[Code of Federal Regulations]
[Title 26, Volume 5]
[Revised as of January 1, 2007]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.401(k)-1]

[Page 301-320]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.401(k)-1  Certain cash or deferred arrangements.

    (a) General rules--(1) Certain plans permitted to include cash or 
deferred arrangements. A plan, other than a profit-sharing, stock bonus, 
pre-ERISA money purchase pension, or rural cooperative plan, does not 
satisfy the requirements of section 401(a) if the plan includes a cash 
or deferred arrangement. A profit-sharing, stock bonus, pre-ERISA money 
purchase pension, or rural cooperative plan does not fail to satisfy the 
requirements of section

[[Page 302]]

401(a) merely because the plan includes a cash or deferred arrangement. 
A cash or deferred arrangement is part of a plan for purposes of this 
section if any contributions to the plan, or accruals or other benefits 
under the plan, are made or provided pursuant to the cash or deferred 
arrangement.
    (2) Rules applicable to cash or deferred arrangements generally--(i) 
Definition of cash or deferred arrangement. Except as provided in 
paragraphs (a)(2)(ii) and (iii) of this section, a cash or deferred 
arrangement is an arrangement under which an eligible employee may make 
a cash or deferred election with respect to contributions to, or 
accruals or other benefits under, a plan that is intended to satisfy the 
requirements of section 401(a) (including a contract that is intended to 
satisfy the requirements of section 403(a)).
    (ii) Treatment of after-tax employee contributions. A cash or 
deferred arrangement does not include an arrangement under which amounts 
contributed under a plan at an employee's election are designated or 
treated at the time of contribution as after-tax employee contributions 
(e.g., by treating the contributions as taxable income subject to 
applicable withholding requirements). See also section 414(h)(1). A 
designated Roth contribution, however, is not treated as an after-tax 
contribution for purposes of this section, Sec. 1.401(k)-2 through 
Sec. 1.401(k)-6 and Sec. 1.401(m)-1 through Sec. 1.401(m)-5. A 
contribution can be an after-tax employee contribution under the rule of 
this paragraph (a)(2)(ii) even if the employee's election to make after-
tax employee contributions is made before the amounts subject to the 
election are currently available to the employee.
    (iii) Treatment of ESOP dividend election. A cash or deferred 
arrangement does not include an arrangement under an ESOP under which 
dividends are either distributed or invested pursuant to an election 
made by participants or their beneficiaries in accordance with section 
404(k)(2)(A)(iii).
    (iv) Treatment of elective contributions as plan assets. The extent 
to which elective contributions constitute plan assets for purposes of 
the prohibited transaction provisions of section 4975 and Title I of the 
Employee Retirement Income Security Act of 1974 (88 Stat. 829), Public 
Law 93-406, is determined in accordance with regulations and rulings 
issued by the Department of Labor. See 29 CFR 2510.3-102.
    (3) Rules applicable to cash or deferred elections generally--(i) 
Definition of cash or deferred election. A cash or deferred election is 
any direct or indirect election (or modification of an earlier election) 
by an employee to have the employer either--
    (A) Provide an amount to the employee in the form of cash (or some 
other taxable benefit) that is not currently available; or
    (B) Contribute an amount to a trust, or provide an accrual or other 
benefit, under a plan deferring the receipt of compensation.
    (ii) Automatic enrollment. For purposes of determining whether an 
election is a cash or deferred election, it is irrelevant whether the 
default that applies in the absence of an affirmative election is 
described in paragraph (a)(3)(i)(A) of this section (i.e., the employee 
receives an amount in cash or some other taxable benefit) or in 
paragraph (a)(3)(i)(B) of this section (i.e., the employer contributes 
an amount to a trust or provides an accrual or other benefit under a 
plan deferring the receipt of compensation).
    (iii) Rules related to timing--(A) Requirement that amounts not be 
currently available. A cash or deferred election can only be made with 
respect to an amount that is not currently available to the employee on 
the date of the election. Further, a cash or deferred election can only 
be made with respect to amounts that would (but for the cash or deferred 
election) become currently available after the later of the date on 
which the employer adopts the cash or deferred arrangement or the date 
on which the arrangement first becomes effective.
    (B) Contribution may not precede election. A contribution is made 
pursuant to a cash or deferred election only if the contribution is made 
after the election is made.
    (C) Contribution may not precede services--(1) General rule. 
Contributions are made pursuant to a cash or deferred election only if 
the contributions are

[[Page 303]]

made after the employee's performance of service with respect to which 
the contributions are made (or when the cash or other taxable benefit 
would be currently available, if earlier).
    (2) Exception for bona fide administrative considerations. The 
timing of contributions will not be treated as failing to satisfy the 
requirements of this paragraph (a)(3)(iii)(C) merely because 
contributions for a pay period are occasionally made before the services 
with respect to that pay period are performed, provided the 
contributions are made early in order to accommodate bona fide 
administrative considerations (for example, the temporary absence of the 
bookkeeper with responsibility to transmit contributions to the plan) 
and are not paid early with a principal purpose of accelerating 
deductions.
    (iv) Current availability defined. Cash or another taxable benefit 
is currently available to the employee if it has been paid to the 
employee or if the employee is able currently to receive the cash or 
other taxable benefit at the employee's discretion. An amount is not 
currently available to an employee if there is a significant limitation 
or restriction on the employee's right to receive the amount currently. 
Similarly, an amount is not currently available as of a date if the 
employee may under no circumstances receive the amount before a 
particular time in the future. The determination of whether an amount is 
currently available to an employee does not depend on whether it has 
been constructively received by the employee for purposes of section 
451.
    (v) Certain one-time elections not treated as cash or deferred 
elections. A cash or deferred election does not include a one-time 
irrevocable election made no later than the employee's first becoming 
eligible under the plan or any other plan or arrangement of the employer 
that is described in section 219(g)(5)(A) (whether or not such other 
plan or arrangement has terminated), to have contributions equal to a 
specified amount or percentage of the employee's compensation (including 
no amount of compensation) made by the employer on the employee's behalf 
to the plan and a specified amount or percentage of the employee's 
compensation (including no amount of compensation) divided among all 
other plans or arrangements of the employer (including plans or 
arrangements not yet established) for the duration of the employee's 
employment with the employer, or in the case of a defined benefit plan 
to receive accruals or other benefits (including no benefits) under such 
plans. Thus, for example, employer contributions made pursuant to a one-
time irrevocable election described in this paragraph are not treated as 
having been made pursuant to a cash or deferred election and are not 
includible in an employee's gross income by reason of Sec. 1.402(a)-
1(d). In the case of an irrevocable election made on or before December 
23, 1994--
    (A) The election does not fail to be treated as a one-time 
irrevocable election under this paragraph (a)(3)(v) merely because an 
employee was previously eligible under another plan of the employer 
(whether or not such other plan has terminated); and
    (B) In the case of a plan in which partners may participate, the 
election does not fail to be treated as a one-time irrevocable election 
under this paragraph (a)(3)(v) merely because the election was made 
after commencement of employment or after the employee's first becoming 
eligible under any plan of the employer, provided that the election was 
made before the first day of the first plan year beginning after 
December 31, 1988, or, if later, March 31, 1989.
    (vi) Tax treatment of employees. An amount generally is includible 
in an employee's gross income for the taxable year in which the employee 
actually or constructively receives the amount. But for section 
402(e)(3), an employee is treated as having received an amount that is 
contributed to an exempt trust or plan described in section 401(a) or 
403(a) pursuant to the employee's cash or deferred election. This is the 
case even if the election to defer is made before the year in which the 
amount is earned, or before the amount is currently available. See Sec. 
1.402(a)-1(d).
    (vii) Examples. The following examples illustrate the application of 
this paragraph (a)(3):


[[Page 304]]


