A nondiscrimination test is required for 401(k) plans to ensure that the plan does not improperly favor highly-paid employees or "key" employees, such as the owners. The tests establish what percentage of the assets belong to highly-compensated employees and key employees, how much the company contributes, and how much of their income employees defer.
Nondiscrimination Testing for 401(k) Plans FAQs
Nondiscrimination testing is the process of ensuring that the contributions and benefits of a 401(k) plan are distributed fairly among all eligible employees, regardless of their income level or position in the company. This means that highly compensated employees cannot receive more favorable benefits than those who earn lower wages.
Generally, nondiscrimination testing must be performed each year as part of the annual filing requirements associated with a 401(k) plan. However, it’s important to note that if significant changes occur during the year, additional testing may be required.
Nondiscrimination testing is usually conducted by the plan sponsor, often with the help of a professional service provider experienced in administering 401(k) plans.
If a plan fails the test, it may be subject to corrective actions such as reducing or refunding contributions made by highly compensated employees or adjusting benefits available from the plan.
Yes, there are various exceptions and safe-harbor rules that may allow certain plans to pass otherwise difficult nondiscrimination tests. Consulting a professional experienced in administering 401(k) plans is the best way to determine if any of these options are available for your plan.
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.
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