401(k) plans can greatly benefit employers and their eligible employees. However, to help track that 401(k) plans, deferred wages, and employer contributions aren't favoring specific employees, such as highly-compensated employees (HCEs) or key employees, they must pass annual nondiscrimination testing (NDT) based on the features of the plan. Failing NDT is fairly common, and business owners must take corrective action in these situations to avoid plan disqualification.
There are some important dates to remember to allow for time to prepare and review nondiscrimination testing results. This guide reviews key compliance deadlines to remember if you’re administering a 401(k) retirement plan with a calendar year-end. Your 401(k) provider may need some information from you directly to help you hit these deadlines, so be extra safe and get the ball rolling well before these dates!
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NDT testing compliance deadlines
Here’s a quick summary of important NDT deadlines:
October 1: Deadline to launch a new safe harbor match 401(k) plan for the current year
January 1: Date on which plans with a new safe harbor match feature can take effect
March 15: Deadline for any corrections for a non-EACA plan for Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) nondiscrimination testing failures before a 10% excise tax is assessed on any refunds via IRS Form 5330
April 15: Deadline for any corrections for 402(g) excess deferrals in the prior year for plan participants to avoid double taxation
June 30: Deadline for any corrections for an EACA plan for ADP and ACP nondiscrimination testing failures before a 10% excise tax is assessed on any refunds via IRS Form 5330
December 31: Deadline for corrections for ADP and ACP testing failures for the plan to stay in qualified status (10% penalty applies after March 15 or June 30 if refunds are required)
Testing results and notifications: Your plan service provider is usually responsible for conducting IRS nondiscrimination testing and communicating your results and correction options (if applicable), generally before the date any corrective refunds must be made without penalty.
However, the results may be delayed based on when your service provider receives the necessary information to perform the nondiscrimination testing. Your service provider will also communicate the last day for depositing any required employer contributions due to the plan based on testing results.
Corrective distributions and refund deadlines and logistics
As we describe in our article about nondiscrimination testing, it’s not uncommon for plans to fail ADP or ACP testing. However, corrective measures must be taken in a timely manner, or employers may be assessed an extra 10% excise tax on the delayed refunds.
Plan service providers usually begin conducting annual testing in January for the previous year and will communicate results soon after that. Providers often require you to begin the process by providing certain information. Because the deadline for corrections is March 15 or June 30 (based on plan provisions), you can see that the earlier you provide this requested information, the better.
What happens if a plan fails ADP or ACP testing?
In these situations, plan service providers will provide options available to correct the testing failure. They may include one or more of the following items: amounts to be refunded to HCEs, a retroactive 4% safe harbor non-elective contribution, or the amount of the qualified non-elective contribution (QNEC) the employer needs to deposit on behalf of NHCEs.
ADP or ACP refunds must be made by March 15 or June 30 to avoid penalties, while safe harbor non-elective or QNEC contributions must be deposited by the end of the calendar year. Most plan sponsors choose to process HCE refunds since this option does not require any additional funding to the plan.
What if an employer misses the deadline to process ADP or ACP refunds without penalty?
If an employer chooses to correct a failed test via refund to the HCEs, but the checks are issued after the appropriate deadline, the plan sponsor is responsible for paying a 10% excise tax. In this situation, the plan service provider will prepare IRS Form 5330: Return of Excise Taxes Related to Employee Benefit Plans, which the employer submits to the IRS along with the penalty.
What happens if ADP or ACP corrections are not made by December 31 of the following plan year?
The Employee Plans Correction Resolution System (EPCRS), provided by the IRS, outlines the options available when a plan does not complete nondiscrimination testing corrections within the 12-month period following the year-end. There are two options available for plans that miss the 12-month correction window:
QNEC. The sponsor may choose to provide a QNEC that will increase the NHCE average to the appropriate level to allow the ADP or ACP tests to pass. Essentially, this is the same correction as allowed during the 12-month correction window, but the QNEC must now be increased for earnings between the due date of the correction versus the actual date the contribution was made to the plan.
