of a plan that is a defined benefit excess plan as of the fresh-start date, each employee's frozen accrued benefit is adjusted so that the base benefit percentage is not less than 50 percent of the excess benefit percentage. In the case of a plan that is a PIA offset plan (as defined in paragraph (2)(iii) of the definition of QSUPP in section 1.401(a)(4)-12) as of the fresh-start date, each employee's offset as applied to determine the frozen accrued benefit is adjusted so that it does not exceed 50 percent of the benefit determined without applying the offset.

(iii) OTHER PLANS. In the case of a plan that is not described in paragraph (d)(7)(ii) of this section, each employee's frozen accrued benefit is adjusted in a manner that is economically equivalent to the adjustment required under that paragraph, taking into account the plan's benefit formula, accrual rate, and relevant employee factors, such as period of service.

(8) ADJUSTED ACCRUED BENEFIT -- (i) GENERAL RULE. The term adjusted accrued benefit means an employee's frozen accrued benefit that is adjusted as provided in paragraph (d)(7) of this section and then multiplied by a fraction (not less than one), the numerator of which is the employee's compensation for the current plan year and the denominator of which is the employee's compensation as of the fresh-start date determined under the same definition. For purposes of this adjustment, the compensation definition must be either the same compensation definition and formula used to determine the frozen accrued benefit or average annual compensation (determined without regard to section 1.401(a)(4)-3(e)(2)(ii)(A) (use of plan year compensation)).

(ii) ALTERNATIVE FORMULA FOR PRE-EFFECTIVE-DATE FRESH STARTS. In the case of a fresh-start date before the effective date that applies to the plan under paragraph (a) or (b) of this section, the adjusted accrued benefit may be determined by multiplying the frozen accrued benefit by a fraction (not less than one) determined under this paragraph (d)(8)(ii). The numerator of the fraction is the employee's average annual compensation for the current plan year. The denominator of the fraction is the employee's reconstructed average annual compensation as of the fresh-start date. An employee's reconstructed average annual compensation is determined by --

(A) Selecting a single plan year beginning after the fresh-start date but beginning not later than the last day of the first plan year to which these regulations apply under paragraph (a) or (b) of this section;

(B) Determining the employee's average annual compensation for the selected plan year under the same method used to determine the employee's average annual compensation for the current plan year under this paragraph (d)(8)(ii); and

(C) Multiplying the employee's average annual compensation for the selected plan year by a fraction, the numerator of which is the employee's compensation as of the fresh-start date determined under the same compensation definition and formula used to determine the employee's frozen accrued benefit and the denominator of which is the employee's compensation for the selected plan year determined under the compensation definition and formula used to determine the employee's frozen accrued benefit.

(iii) EFFECT OF SECTION 401(a)(17). In determining the numerators and the denominators of the fractions described in this paragraph (d)(8), the annual compensation limit under section 401(a)(17) generally applies. See, however, section 1.401(a)(17)- 1(e)(4) for special rules applicable to section 401(a)(17) employees.

(iv) OPTION TO MAKE LESS THAN THE FULL PERMITTED ADJUSTMENT. A plan may limit the increase in an employee's frozen accrued benefit for the current and all future years to a percentage (not more than 100 percent) of the increase otherwise provided under this paragraph (d)(8). Furthermore, the plan may, at any time, terminate all future adjustments permitted under this paragraph (d).

(v) ALTERNATIVE DETERMINATION OF ADJUSTED ACCRUED BENEFIT. In lieu of applying the fractions in paragraph (d)(8)(i) or (ii) of this section, a plan may determine an employee's adjusted accrued benefit by substituting the employee's compensation for the current plan year (determined under the same compensation formula and underlying definition of compensation used to determine the employee's frozen accrued benefit) in the benefit formula used to determine the frozen accrued benefit. For this purpose, insignificant changes in the underlying definition of compensation to reflect current compensation practices will not be treated as a change in the definition of compensation. A plan may apply the alternative in this paragraph (d)(8)(v), only if it is reasonable to expect as of the fresh-start date that, over time, the use of this method instead of the general rule of paragraph (d)(8)(i) will not discriminate significantly in favor of HCEs.

(9) EXAMPLES. The following examples illustrate the rules of this paragraph (d).

