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What is 401(k) Plan Testing?

What is 401k plan testing

Understanding Employer Obligations

What is 401(k) Plan Testing? Understanding Employer Obligations

401(k) plans are a fantastic vehicle for helping employees save for retirement. However, for employers, offering a 401(k) plan comes with certain responsibilities, one of which is ensuring the plan’s compliance with federal regulations. Enter the realm of 401(k) plan testing. But what is this testing all about, and how can employers ensure they’re meeting their obligations?

Understanding 401(k) Plan Testing

At its core, 401(k) plan testing ensures that retirement plans don’t heavily favor higher-paid employees or company owners. The Internal Revenue Service (IRS) has established guidelines to make sure that plans benefit a broad cross-section of employees and not just a select few. To this end, several tests are conducted annually, including:

  1. Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) Tests: These tests compare the average contributions of highly compensated employees (HCEs) to those of non-highly compensated employees (NHCEs). If the contributions of HCEs are disproportionately higher, the plan might fail these tests.
  2. Top Heavy Test: This test determines if the total value of the plan assets owned by “key employees” (typically company owners and officers) exceeds 60% of the entire plan’s assets. If so, the plan is deemed “top-heavy,” and certain minimum benefits might need to be provided to NHCEs.
  3. Coverage Test: This ensures that the plan benefits a reasonable percentage of non-highly compensated employees compared to highly compensated ones.

Employer’s Obligations

If a 401(k) plan fails any of the compliance tests, corrective actions are needed. These might include refunding contributions to HCEs or making additional contributions to NHCEs. Not only can these corrections be costly, but consistently failing these tests can also jeopardize the plan’s tax-qualified status.

Employers have the duty to:

  • Regularly review their 401(k) plan’s design and participant behavior.
  • Ensure timely execution of the required tests.
  • Take corrective measures as necessary.

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Offering a 401(k) plan is not just about providing a benefit; it’s about ensuring fairness, compliance, and safeguarding the future of all employees. With the complexities surrounding compliance testing, partnering with experts like PPC can be an invaluable decision, ensuring the plan’s success and the employer’s peace of mind.