Three Year Coverage Rule

The 3 year coverage rule applies to the coverage requirements under 410(b). Under 410(b), a plan must benefit at least 70% as much for non-highly compensated employees as for highly compensated employees. You are permitted to rely on prior year testing if there are no significant changes. So, if you pass the test for 2003, and there are no significant changes, you would not have to perform this test for 2004 and 2005, you would rely on the 2003 test and the fact that the employer is in the same situation as in 2003. In 2006, the test would have to be done to pass these requirements. The 410(b) test is done on schedule T of Form 5500. If you rely on this three year cycle, you are exempt from filing Schedule T, and you indicate on the 5500 which year you passed the test. Below is an excerpt from Revenue Procedure 93-42.

An employer may rely for the two succeeding plan years on the tests substantiating that a plan complies with the nondiscrimination requirements for a plan year if the employer reasonably concludes that there are no significant changes subsequent to the test (e.g., significant changes in plan provisions, the employer's workforce, or compensation practices). For this purpose, whether a change is significant depends upon the relative margin by which the plan has satisfied the nondiscrimination requirements in the most recent year in which the plan was tested and the likelihood that the change would eliminate that margin. If there is a significant change in one plan provision, the effect of which can be isolated from the effect of other provisions, the employer may continue to rely on the prior test during the interim two years, provided that the employer can demonstrate that the effect of the amended plan provision is nondiscriminatory.

Employers using the three-year testing cycle for purposes of substantiating compliance generally must treat the year in which the final regulations under sections 401(a)(4) and 410(b) of the Code become effective with regard to the plan as a year of significant change requiring actual testing. However, if a plan first complies with these regulations in a year prior to their effective date, then the employer may treat that year, rather than the year in which the regulations are first effective, as a year of significant change for purposes of beginning the three-year testing cycle.

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