# 410(b) Test

### Reviewed by Subject Matter Experts

Updated on July 11, 2023

## Definition of 410(b) Test

The 410(b) Test is a critical aspect of managing qualified retirement plans in the United States. Ensuring compliance with the Internal Revenue Code (IRC) Section 410(b) is essential to maintain the tax-qualified status of a retirement plan.

## Importance of the 410(b) Test

### Ensuring Fairness in Retirement Plans

The 410(b) Test promotes fairness in retirement plans by ensuring that plans do not disproportionately benefit HCEs at the expense of NHCEs.

### Compliance with IRS Regulations

By complying with the 410(b) Test, employers and plan administrators can maintain the tax-qualified status of their retirement plans, preserving valuable tax benefits for both the employer and employees.

### Protecting Tax Benefits for Employers and Employees

The 410(b) Test helps protect the tax benefits associated with qualified retirement plans, which can lead to increased employee participation and better retirement outcomes for all employees.

## Requirements of the 410(b) Test

The 410(b) Test comprises two primary requirements that retirement plans must meet to be considered tax-qualified: minimum coverage requirements and nondiscriminatory classification.

### Minimum Coverage Requirements

The minimum coverage requirements of the 410(b) Test ensure that a sufficient number of Non-highly Compensated Employees (NHCEs) participate in the plan relative to Highly Compensated Employees (HCEs).

There are two tests under the minimum coverage requirements: the Ratio Percentage Test and the Average Benefits Test.

### Nondiscriminatory Classification Test

The nondiscriminatory classification test ensures that the plan does not favor HCEs over NHCEs through its provisions and eligibility requirements.

## Ratio Percentage Test

### Definition and Formula

The Ratio Percentage Test is a quantitative comparison of the plan's coverage among NHCEs and HCEs. The test is satisfied if the following formula is met:

### Example of Ratio Percentage Test Calculation

Suppose an organization has 100 employees, with 10 HCEs and 90 NHCEs. If 8 HCEs and 50 NHCEs participate in the plan, the calculation would be:

In this example, the plan fails the Ratio Percentage Test because the result is less than 70%.

### Passing the Ratio Percentage Test

If the plan passes the Ratio Percentage Test with a result of 70% or higher, it satisfies the minimum coverage requirements for the 410(b) Test.

## Average Benefits Test

### Definition and Components

The Average Benefits Test measures whether the average benefits provided to NHCEs are at least a certain percentage of the average benefits provided to HCEs. The test is composed of two components: the benefits component and the contributions component.

#### Benefits Component

The benefits component examines the benefits provided to NHCEs as a percentage of the benefits provided to HCEs. To pass this component, the plan must meet one of the following conditions:

• The average benefit for NHCEs is at least 70% of the average benefit for HCEs, or

• The average benefit for NHCEs is at least 80% of the average benefit for HCEs, and the plan meets a classification requirement (such as the Safe Harbor requirements)

#### Contributions Component

The contributions component evaluates the contributions made on behalf of NHCEs as a percentage of the contributions made on behalf of HCEs.

To pass this component, the plan must meet one of the following conditions:

• The average contribution for NHCEs is at least 70% of the average contribution for HCEs, or

• The average contribution for NHCEs is at least 80% of the average contribution for HCEs, and the plan meets a classification requirement (such as the Safe Harbor requirements).

### Example of Average Benefits Test Calculation

Suppose the average benefit for HCEs is \$10,000, and the average benefit for NHCEs is \$7,500. The calculation would be:

In this example, the plan passes the Benefits Component of the Average Benefits Test because the result is more than 70%.

Now, suppose the average contribution for HCEs is \$5,000, and the average contribution for NHCEs is \$3,500. The calculation would be:

In this example, the plan passes the Contributions Component of the Average Benefits Test because the result is equal to 70%.

### Passing the Average Benefits Test

If the plan passes both the Benefits Component and the Contributions Component of the Average Benefits Test, it satisfies the minimum coverage requirements for the 410(b) Test.

## Nondiscriminatory Classification Test

### Purpose and Overview

The Nondiscriminatory Classification Test aims to ensure that the plan's eligibility requirements and provisions do not unfairly favor HCEs over NHCEs.

### Reasonable Classification

To satisfy the Nondiscriminatory Classification Test, the plan must use a reasonable classification of employees that does not discriminate in favor of HCEs. A classification is considered reasonable if it is based on bona fide business criteria, such as job function, location, or years of service.

### Safe Harbor Requirements

A plan can satisfy the Nondiscriminatory Classification Test if it meets the Safe Harbor requirements outlined by the IRS. These requirements include specific coverage percentages and non-discrimination tests that ensure the plan is equitable for both HCEs and NHCEs.

## Consequences of Failing the 410(b) Test

### Disqualification of the Plan

If a retirement plan fails the 410(b) Test, it risks losing its tax-qualified status. This disqualification can have significant consequences for both the employer and employees.

### Tax Implications for the Employer and Employees

If a plan loses its tax-qualified status, the employer may lose tax deductions for contributions made to the plan. Employees may also be subject to immediate taxation on their vested benefits and face additional taxes and penalties.

### Corrective Actions and Amendments

If a plan fails the 410(b) Test, the employer and plan administrators can take corrective actions to bring the plan into compliance. These actions may include amending plan provisions, making additional contributions for NHCEs, or refunding excess contributions made by HCEs.

## Conclusion

The 410(b) Test plays a vital role in managing qualified retirement plans in the United States by ensuring fairness and equity between highly compensated employees (HCEs) and non-highly compensated employees (NHCEs).

Complying with the test's requirements, which include minimum coverage requirements and nondiscriminatory classification, helps preserve the tax-qualified status of retirement plans and the associated tax benefits for both employers and employees.

Employers and plan administrators should stay vigilant and periodically review their plans to ensure ongoing compliance.

In cases where a plan fails the 410(b) Test, it is crucial to take corrective actions to restore compliance and safeguard the plan's tax benefits.