[Code of Federal Regulations]
[Title 26, Volume 5]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.401-3]

[Page 14-19]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.401-3  Requirements as to coverage.

    (a)(1) In order to insure that stock bonus, pension, and profit-
sharing plans are utilized for the welfare of employees in general, and 
to prevent the trust device from being used for the principal benefit of 
shareholders, officers, persons whose principal duties consist in 
supervising the work of other employees, or highly paid employees, or as 
a means of tax avoidance, a trust will not be qualified unless it is 
part of a plan which satisfies the coverage requirements of section 
401(a)(3). However, if the plan covers any individual who is an owner-
employee, as defined in section 401(c)(3), the requirements of section 
401(a)(3) and this section are not applicable to such plan, but the plan 
must satisfy

[[Page 15]]

the requirements of section 401(d) (see Sec. 1.401-12).
    (2) The percentage requirements in section 401(a)(3)(A) refer to a 
percentage of all the active employees, including employees temporarily 
on leave, such as those in the Armed Forces of the United States, if 
such employees are eligible under the plan.
    (3) The application of section 401(a)(3)(A) may be illustrated by 
the following example:

    Example. A corporation adopts a plan at a time when it has 1,000 
employees. The plan provides that all full-time employees who have been 
employed for a period of two years and have reached the age of 30 shall 
be eligible to participate. The plan also requires participating 
employees to contribute 3 percent of their monthly pay. At the time the 
plan is made effective 100 of the 1,000 employees had not been employed 
for a period of two years. Fifty of the employees were seasonal 
employees whose customary employment did not exceed five months in any 
calendar year. Twenty-five of the employees were part-time employees 
whose customary employment did not exceed 20 hours in any one week. One 
hundred and fifty of the full-time employees who had been employed for 
two years or more had not yet reached age 30. The requirements of 
section 401(a)(3)(A) will be met if 540 employees are covered by the 
plan, as shown by the following computation:

(i) Total employees with respect to whom the percentage              825
 requirements are applicable (1,000 minus 175 (100 plus 50
 plus 25) )..................................................
(ii) Employees not eligible to participate because of age            150
 requirements................................................
                                                              ----------
(iii) Total employees eligible to participate................        675
(iv) Percentage of employees in item (i) eligible to                81+%
 participate.................................................
(v) Minimum number of participating employees to qualify the         540
 plan (80 percent of 675)....................................



If only 70 percent, or 578, of the 825 employees satisfied the age and 
service requirements, then 462 (80 percent of 578) participating 
employees would satisfy the percentage requirements.

    (b) If a plan fails to qualify under the percentage requirements of 
section 401(a)(3)(A), it may still qualify under section 401(a)(3)(B) 
provided always that (as required by section 401(a) (3) and (4)) the 
plan's eligibility conditions, benefits, and contributions do not 
discriminate in favor of employees who are officers, shareholders, 
persons whose principal duties consist in supervising the work of other 
employees, or the highly compensated employees.
    (c) Since, for the purpose of section 401, a profit-sharing plan is 
a plan which provides for distributing the funds accumulated under the 
plan after a fixed number of years, the attainment of a stated age, or 
upon the prior occurrence of some event such as illness, disability, 
retirement, death, layoff, or severance of employment, employees who 
receive the amounts allocated to their accounts before the expiration of 
such a period of time or the occurrence of such a contingency shall not 
be considered covered by a profit-sharing plan in determining whether 
the plan meets the coverage requirements of section 401(a)(3) (A) and 
(B). Thus, in case a plan permits employees to receive immediately the 
amounts allocated to their accounts, or to have such amounts paid to a 
profit- sharing plan for them, the employees who receive the shares 
immediately shall not, for the purpose of section 401, be considered 
covered by a profit-sharing plan.
    (d) Section 401(a)(5) sets out certain classifications that will not 
in themselves be considered discriminatory. However, those so designated 
are not intended to be exclusive. Thus, plans may qualify under section 
401(a)(3)(B) even though coverage thereunder is limited to employees who 
have either reached a designated age or have been employed for a 
designated number of years, or who are employed in certain designated 
departments or are in other classifications, provided the effect of 
covering only such employees does not discriminate in favor of officers, 
shareholders, employees whose principal duties consist in supervising 
the work of other employees, or highly compensated employees. For 
example, if there are 1,000 employees, and the plan is written for only 
salaried employees, and consequently only 500 employees are covered, 
that fact alone will not justify the conclusion that the plan does not 
meet the coverage requirements of section 401(a)(3)(B). Conversely, if a 
contributory plan is offered to all of the employees but the 
contributions required of the employee participants are so burdensome as 
to make the plan acceptable only to the

