401(k) Nondiscrimination Testing: Rules, Key Tests & Compliance Tips

If your business offers a 401(k), it’s not just about setting up the plan and forgetting about it. Each year, the IRS requires a type of testing known as 401(k) nondiscrimination testing.

These checks make sure the plan isn’t designed to favor business owners or top executives over regular employees. Passing the tests helps you avoid penalties and keeps your retirement plan fully compliant.

What is 401(k) Nondiscrimination Testing?

At its core, 401(k) nondiscrimination testing is a set of IRS rules that confirm all employees, regardless of their compensation level, are treated fairly in the plan. It measures contributions, benefits, and participation levels across different groups of workers.

Why Does IRS 401(k) Nondiscrimination Testing Matter?

The federal government gives 401(k) plans special tax benefits. Nondiscrimination testing is how the IRS ensures those perks don’t end up helping only the company’s owners or highest earners.

401(k) plan nondiscrimination testing fulfills the following purposes

• Keeps the Tax Advantages IntactThese annual tests make sure that everyone in the company benefits fairly, not just top executives. Otherwise, the IRS could take away the tax breaks that make a 401(k) so valuable.
• Maintains the Plan’s Qualified StatusPassing nondiscrimination testing shows the plan is following IRS rules. This keeps the plan “qualified,” which is necessary for it to stay legal and continue offering tax-deferred growth.

What are the Key Terms of Nondiscrimination Testing for 401(k) Plans?

Before diving deeper, it helps to know how employees are grouped for testing

• Highly Compensated Employee (HCE)This is an employee who owned more than 5% of the company in the prior year or earned over $160,000 in 2025. They are usually owners or high-level executives.
• Non-Highly Compensated Employee (NHCE)This refers to employees who do not meet the HCE criteria. Most of the regular workforce falls into this group.
• Key EmployeesThese are typically company owners or senior officers with high compensation. For 2025, it includes officers earning more than $220,000.

What are the Main Tests Every 401(k) Plan Faces?

Each year, plans are reviewed under a few different IRS tests. Together, these tests determine whether the plan is balanced for everyone, not just the higher earners.

Here are the most common ones

1. Coverage Test (IRC §410(b))

   Make sure enough lower-paid employees are actually covered by the plan. A plan that mostly benefits executives is likely to fail this test.

2. Actual Deferral Percentage (ADP) Test

   Looks at how much employees contribute from their salaries.

   • Example: If NHCEs contribute an average of 4%, HCEs can’t average more than about 6%.

3. Actual Contribution Percentage (ACP) Test

   Focuses on employer matching and after-tax contributions.

   • Example: If NHCEs receive a 3% average match, HCEs can’t average above 5%.

4. General Nondiscrimination Test (IRC §401(a)(4))

   A broader review of whether benefits and contributions are fairly distributed.

5. Safe Harbor 401(k) Plans

   Employers can avoid most of these tests by adopting a Safe Harbor plan. These require guaranteed employer contributions but offer automatic compliance.

How to Improve Your Chances of Passing 401(k) Nondiscrimination Testing?

You don’t have to wait until testing season to act. Some steps that help include

1. Automatic Enrollment

   By enrolling staff automatically, more employees, especially those who might otherwise delay, start saving right away. This widens participation and balances contributions between highly compensated and non-highly compensated employees.

2. Simplified Options

   When plan choices are too complex, employees may hesitate to participate. Streamlining options and offering straightforward contribution rates can remove confusion and encourage wider enrollment.

3. Education Sessions

   Workshops or short training sessions help employees understand how saving even a small amount now grows significantly over time. This awareness motivates more consistent contributions, supporting better compliance with testing.

What if Your Plan Doesn’t Pass the 401 (K) Nondiscrimination Test?

A failed 401(k) nondiscrimination test isn’t the end of the road, but it does mean quick fixes are needed

1. Double-Check Results

   Errors in calculations are more common than many realize. Reviewing the results or even using an alternative testing method can sometimes resolve the issue without making changes to contributions.

2. Take Corrective Action

   If the failure is confirmed, employers may need to refund excess contributions made by highly compensated employees (HCEs) or add extra contributions for non-highly compensated employees (NHCEs). Both options help bring the plan back into compliance.

3. Plan Ahead

   To avoid future problems, focus on increasing participation among lower-paid employees. Automatic enrollment, employer match programs, and ongoing education can boost contributions and reduce the risk of repeated failures.

401(k) nondiscrimination testing may feel like just another IRS hurdle, but it plays a critical role in keeping your plan tax-favored and fair. With the right plan design and employee engagement, most businesses can pass these tests without stress.