(b)lines Ask the Experts – What Are 410(b) and 401(a)(4) Tests?

“We recently established an ERISA 403(b) plan with both a base (discretionary) and a matching contribution at a newly created tax-exempt entity at which I work.

“In addition to the Average Contribution Percentage (ACP) Test about which I was aware through a prior employer, our recordkeeper says we need to pass 410(b) coverage and 401(a)(4) general nondiscrimination testing. Can the Experts provide a basic explanation of these tests?” 

David Levine and David Powell, with Groom Law Group, and Michael A. Webb, vice president, Retirement Plan Services, Cammack Retirement Group, answer: 

We will try, but these tests are indeed quite complicated! But before we begin to attempt to summarize these tests, it is important to understand that such tests are designed to prevent discrimination in favor of what are called “Highly Compensated Employees”, or HCEs. HCEs are generally defined as those employee who are a) 5% owners (generally not applicable for tax-exempts) and b) those employees whose total compensation exceeded a certain threshold in the prior year ($120,000 in 2016 for 2017 testing purposes). Thus, if you do not employ any individuals who earned more than $120,000 in 2016, your retirement plan is NOT subject to 410(b) or 401(a)(4) testing at all! This may indeed be the case if your organization is small, or was established recently (since prior-year compensation is used to determine HCEs).

To answer your question, here is the Experts’ attempt to simplify what are quite complex tests:

1)      410(b) coverage testing is a “counting” form of testing, where you are basically comparing the ratio of the number of HCE’s who benefit under the plan to the total number of statutorily eligible HCEs, to a similar ratio for everyone else (who,, by process of elimination, are known as Non-highly Compensated Employees, or NHCEs). The ratio of NHCE’s benefitting must equal or exceed a stated percentage of HCE’s benefitting (70% in the standard test, but lower ratios are permitted to satisfy more complex alternate tests) in order for the coverage test to pass. There are “safe harbor” designs that can be used so that such testing is automatically passed without a requirement for these complicated calculations to be performed.

2)      401(a)(4) general nondiscrimination testing is a “contributions” form of testing, where contributions of NHCEs  are compared to HCEs to determine if contributions provided to HCEs are proportional to those provided to NHCEs. The methods used to determine whether 401(a)(4) testing is passed range from the somewhat complicated to the extremely complicated, the latter of which may require the services of an actuary. Again, there are “safe harbor: designs that can be used so that such testing is automatically passed without a requirement for such complex calculations to be performed.

It should be emphasized that there is a LOT more to such testing that could possibly be covered in an Ask the Experts column. You should be consulting with individuals with extensive background and expertise in performing nondiscrimination testing to determine to applicability of such testing to your plan and ensure that such testing is completed accurately.


NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.  

Do YOU have a question for the Experts? If so, we would love to hear from you! Simply forward your question to Rebecca.Moore@strategic-i.com with Subject: Ask the Experts, and the Experts will do their best to answer your question in a future Ask the Experts column.