Plans Using Different Testing Methods for the ADP and ACP Test

The Plan may use the current year testing method or prior year testing method for the ADP test for a Plan Year without regard to whether the current year testing method or prior year testing method is used for the ACP test for that Plan Year. However, if different testing methods are used, then the Plan cannot use:

• The recharacterization method of Regulation Section 1.401(k)-2(b)(3) to correct excess contributions for a Plan Year;
• The rules of Regulation Section 1.401(m)-2(a)(6)(ii) to take Elective Contributions into account under the ACP test; or
• The rules of Regulation Section 1.401(k)-2(a)(6)(v) to take Qualified Matching Contributions into account under the ADP test.

Distribution of Income Attributable to Excess Contributions

The final regulations provide that income on excess contributions must include the gap period income. However, for administrative convenience, the amount of income can be determined up to 7 days before the date of distribution.

Hardship Distributions

The hardship distribution rules reflect the change made by EGTRRA to shorten from 12 to 6 months the required contribution suspension period following a safe harbor hardship distribution, and eliminate the deferral limitation that had applied in the year after the suspension period. In addition, the regulations clarify that a plan may apply the safe harbor conditions to satisfy either requirement of the hardship distribution (i.e., that the distribution is because of an immediate and heavy financial need, or that the distribution is necessary to satisfy the need), but it is not necessary to apply the safe harbor conditions for both requirements. Also, a hardship distribution may only be made to the extent the hardship cannot be relieved by other sources, even if the other sources cannot relieve the entire hardship (except that a commercial loan must only be used if it will relieve the entire hardship).

Hardship Distribution Safe Harbor

The final regulations expand the list of circumstances that satisfy the safe harbor for immediate and heavy financial need to include:

• payments for burial or funeral expenses for the employee's deceased parent, spouse, children or other dependents; and
• expenses for the repair of damage to the employee’s principal residence that qualify for the casualty loss deduction under the Internal Revenue Code.

Automatic Enrollment

The final regulation permits a plan deferral to be made unless the employee elects to receive cash (a “negative” election). The plan may specify any contribution rate. The IRS intends to issue separate guidance addressing employee notice standards. A negative deferral election is not considered a participant investment election for purposes of ERISA Section 404(c), so the plan fiduciary is responsible for the investment of the contribution until the employee makes an affirmative investment direction.

Prefunding Contributions

The final regulations provide that an elective contribution can only be made after the employee’s deferral election is made, and after the employee performs the services for which the contribution is made or, if earlier, the date the compensation would have been paid (subject to an exception for bona fide administrative considerations). Any prefunding is treated as an employer profit sharing contribution and cannot be used to offset future salary deferrals. Thus, employers are no longer able to accelerate deductions under Notice 2002-48.