[[Page 16]]

highly paid employees, the classification will be considered 
discriminatory in favor of such highly paid employees.
    (e)(1) Section 401(a)(5) contains a provision to the effect that a 
classification shall not be considered discriminatory within the meaning 
of section 401(a)(3)(B) merely because all employees whose entire annual 
remuneration constitutes ``wages'' under section 3121(a)(1) (for 
purposes of the Federal Insurance Contributions Act, chapter 21 of the 
Code) are excluded from the plan. A reference to section 3121(a)(1) for 
years after 1954 shall be deemed a reference to section 1426(a)(1) of 
the Internal Revenue Code of 1939 for years before 1955. This provision, 
in conjunction with section 401(a)(3)(B), is intended to permit the 
qualification of plans which supplement the old-age, survivors, and 
disability insurance benefits under the Social Security Act (42 U.S.C. 
ch. 7). Thus, a classification which excludes all employees whose entire 
remuneration constitutes ``wages'' under section 3121(a)(1), will not be 
considered discriminatory merely because of such exclusion. Similarly, a 
plan which includes all employees will not be considered discriminatory 
solely because the contributions or benefits based on that part of their 
remuneration which is excluded from wages under section 3121(a)(1) 
differ from the contributions or benefits based on that part of their 
remuneration which is not so excluded. However, in making his 
determination with respect to discrimination in classification under 
section 401(a)(3)(B), the Commissioner will consider whether the total 
benefits resulting to each employee under the plan and under the Social 
Security Act, or under the Social Security Act only, establish an 
integrated and correlated retirement system satisfying the tests of 
section 401(a). If, therefore, a classification of employees under a 
plan results in relatively or proportionately greater benefits for 
employees earning above any specified salary amount or rate than for 
those below any such salary amount or rate, it may be found to be 
discriminatory within the meaning of section 401(a)(3)(B). If, however, 
the relative or proportionate differences in benefits which result from 
such classification are approximately offset by the old-age, survivors, 
and disability insurance benefits which are provided by the Social 
Security Act and which are not attributable to employee contributions 
under the Federal Insurance Contributions Act, the plan will be 
considered to be properly integrated with the Social Security Act and 
will, therefore, not be considered discriminatory.
    (2)(i) For purposes of determining whether a plan is properly 
integrated with the Social Security Act, the amount of old-age, 
survivors, and disability insurance benefits which may be considered as 
attributable to employer contributions under the Federal Insurance 
Contributions Act is computed on the basis of the following:
    (A) The rate at which the maximum monthly old-age insurance benefit 
is provided under the Social Security Act is considered to be the 
average of (1) the rate at which the maximum benefit currently payable 
under the Act (i.e., in 1971) is provided to an employee retiring at age 
65, and (2) the rate at which the maximum benefit ultimately payable 
under the Act (i.e., in 2010) is provided to an employee retiring at age 
65. The resulting figure is 43 percent of the average monthly wage on 
which such benefit is computed.
    (B) The total old-age, survivors, and disability insurance benefits 
with respect to an employee is considered to be 162 percent of the 
employee's old-age insurance benefits. The resulting figure is 70 
percent of the average monthly wage on which it is computed.
    (C) In view of the fact that social security benefits are funded 
through equal contributions by the employer and employee, 50 percent of 
such benefits is considered attributable to employer contributions. The 
resulting figure is 35 percent of the average monthly wage on which the 
benefit is computed.

