The 401(k) retirement plans are subject to a variety of rules and regulations laid down by the IRS and DOL for ERISA retirement plans. All 401(k) plan sponsors must participate in the annual nondiscrimination and Compliance Testing.

It helps the Federal Government to ensure the plan and tax benefits of the 401(k) plan are not utilized unfairly. Compliance Testing ensures business owners, highly compensated employees (HCE), and key employees are receiving the same benefits from the plan as other employees of the organization.

Failing the annual Compliance Test leads to corrective measures to be taken before the end of the 12-month correction period. It is, therefore, a crucial fiduciary responsibility to be fulfilled by plan sponsors and administrators.

What is Compliance Testing?

Compliance Testing verifies that HCEs and key employees contribute to the plan at the same rate as the NHCEs (Non-Highly Compensated Employees). It is important to understand these categories of your employees to make the proper contribution calculations. You can classify your 401(k) plan participants into one of the following categories:

  • Highly Compensated Employee (HCE) is an employee who has more than a 5% stake in your company or whose compensation for the previous two years is at least $120,000. The compensation amount used for determination may vary yearly as it must be adjusted according to inflation.
  • Key Employee is an employee with a 5% or more stake in the company or a direct relationship with an owner. Alternatively, the Employee may own more than 1% of the company and their compensation may be more than $150,000. An officer whose annual compensation in the previous two years has been more than $170,000 may also be considered a key employee. The compensation is subject to inflation and must be adjusted accordingly.
  • Benefiting Employee is anemployee who is eligible to participate in the plan.

The Compliance Testing process involves a series of numerical nondiscrimination tests to measure the participation levels of HCEs and NHCEs in the plan. It prevents the retirement plan benefits from being overly utilized by HCEs during the plan year, known as the “determination year.”

The key 401(k) Compliance Tests are:

  • Actual Deferral Percentage test (ADP): It compares the average deferral rate of HCEs and Non-HCEsin traditional 401(k) plans. It would help if you calculated the Annual HCE Contribution Rate and Annual NHCE Contribution Rate to compare deferral rates.
  • Actual Contribution Percentage test (ACP) compares the average employer contributions to HCEs and NHCEs. The calculation is based on employer match and after-tax contributions.
  • Top Heavy Testing: It compares the total account balances of key employees with all other employees. The determination is based on the data from the last day of the testing period.
  • Coverage testing: It ensures that the retirement plan covers enough NHCEs in comparison to HCEs and key employees.

401(k) plans are intricate and the Compliance Tests are subject to other complicated regulations to follow. Testing is affected by factors such as legally excludable employees and affiliated service groups.

Challenges in Compliance Testing

The complexity of Compliance Testing constantly pressures plan sponsors and administrators. Compliance Testing is an intricate process that requires great precision and expertise.

Compliance Testing involves managing a lot of census data of 401k employees. Plan service providers ensure the data is accurate and compliant with IRS regulations. The large volume of plan participant data cannot be accurately processed manually, so Compliance Testing software is needed. It scrutinizes and cleans the data from the recordkeeping system to generate eligibility results as per guidelines.

Maintaining data accuracy is a significant challenge for recordkeepers as the report is largely impacted by the data provided. Retirement plan administrators must have enough industry knowledge and experience to handle the data appropriately. They must review and fine-tune it to meet the 401(k) compliance rules and regulations. They also ensure that the reports are compliant and the software has made no omissions. Maintaining accuracy in all testing processes related to Compliance Testing is critical.

The seasonal workload of Compliance Testing poses another challenge for plan service providers. Besides handling their core operations, retirement plan administrators must take care of the additional testing tasks. Hiring extra resources for the seasonal task is an expensive fair.

Steps for Compliance Testing

A 401(k) plan must neither be discriminatory nor top-heavy to pass Compliance Testing. As per guidelines, 401(k) plan administrators must perform Compliance Testing annually. However, regularly monitoring contribution percentages reduces the risk of failing the tests. Proactively maintaining and updating records eliminates the need to make significant adjustments at the year’s end.

Encouraging NHCEs to contribute to their 401(k) plans helps maintain the ratio with the HCEs. It helps plan sponsors pass the nondiscrimination testing (NDT). Here are three steps to streamline your Compliance Testing process:

  • Auto-enrolment: Automatically enrolling employees into your 401(k) plan helps keep records up to date and increases overall participation rates.
  • Educate participants: Financial literacy is crucial for participants. Making them aware of the importance of contributing to a 401(k) boosts contributions. More NHCEs contributing to the plan help your organization pass NDT and secure their financial future as well. Similarly, you must notify your HCEs about their 401(k) contribution limit and adjust amounts if they have already contributed too much.
  • Provide self-service options: Offering a self-service platform with an intuitive dashboard uncomplicates the contribution process. The ease of use makes it more likely for them to opt for a 401(k) plan and they can easily keep track of contributions as needed.
  • Make adjustments: Regular tracking allows you to adopt proactive measures to maintain the contribution ratio. For instance, if your plan is top-heavy, you can exclude Key employees to avoid the minimum contribution of 3%. They can also curb contributions for the current plan year. Similarly, a qualified non-elective contribution (QNEC) can also be made through an end-of-year bonus into the accounts of NHCEs. However, if your 401(k) plan is found to be discriminatory during the Compliance Testing, you can initiate a refund to HCEs by March 15 of the following year.

These measures can help you pass IRS Compliance Tests or make amendments if you fail the test. However, you can also consider the Safe Harbor plan automatically avoiding ADP and ACP tests and satisfying top-heavy testing requirements. It offers a significant recruitment and retention benefit for the organization. You can retain talented employees as they can contribute the maximum allowable amounts to their 401(k).

Outsourcing 401(k) Compliance Testing

Plan sponsors look for retirement plan administrators and compliance service providers to outsource 401(k) Compliance Testing. It is practical and cost-efficient to outsource the Compliance Testing service compared to hiring full-time experts.

Outsourcing Compliance Testing to a specialist outsourced plan administration services provider frees you to focus on other business operations. From complex calculations to testing issues, an expert can handle Compliance Tests for your retirement plan. A firm with industry expertise and experience in Compliance Testing will be able to help you with the following:

  • Contribution calculations
  • Annual testing
  • Top heavy analysis
  • Nondiscrimination testing
  • Plan valuations
  • ADP/ACP testing
  • Preparation of Summary Annual Report for participants

You can avail the following benefits by outsourcing Compliance Testing for retirement plans:

  • Avail professional services irrespective of the scale of your business
  • Get results at a higher speed along with regular monitoring
  • Leverage software powered by advanced technology such as AI and ML
  • Proactively determine eligibility, key employees, and HCE to maintain the contribution ratio
  • Maintain data accuracy for precise projections on the health of your plan
  • Get expert guidance for adjustments and safe harbor considerations
  • Eliminate time-consuming data management techniques
  • Avoid data manipulations in case of failed ADP/ACP tests and get better solutions
  • Save costs on hiring in-house experts for a seasonal activity
  • Evade fiduciary penalties with timely testing, reporting, and filing

Congruent Solutions – 401(k) plan Compliance Testing services

Congruent Solutions is a specialist outsourced plan administration services provider with over 18 years of industry expertise. A team of industry experts with thorough knowledge and experience in Compliance Testing works closely with you.

We help you avoid year-end stress by continuously assisting you through the data management and reporting procedures.

Contact our team of experts to get support for Compliance Testing from our experts.

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