    Example 1. (i) An employer maintains a profit-sharing plan under 
which each eligible employee has an election to defer an annual bonus 
payable on January 30 each year. The bonus equals 10% of compensation 
during the previous calendar year. Deferred amounts are not treated as 
after-tax employee contributions. The bonus is currently available on 
January 30.
    (ii) An election made prior to January 30 to defer all or part of 
the bonus is a cash or deferred election, and the bonus deferral 
arrangement is a cash or deferred arrangement.
    Example 2. (i) An employer maintains a profit-sharing plan which 
provides for discretionary profit sharing contributions and under which 
each eligible employee may elect to reduce his compensation by up to 10% 
and to have the employer contribute such amount to the plan. The 
employer pays each employee every two weeks for services during the 
immediately preceding two weeks. The employee's election to defer 
compensation for a payroll period must be made prior to the date the 
amount would otherwise be paid. The employer contributes to the plan the 
amount of compensation that each employee elected to defer, at the time 
it would otherwise be paid to the employee, and does not treat the 
contribution as an after-tax employee contribution.
    (ii) The election is a cash or deferred election and the 
contributions are elective contributions.
    Example 3. (i) The facts are the same as in Example 2, except that 
the employer makes a $10,000 contribution on January 31 of the plan year 
that is in addition to the contributions that satisfy the employer's 
obligation to make contributions with respect to cash or deferred 
elections for prior payroll periods. Employee A makes an election on 
February 15 to defer $2,000 from compensation that is not currently 
available and the employer reduces the employee's compensation to 
reflect the election.
    (ii) None of the additional $10,000 contributed January 31 is a 
contribution made pursuant to Employee A's cash or deferred election, 
because the contribution was made before the election was made. 
Accordingly, the employer must make an additional contribution of $2,000 
in order to satisfy its obligation to contribute an amount to the plan 
pursuant to Employee A's election. The $10,000 contribution may be 
allocated under the plan terms providing for discretionary profit 
sharing contributions.
    Example 4. (i) The facts are the same as in Example 3, except that 
Employee A had an outstanding election to defer $500 from each payroll 
period's compensation. The $10,000 additional payment that is 
contributed early is not made early in order to accommodate bona fide 
administrative considerations.
    (ii) None of the additional $10,000 contributed January 31 is a 
contribution made pursuant to Employee A's cash or deferred election for 
future payroll periods, because the contribution was made before the 
earlier of Employee A's performance of services to which the 
contribution is attributable or when the compensation would be currently 
available. Furthermore, the exception for early contributions in 
paragraph (a)(3)(iii)(C)(2) of this section does not apply. Accordingly, 
the employer must make an additional contribution of $500 per payroll 
period in order to satisfy its obligation to contribute an amount to the 
plan pursuant to Employee A's election. The $10,000 contribution may be 
allocated under the plan terms providing for discretionary profit 
sharing contributions.
    Example 5. (i) Employer B establishes a money purchase pension plan 
in 1986. This is the first qualified plan established by Employer B. All 
salaried employees are eligible to participate under the plan. Hourly-
paid employees are not eligible to participate under the plan. In 2000, 
Employer B establishes a profit-sharing plan under which all employees 
(both salaried and hourly) are eligible. Employer B permits all 
employees on the effective date of the profit-sharing plan to make a 
one-time irrevocable election to have Employer B contribute 5% of 
compensation on their behalf to the plan and make no other contribution 
to any other plan of Employer B (including plans not yet established) 
for the duration of the employee's employment with Employer B, and have 
their salaries reduced by 5%.
    (ii) The election provided under the profit-sharing plan is not a 
one-time irrevocable election within the meaning of paragraph (a)(3)(v) 
of this section with respect to the salaried employees of Employer B 
who, before becoming eligible to participate under the profit-sharing 
plan, became eligible to participate under the money purchase pension 
plan. The election under the profit-sharing plan is a one-time 
irrevocable election within the meaning of paragraph (a)(3)(v) of this 
section with respect to the hourly employees, because they were not 
previously eligible to participate under another plan of the employer.

    (4) Rules applicable to qualified cash or deferred arrangements--(i) 
Definition of qualified cash or deferred arrangement. A qualified cash 
or deferred arrangement is a cash or deferred arrangement that satisfies 
the requirements of paragraphs (b), (c), (d), and (e) of this section.
    (ii) Treatment of elective contributions as employer contributions. 
Except as otherwise provided in Sec. 1.401(k)-2(b)(3), elective 
contributions under a qualified

[[Page 305]]

cash or deferred arrangement (including designated Roth contributions) 
are treated as employer contributions. Thus, for example, elective 
contributions under such an arrangement are treated as employer 
contributions for purposes of sections 401(a), 401(k), 402, 404, 409, 
411, 412, 415, 416, and 417.
    (iii) Tax treatment of employees. Except as provided in section 
402(g), 402A (effective for taxable years beginning after December 31, 
2005), or Sec. 1.401(k)-2(b)(3), elective contributions under a 
qualified cash or deferred arrangement are neither includible in an 
employee's gross income at the time the cash would have been includible 
in the employee's gross income (but for the cash or deferred election), 
nor at the time the elective contributions are contributed to the plan. 
See Sec. 1.402(a)-1(d)(2)(i).
    (iv) Application of nondiscrimination requirements to plan that 
includes a qualified cash or deferred arrangement--(A) Exclusive means 
of amounts testing. Elective contributions (including elective 
contributions that are designated Roth contributions) under a qualified 
cash or deferred arrangement satisfy the requirements of section 
401(a)(4) with respect to amounts if and only if the amount of elective 
contributions satisfies the nondiscrimination test of section 401(k) 
under paragraph (b)(1) of this section. See Sec. 1.401(a)(4)-
1(b)(2)(ii)(B).
    (B) Testing benefits, rights and features. A plan that includes a 
qualified cash or deferred arrangement must satisfy the requirements of 
section 401(a)(4) with respect to benefits, rights and features in 
addition to the requirements regarding amounts described in paragraph 
(a)(4)(iv)(A) of this section. For example, the right to make each level 
of elective contributions under a cash or deferred arrangement and the 
right to make designated Roth contributions are rights or features 
subject to the requirements of section 401(a)(4). See Sec. 1.401(a)(4)-
4(e)(3)(i) and (iii)(D). Thus, for example, if all employees are 
eligible to make a stated level of elective contributions under a cash 
or deferred arrangement, but that level of contributions can only be 
made from compensation in excess of a stated amount, such as the Social 
Security taxable wage base, the arrangement will generally favor HCEs 
with respect to the availability of elective contributions and thus will 
generally not satisfy the requirements of section 401(a)(4).
    (C) Minimum coverage requirement. A qualified cash or deferred 
arrangement is treated as a separate plan that must satisfy the 
requirements of section 410(b). See Sec. 1.410(b)-7(c)(1) for special 
rules. The determination of whether a cash or deferred arrangement 
satisfies the requirements of section 410(b) must be made without regard 
to the modifications to the disaggregation rules set forth in paragraph 
(b)(4)(v) of this section. See also Sec. 1.401(a)(4)-11(g)(3)(vii)(A), 
relating to corrective amendments that may be made to satisfy the 
minimum coverage requirements of section 410(b).
    (5) Rules applicable to nonqualified cash or deferred arrangements--
(i) Definition of nonqualified cash or deferred arrangement. A 
nonqualified cash or deferred arrangement is a cash or deferred 
arrangement that fails to satisfy one or more of the requirements in 
paragraph (b), (c), (d) or (e) of this section.
    (ii) Treatment of elective contributions as nonelective 
contributions. Except as specifically provided otherwise, elective 
contributions under a nonqualified cash or deferred arrangement are 
treated as nonelective employer contributions. Thus, for example, the 
elective contributions under such an arrangement are treated as 
nonelective employer contributions for purposes of sections 401(a) 
(including section 401(a)(4)) and 401(k), 404, 409, 411, 412, 415, 416, 
and 417 and are not subject to the requirements of section 401(m).
    (iii) Tax treatment of employees. Elective contributions under a 
nonqualified cash or deferred arrangement are includible in an 
employee's gross income at the time the cash or other taxable amount 
that the employee would have received (but for the cash or deferred 
election) would have been includible in the employee's gross income. See 
Sec. 1.402(a)-1(d)(1).
    (iv) Qualification of plan that includes a nonqualified cash or 
deferred arrangement--(A) In general. A profit-sharing, stock bonus, 
pre-ERISA money purchase pension, or rural cooperative

[[Page 306]]

plan does not fail to satisfy the requirements of section 401(a) merely 
because the plan includes a nonqualified cash or deferred arrangement. 
In determining whether the plan satisfies the requirements of section 
401(a)(4), the nondiscrimination tests of sections 401(k), paragraph 
(b)(1) of this section, section 401(m)(2) and Sec. 1.401(m)-1(b) may 
not be used. See Sec. Sec. 1.401(a)(4)-1(b)(2)(ii)(B) and 1.410(b)-9 
(definition of section 401(k) plan).
    (B) Application of section 401(a)(4) to certain plans. The amount of 
employer contributions under a nonqualified cash or deferred arrangement 
is treated as satisfying section 401(a)(4) if the arrangement is part of 
a collectively bargained plan that automatically satisfies the 
requirements of section 410(b). See Sec. Sec. 1.401(a)(4)-(c)(5) and 
1.410(b)-2(b)(7). Additionally, the requirements of sections 401(a)(4) 
and 410(b) do not apply to a governmental plan (within the meaning of 
section 414(d)) maintained by a State or local government or political 
subdivision thereof (or agency or instrumentality thereof). See sections 
401(a)(5) and 410(c)(1)(A).
    (v) Example. The following example illustrates the application of 
this paragraph (a)(5):
    Example. (i) For the 2006 plan year, Employer A maintains a 
collectively bargained plan that includes a cash or deferred 
arrangement. Employer contributions under the cash or deferred 
arrangement do not satisfy the nondiscrimination test of section 401(k) 
and paragraph (b) of this section.
    (ii) The arrangement is a nonqualified cash or deferred arrangement. 
The employer contributions under the cash or deferred arrangement are 
considered to be nondiscriminatory under section 401(a)(4), and the 
elective contributions are generally treated as employer contributions 
under paragraph (a)(5)(ii) of this section. Under paragraph (a)(5)(iii) 
of this section and under Sec. 1.402(a)-1(d)(1), however, the elective 
contributions are includible in each employee's gross income.

