Compliance testing is a crucial annual responsibility for 401(k) plan sponsors, mandated by the Internal Revenue Service (IRS). It ensures that a company’s 401(k) plan remains equitable, not favoring owners and highly compensated employees (HCEs), and stays within IRS-prescribed limits. For employers offering 401(k) retirement plans, comprehending these tests is vital as non-compliance may lead to penalties and additional expenses.
Types of Compliance Tests:
- Nondiscrimination Testing: Nondiscrimination tests aim to ensure that 401(k) plans are accessible to all employees and that benefits are distributed fairly. Key nondiscrimination tests include:
- Actual Deferral Percentage Test (ADP): This assesses the average deferral percentage of HCEs against that of non-highly compensated employees (NHCEs).
- Actual Contribution Percentage Test (ACP): It compares the average employer-matching contribution percentage of HCEs with that of NHCEs.
- Top-Heavy Test: This test ensures that if “key employees” hold over 60% of total account balances in a 401(k) plan, non-key employees receive a minimum contribution.
- Limits Testing: These tests confirm that the plan adheres to IRS-mandated limits, including the annual deferral limit, annual additions limit, compensation limit, and employer deduction limit. It’s important to note that these are not exhaustive, as InSight applies other limits and nondiscrimination tests during the year and when calculating contributions.
Consequences of Failing Tests or Exceeding Limits:
If a 401(k) plan fails compliance testing, corrective actions must be taken within a specified timeframe. Neglecting to address issues can result in penalties, plan disqualification, adverse tax consequences for employers or employees, and the loss of tax benefits associated with the plan.
In cases of limit breaches, InSight may automatically process excess contributions depending on the type of overage. Excess employee deferrals are typically refunded to employees, while excess employer contributions are used to offset future contributions until depleted.
For failing nondiscrimination tests, InSight will provide guidance on correction procedures and deadlines. It’s essential to provide compensation data promptly to avoid additional costs, especially if your plan fails the ADP or ACP tests. Monitoring your compliance dashboard diligently is crucial for positioning your plan to pass compliance testing successfully.
How InSight Simplifies Compliance Testing:
Compliance testing can appear daunting, but InSight streamlines the process, allowing you to concentrate on your business and employees. Throughout the year, our systems and recordkeepers utilize the data you provide to generate projected test results, accessible through the Compliance section of your InSight dashboard. These projections offer real-time insights into your plan’s compliance status.
Please note that these reports provide projections, and actual results will be known after the plan year ends when all contributions are processed, and final census data is available. Promptly providing employee compensation data is critical for timely calculations.
Review your Compliance dashboard regularly to monitor your plan’s compliance risk. If you have questions, our specialists can discuss correction options with you.
How to Simplify Nondiscrimination Requirements:
To support your employees’ retirement while minimizing the burden of nondiscrimination testing, consider adopting a Safe Harbor plan design. Safe Harbor 401(k) plans typically satisfy most nondiscrimination requirements, exempting your plan from the majority of nondiscrimination tests. Learn more about the advantages of implementing a Safe Harbor plan.