CODA (Cash or Deferred Arrangement)
The IRS (Section 1.401(k)–1(a)(2)) defines a cash or deferred arrangement (CODA) as 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). Contributions that are made pursuant to a cash or deferred election under a qualified CODA are commonly
referred to as elective contributions.
In simple terms, a qualified cash or deferred arrangement (CODA) is a qualified profit-sharing, stock bonus or money purchase plan that is commonly referred to as a 401k plan. A CODA allows an employee to choose between receiving cash or electing to have the cash placed in a qualified pension plan thereby deferring current recognition of income
In order for a CODA to be a qualified CODA, it must satisfy a number of requirements. For example, contributions under the CODA must satisfy either the nondiscrimination test set forth in section 401(k)(3), called the actual deferral percentage (ADP) test, or one of the design-based alternatives in section 401(k)(11), 401(k)(12), or 401(k)(13). Under the ADP test, the average percentage of compensation
deferred for eligible highly compensated employees (HCEs) is compared to the average percentage of compensation deferred for eligible non-highly compensated employees (NHCEs), and if certain deferral percentage limits are exceeded with respect to HCEs, corrective action must be taken.
According to the Investment Company Institute, the CODA concept originated with banks in the 1950's:
In the 1950s, a number of companies, particularly banks, added to their profit-sharing plans a new feature that came to be called a “cash or deferred arrangement,” or CODA. Each year, when employees were awarded profit-sharing bonuses, they were given the option to deposit some or all of the bonus into the plan instead of receiving the bonus in cash. Even though the employee had the right to receive the bonus in cash, which normally would trigger immediate income tax, a CODA sought to treat any amount the employee contributed to the plan as if it were an employer contribution, and therefore tax-deferred. In 1956, the IRS issued the first in a series of rulings allowing profit-sharing plans to include a CODA and still be eligible for the favorable tax treatment accorded employer contributions. The IRS reaffirmed its favorable view of CODA's in 1963 after a court case that same year suggested that immediate taxation of employee contributions might apply.
