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401(k) Annual Discrimination Testing-FAILURE

Published by Kim Moore on Feb 22, 2021 6:00:00 AM

What Should You Do if Your 401(k) Plan Fails the Required Discrimination Testing?

In a previous blog post we discussed the definition and importance of your Plan’s annual discrimination testing. Once the testing is completed, you will receive the results and related reporting from your service provider. If you see the word “FAIL” on the test results, what should you do now?

First of all, relax. Many Plans fail their testing. You are required to act, but you do have options and time to fix the situation. We recommend the following steps:

  1. Review the testing packet that your provider delivers. The packet may include a page of items to review such as:

    • Employees shown as active but with no compensation.
    • Employees with no hire dates.
    • Terminated employees that had compensation.Required Discrimination Report

Make sure all the employees that participated in the Plan are shown correctly with accurate compensation and deferral amounts. Review the information presented to ensure the data the testing is based upon is accurate and complete.

  1. Review the employees listed as highly compensated and those shown as “key”. If you are unsure of the definitions for those items, check with your Provider.

  2. If you find any errors in the employee identifications from steps #1 and #2 above, discuss the corrections with your provider and consider re-running the tests.

  3. Once the above is completed, if you still have failed tests, review the options for correction. The options will depend on the specific tests that failed and what is allowed per your 401(k) Plan Document. Your provider will usually specify the options available in the testing summary that they provide but if you are unsure schedule time to discuss the various options with your assigned Representative.

  4. Then, take the required action. It is important that you fully complete the correction process so that your Plan remains qualified and in compliance with Internal Revenue Service requirements. There are also deadlines for completion of the tasks, especially if refunds are required to participants. Make sure you follow the instructions from your provider to ensure you meet the required timelines.

  5. Lastly, communicate any required actions with the impacted employees so they are not surprised. If participants will be receiving a corrective distribution, discuss the procedure with them and provide information on the necessity of the correction for the overall health of the Plan. Provide informational materials from your provider to assist the employee with potentially adjusting their future contributions to avoid requiring correction in future years.

Reviewing the non-discrimination testing packet with your provider as soon as possible after you receive it, will ensure you understand the results and can take any necessary action timely to avoid penalties from the IRS.

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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.

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