though nondiscrimination testing is likely performed by a plan’s recordkeeper
or third-party administrator (TPA), plan sponsors need to understand the basics of
the tests, including the types of contributions that are tested, the methods
used and the consequences of failing.
Employee Retirement Income Security Act (ERISA) requires several tests each
year to prove 401(k) plans do not discriminate in favor of employees with
some of the tests, employees are divided between non-highly compensated
employees (NHCEs) and highly compensated employees (HCEs). The Internal Revenue
Service (IRS) defines "highly compensated employee" as an individual who:
more than 5% of the interest in the business at any time during the year or the
preceding year, regardless of how much compensation that person earned or received,
the preceding year, received compensation from the business of more than
$115,000 (if the preceding year is 2013 or 2014; $120,000 if the preceding year
is 2015), and, if the employer so chooses, was in the top 20% of employees when
ranked by compensation.
compensation used for determining whether an employee is an HCE is indexed each
Richter, vice president with SunGard’s wealth and retirement unit, breaks the
nondiscrimination rules into three parts. First, he says, there are rules
to ensure there is broad coverage of employees; those compose the 410(b)
once you have a sufficient number of NHCEs covered, you look at the benefits,
rights and features of the plan to ensure they are nondiscriminatory. This is tested
by the ADP and ACP tests.
ADP stands for actual
deferral percentage, explains Robert Kaplan, national retirement consultant for
Voya Retirement Solutions. This test compares the average of salary deferral
percentages for HCEs with the average of salary deferral percentages for NHCEs.
The ADP test applies to pre-tax and Roth elective deferrals. Kaplan says the
purpose of this test is to ensure that all participants, both HCEs and NHCEs, are
benefitting from the plan.