    (6) Rules applicable to cash or deferred arrangements of self-
employed individuals--(i) Application of general rules. Generally, a 
partnership or sole proprietorship is permitted to maintain a cash or 
deferred arrangement, and individual partners or owners are permitted to 
make cash or deferred elections with respect to compensation 
attributable to services rendered to the entity, under the same rules 
that apply to other cash or deferred arrangements. For example, any 
contributions made on behalf of an individual partner or owner pursuant 
to a cash or deferred arrangement of a partnership or sole 
proprietorship are elective contributions unless they are designated or 
treated as after-tax employee contributions. In the case of a 
partnership, a cash or deferred arrangement includes any arrangement 
that directly or indirectly permits individual partners to vary the 
amount of contributions made on their behalf. Consistent with Sec. 
1.402(a)-1(d), the elective contributions under such an arrangement are 
includible in income and are not deductible under section 404(a) unless 
the arrangement is a qualified cash or deferred arrangement (i.e., the 
requirements of section 401(k) and this section are satisfied). Also, 
even if the arrangement is a qualified cash or deferred arrangement, the 
elective contributions are includible in gross income and are not 
deductible under section 404(a) to the extent they exceed the applicable 
limit under section 402(g). See also Sec. 1.401(a)-30.
    (ii) Treatment of matching contributions made on behalf of self-
employed individuals. Under section 402(g)(8), matching contributions 
made on behalf of a self-employed individual are not treated as elective 
contributions made pursuant to a cash or deferred election, without 
regard to whether such matching contributions indirectly permit 
individual partners to vary the amount of contributions made on their 
behalf.
    (iii) Timing of self-employed individual's cash or deferred 
election. For purposes of paragraph (a)(3)(iv) of this section, a 
partner's compensation is deemed currently available on the last day of 
the partnership taxable year and a sole proprietor's compensation is 
deemed currently available on the last day of the individual's taxable 
year. Accordingly, a self-employed individual may not make a cash or 
deferred election with respect to compensation for a partnership or sole 
proprietorship taxable year after the last day of that year. See Sec. 
1.401(k)-2(a)(4)(ii) for the rules regarding when these contributions 
are treated as allocated.

[[Page 307]]

    (iv) Special rule for certain payments to self-employed individuals. 
For purposes of sections 401(k) and 401(m), the earned income of a self-
employed individual for a taxable year constitutes payment for services 
during that year. Thus, for example, if a partnership provides for cash 
advance payments during the taxable year to be made to a partner based 
on the value of the partner's services prior to the date of payment (and 
which do not exceed a reasonable estimate of the partner's earned income 
for the taxable year), a contribution of a portion of these payments to 
a profit sharing plan in accordance with an election to defer the 
portion of the advance payments does not fail to be made pursuant to a 
cash or deferred election within the meaning of paragraph (a)(3)(iii) of 
this section merely because the contribution is made before the amount 
of the partner's earned income is finally determined and reported. 
However, see Sec. 1.401(k)-2(a)(4)(ii) for rules on when earned income 
is treated as received.
    (b) Coverage and nondiscrimination requirements--(1) In general. A 
cash or deferred arrangement satisfies this paragraph (b) for a plan 
year only if--
    (i) The group of eligible employees under the cash or deferred 
arrangement (including any employees taken into account for purposes of 
section 410(b) pursuant to Sec. 1.401(a)(4)-11(g)(3)(vii)(A)) satisfies 
the requirements of section 410(b) (including the average benefit 
percentage test, if applicable); and
    (ii) The cash or deferred arrangement satisfies--
    (A) The ADP test of section 401(k)(3) described in Sec. 1.401(k)-2;
    (B) The ADP safe harbor provisions of section 401(k)(12) described 
in Sec. 1.401(k)-3; or
    (C) The SIMPLE 401(k) provisions of section 401(k)(11) described in 
Sec. 1.401(k)-4.
    (2) Automatic satisfaction by certain plans. Notwithstanding 
paragraph (b)(1) of this section, a governmental plan (within the 
meaning of section 414(d)) maintained by a State or local government or 
political subdivision thereof (or agency or instrumentality thereof) 
shall be treated as meeting the requirements of this paragraph (b).
    (3) Anti-abuse provisions. This section and Sec. Sec. 1.401(k)-2 
through 1.401(k)-6 are designed to provide simple, practical rules that 
accommodate legitimate plan changes. At the same time, the rules are 
intended to be applied by employers in a manner that does not make use 
of changes in plan testing procedures or other plan provisions to 
inflate inappropriately the ADP for NHCEs (which is used as a benchmark 
for testing the ADP for HCEs) or to otherwise manipulate the 
nondiscrimination testing requirements of this paragraph (b). Further, 
this paragraph (b) is part of the overall requirement that benefits or 
contributions not discriminate in favor of HCEs. Therefore, a plan will 
not be treated as satisfying the requirements of this paragraph (b) if 
there are repeated changes to plan testing procedures or plan provisions 
that have the effect of distorting the ADP so as to increase 
significantly the permitted ADP for HCEs, or otherwise manipulate the 
nondiscrimination rules of this paragraph, if a principal purpose of the 
changes was to achieve such a result.
    (4) Aggregation and restructuring--(i) In general. This paragraph 
(b)(4) contains the exclusive rules for aggregating and disaggregating 
plans and cash or deferred arrangements for purposes of this section, 
and Sec. Sec. 1.401(k)-2 through 1.401(k)-6.
    (ii) Aggregation of cash or deferred arrangements within a plan. 
Except as otherwise specifically provided in this paragraph (b)(4), all 
cash or deferred arrangements included in a plan are treated as a single 
cash or deferred arrangement and a plan must apply a single test under 
paragraph (b)(1)(ii) of this section with respect to all such 
arrangements within the plan. Thus, for example, if two groups of 
employees are eligible for separate cash or deferred arrangements under 
the same plan, all contributions under both cash or deferred 
arrangements must be treated as made under a single cash or deferred 
arrangement subject to a single test, even if they have significantly 
different features, such as different limits on elective contributions.
    (iii) Aggregation of plans--(A) In general. For purposes of this 
section and Sec. Sec. 1.401(k)-2 through 1.401(k)-6, the term

[[Page 308]]

plan means a plan within the meaning of Sec. 1.410(b)-7(a) and (b), 
after application of the mandatory disaggregation rules of Sec. 
1.410(b)-7(c), and the permissive aggregation rules of Sec. 1.410(b)-
7(d), as modified by paragraph (b)(4)(v) of this section. Thus, for 
example, two plans (within the meaning of Sec. 1.410(b)-7(b)) that are 
treated as a single plan pursuant to the permissive aggregation rules of 
Sec. 1.410(b)-7(d) are treated as a single plan for purposes of 
sections 401(k) and (m).
    (B) Plans with inconsistent ADP testing methods. Pursuant to 
paragraph (b)(4)(ii) of this section, a single testing method must apply 
with respect to all cash or deferred arrangements under a plan. Thus, in 
applying the permissive aggregation rules of Sec. 1.410(b)-7(d), an 
employer may not aggregate plans (within the meaning of Sec. 1.410(b)-
7(b)) that apply inconsistent testing methods. For example, a plan 
(within the meaning of Sec. 1.410(b)-7(b)) that applies the current 
year testing method may not be aggregated with another plan that applies 
the prior year testing method. Similarly, an employer may not aggregate 
a plan (within the meaning of Sec. 1.410(b)-7(b)) using the ADP safe 
harbor provisions of section 401(k)(12) and another plan that is using 
the ADP test of section 401(k)(3).
    (iv) Disaggregation of plans and separate testing--(A) In general. 
If a cash or deferred arrangement is included in a plan (within the 
meaning of Sec. 1.410(b)-7(b)) that is mandatorily disaggregated under 
the rules of section 410(b) (as modified by this paragraph (b)(4)), the 
cash or deferred arrangement must be disaggregated in a consistent 
manner. For example, in the case of an employer that is treated as 
operating qualified separate lines of business under section 414(r), if 
the eligible employees under a cash or deferred arrangement are in more 
than one qualified separate line of business, only those employees 
within each qualified separate line of business may be taken into 
account in determining whether each disaggregated portion of the plan 
complies with the requirements of section 401(k), unless the employer is 
applying the special rule for employer-wide plans in Sec. 1.414(r)-
1(c)(2)(ii) with respect to the plan. Similarly, if a cash or deferred 
arrangement under which employees are permitted to participate before 
they have completed the minimum age and service requirements of section 
410(a)(1) applies section 410(b)(4)(B) for determining whether the plan 
complies with section 410(b)(1), then the arrangement must be treated as 
two separate arrangements, one comprising all eligible employees who 
have met the age and service requirements of section 410(a)(1) and one 
comprising all eligible employees who have not met the age and service 
requirements under section 410(a)(1), unless the plan is using the rule 
in Sec. 1.401(k)-2(a)(1)(iii)(A).
    (B) Restructuring prohibited. Restructuring under Sec. 1.401(a)(4)-
9(c) may not be used to demonstrate compliance with the requirements of 
section 401(k). See Sec. 1.401(a)(4)-9(c)(3)(ii).
    (v) Modifications to section 410(b) rules--(A) Certain 
disaggregation rules not applicable. The mandatory disaggregation rules 
relating to section 401(k) plans and section 401(m) plans set forth in 
Sec. 1.410(b)-7(c)(1) and ESOP and non-ESOP portions of a plan set 
forth in Sec. 1.410(b)-7(c)(2) shall not apply for purposes of this 
section and Sec. Sec. 1.401(k)-2 through 1.401(k)-6. Accordingly, 
notwithstanding Sec. 1.410(b)-7(d)(2), an ESOP and a non-ESOP which are 
different plans (within the meaning of section 414(l), as described in 
Sec. 1.410(b)-7(b)) are permitted to be aggregated for these purposes.
    (B) Permissive aggregation of collective bargaining units. 
Notwithstanding the general rule under section 410(b) and Sec. 
1.410(b)-7(c) that a plan that benefits employees who are included in a 
unit of employees covered by a collective bargaining agreement and 
employees who are not included in the collective bargaining unit is 
treated as comprising separate plans, an employer can treat two or more 
separate collective bargaining units as a single collective bargaining 
unit for purposes of this section and Sec. Sec. 1.401(k)-2 through 
1.401(k)-6, provided that the combinations of units are determined on a 
basis that is reasonable and reasonably consistent from year to year. 
Thus, for example, if a plan benefits employees in three categories 
(e.g., employees included in collective bargaining unit A, employees

