Non-Discrimination Testing
Deciphering Non-Discrimination Testing: Ensuring Fair Benefits for All
Understanding Non-Discrimination Testing
Non-discrimination testing (NDT) is a set of tests mandated by the Internal Revenue Service (IRS) to ascertain the fairness of a company’s benefits, specifically evaluating equality between highly-compensated employees (HCEs) and non-highly compensated employees (NHCEs).
Purpose of Discrimination Testing
The primary objective of NDT is to ensure that benefits contribution rates for HCEs are in line with what NHCEs can feasibly match. This aims to promote financial equality within the workplace. Additionally, by regulating contributions, it prevents business owners from unfairly leveraging substantial tax advantages.
Mandatory Nature of Non-Discrimination Testing
Originally established for 401(k) plans, NDT now extends to various plans under Section 125. Examples include health savings plans such as flexible spending accounts (FSAs), health savings accounts (HSAs), and health reimbursement accounts (HRAs).
Performing Non-Discrimination Testing
The process of NDT varies for different benefit plan types. For 401(k) plans, the three most common tests are:
- Actual Deferral Percentage (ADP) Test
- Actual Contribution Percentage (ACP) Test
- Top-Heavy Test
Actual Deferral Percentage (ADP) Test
This test compares the average salary deferrals of HCEs to NHCEs for their 401(k) plans. It ensures a reasonable balance in contributions. To pass, the ADP for HCEs must not exceed specified percentages in relation to NHCEs.
Actual Contribution Percentage (ACP) Test
Similar to the ADP test, the ACP test includes employer-matched contributions and after-tax contributions. It assesses whether all employees receive fair compensation, with specific percentages defining compliance.
Top-Heavy Test
This test evaluates whether key employees benefit disproportionately from a company’s retirement plans. Key employees are defined by the IRS based on income and ownership percentages. If key employees own more than 60% of plan assets, the plan fails NDT.
Non-Discrimination Test Correction
In the event of NDT failure, employers must take corrective measures to align the plan with compliance standards. The corrective action required and the deadline depend on the specific NDT type and the plan’s provisions. Conducting NDTs early in the plan year provides ample time for corrections.
Conclusion: Navigating Non-Discrimination Testing
Non-discrimination testing is a critical aspect of maintaining fair and equitable benefits within a company. Understanding the intricacies of each test and taking prompt corrective action when needed ensures compliance with IRS regulations and fosters a balanced workplace financial environment.