The IRS requires most 401(k) plans (except those with a Safe Harbor provision) to undergo annual non-discrimination testing. This ensures that business owners and highly compensated employees (HCEs) do not disproportionately benefit compared to other employees, keeping the plan fair and compliant.
Who This Applies To
This information is for 401(k) Plan Sponsors and Plan Administrators responsible for providing employee census data and ensuring compliance with annual IRS non-discrimination testing requirements.
- You must supply accurate information on all eligible employees, including those who do not participate in the plan.
- You are responsible for reviewing test results, approving any required corrections, and considering plan design options such as adopting a Safe Harbor provision.
Who Must Be Included in Testing
All employees who met your plan’s age and service eligibility requirements during the plan year must be included in census data, regardless of whether they chose to participate. This includes employees who:
- Terminated employment during the year but were eligible at some point.
- Are non-participants (eligible but not contributing).
Employees who were not eligible in the plan year, or who were hired after December 31 of the testing year, are excluded. See: How Do I Complete My Annual Census Verification?
Who Qualifies as a Highly Compensated Employee (HCE)?
For 2024, an HCE is any eligible employee who meets one or more of the following:
- Earned more than $150,000 in 2023 (prior year)*
- Owned more than 5% of the company in 2023 or 2024
- Is the spouse, parent, child, or grandparent of a more than 5% owner (family attribution rule)
*Important Notes:
- The IRS compensation threshold for identifying HCEs rises to $155,000 in 2024 (for determining HCE status in 2025).
- Employees hired in 2024 do not receive HCE status based solely on 2024 earnings, unless 2024 is the first year the plan was effective.
- What Non-Discrimination Testing Measures
Two IRS tests evaluate whether contributions are fairly distributed:
- ADP (Average Deferral Percentage) Test – measures employee salary deferrals.
- ACP (Average Contribution Percentage) Test – measures employer matching contributions.
Plans may use either:
- Current-Year Testing – based on actual contributions made by non-HCEs during the plan year.
- Prior-Year Testing – based on the prior year’s non-HCE contribution rates, which allows employers to predict allowable HCE contribution rates in advance.
Your Adoption Agreement specifies which method applies to your plan.
What Happens if the Plan Fails Testing
If your plan fails ADP/ACP testing, you must take corrective action by:
- Refunding excess contributions to HCEs (most common), or
- Making a Qualified Non-Elective Contribution (QNEC) to non-HCEs, or
- Adding a 4% Safe Harbor non-elective contribution to all eligible employees as of December 31.
Key Deadlines for 2024 Testing
- Census verification deadline: February 21, 2025
- Correction deadline: March 15, 2025
Your designated plan administrator will receive test results by email once Ubiquity completes the testing (typically 3–4 business days after census submission).
Safe Harbor Plans: An Alternative
Plans that adopt a Safe Harbor provision for the full plan year are exempt from ADP/ACP testing. Safe Harbor plans provide:
- Automatic compliance with nondiscrimination rules
- Predictable contributions and fewer administrative corrections
- The ability for HCEs to contribute up to the IRS maximum each year
If your plan removed or failed to meet Safe Harbor requirements mid-year, it will still be subject to nondiscrimination testing for that year.
How to Improve Future Test Results
- Encourage non-HCEs to contribute more through employee education.
- Consider adding automatic enrollment to boost participation.
- Add a Safe Harbor provision to avoid testing altogether.
- Request a mid-year test (available beginning August 19, 2025) to anticipate year-end results.
Need Help?
If you have questions about non-discrimination testing, please contact us.