[[Page 309]]

included in collective bargaining unit B, and employees who are not 
included in any collective bargaining unit), the plan can be treated as 
comprising three separate plans, each of which benefits only one 
category of employees. However, if collective bargaining units A and B 
are treated as a single collective bargaining unit, the plan will be 
treated as comprising only two separate plans, one benefiting all 
employees who are included in a collective bargaining unit and another 
benefiting all other employees. Similarly, if a plan benefits only 
employees who are included in collective bargaining unit A and employees 
who are included in collective bargaining unit B, the plan can be 
treated as comprising two separate plans. However, if collective 
bargaining units A and B are treated as a single collective bargaining 
unit, the plan will be treated as a single plan. An employee is treated 
as included in a unit of employees covered by a collective bargaining 
agreement if and only if the employee is a collectively bargained 
employee within the meaning of Sec. 1.410(b)-6(d)(2).
    (C) Multiemployer plans. Notwithstanding Sec. 1.410(b)-
7(c)(4)(ii)(C), the portion of the plan that is maintained pursuant to a 
collective bargaining agreement (within the meaning of Sec. 1.413-
1(a)(2)) is treated as a single plan maintained by a single employer 
that employs all the employees benefiting under the same benefit 
computation formula and covered pursuant to that collective bargaining 
agreement. The rules of paragraph (b)(4)(v)(B) of this section 
(including the permissive aggregation of collective bargaining units) 
apply to the resulting deemed single plan in the same manner as they 
would to a single employer plan, except that the plan administrator is 
substituted for the employer where appropriate and that appropriate 
fiduciary obligations are taken into account. The noncollectively 
bargained portion of the plan is treated as maintained by one or more 
employers, depending on whether the noncollectively bargaining unit 
employees who benefit under the plan are employed by one or more 
employers.
    (vi) Examples. The following examples illustrate the application of 
this paragraph (b)(4):

    Example 1. (i) Employer A maintains Plan V, a profit-sharing plan 
that includes a cash or deferred arrangement in which all of the 
employees of Employer A are eligible to participate. For purposes of 
applying section 410(b), Employer A is treated as operating qualified 
separate lines of business under section 414(r) in accordance with Sec. 
1.414(r)-1(b). However, Employer A applies the special rule for 
employer-wide plans in Sec. 1.414(r)-1(c)(2)(ii) to the portion of its 
profit-sharing plan that consists of elective contributions under the 
cash or deferred arrangement (and to no other plans or portions of 
plans).
    (ii) Under these facts, the requirements of this section and 
Sec. Sec. 1.401(k)-2 through 1.401(k)-6 must be applied on an employer-
wide rather than a qualified separate line of business basis.
    Example 2. (i) Employer B maintains Plan W, a profit-sharing plan 
that includes a cash or deferred arrangement in which all of the 
employees of Employer B are eligible to participate. For purposes of 
applying section 410(b), the plan treats the cash or deferred 
arrangement as two separate plans, one for the employees who have 
completed the minimum age and service eligibility conditions under 
section 410(a)(1) and the other for employees who have not completed the 
conditions. The plan provides that it will satisfy the section 401(k) 
safe harbor requirement of Sec. 1.401(k)-3 with respect to the 
employees who have met the minimum age and service conditions and that 
it will meet the ADP test requirements of Sec. 1.401(k)-2 with respect 
to the employees who have not met the minimum age and service 
conditions.
    (ii) Under these facts, the cash or deferred arrangement must be 
disaggregated on a consistent basis with the disaggregation of Plan W. 
Thus, the requirements of Sec. 1.401(k)-2 must be applied by comparing 
the ADP for eligible HCEs who have not completed the minimum age and 
service conditions with the ADP for eligible NHCEs for the applicable 
year who have not completed the minimum age and service conditions.
    Example 3. (i) Employer C maintains Plan X, a stock-bonus plan 
including an ESOP. The plan also includes a cash or deferred arrangement 
for participants in the ESOP and non-ESOP portions of the plan.
    (ii) Pursuant to paragraph (b)(4)(v)(A) of this section the ESOP and 
non-ESOP portions of the stock-bonus plan are a single cash or deferred 
arrangement for purposes of this section and Sec. Sec. 1.401(k)-2 
through 1.401(k)-6. However, as provided in paragraph (a)(4)(iv)(C) of 
this section, the ESOP and non-ESOP portions of the plan are still 
treated as separate plans for purposes of satisfying the requirements of 
section 410(b).


[[Page 310]]


    (c) Nonforfeitability requirements--(1) General rule. A cash or 
deferred arrangement satisfies this paragraph (c) only if the amount 
attributable to an employee's elective contributions are immediately 
nonforfeitable, within the meaning of paragraph (c)(2) of this section, 
are disregarded for purposes of applying section 411(a)(2) to other 
contributions or benefits, and the contributions remain nonforfeitable 
even if the employee makes no additional elective contributions under a 
cash or deferred arrangement.
    (2) Definition of immediately nonforfeitable. An amount is 
immediately nonforfeitable if it is immediately nonforfeitable within 
the meaning of section 411, and would be nonforfeitable under the plan 
regardless of the age and service of the employee or whether the 
employee is employed on a specific date. An amount that is subject to 
forfeitures or suspensions permitted by section 411(a)(3) does not 
satisfy the requirements of this paragraph (c).
    (3) Example. The following example illustrates the application of 
this paragraph (c):

    Example. (i) Employees B and C are covered by Employer Y's stock 
bonus plan, which includes a cash or deferred arrangement. All employees 
participating in the plan have a nonforfeitable right to a percentage of 
their account balance derived from all contributions (including elective 
contributions) as shown in the following table:

------------------------------------------------------------------------
                                                         Nonforfeitable
                   Years of service                        percentage
------------------------------------------------------------------------
Less than 1..........................................                  0
1....................................................                 20
2....................................................                 40
3....................................................                 60
4....................................................                 80
5 or more............................................                100
------------------------------------------------------------------------

    (ii) The cash or deferred arrangement does not satisfy paragraph (c) 
of this section because elective contributions are not immediately 
nonforfeitable. Thus, the cash or deferred arrangement is a nonqualified 
cash or deferred arrangement.

    (d) Distribution limitation--(1) General rule. A cash or deferred 
arrangement satisfies this paragraph (d) only if amounts attributable to 
elective contributions may not be distributed before one of the 
following events, and any distributions so permitted also satisfy the 
additional requirements of paragraphs (d)(2) through (5) of this section 
(to the extent applicable)--
    (i) The employee's death, disability, or severance from employment;
    (ii) In the case of a profit-sharing, stock bonus or rural 
cooperative plan, the employee's attainment of age 59\1/2\, or the 
employee's hardship; or
    (iii) The termination of the plan.
    (2) Rules applicable to distributions upon severance from 
employment. An employee has a severance from employment when the 
employee ceases to be an employee of the employer maintaining the plan. 
An employee does not have a severance from employment if, in connection 
with a change of employment, the employee's new employer maintains such 
plan with respect to the employee. For example, a new employer maintains 
a plan with respect to an employee by continuing or assuming sponsorship 
of the plan or by accepting a transfer of plan assets and liabilities 
(within the meaning of section 414(l)) with respect to the employee.
    (3) Rules applicable to hardship distributions--(i) Distribution 
must be on account of hardship. A distribution is treated as made after 
an employee's hardship for purposes of paragraph (d)(1)(ii) of this 
section if and only if it is made on account of the hardship. For 
purposes of this rule, a distribution is made on account of hardship 
only if the distribution both is made on account of an immediate and 
heavy financial need of the employee and is necessary to satisfy the 
financial need. The determination of the existence of an immediate and 
heavy financial need and of the amount necessary to meet the need must 
be made in accordance with nondiscriminatory and objective standards set 
forth in the plan.
    (ii) Limit on maximum distributable amount--(A) General rule. A 
distribution on account of hardship must be limited to the maximum 
distributable amount. The maximum distributable amount is equal to the 
employee's total elective contributions as of the date of distribution, 
reduced by the amount of previous distributions of elective 
contributions. Thus, the maximum distributable amount does not include 
earnings, QNECs or QMACs, unless grandfathered under paragraph 
(d)(3)(ii)(B) of this section.