One-to-one correction method. If the sponsor wishes to refund the HCEs to correct the testing failure, they may do so, but only if they contribute a QNEC in the same amount as the refunds to the NHCEs. In addition, the 10% excise tax on the late refunds still applies.
FAQs about nondiscrimination testing
What is the purpose of 401(k) nondiscrimination testing?
The primary purpose of 401(k) nondiscrimination testing is to ensure that retirement plans do not unfairly favor highly compensated employees over non-highly compensated employees or key employees over non-key employees. The IRS requires these tests to maintain the tax-qualified status of the 401(k) plan and to prevent the plan from becoming discriminatory.
What are the tax implications of failing to correct a 401(k) nondiscrimination test?
While there are tax benefits for following all the regulations and passing the tests, if you fail to correct the plan in a timely manner, it can have significant tax implications for both HCEs and the employer sponsoring the plan. In severe cases, a plan can lose its tax-qualified status, which could lead to several consequences:
Taxable Income: Highly compensated employees who made contributions to the plan may face immediate taxation on the excess contributions, both on their deferrals and any related employer-matching contributions.
Excise Tax: The employer may be subject to a 10% excise tax on the excess contributions that caused the plan not to pass the nondiscrimination test.
Plan Disqualification: If corrective actions are not taken on time, the entire 401(k) plan could be disqualified, resulting in all contributions and earnings becoming immediately taxable for all participants.
What is the top-heavy test?
The top-heavy test is done to measure whether key employees own more than 60% of the total plan assets. The top-heavy test is conducted by comparing the account balances of key employees to non-key employees at the end of the plan year.
While this isn’t technically an NDT, it is done to ensure employees with smaller compensations aren’t being treated unfairly.
What is considered a “key employee” in regard to nondiscrimination testing?
A key employee is defined as any employee who is:
An officer making $220,000 or more (in 2024)
Any employee who owns more than 5% of the business
Any employee who owns more than 1% of the business and makes $155,000 or more throughout the course of the plan year
What is considered a highly compensated employee (HCE) in regard to nondiscrimination testing?
A highly compensated employee (HCE), as defined by the IRS, is an individual who earned more than $155,000 in 2024 ($150,000 in 2023) (the income threshold for HCEs is subject to change annually), owned more than 5% of the business at any time during the year or the preceding year, or is attributed ownership greater than 5% via familial relationship.
Nondiscrimination testing serves a vital role in ensuring that the benefits of retirement plans are not disproportionately skewed in favor of HCEs. Think of it as a fairness check that helps maintain tax benefits for the employer offering the plan, while also safeguarding equitable treatment for all employees. During testing, plans are reviewed to ensure that HCEs are not receiving preferential treatment in comparison to non-HCEs. This involves examining contributions, benefits, and the availability of plan options.
Learn more about highly compensated employees.
Human Interest and NDT deadlines
Looking for a 401(k) provider that will help with NDT compliance testing? Human Interest offers flexible, affordable 401(k) retirement savings plans that include support for compliance. We work with all of our clients to:
Set expectations upfront (some companies inherently have a higher risk of failing NDT than others).
Fully inform clients of deadlines in advance: We’re happy to explain the ins and outs of NDT so our clients aren’t left in the dark and blindsided by a last-minute deadline.
Advise on safe harbor plan designs that allow the plan to avoid some NDT, so corrective measures don’t have to be dealt with in the first place.
More advantages with a Safe Harbor Plan
With a Safe Harbor plan, you can get the benefits of both a traditional 401(k) and profit sharing plan.
If you’d like more context on nondiscrimination testing in general (or need more clarity on terms like “safe harbor” and “QNECs”), here are some more articles on NDT:
Article By
Vicki WaunVicki Waun, QPA, QKC, QKA, CMFC, CRPS, CEBS, is a Senior Legal Product Analyst at Human Interest and has over 20 years experience with recordkeeping qualified plans, along with extensive experience in compliance testing. She earned her BSBA in Accounting from Old Dominion University and is a member of ASPPA.