Under these assumptions, the maximum old-age, survivors, and disability 
insurance benefits which may be attributed to employer contributions 
under the Federal Insurance Contributions Act is an amount equal to 35 
percent of the earnings on which they are computed. These computations 
take into account all amendments to the

[[Page 17]]

Society Security Act through the Social Security Amendments of 1971 (85 
Stat. 6). It is recognized, however, that subsequent amendments to this 
Act may increase the percentages described in (A) or (B) of this 
subdivision (i), or both. If this occurs, the method used in this 
subparagraph for determining the integration formula may result in a 
figure under (C) of this subdivision (i) which is greater than 35 
percent and a plan could be amended to adopt such greater figure in its 
benefit formula. In order to minimize future plan amendments of this 
nature, an employer may anticipate future changes in the Social Security 
Act by immediately utilizing such a higher figure, but not in excess of 
37\1/2\ percent, in developing its benefit formula.
    (ii) Under the rules provided in this subparagraph, a classification 
of employees under a noncontributory pension or annuity plan which 
limits coverage to employees whose compensation exceeds the applicable 
integration level under the plan will not be considered discriminatory 
within the meaning of section 401(a)(3)(B), where:
    (A) The integration level applicable to an employee is his covered 
compensation, or is (1) in the case of an active employee, a stated 
dollar amount uniformly applicable to all active employees which is not 
greater than the covered compensation of any active employee, and (2) in 
the case of a retired employee an amount which is not greater than his 
covered compensation. (For rules relating to determination of an 
employee's covered compensation, see subdivision (iv) of this 
subparagraph.)
    (B) The rate at which normal annual retirement benefits are provided 
for any employee with respect to his average annual compensation in 
excess of the plan's integration level applicable to him does not exceed 
37\1/2\ percent.
    (C) Average annual compensation is defined to mean the average 
annual compensation over the highest 5 consecutive years.
    (D) There are no benefits payable in case of death before 
retirement.
    (E) The normal form of retirement benefits is a straight life 
annuity, and if there are optional forms, the benefit payments under 
each optional form are actuarially equivalent to benefit payments under 
the normal form.
    (F) In the case of any employee who reaches normal retirement age 
before completion of 15 years of service with the employer, the rate at 
which normal annual retirement benefits are provided for him with 
respect to his average annual compensation in excess of the plan's 
integration level applicable to him does not exceed 2\1/2\ percent for 
each year of service.
    (G) Normal retirement age is not lower than age 65.
    (H) Benefits payable in case of retirement or any other severance of 
employment before normal retirement age cannot exceed the actuarial 
equivalent of the maximum normal retirement benefits, which might be 
provided in accordance with (A) through (G) of this subdivision (ii), 
multiplied by a fraction, the numerator of which is the actual number of 
years of service of the employee at retirement or severance, and the 
denominator of which is the total number of years of service he would 
have had if he had remained in service until normal retirement age. A 
special disabled life mortality table shall not be used in determining 
the actuarial equivalent in the case of severance due to disability.
    (iii) (A) If a plan was properly integrated with old-age and 
survivors insurance benefits on July 5, 1968 (hereinafter referred to as 
an ``existing plan''), then, notwithstanding the fact that such plan 
does not satisfy the requirements of subdivision (ii) of this 
subparagraph, it will continue to be considered properly integrated with 
such benefits until January 1, 1972. Such plan will be considered 
properly integrated after December 31, 1971, so long as the benefits 
provided under the plan for each employee equal the sum of--
    (1) The benefits to which he would be entitled under a plan which, 
on July 5, 1968, would have been considered properly integrated with 
old-age and survivors insurance benefits, and under which benefits are 
provided at the same (or a lesser) rate with respect to the same portion 
of compensation with respect to which benefits are provided under the 
existing plan, multiplied by the percentage of his total service with

[[Page 18]]