[[Page 311]]

    (B) Grandfathered amounts. If the plan so provides, the maximum 
distributable amount may be increased for amounts credited to the 
employee's account as of a date specified in the plan that is no later 
than December 31, 1988, or if later, the end of the last plan year 
ending before July 1, 1989 (or in the case of a collectively bargained 
plan, the earlier of--
    (1) The later of January 1, 1989, or the date on which the last of 
the collective bargaining agreements in effect on March 1, 1986 
terminates (determined without regard to any extension thereof after 
February 28, 1986); or
    (2) January 1, 1991 and consisting of--
    (i) Income allocable to elective contributions;
    (ii) Qualified nonelective contributions and allocable income; and
    (iii) Qualified matching contributions and allocable income.
    (iii) Immediate and heavy financial need--(A) In general. Whether an 
employee has an immediate and heavy financial need is to be determined 
based on all the relevant facts and circumstances. Generally, for 
example, the need to pay the funeral expenses of a family member would 
constitute an immediate and heavy financial need. A distribution made to 
an employee for the purchase of a boat or television would generally not 
constitute a distribution made on account of an immediate and heavy 
financial need. A financial need may be immediate and heavy even if it 
was reasonably foreseeable or voluntarily incurred by the employee.
    (B) Deemed immediate and heavy financial need. A distribution is 
deemed to be on account of an immediate and heavy financial need of the 
employee if the distribution is for--
    (1) Expenses for (or necessary to obtain) medical care that would be 
deductible under section 213(d) (determined without regard to whether 
the expenses exceed 7.5% of adjusted gross income);
    (2) Costs directly related to the purchase of a principal residence 
for the employee (excluding mortgage payments);
    (3) Payment of tuition, related educational fees, and room and board 
expenses, for up to the next 12 months of post-secondary education for 
the employee, or the employee's spouse, children, or dependents (as 
defined in section 152, and, for taxable years beginning on or after 
January 1, 2005, without regard to section 152(b)(1), (b)(2) and 
(d)(1)(B));
    (4) Payments necessary to prevent the eviction of the employee from 
the employee's principal residence or foreclosure on the mortgage on 
that residence;
    (5) Payments for burial or funeral expenses for the employee's 
deceased parent, spouse, children or dependents (as defined in section 
152, and, for taxable years beginning on or after January 1, 2005, 
without regard to section 152(d)(1)(B)); or
    (6) Expenses for the repair of damage to the employee's principal 
residence that would qualify for the casualty deduction under section 
165 (determined without regard to whether the loss exceeds 10% of 
adjusted gross income).
    (iv) Distribution necessary to satisfy financial need--(A) 
Distribution may not exceed amount of need. A distribution is treated as 
necessary to satisfy an immediate and heavy financial need of an 
employee only to the extent the amount of the distribution is not in 
excess of the amount required to satisfy the financial need. For this 
purpose, the amount required to satisfy the financial need may include 
any amounts necessary to pay any federal, state, or local income taxes 
or penalties reasonably anticipated to result from the distribution.
    (B) No alternative means available. A distribution is not treated as 
necessary to satisfy an immediate and heavy financial need of an 
employee to the extent the need may be relieved from other resources 
that are reasonably available to the employee. This determination 
generally is to be made on the basis of all the relevant facts and 
circumstances. For purposes of this paragraph (d)(3)(iv), the employee's 
resources are deemed to include those assets of the employee's spouse 
and minor children that are reasonably available to the employee. Thus, 
for example, a vacation home owned by the employee and the employee's

[[Page 312]]

spouse, whether as community property, joint tenants, tenants by the 
entirety, or tenants in common, generally will be deemed a resource of 
the employee. However, property held for the employee's child under an 
irrevocable trust or under the Uniform Gifts to Minors Act (or 
comparable State law) is not treated as a resource of the employee.
    (C) Employer reliance on employee representation. For purposes of 
paragraph (d)(3)(iv)(B) of this section, an immediate and heavy 
financial need generally may be treated as not capable of being relieved 
from other resources that are reasonably available to the employee, if 
the employer relies upon the employee's representation (made in writing 
or such other form as may be prescribed by the Commissioner), unless the 
employer has actual knowledge to the contrary, that the need cannot 
reasonably be relieved--
    (1) Through reimbursement or compensation by insurance or otherwise;
    (2) By liquidation of the employee's assets;
    (3) By cessation of elective contributions or employee contributions 
under the plan;
    (4) By other currently available distributions (including 
distribution of ESOP dividends under section 404(k)) and nontaxable (at 
the time of the loan) loans, under plans maintained by the employer or 
by any other employer; or
    (5) By borrowing from commercial sources on reasonable commercial 
terms in an amount sufficient to satisfy the need.
    (D) Employee need not take counterproductive actions. For purposes 
of this paragraph (d)(3)(iv), a need cannot reasonably be relieved by 
one of the actions described in paragraph (d)(3)(iv)(C) of this section 
if the effect would be to increase the amount of the need. For example, 
the need for funds to purchase a principal residence cannot reasonably 
be relieved by a plan loan if the loan would disqualify the employee 
from obtaining other necessary financing.
    (E) Distribution deemed necessary to satisfy immediate and heavy 
financial need. A distribution is deemed necessary to satisfy an 
immediate and heavy financial need of an employee if each of the 
following requirements are satisfied--
    (1) The employee has obtained all other currently available 
distributions (including distribution of ESOP dividends under section 
404(k), but not hardship distributions) and nontaxable (at the time of 
the loan) loans, under the plan and all other plans maintained by the 
employer; and
    (2) The employee is prohibited, under the terms of the plan or an 
otherwise legally enforceable agreement, from making elective 
contributions and employee contributions to the plan and all other plans 
maintained by the employer for at least 6 months after receipt of the 
hardship distribution.
    (F) Definition of other plans. For purposes of paragraph 
(d)(3)(iv)(C)(4) and (E)(1) of this section, the phrase plans maintained 
by the employer means all qualified and nonqualified plans of deferred 
compensation maintained by the employer, including a cash or deferred 
arrangement that is part of a cafeteria plan within the meaning of 
section 125. However, it does not include the mandatory employee 
contribution portion of a defined benefit plan or a health or welfare 
benefit plan (including one that is part of a cafeteria plan). In 
addition, for purposes of paragraph (d)(3)(iv)(E)(2) of this section, 
the phrase plans maintained by the employer also includes a stock 
option, stock purchase, or similar plan maintained by the employer. See 
Sec. 1.401(k)-6 for the continued treatment of suspended employees as 
eligible employees.
    (v) Commissioner may expand standards. The Commissioner may 
prescribe additional guidance of general applicability, published in the 
Internal Revenue Bulletin (see Sec. 601.601(d)(2) of this chapter), 
expanding the list of deemed immediate and heavy financial needs and 
prescribing additional methods for distributions to be deemed necessary 
to satisfy an immediate and heavy financial need.
    (4) Rules applicable to distributions upon plan termination--(i) No 
alternative defined contribution plan. A distribution may not be made 
under paragraph (d)(1)(iii) of this section if the employer establishes 
or maintains an alternative defined contribution plan. For purposes

[[Page 313]]