EXAMPLE 1. (a) Employer X maintains a defined benefit plan that is an excess plan with a calendar plan year. For plan years before 1989, the plan is integrated with benefits provided under the Social Security Act, providing each employee with a normal retirement benefit equal to one percent of the employee's average annual compensation in excess of the employee's covered compensation, multiplied by the employee's years of service for Employer X. The benefit formula thus provides no benefit with respect to average annual compensation up to covered compensation.

(b) As of December 31, 1988, Employee M has 10 years of service for Employer X and has covered compensation of $25,000 and average annual compensation of $20,000. Employee M's average annual compensation has never exceeded $20,000. Therefore, as of December 31, 1988, Employee M's accrued benefit under the plan is zero.

(c) Effective with the 1989 plan year, the plan is amended to provide each employee with a normal retirement benefit of 0.6 percent of average annual compensation up to covered compensation plus 1.2 percent of average annual compensation in excess of covered compensation, multiplied by the employee's years of service up to 35. The plan also provides that, for plan years after 1988, each employee's accrued benefit is determined under the formula in paragraph (c)(4)(i) of this section (formula without wear-away) and, in applying the fresh-start formula, each employee's frozen accrued benefit under paragraph (c)(4)(i) of this section will be adjusted under this paragraph (d), using the same compensation definition and formula used to determine the frozen accrued benefit under paragraph (d)(8)(i) of this section.

(d) The plan uses the permitted disparity of section 401(l) and thus must also make the minimum benefit adjustment under paragraph (d)(7) of this section. Because the excess benefit percentage under the plan for years before 1989 was one percent, the plan must provide a base benefit percentage for those years of at least 0.5 percent. After the minimum benefit adjustment, Employee M's accrued benefit as of December 31, 1988, is $1,000 (0.5 percent x $20,000 x 10 years).

(e) As of December 31, 1992, Employee M has 14 years of service and has covered compensation of $30,000 and average annual compensation of $35,000. Employee M's adjusted accrued benefit as of December 31, 1992, is $1,750 ($1,000 x $35,000/$20,000), and Employee M's accrued benefit as of December 31, 1992, is $2,710 (the sum of $1,750 plus $960 ((0.6 percent x $30,000 x 4 years) plus (1.2 percent x $5,000 x 4 years))).

EXAMPLE 2. (a) The facts are the same as in EXAMPLE 1, except that in determining adjusted accrued benefits, the plan specifies the alternative method of paragraph (d)(8)(v) of this section. This method may be used because it is reasonable to expect as of the fresh-start date that, over time, the use of this method instead of the general rule of paragraph (d)(8)(i) will not discriminate significantly in favor of HCEs.

(b) As of December 31, 1992, Employee M's adjusted accrued benefit is $2,000 (10 years of service prior to the fresh-start date x (0.5 percent of $30,000 + 1.0 percent of the excess of $35,000 over $30,000)).

(c) Alternatively, Employer X may choose to use the method of paragraph (d)(8)(v) of this section but freezes the covered compensation level at the dollar level in place as of the fresh- start date. In such case, Employee M's adjusted accrued benefit as of December 31, 1992, would have been $2,250 (10 years of service prior to the fresh-start date x (0.5 percent of $25,000 + 1.0 percent of the excess of $35,000 over $25,000)). This method may be used because it is reasonable to expect as of the fresh-start date that, over time, the use of this method instead of the general rule of paragraph (d)(8)(i) will not discriminate significantly in favor of HCEs.

EXAMPLE 3. (a) The facts are the same as in EXAMPLE 1, except that for plan years before 1989, the plan provided a minimum benefit to certain employees equal to $120 per year of service. Employee M is entitled to the minimum benefit, and thus, Employee M's frozen accrued benefit as of December 31, 1988 was $1,200 (the greater of 10 years of service x $120 and $1,000, Employee M's benefit under the underlying formula, after the minimum benefit adjustment of paragraph (d)(7) of this section).

(b) Employer X's plan specifies instead the alternative method of adjusting accrued benefits described in paragraph (d)(8)(v) of this section. (The fact that a minimum benefit applying to certain employees is not adjusted under the alternative method of paragraph (d)(8)(v) of this section, but would be adjusted under the general rule of paragraph (d)(8)(i) of this section does not change the conclusion in EXAMPLE 2, that the plan may apply the alternative method).

