What Is Discrimination Testing in a 401(k) Plan – What will Your Auditor Review?
It is that time of year when you should receive an e-mail or “to do” item from your 401(k) service provider. If you are the Plan Sponsor or the individual that works on a day-to-day basis with the plan, you will receive notice from your plan provider that your non-discrimination testing, ADP/ACP testing, Top Heavy testing, etc. are ready for your review. You are probably wondering “how do I review this information and what is it?”
401(k) Plans are required to conduct what is called non-discrimination testing each year to remain compliant with ERISA (the Employee Retirement Income Security Act). There are several required tests, but some may not apply to your plan depending on its design. It’s important to understand the types of tests and what you should review in the results.
- ADP/ACP Testing – Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests are used to ensure the plan does not discriminate or favor highly compensated employees and participants when compared to all employees/participants. Items to review for in these tests involve the Plan Census to make sure it includes all employees and that the compensation and deferral amounts are accurate. You also should ensure the employees identified as highly compensated are correct. The definition of highly compensated changes each year so double check the IRS website to verify the dollar amount used for each year has been applied accurately.
- Top Heavy Testing – This test is reviewing overall accumulation of benefits in the plan to ensure the employees designated as “key” have not accumulated more than 60% of the total assets in the plan. The important item to review for this test is the employees designated as “key”. The IRS defines a “key” employee as an officer of the company making more than a specified dollar amount (this changes each year so check the IRS website to verify the appropriate indexed amount) or an owner of the company that owns either 5% or more of the business or owns more than 1% of the business and had compensation greater than $150,000 during the year. Double check that you have identified the individuals that should be designated as “key” and that this was applied during the testing.
- 410(b) Coverage Testing – This test compares the percentage of eligible highly compensated employees that are benefitting from the plan to the percentage of non-highly compensated ones. This is to ensure, again, that the plan is not overly benefitting only the highly compensated employees. As long as you have designated the individuals as highly compensated (see above) correctly and verified the Plan Census data is complete and accurate the results of this testing should be accurate as well.
Review and Verify Accuracy
Once you have reviewed the data used in the testing and verified its accuracy, review the results of the testing. The provider will indicate if corrections are needed. Follow the instructions and ensure the corrections are made to the timeline specified. If you have any questions, contact your plan provider to ensure you complete all required actions.
After the testing is complete, your auditor will want to review it to make sure it was completed timely, the data inputs into the testing are accurate and complete, and that any needed corrective actions were completed.
You will need to provide documentation of the inputs into the testing (usually the Census or other data template), the results provided by the service provider, and evidence of the completed actions taken (if any).
Be prepared for questions if the testing failed! It’s also important that you retain documentation of the testing and the corrective actions taken. This is an important regulatory requirement for your plan and the Department of Labor or IRS may need to see evidence of the testing at some point in the future.
At Summit CPA, we understand that plan administration can be a huge burden to companies especially with all the complexities added due to the pandemic. However, don’t let your guard down regarding your 401(k) plan. It is an important responsibility of the plan fiduciaries to ensure compliance at all times. A review of current compliance and administration now will help make things a little less stressful. For more information on how we can help, contact our office at (866) 497-9761.