of the preceding sentence, the definition of the term ``employer'' 
contained in Sec. 1.401(k)-6 is applied as of the date of plan 
termination, and a plan is an alternative defined contribution plan only 
if it is a defined contribution plan that exists at any time during the 
period beginning on the date of plan termination and ending 12 months 
after distribution of all assets from the terminated plan. However, if 
at all times during the 24-month period beginning 12 months before the 
date of plan termination, fewer than 2% of the employees who were 
eligible under the defined contribution plan that includes the cash or 
deferred arrangement as of the date of plan termination are eligible 
under the other defined contribution plan, the other plan is not an 
alternative defined contribution plan. In addition, a defined 
contribution plan is not treated as an alternative defined contribution 
plan if it is an employee stock ownership plan as defined in section 
4975(e)(7) or 409(a), a simplified employee pension as defined in 
section 408(k), a SIMPLE IRA plan as defined in section 408(p), a plan 
or contract that satisfies the requirements of section 403(b), or a plan 
that is described in section 457(b) or (f).
    (ii) Lump sum requirement for certain distributions. A distribution 
may be made under paragraph (d)(1)(iii) of this section only if it is a 
lump sum distribution. The term lump sum distribution has the meaning 
provided in section 402(e)(4)(D) (without regard to section 
402(e)(4)(D)(i)(I), (II), (III) and (IV)). In addition, a lump sum 
distribution includes a distribution of an annuity contract from a trust 
that is part of a plan described in section 401(a) and which is exempt 
from tax under section 501(a) or an annuity plan described in 403(a).
    (5) Rules applicable to all distributions--(i) Exclusive 
distribution rules. Amounts attributable to elective contributions may 
not be distributed on account of any event not described in this 
paragraph (d), such as completion of a stated period of plan 
participation or the lapse of a fixed number of years. For example, if 
excess deferrals (and income) for an employee's taxable year are not 
distributed within the time prescribed in Sec. 1.402(g)-1(e)(2) or (3), 
the amounts may be distributed only on account of an event described in 
this paragraph (d). Pursuant to section 401(k)(8), the prohibition on 
distributions set forth in this section does not apply to a distribution 
of excess contributions under Sec. 1.401(k)-2(b).
    (ii) Deemed distributions. The cost of life insurance (determined 
under section 72) is not treated as a distribution for purposes of 
section 401(k)(2) and this paragraph (d). The making of a loan is not 
treated as a distribution, even if the loan is secured by the employee's 
accrued benefit attributable to elective contributions or is includible 
in the employee's income under section 72(p). However, the reduction, by 
reason of default on a loan, of an employee's accrued benefit derived 
from elective contributions is treated as a distribution.
    (iii) ESOP dividend distributions. A plan does not fail to satisfy 
the requirements of this paragraph (d) merely by reason of a dividend 
distribution described in section 404(k)(2).
    (iv) Limitations apply after transfer. The limitations of this 
paragraph (d) generally continue to apply to amounts attributable to 
elective contributions (including QNECs and qualified matching 
contributions taken into account for the ADP test under Sec. 1.401(k)-
2(a)(6)) that are transferred to another qualified plan of the same or 
another employer. Thus, the transferee plan will generally fail to 
satisfy the requirements of section 401(a) and this section if 
transferred amounts may be distributed before the times specified in 
this paragraph (d). In addition, a cash or deferred arrangement fails to 
satisfy the limitations of this paragraph (d) if it transfers amounts to 
a plan that does not provide that the transferred amounts may not be 
distributed before the times specified in this paragraph (d). The 
transferor plan does not fail to comply with the preceding sentence if 
it reasonably concludes that the transferee plan provides that the 
transferred amounts may not be distributed before the times specified in 
this paragraph (d). What constitutes a basis for a reasonable conclusion 
is determined under standards comparable to those under the rules 
related to acceptance of rollover distributions. See Sec. 1.401(a)(31)-
1,

[[Page 314]]

A-14. The limitations of this paragraph (d) cease to apply after the 
transfer, however, if the amounts could have been distributed at the 
time of the transfer (other than on account of hardship), and the 
transfer is an elective transfer described in Sec. 1.411(d)-4, Q&A-
3(b)(1). The limitations of this paragraph (d) also do not apply to 
amounts that have been paid in a direct rollover to the plan after being 
distributed by another plan.
    (6) Examples. The following examples illustrate the application of 
this paragraph (d):

    Example 1. Employer M maintains Plan V, a profit-sharing plan that 
includes a cash or deferred arrangement. Elective contributions under 
the arrangement may be withdrawn for any reason after two years 
following the end of the plan year in which the contributions were made. 
Because the plan permits distributions of elective contributions before 
the occurrence of one of the events specified in section 401(k)(2)(B) 
and this paragraph (d), the cash or deferred arrangement is a 
nonqualified cash or deferred arrangement and the elective contributions 
are currently includible in income under section 402.
    Example 2. (i) Employer N maintains Plan W, a profit-sharing plan 
that includes a cash or deferred arrangement. Plan W provides for 
distributions upon a participant's severance from employment, death or 
disability. All employees of Employer N and its wholly owned subsidiary, 
Employer O, are eligible to participate in Plan W. Employer N agrees to 
sell all issued and outstanding shares of Employer O to an unrelated 
entity, Employer T, effective on December 31, 2006. Following the 
transaction, Employer O will be a wholly owned subsidiary of Employer T. 
Additionally, individuals who are employed by Employer O on the 
effective date of the sale continue to be employed by Employer O 
following the sale. Following the transaction, all employees of Employer 
O will cease to participate in Plan W and will become eligible to 
participate in the cash or deferred arrangement maintained by Employer 
T, Plan X. No assets will be transferred from Plan W to Plan X, except 
in the case of a direct rollover within the meaning of section 
401(a)(31).
    (ii) Employer O ceases to be a member of Employer N's controlled 
group as a result of the sale. Therefore, employees of Employer O who 
participated in Plan W will have a severance from employment and are 
eligible to receive a distribution from Plan W.
    Example 3. (i) Employer Q maintains Plan Y, a profit-sharing plan 
that includes a cash or deferred arrangement. Plan Y, the only plan 
maintained by Employer Q, does not provide for loans. However, Plan Y 
provides that elective contributions under the arrangement may be 
distributed to an eligible employee on account of hardship using the 
deemed immediate and heavy financial need provisions of paragraph 
(d)(3)(iii)(B) of this section and provisions regarding distributions 
necessary to satisfy financial need of paragraphs (d)(3)(iv)(A) through 
(D) of this section. Employee A is an eligible employee in Plan Y with 
an account balance of $50,000 attributable to elective contributions 
made by Employee A. The total amount of elective contributions made by 
Employee A, who has not previously received a distribution from Plan Y, 
is $20,000. Employee A requests a $15,000 hardship distribution of his 
elective contributions to pay 6 months of college tuition and room and 
board expenses for his dependent. At the time of the distribution 
request, the sole asset of Employee A (that is reasonably available to 
Employee A within the meaning of paragraph (d)(3)(iv)(B) of this 
section) is a savings account with an available balance of $10,000.
    (ii) A distribution is made on account of hardship only if the 
distribution both is made on account of an immediate and heavy financial 
need of the employee and is necessary to satisfy the financial need. 
Under paragraph (d)(3)(iii)(B) of this section, a distribution for 
payment of up to the next 12 months of post-secondary education and room 
and board expenses for Employee A's dependent is deemed to be on account 
of an immediate and heavy financial need of Employee A.
    (iii) A distribution is treated as necessary to satisfy Employee A's 
immediate and heavy financial need to the extent the need may not be 
relieved from other resources reasonably available to Employee A. Under 
paragraph (d)(3)(iv)(B) of this section, Employee A's $10,000 savings 
account is a resource that is reasonably available to the employee and 
must be taken into account in determining the amount necessary to 
satisfy Employee A's immediate and heavy financial need. Thus, Employee 
A may receive a distribution of only $5,000 of his elective 
contributions on account of this hardship, plus an amount necessary to 
pay any federal, state, or local income taxes or penalties reasonably 
anticipated to result from the distribution.
    Example 4. (i) The facts are the same as in Example 3. Employee B, 
another employee of Employer Q has an account balance of $25,000, 
attributable to Employee B's elective contributions. The total amount of 
elective contributions made by Employee B, who has not previously 
received a distribution from Plan Y, is $15,000. Employee B requests a 
$10,000 distribution of his elective contributions to pay 6 months of 
college tuition and room and board expenses for his child. Employee B 
makes a written representation

[[Page 315]]

(with respect to which Employer Q has no actual knowledge to the 
contrary) that the need cannot reasonably be relieved:
    (A) Through reimbursement or compensation by insurance or otherwise;
    (B) By liquidation of the employee's assets;
    (C) By cessation of elective contributions or employee contributions 
under the plan;
    (D) By other distributions or nontaxable (at the time of the loan) 
loans from plans maintained by the employer or by any other employer; or
    (E) By borrowing from commercial sources on reasonable commercial 
terms in an amount sufficient to satisfy the need.
    (ii) Under paragraph (d)(3)(iii)(B) of this section, a distribution 
for payment of up to the next 12 months of post-secondary education and 
room and board expenses for Employee B's child is deemed to be on 
account of an Employee B's immediate and heavy financial need. In 
addition, because Employer Q can rely on Employee B's written 
representation, the distribution is considered necessary to satisfy 
Employee B's immediate and heavy financial need. Therefore, Employee B 
may receive a $10,000 distribution of his elective contributions on 
account of hardship plus an amount necessary to pay any federal, state, 
or local income taxes or penalties reasonably anticipated to result from 
the distribution.
    Example 5. (i) The facts are the same as in Example 3, except Plan Y 
provides for hardship distributions using the safe harbor rule of 
paragraph (d)(3)(iv)(E) of this section. Accordingly, Plan Y provides 
for a 6 month suspension of an eligible employee's elective 
contributions and employee contributions to the plan after the receipt 
of a hardship distribution by such eligible employee.
    (ii) Under paragraph (d)(3)(iii)(B) of this section, a distribution 
for payment of up to the next 12 months of post-secondary education and 
room and board expenses for Employee A's dependent is deemed to be on 
account of an Employee A's immediate and heavy financial need. In 
addition, because Employee A is not eligible for any other distribution 
or loan from Plan Y and Plan Y suspends Employee A's elective 
contributions and employee contributions following receipt of the 
hardship distribution, the distribution will be deemed necessary to 
satisfy Employee A's immediate and heavy financial need (and Employee A 
is not required to first liquidate his savings account). Therefore, 
Employee A may receive a $15,000 distribution of his elective 
contributions on account of hardship plus an amount necessary to pay any 
federal, state, or local income taxes or penalties reasonably 
anticipated to result from the distribution.
    Example 6. Employer R maintains a pre-ERISA money purchase pension 
plan that includes a cash or deferred arrangement that is not a rural 
cooperative plan. Elective contributions under the arrangement may be 
distributed to an employee on account of hardship. Under paragraph 
(d)(1) of this section, hardship is a permissible distribution event 
only in a profit-sharing, stock bonus or rural cooperative plan. Since 
elective contributions under the arrangement may be distributed before a 
permissible distribution event occurs, the cash or deferred arrangement 
does not satisfy this paragraph (d), and is not a qualified cash or 
deferred arrangement. Moreover, the plan is not a qualified plan because 
a money purchase pension plan may not provide for payment of benefits 
upon hardship. See Sec. 1.401-1(b)(1)(i).