(e) DETERMINATION OF INITIAL THEORETICAL RESERVE FOR TARGET BENEFIT PLANS -- (1) GENERAL RULE. In the case of a target benefit plan the stated benefit formula under which takes into account service for years in which the plan did not satisfy section 1.401(a)(4)-8(b)(3), as permitted under section 1.401(a)(4)- 8(b)(3)(vii), the theoretical reserve as of the determination date for the last plan year beginning before the first day of the first plan year in which the plan satisfies section 1.401(a)(4)-8(b)(3) of an employee who was a participant in the plan on that determination date, is determined as follows:

(i) Determine the actuarial present value, as of that determination date, of the stated benefit that the employee is projected to have at the employee's normal retirement age, using the actuarial assumptions, the provisions of the plan, and the employee's compensation as of that determination date. For an employee whose attained age equals or exceeds the employee's normal retirement age, determine the actuarial present value of the employee's stated benefit at the employee's current age, but using an immediate straight life annuity factor for an employee whose attained age equals the employee's normal retirement age.

(ii) Calculate the actuarial present value of future required employer contributions (without regard to limitations under section 415 or additional contributions described in section 1.401(a)(4)- 8(b)(3)(v)) as of that determination date (i.e., the actuarial present value of the level contributions due for each plan year through the end of the plan year in which the employee attains normal retirement age). This calculation is made assuming that the required contribution in each future year will be equal to the required contribution for the plan year that includes that determination date, and applying the interest rate that was used in determining that required contribution.

(iii) Determine the excess, if any, of the amount determined in paragraph (e)(1)(i) of this section over the amount determined in paragraph (e)(1)(ii) of this section. This excess is the employee's theoretical reserve on that determination date.

(2) EXAMPLE. The following example illustrates the determination of an employee's theoretical reserve.

EXAMPLE. (a) A target benefit plan was adopted and in effect before September 19, 1991, and satisfied the requirements of Rev. Rul. 76-464, 1976-2 C.B. 115, with respect to all years credited under the stated benefit formula through 1993. The plan provides a stated benefit equal to 40 percent of compensation, payable annually as a straight life annuity beginning at normal retirement age. Normal retirement age under the plan is 65. The stated interest rate under the plan is six percent. The determination date for required contributions under the plan is the last day of the plan year. Employee M is 38 years old on the determination date for the 1993 plan year, has participated in the plan for five years, and has compensation equal to $60,000 in 1993. The amount of employer contribution to Employee M's account for 1993 was $2,468.

(b) Under these facts, Employee M's theoretical reserve is equal to $13,909, calculated as follows:

(1) The actuarial present value of Employee M's stated benefit is calculated using the actuarial assumptions, provisions of the plan and Employee M's compensation as of the determination date for the 1993 plan year. This amount is equal to $46,512, Employee M's stated benefit of $24,000 ($60,000 multiplied by 40 percent), multiplied by 1.938, the actuarial present value factor applicable to a participant who is 38 years old using a stated interest rate of six percent.

(2) The actuarial present value of future employer contributions is calculated assuming that the required contribution in each future year will be equal to the required contribution for the 1993 plan year and assuming the same interest rate as was used in determining that contribution. This amount is equal to $32,603, which is equal to the amount of the level annual employer contribution ($2,468) multiplied by a factor of 13.2105 (the temporary annuity factor for a period of 27 years, assuming the six percent interest rate that was used to determine the required employer contribution).

(3) Employee M's theoretical reserve is $13,909, the excess of the amount determined in paragraph (b)(1) of this EXAMPLE over the amount determined in paragraph (b)(2) of this EXAMPLE.

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Par. 5. Section 1.411(d)-4 is amended by revising the sentence at the end of paragraph A-1(b)(1) to read as follows:

SECTION 1.411(d)-4 SECTION 411(d)(6) PROTECTED BENEFITS.

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A-1: * * *

(b) * * * (1) * * * See section 1.401(a)(4)-4(d) for the definition of an optional form of benefit for plan years beginning on or after January 1, 1994 (or January 1, 1996, in the case of plans maintained by organizations exempt from income taxation under section 501(a), including plans subject to section 403(b)(12)(A)(i) (nonelective plans)).

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