The IRS wants 401(k) plans to benefit all employees fairly. To maintain that balance, they require all 401(k) plans to meet certain compliance standards. Therefore, the Employee Retirement Income Security Act of 1974, better known as ERISA, mandates a series of tests called non-discrimination tests in order for the plan to remain in tax-qualified status.<\/p>\n\n\n\n
If your company-sponsored 401(k) plan fails non-discrimination testing, don\u2019t worry, you\u2019re not alone. It\u2019s common for businesses to fail testing from time to time. Fortunately, you\u2019ll have a chance to make corrections. The following information will help you understand how to get your plan corrected and keep it compliant.<\/p>\n\n\n\n
Non-discrimination<\/a> testing aims to ensure that all employees are contributing a proportionate amount of funds into their accounts.<\/p>\n\n\n\n There are two primary non-discrimination tests:<\/strong><\/p>\n\n\n\n HCEs and NHCEs are defined as:<\/strong><\/p>\n\n\n\n The top-heavy test is the third type of test used for plan compliance. This test compares the account balances of Key Employees as compared to Non-Key Employees.<\/p>\n\n\n\n Family attribution rules apply to both HCEs and Key employees. If you employ a spouse, child, parent, or grandparent, they will also be considered owners.<\/p>\n\n\n\n Failing the ADP or ACP tests ultimately means that the plan deferral or contribution percentages are imbalanced between highly compensated employees (HCEs) and non-highly compensated employees (NHCEs).<\/p>\n\n\n\n To correct these imbalances, you have two options<\/strong>:<\/p>\n\n\n\n Your plan is top-heavy if your key employee balances are more than 60% of plan assets. You can correct this by contributing funds to non-key employees of 3% of their compensation according to IRS regulations.<\/p>\n\n\n\n The 3% top-heavy contribution can be offset by employer matching or profit-sharing contributions. To avoid top-heavy failures in subsequent years, you can limit the contributions (employee contributions, employer match, and profit sharing) of Key Employees, or consider a safe harbor plan design.<\/p>\n\n\n\n Fortunately, you do not face penalties for a failed non-discrimination test. However, you will face a penalty if you fail to make corrections to your plan in a timely manner. The deadline for correcting a failed ADP or ACP test is within 12 months of the close of the plan year, so if your plan failed this year, you\u2019d have until December 31st of next year to make your corrections.<\/p>\n\n\n\n Though you technically have until December of the following year, you will be subject to an excise tax of 10% of the required contribution returns if the corrections aren\u2019t made by March 15th of the following plan year.<\/p>\n\n\n\n If you fail to make these corrections, you\u2019ll need to file a form 5330 with the IRS to advise of the failure and remit payment of the excise tax.<\/p>\n\n\n\n The IRS Employee Plans Compliance Resolution System (EPCRS) will provide you with the following options to bring your plan into compliance<\/strong>:<\/p>\n\n\n\n Failing non-discrimination testing could be the result of a few factors<\/strong>:<\/p>\n\n\n\n Adopting a Safe Harbor plan design will typically exempt the plan from compliance testing. However, exemption from all compliance testing will depend on the plan features you choose. Normally, the Safe Harbor option must be in place more than 30 days prior to the start of a new year. A Safe Harbor plan requires an employer match or non-elective contribution.<\/p>\n\n\n\n However, the benefit is that the HCEs and Key Employees can contribute up to the allowed limit for the year without risk of failing compliance tests and having to either remove their money or fund more money into participant accounts.<\/p>\n\n\n\n If you fail top-heavy testing, there is another option. You are permitted to retroactively enroll in a Safe Harbor Non-Elective Contribution, (NEC) which will exempt you from needing to make corrections. ACP and ADP exemption is based on your plan\u2019s design. A retroactive Safe Harbor plan enrollment will do a few things:<\/strong><\/p>\n\n\n\n 1. Your plan for 2023 will be amended into a Safe Harbor Plan with a 4% NEC. If you decide to retroactively enroll in a Safe Harbor plan, do not accept the results of your failed compliance tests. Once the amendment to your plan is complete, your compliance tests will be updated. It\u2019s important to note that you may still be subject to top-heavy testing if you contribute more than the 3% required to an employee\u2019s retirement Plan.<\/p>\n\n\n\n Working with a third-party plan provider such as ePlan Services can help take the guesswork out of plan management. We provide you with the education you and your employees need to ensure that you understand the components of your plan.<\/p>\n\n\n\n You and your employees will also have access to our helpful tools, such as our employee dashboard and Retirement Outlook Calculator. We\u2019ll work with you to help keep your plan compliant. For more information on how ePlan Services can help keep your plan compliant, reach out to our knowledgeable consultants today<\/a> or visit our Help Center<\/a>.<\/p>\n\n\n\n\n\n
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What to do if you fail the ADP or ACP tests<\/h2>\n\n\n\n
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What to do if you fail the top-heavy test<\/h2>\n\n\n\n
The penalty for failure<\/h2>\n\n\n\n
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Possible reasons for failing non-discrimination testing<\/h2>\n\n\n\n
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Eliminate the risk of failing compliance testing<\/h2>\n\n\n\n
2. Based on each eligible employee’s compensation, each employee will receive a 4% NEC for the plan year.
3. Your plan will be automatically amended for the 2024 plan year allowing for a 3% NEC<\/p>\n\n\n\nHow to maintain plan compliance<\/h2>\n\n\n\n