    (e) Additional requirements for qualified cash or deferred 
arrangements--(1) Qualified plan requirement. A cash or deferred 
arrangement satisfies this paragraph (e) only if the plan of which it is 
a part is a profit-sharing, stock bonus, pre-ERISA money purchase or 
rural cooperative plan that otherwise satisfies the requirements of 
section 401(a) (taking into account the cash or deferred arrangement). A 
plan that includes a cash or deferred arrangement may provide for other 
contributions, including employer contributions (other than elective 
contributions), employee contributions, or both. However, except as 
expressly permitted under section 401(m), 410(b)(2)(A)(ii) or 
416(c)(2)(A), elective contributions and matching contributions taken 
into account under Sec. 1.401(k)-2(a) may not be taken into account for 
purposes of determining whether any other contributions under any plan 
(including the plan to which the contributions are made) satisfy the 
requirements of section 401(a).
    (2) Election requirements--(i) Cash must be available. A cash or 
deferred arrangement satisfies this paragraph (e) only if the 
arrangement provides that the amount that each eligible employee may 
defer as an elective contribution is available to the employee in cash. 
Thus, for example, if an eligible employee is provided the option to 
receive a taxable benefit (other than cash) or to have the employer 
contribute on the employee's behalf to a profit-sharing plan an amount 
equal to the value of the taxable benefit, the arrangement is not a 
qualified cash or deferred arrangement. Similarly, if an employee has 
the option to receive a specified amount in cash or to have the employer 
contribute an amount in excess

[[Page 316]]

of the specified cash amount to a profit-sharing plan on the employee's 
behalf, any contribution made by the employer on the employee's behalf 
in excess of the specified cash amount is not treated as made pursuant 
to a qualified cash or deferred arrangement, but would be treated as a 
matching contribution. This cash availability requirement applies even 
if the cash or deferred arrangement is part of a cafeteria plan within 
the meaning of section 125.
    (ii) Frequency of elections. A cash or deferred arrangement 
satisfies this paragraph (e) only if the arrangement provides an 
employee with an effective opportunity to make (or change) a cash or 
deferred election at least once during each plan year. Whether an 
employee has an effective opportunity is determined based on all the 
relevant facts and circumstances, including the adequacy of notice of 
the availability of the election, the period of time during which an 
election may be made, and any other conditions on elections.
    (3) Separate accounting requirement--(i) General rule. A cash or 
deferred arrangement satisfies this paragraph (e) only if the portion of 
an employee's benefit subject to the requirements of paragraphs (c) and 
(d) of this section is determined by an acceptable separate accounting 
between that portion and any other benefits. Separate accounting is not 
acceptable unless contributions and withdrawals are attributed to the 
separate accounts and gains, losses, and other credits or charges are 
separately allocated on a reasonable and consistent basis to the 
accounts subject to the requirements of paragraphs (c) and (d) of this 
section and to other accounts. Subject to section 401(a)(4), forfeitures 
are not required to be allocated to the accounts in which benefits are 
subject to paragraphs (c) and (d) of this section. The separate 
accounting requirement of this paragraph (e)(3)(i) applies at the time 
the elective contribution is contributed to the plan and continues to 
apply until the contribution is distributed under the plan.
    (ii) Satisfaction of separate accounting requirement. The 
requirements of paragraph (e)(3)(i) of this section are treated as 
satisfied if all amounts held under a plan that includes a qualified 
cash or deferred arrangement (and, if applicable, under another plan to 
which QNECs and QMACs are made) are subject to the requirements of 
paragraphs (c) and (d) of this section.
    (4) Limitations on cash or deferred arrangements of state and local 
governments--(i) General rule. A cash or deferred arrangement does not 
satisfy the requirements of this paragraph (e) if the arrangement is 
adopted after May 6, 1986, by a State or local government or political 
subdivision thereof, or any agency or instrumentality thereof (a 
governmental unit). For purposes of this paragraph (e)(4), an employer 
that has made a legally binding commitment to adopt a cash or deferred 
arrangement is treated as having adopted the arrangement on that date.
    (ii) Rural cooperative plans and Indian tribal governments. This 
paragraph (e)(4) does not apply to a rural cooperative plan or to a plan 
of an employer which is an Indian tribal government (as defined in 
section 7701(a)(40)), a subdivision of an Indian tribal government 
(determined in accordance with section 7871(d)), an agency or 
instrumentality of an Indian tribal government or subdivision thereof, 
or a corporation chartered under Federal, State or tribal law which is 
owned in whole or in part by any of the entities in this paragraph 
(e)(4)(ii).
    (iii) Adoption after May 6, 1986. A cash or deferred arrangement is 
treated as adopted after May 6, 1986, with respect to all employees of 
any employer that adopts the arrangement after such date.
    (iv) Adoption before May 7, 1986. If a governmental unit adopted a 
cash or deferred arrangement before May 7, 1986, then any cash or 
deferred arrangement adopted by the unit at any time is treated as 
adopted before that date. If an employer adopted an arrangement prior to 
such date, all employees of the employer may participate in the 
arrangement.
    (5) One-year eligibility requirement. A cash or deferred arrangement 
satisfies this paragraph (e) only if no employee is required to complete 
a period of service with the employer maintaining the plan extending 
beyond the period permitted under section 410(a)(1) (determined without 
regard to section

[[Page 317]]

410(a)(1)(B)(i)) to be eligible to make a cash or deferred election 
under the arrangement.
    (6) Other benefits not contingent upon elective contributions--(i) 
General rule. A cash or deferred arrangement satisfies this paragraph 
(e) only if no other benefit is conditioned (directly or indirectly) 
upon the employee's electing to make or not to make elective 
contributions under the arrangement. The preceding sentence does not 
apply to--
    (A) Any matching contribution (as defined in Sec. 1.401(m)-1(a)(2)) 
made by reason of such an election;
    (B) Any benefit, right or feature (such as a plan loan) that 
requires, or results in, an amount to be withheld from an employee's pay 
(e.g. to pay for the benefit or to repay the loan), to the extent the 
cash or deferred arrangement restricts elective contributions to amounts 
available after such withholding from the employee's pay (after 
deduction of all applicable income and employment taxes);
    (C) Any reduction in the employer's top-heavy contributions under 
section 416(c)(2) because of matching contributions that resulted from 
the elective contributions; or
    (D) Any benefit that is provided at the employee's election under a 
plan described in section 125(d) in lieu of an elective contribution 
under a qualified cash or deferred arrangement.
    (ii) Definition of other benefits. For purposes of this paragraph 
(e)(6), other benefits include, but are not limited to, benefits under a 
defined benefit plan; nonelective contributions under a defined 
contribution plan; the availability, cost, or amount of health benefits; 
vacations or vacation pay; life insurance; dental plans; legal services 
plans; loans (including plan loans); financial planning services; 
subsidized retirement benefits; stock options; property subject to 
section 83; and dependent care assistance. Also, increases in salary, 
bonuses or other cash remuneration (other than the amount that would be 
contributed under the cash or deferred election) are benefits for 
purposes of this paragraph (e)(6). The ability to make after-tax 
employee contributions is a benefit, but that benefit is not contingent 
upon an employee's electing to make or not make elective contributions 
under the arrangement merely because the amount of elective 
contributions reduces dollar-for-dollar the amount of after-tax employee 
contributions that may be made. Additionally, benefits under any other 
plan or arrangement (whether or not qualified) are not contingent upon 
an employee's electing to make or not to make elective contributions 
under a cash or deferred arrangement merely because the elective 
contributions are or are not taken into account as compensation under 
the other plan or arrangement for purposes of determining benefits.
    (iii) Effect of certain statutory limits. Any benefit under an 
excess benefit plan described in section 3(36) of the Employee 
Retirement Income Security Act of 1974 (88 Stat. 829), Public Law 93-
406, that is dependent on the employee's electing to make or not to make 
elective contributions is not treated as contingent. Deferred 
compensation under a nonqualified plan of deferred compensation that is 
dependent on an employee's having made the maximum elective deferrals 
under section 402(g) or the maximum elective contributions permitted 
under the terms of the plan also is not treated as contingent.
    (iv) Nonqualified deferred compensation. Except as otherwise 
provided in paragraph (e)(6)(iii) of this section, participation in a 
nonqualified deferred compensation plan is treated as contingent for 
purposes of this paragraph (e)(6) to the extent that an employee may 
receive additional deferred compensation under the nonqualified plan to 
the extent the employee makes or does not make elective contributions.
    (v) Plan loans and distributions. A loan or distribution of elective 
contributions is not a benefit conditioned on an employee's electing to 
make or not make elective contributions under the arrangement merely 
because the amount of the loan or distribution is based on the amount of 
the employee's account balance.
    (vi) Examples. The following examples illustrate the application of 
this paragraph (e)(6):

    Example 1. Employer T maintains a cash or deferred arrangement for 
all of its employees. Employer T also maintains a nonqualified deferred 
compensation plan for two

[[Page 318]]

highly paid executives, Employees R and C. Under the terms of the 
nonqualified deferred compensation plan, R and C are eligible to 
participate only if they do not make elective contributions under the 
cash or deferred arrangement. Participation in the nonqualified plan is 
a contingent benefit for purposes of this paragraph (e)(6), because R's 
and C's participation is conditioned on their electing not to make 
elective contributions under the cash or deferred arrangement.
    Example 2. Employer T maintains a cash or deferred arrangement for 
all its employees. Employer T also maintains a nonqualified deferred 
compensation plan for two highly paid executives, Employees R and C. 
Under the terms of the arrangements, Employees R and C may defer a 
maximum of 10% of their compensation, and may allocate their deferral 
between the cash or deferred arrangement and the nonqualified deferred 
compensation plan in any way they choose (subject to the overall 10% 
maximum). Because the maximum deferral available under the nonqualified 
deferred compensation plan depends on the elective deferrals made under 
the cash or deferred arrangement, the right to participate in the 
nonqualified plan is a contingent benefit for purposes of this paragraph 
(e)(6).