the employer performed before a specified date not later than January 1, 
1972; and
    (2) The benefits to which he would be entitled under a plan 
satisfying the requirements of subdivision (ii) of this subparagraph, 
multiplied by the percentage of his total service with the employer 
performed on and after such specified date.
    (B) A plan which, on July 5, 1968, was properly integrated with old-
age and survivors insurance benefits will not be considered not to be 
properly integrated with such benefits thereafter merely because such 
plan provides a minimum benefit for each employee (other than an 
employee who owns, directly or indirectly, stock possessing more than 10 
percent of the total combined voting power or value of all classes of 
stock of the employer corporation) equal to the benefit to which he 
would be entitled under the plan as in effect on July 5, 1968, if he 
continued to earn annually until retirement the same amount of 
compensation as he earned in 1967.
    (C) If a plan was properly integrated with old-age and survivors 
insurance benefits on May 17, 1971, notwithstanding the fact that such 
plan does not satisfy the requirements of subdivision (ii) of this 
subparagraph, it will continue to be considered properly integrated with 
such benefits until January 1, 1972.
    (iv) For purposes of this subparagraph, an employee's covered 
compensation is the amount of compensation with respect to which old-age 
insurance benefits would be provided for him under the Social Security 
Act (as in effect at any uniformly applicable date occurring before the 
employee's separation from the service) if for each year until he 
attains age 65 his annual compensation is at least equal to the maximum 
amount of earnings subject to tax in each such year under the Federal 
Insurance Contributions Act. A plan may provide that an employee's 
covered compensation is the amount determined under the preceding 
sentence rounded to the nearest whole multiple of a stated dollar amount 
which does not exceed $600.
    (v) In the case of an integrated plan providing benefits different 
from those described in subdivision (ii) or (iii) (whichever is 
applicable) of this subparagraph, or providing benefits related to years 
of service, or providing benefits purchasable by stated employer 
contributions, or under the terms of which the employees contribute, or 
providing a combination of any of the foregoing variations, the plan 
will be considered to be properly integrated only if, as determined by 
the Commissioner, the benefits provided thereunder by employer 
contributions cannot exceed in value the benefits described in 
subdivision (ii) or (iii) (whichever is applicable) of this 
subparagraph. Similar principles will govern in determining whether a 
plan is properly integrated if participation therein is limited to 
employees earning in excess of amounts other than those specified in 
subdivision (iv) of this subparagraph, or if it bases benefits or 
contributions on compensation in excess of such amounts, or if it 
provides for an offset of benefits otherwise payable under the plan on 
account of old-age, survivors, and disability insurance benefits. 
Similar principles will govern in determining whether a profit-sharing 
or stock bonus plan is properly integrated with the Social Security Act.
    (3) A plan supplementing the Social Security Act and excluding all 
employees whose entire annual remuneration constitutes ``wages'' under 
section 3121(a)(1) will not, however, be deemed discriminatory merely 
because, for administrative convenience, it provides a reasonable 
minimum benefit not to exceed $20 a month.
    (4) Similar considerations, to the extent applicable in any case, 
will govern classifications under a plan supplementing the benefits 
provided by other Federal or State laws. See section 401(a)(5).
    (5) If a plan provides contributions or benefits for a self-employed 
individual, the rules relating to the integration of such a plan with 
the contributions or benefits under the Social Security Act are set 
forth in paragraph (c) of Sec. 1.401-11 and paragraph (h) of Sec. 
1.401-12.
    (6) This paragraph (e) does not apply to plan years beginning on or 
after January 1, 1989.
    (f) An employer may designate several trusts or a trust or trusts 
and an

[[Page 19]]

annuity plan or plans as constituting one plan which is intended to 
qualify under section 401(a)(3), in which case all of such trusts and 
plans taken as a whole may meet the requirements of such section. The 
fact that such combination of trusts and plans fails to qualify as one 
plan does not prevent such of the trusts and plans as qualify from 
meeting the requirements of section 401(a).
    (g) It is provided in section 401(a)(6) that a plan will satisfy the 
requirements of section 401(a)(3), if on at least one day in each 
quarter of the taxable year of the plan it satisfies such requirements. 
This makes it possible for a new plan requiring contributions from 
employees to qualify if by the end of the quarter-year in which the plan 
is adopted it secures sufficient contributing participants to meet the 
requirements of section 401(a)(3). It also affords a period of time in 
which new participants may be secured to replace former participants, so 
as to meet the requirements of either subparagraph (A) or (B) of section 
401(a)(3).

[T.D. 6500, 25 FR 11672, Nov. 26, 1960, as amended by T.D. 6675, 28 FR 
10119, Sept. 17, 1963; T.D. 6982, 33 FR 16499, Nov. 13, 1968; T.D. 7134, 
36 FR 13592, July 22, 1971; 36 FR 13990, July 29, 1971; T.D. 8359, 56 FR 
47614, Sept. 19, 1991]