New hire rollovers don't trigger immediate coverage testing requirement.

In general, employees can be excluded from entering a retirement plan until they have attained age 21 and completed one year of service. Until recently, it was unclear whether plans that waived the eligibility requirements solely for rollover contributions by newly hired employees were forced to take such employees into account when conducting coverage and nondiscrimination tests under Sec. 410(b). The concern was that the inclusion of these employees would create an added challenge in satisfying these testing requirements, because the employees would often be nonhighly compensated and unable to make deferrals under the terms of the plan until the service requirement was met.

In Rev. Rul. 96-48 the IRS ruled that for qualified plan coverage and nondiscrimination testing purposes, a Sec. 401 (k) plan may exclude employees who are allowed to make ronover contributions to the plans trust but have not yet satisfied minimum age and service requirements for participation in a plan year. This ruling makes clear that Sec. 401(k) plans can allow newly hired employees to roll over assets into the plan immediately, rather than waiting until the employee has satisfied the plans age and service requirements. Allowing new hires to make immediate rollovers without the burden of including these employees for coverage and nondiscrimination testing purposes @until they meet the plan's age and service requirements) may be helpful in recruiting and should enhance the portability of defined contribution plan assets for employees who change jobs.

Coverage Testing

A qualified plan must generally cover a certain percentage of nonhighly compensated employees to satisfy minimum coverage requirement under Sec. 410(b). Rev. Rul. 96-48 states that a Sec. 40(k) plan providing elective contributions, employee and matching contributions and nonelective contributions is treated as three separate plans for coverage testing purposes. Each of these plans must independently satisfy the coverage tests. According to the Service, employees who make (or are eligible to make) rollover contributions and who have not met the plans service requirement are not treated as benefiting under any of the three portions of the plan, and may thus be excluded when applying the coverage tests.

This treatment applies only to rollover contributions. If a newly hired employee is allowed to make elective contributions or receive matching contributions, the employee would be includible for purposes of coverage testing (and nondiscrimination testing). However, special rules permit such employees to be tested separately (for both coverage and nondiscrimination) from employees who have met age and service requirements. These rules were liberalized by Section 1459 of the recently enacted Small Business job Protection Act of 1996, which added a new alternative nondiscrimination test effective for Sec. 401 (k) plans allow early participation.

Nondiscrimination Testing

Sec. 40 (a)(4) prohibits a qualified plan from discriminating in favor of highly compensated employees with respect to contributions or benefits under the plan and with respect to the availability of plan benefits, rights or features. Rev. Rul. 96-48 states that newly hired employees eligible to make rollover contributions but not eligible to make salary deferral contributions or receive matching contributions may be excluded when applying the special nondiscrimination tests that measure contributions and benefits provided under a Sec. 401(k) plan. The ruling further provides that the right to make a rollover contribution is a benefit, right or feature of the plan, and must be offered on a uniform basis to be considered nondiscriminatory. The ruling also sets forth a special safe harbor rule for determining whether the right to make a rollover contribution is offered on a uniform basis.