    (7) Plan provision requirement. A plan that includes a cash or 
deferred arrangement satisfies this paragraph (e) only if it provides 
that the nondiscrimination requirements of section 401(k) will be met. 
Thus, the plan must provide for satisfaction of one of the specific 
alternatives described in paragraph (b)(1)(ii) of this section and, if 
with respect to that alternative there are optional choices, which of 
the optional choices will apply. For example, a plan that uses the ADP 
test of section 401(k)(3), as described in paragraph (b)(1)(ii)(A) of 
this section, must specify whether it is using the current year testing 
method or prior year testing method. Additionally, a plan that uses the 
prior year testing method must specify whether the ADP for eligible 
NHCEs for the first plan year is 3% or the ADP for the eligible NHCEs 
for the first plan year. Similarly, a plan that uses the safe harbor 
method of section 401(k)(12), as described in paragraph (b)(1)(ii)(B) of 
this section, must specify whether the safe harbor contribution will be 
the nonelective safe harbor contribution or the matching safe harbor 
contribution and is not permitted to provide that ADP testing will be 
used if the requirements for the safe harbor are not satisfied. For 
purposes of this paragraph (e)(7), a plan may incorporate by reference 
the provisions of section 401(k)(3) and Sec. 1.401(k)-2 if that is the 
nondiscrimination test being applied. The Commissioner may, in guidance 
of general applicability, published in the Internal Revenue Bulletin 
(see Sec. 601.601(d)(2) of this chapter), specify the options that will 
apply under the plan if the nondiscrimination test is incorporated by 
reference in accordance with the preceding sentence.
    (f) Special rules for designated Roth contributions--(1) In general. 
The term designated Roth contribution means an elective contribution 
under a qualified cash or deferred arrangement that, to the extent 
permitted under the plan, is--
    (i) Designated irrevocably by the employee at the time of the cash 
or deferred election as a designated Roth contribution that is being 
made in lieu of all or a portion of the pre-tax elective contributions 
the employee is otherwise eligible to make under the plan;
    (ii) Treated by the employer as includible in the employee's gross 
income at the time the employee would have received the amount in cash 
if the employee had not made the cash or deferred election (e.g., by 
treating the contributions as wages subject to applicable withholding 
requirements); and
    (iii) Maintained by the plan in a separate account (in accordance 
with paragraph (f)(2) of this section).
    (2) Separate accounting required. Under the separate accounting 
requirement of this paragraph (f)(2), contributions and withdrawals of 
designated Roth contributions must be credited and debited to a 
designated Roth account maintained for the employee and the plan must 
maintain a record of the employee's investment in the contract (i.e., 
designated Roth contributions that have not been distributed) with 
respect to the employee's designated Roth account. In addition, gains, 
losses, and other credits or charges must be separately allocated on a 
reasonable and consistent basis to the designated Roth account and other 
accounts under the plan. However, forfeitures may not be allocated to 
the designated Roth account and no contributions other than

[[Page 319]]

designated Roth contributions and rollover contributions described in 
section 402A(c)(3)(B) may be allocated to such account. The separate 
accounting requirement applies at the time the designated Roth 
contribution is contributed to the plan and must continue to apply until 
the designated Roth account is completely distributed.
    (3) Designated Roth contributions must satisfy rules applicable to 
elective contributions--(i) In general. A designated Roth contribution 
must satisfy the requirements applicable to elective contributions made 
under a qualified cash or deferred arrangement. Thus, for example, a 
designated Roth contribution must satisfy the requirements of paragraphs 
(c) and (d) of this section and is treated as an employer contribution 
for purposes of sections 401(a), 401(k), 402, 404, 409, 411, 412, 415, 
416 and 417. In addition, the designated Roth contributions are treated 
as elective contributions for purposes of the ADP test. Similarly, the 
designated Roth account under the plan is subject to the rules of 
section 401(a)(9)(A) and (B) in the same manner as an account that 
contains pre-tax elective contributions.
    (ii) Special rules for direct rollovers. A direct rollover from a 
designated Roth account under a qualified cash or deferred arrangement 
may only be made to another designated Roth account under an applicable 
retirement plan described in section 402A(e)(1) or to a Roth IRA 
described in section 408A, and only to the extent the rollover is 
permitted under the rules of section 402(c). Moreover, a plan is 
permitted to treat the balance of the participant's designated Roth 
account and the participant's other accounts under the plan as accounts 
held under two separate plans (within the meaning of section 414(l)) for 
purposes of applying the special rule in A-11 of Sec. 1.401(a)(31)-1 
(under which a plan will satisfy section 401(a)(31) even though the plan 
administrator does not permit any distributee to elect a direct rollover 
with respect to eligible rollover distributions during a year that are 
reasonably expected to total less than $200).
    (4) Rules regarding designated Roth contribution elections--(i) 
Frequency of elections. The rules under paragraph (e)(2)(ii) of this 
section regarding frequency of elections apply in the same manner to 
both pre-tax elective contributions and designated Roth contributions. 
Thus, an employee must have an effective opportunity to make (or change) 
an election to make designated Roth contributions at least once during 
each plan year.
    (ii) Default elections--(A) In the case of a plan that provides for 
both pre-tax elective contributions and designated Roth contributions 
and in which, under paragraph (a)(3)(ii) of this section, the default in 
the absence of an affirmative election is to make a contribution under 
the cash or deferred arrangement, the plan terms must provide the extent 
to which the default contributions are pre-tax elective contributions 
and the extent to which the default contributions are designated Roth 
contributions.
    (B) If the default contributions under the plan are designated Roth 
contributions, then an employee who has not made an affirmative election 
is deemed to have irrevocably designated the contributions (in 
accordance with section 402A(c)(1)(B)) as designated Roth contributions.
    (5) Effective date--(i) In general. Section 402A is effective for 
taxable years beginning after December 31, 2005.
    (ii) Sunset provisions. The rules set forth in this paragraph (f) do 
not address the application of section 901 of the Economic Growth and 
Tax Relief Reconciliation Act of 2001 (Public Law 107-16; 115 Stat. 38) 
(under which the amendments made by that Act do not apply to taxable, 
plan, or limitation years beginning after December 31, 2010).
    (g) Effective dates--(1) General rule. Except as otherwise provided 
in this paragraph (g), this section and Sec. Sec. 1.401(k)-2 through 
1.401(k)-6 apply to plan years that begin on or after January 1, 2006.
    (2) Early implementation permitted. A plan is permitted to apply the 
rules of this section and Sec. Sec. 1.401(k)-2 through 1.401(k)-6 to 
any plan year that ends after December 29, 2004, provided the plan 
applies all the rules of this section and Sec. Sec. 1.401(k)-2 through 
1.401(k)-6 and all the rules of Sec. Sec. 1.401(m)-1 through 1.401(m)-
5, to the extent applicable, for

[[Page 320]]

that plan year and all subsequent plan years.
    (3) Collectively bargained plans. In the case of a plan maintained 
pursuant to one or more collective bargaining agreements between 
employee representatives and one or more employers in effect on the date 
described in paragraph (g)(1) of this section, the provisions of this 
section and Sec. Sec. 1.401(k)-2 through 1.401(k)-6 apply to the later 
of the first plan year beginning after the termination of the last such 
agreement or the first plan year described in paragraph (g)(1) of this 
section.
    (4) Applicability of prior regulations. For any plan year before a 
plan applies this section and Sec. Sec. 1.401(k)-2 through 1.401(k)-6 
(either the first plan year beginning on or after January 1, 2006, or 
such earlier year, as provided in paragraph (g)(2) of this section), 
Sec. 1.401(k)-1 (as it appeared in the April 1, 2004 edition of 26 CFR 
part 1) applies to the plan to the extent that section, as it so 
appears, reflects the statutory provisions of section 401(k) as in 
effect for the relevant year.

[T.D. 9169, 69 FR 78154, Dec. 29, 2004, as amended by T.D. 9237, 71 FR 9 
Jan. 3, 2006]