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Understanding 401(k) Nondiscrimination Testing

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What is 401(k) nondiscrimination testing?

401(k) nondiscrimination testing, also known as nondiscrimination testing, is an annual process required by the IRS to help ensure that 401(k) plans benefit all employees fairly and do not disproportionately favor highly compensated employees (HCEs). These tests help maintain equitable access to tax-advantaged retirement savings.

What are the key nondiscrimination tests?

  • Actual Deferral Percentage (ADP) Test: Compares the average salary deferral rates of HCEs to those of non-highly compensated employees (NHCEs) to identify any disparity between the two types of participants. .
  • Actual Contribution Percentage (ACP) Test: Evaluates employer matching contributions and after-tax employee contributions for HCE v. NHCE to verify nondiscriminatory benefit distribution.
  • Top-Heavy Test: While not technically a nondiscrimination test, ERISA § 416 determines if key employees (e.g., business owners,executives and others who meet certain IRS defined criteria) hold more than 60% of the plan’s assets. If so, employers may need to make minimum contributions to NHCEs.

What happens if a plan fails nondiscrimination testing?

If a 401(k) plan fails a nondiscrimination test, corrective actions are required to maintain the plan’s qualified status. These Year-end Actions are found in the Plan Sponsor Dashboard for the Plan Sponsor to act on. Common corrections include:

  • Refunding excess contributions: Distributing excess deferrals or contributions made by participants or the plan  back to them.
  • Making Qualified Nonelective Contributions (QNECs) or Qualified Matching Contributions (QMACs): Providing additional fully vested contributions to NHCEs to bring the plan into compliance.

Failure to correct compliance issues in a timely manner can result in penalties or, in severe cases, disqualification of the 401(k) plan.

How does Betterment assist with nondiscrimination testing?

Betterment helps plan sponsors navigate nondiscrimination testing and maintain regulatory compliance. Our process includes:

  1. Data collection: Plan sponsors complete required questionnaires in the Plan Sponsor Dashboard, typically in early January.
  2. Testing execution: We conduct ADP, ACP, and Top-Heavy tests to assess the plan’s compliance status. We also test to ensure that no one contributed beyond the limit based on the contributions recorded in the Betterment plan. However, we do not have visibility into contributions made at other recordkeepers.
  3. Correction guidance: If a test is failed, we calculate the necessary corrections and create a year-end action task for the Plan Sponsor to execute.  .
  4. Timely reporting: Testing results and required corrections are shared by mid-March for traditional plans and by May 31 for Safe Harbor plans. Betterment offers a Hassle-Free Compliance Guarantee. If a qualifying 401(k) plan's prior-year audit package isn't provided by May 31, the plan sponsor will receive a refund of up to $1,000 on their annual base fee.

By working with Betterment, plan sponsors can effectively manage nondiscrimination testing to help keep their 401(k) plan compliant, while providing equitable benefits to all employees.