Non-discrimination Testing (NDT) is essential to staying compliant with 401(k) regulations. It helps employers ensure that their plans are designed and used in a way that does not discriminate against certain employees or classes of employees, providing equal benefits to all.
This guide will quickly examine what non-discrimination testing is, its importance, and how to conduct a successful NDT.
What is non-discrimination testing?
Non-discrimination testing is an IRS requirement to ensure that 401(k) plans are operated fairly and do not unduly benefit higher-paid employees. It compares the average contribution rate of a plan’s Highly Compensated Employees (HCEs) to those of the non-highly compensated employees (NHCEs). If there is a huge disparity in the contribution rates of these two groups, the plan may fail the test and be considered non-compliant with 401(k) regulations.
Non-discrimination testing must be conducted annually and assess the following five areas:
- Eligibility: Eligibility rules of the plan must not favor HCEs over NHCEs.
- Contributions: Average contribution rate of HCEs and NHCEs must be within a certain percentage of each other to pass the test.
- Vesting: The length of time employees need to stay with the company to receive their full benefits must be the same for both groups.
- Distributions: Rules governing when and how employees can receive distributions from the plan must be equal for both HCEs and NHCEs.
- Top-heavy requirements: The plan must not have too many assets held by HCEs and their families.
401(k) Non-discrimination Tests
401(k) Non-discrimination Tests are designed to ensure that 401(k) plans are not discriminatory in favor of highly-compensated employees (HCEs). The following three tests are used to assess non-discrimination:
- Actual Deferral Percentage (ADP) Test: A test that compares the average deferral percentage of HCEs to that of NHCEs. If they are too far apart, the plan can be considered discriminatory.
- Actual Contribution Percentage (ACP) Test: A test compares the average employer contributions for HCEs to NHCEs. Again, if the difference is significant, it can indicate discrimination.
- Top Heavy Test: A plan is deemed top-heavy when key employees own more than 60% of its assets. This may create an undue advantage and should be avoided to maintain non-discrimination status.
Failure to pass any of these tests can result in a loss of tax benefits for the plan sponsor and participants. However, it is common for plans to fail the non-discrimination testing.
A recent study by Employee Fiduciary calculates ADP, ACP, and Top Heavy Testing failure rates to be 26.47%, 3.74%, and 45.41%. Understanding these tests and ensuring your 401(k) plan complies with them is essential.
Ensuring non-discrimination testing compliance
One way to maintain non-discrimination testing compliance is to use the corrective action provisions of the IRS and DOL. Corrective action is required when a plan fails non-discrimination testing, such as including reallocating funds or contributions, increasing employer matching contributions, or offering more education about retirement planning for lower-paid employees.
Another way to ensure compliance with non-discrimination testing is to fully understand and comply with all rules that apply to your 401(k) plan. It means staying up-to-date on any changes in regulations and understanding the different types of plans available. Make sure you are taking full advantage of any tax benefits available and that you are aware of any potential risks associated with certain investments or strategies.
Outsourcing non-discrimination testing for 401(k) plans
An experienced third-party administrator can provide the most up-to-date data, analyze test results, and provide detailed reports to keep your plan compliant. Since NDT is a seasonal task, outsourcing it provides you with cost savings. It reduces the additional burden on your in-house team and eliminates the need for hiring extra staff.
Experts at Congruent can help you handle non-discrimination testing requirements. Besides staying current on changes in regulations and laws, we have advanced systems that ensure 401(k) plans remain compliant with federal non-discrimination rules.
We provide comprehensive non-discrimination testing services that include:
- Reviewing plan features and customized rules
- Computing the eligibility, contributions, and benefits of each participant
- Analyzing test results for compliance with the ADP, ACP, and Top Heavy tests
- Filing Form 5500 and other required documents
- Generating actionable reports to identify areas where corrections or adjustments may be needed
Contact our team today to ensure retirement plan compliance throughout the year.