Plan Compliance Testing

Plan Compliance Testing

Testing is done each year to monitor whether the plan is in compliance with certain IRS and DOL requirements (check the “Calendar” under Forms, Tools and Resources for the testing dates for your plan). The tests performed are shown below:

Annual additions testing

The Program monitors the dollar limit of the annual additions limit imposed by the IRS on each individual plan participant. The annual additions limit is the lesser of 100% of pay or $69,000 (in 2024, as indexed) per plan year.

Top-heavy testing

Following the close of the plan year, the Program will perform testing to determine if the plan is top-heavy. The plan is top-heavy if more than 60% of the total account balances are in the accounts of “key employees” as of the last day of the prior plan year. A key employee is any employee who, during the prior year, was:

• more than a 5% owner of the firm,
• an officer of the firm receiving annual pay in excess of $220,000 (in 2024), or
• more than a 1% owner of the firm with annual pay in excess of $150,000.

Note: If an employee is a key employee as a result of ownership, then spouses and lineal ascendants and descendants who are also employees are considered key employees as well.

An employee who was previously a key employee, is no longer a key employee but is still employed by the employer is considered to be a former key employee. Former key employee account balances are not considered for top-heavy testing purposes.

Plans that are top-heavy are required by law to make a contribution to all non-key employees in the plan equal to the lesser of 3% of pay or the highest contribution (as a percentage of pay) made to or by any key employee.

Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) nondiscrimination testing

The Program will provide mid-year and end-of-year discrimination testing for profit sharing plans that elect the 401(k) option. The ADP and ACP tests are part of the required nondiscrimination testing of 401(k) plans. Testing is based on information provided by you through the Employee and Contribution Census along with a request to have the testing performed. The Program will contact you approximately two weeks following the close of your plan year to determine if you wish to have testing and/or employer contributions calculated.

Depending on which method of testing was elected in the Adoption Agreement, the non-highly compensated employee (NHCE) average will be based on either current year NHCE averages or prior year NHCE averages.

To pass the ADP test, average elective deferrals (including Roth 401(k) contributions) made by highly compensated employees (HCEs) stated as a percentage of pay (with pay limited to $345,000 in 2024, as indexed) cannot be greater than the larger of:

• 1.25 times the average percentage for eligible NHCEs, or
• two percentage points higher than, but not more than two times, the average percentage for eligible NHCEs.

To pass the ACP test, the average employer’s matching contribution to HCEs plus employee after-tax contributions as a percentage of compensation cannot be greater than:

• 1.25 times the average percentage for eligible NHCEs, or
• two percentage points higher than, but not more than two times, the average percentage for eligible NHCEs.

Note: Firms that have adopted SIMPLE 401(k) plans or have elected a traditional safe harbor contribution arrangement or a qualified automatic contribution arrangement (automatic enrollment safe harbor or QACA) and that satisfy the requirements of those plans are not subject to the ADP or ACP tests.

Note: If you have elected a safe harbor contribution formula (traditional or automatic enrollment), you must provide the required annual notification to your eligible employees no earlier than October 3 and no later than December 2 of each year.

Highly compensated employees

In general, a highly compensated employee (HCE) is any employee who:

• Was more than a 5% owner at any time during the year or preceding year, or
• Received compensation in excess of $125,000 during the plan year being tested or the preceding year.
  • Note: If your firm elects in your adoption agreement, this group can be limited to the top-paid group of employees for the preceding year. (“Top-paid group” means, when ranked by prior year pay, the employee was in the top 20% of your firm.) All “greater than 5% owners” will still be part of the HCE group even if not in the top paid group.

A non-highly compensated employee (NHCE) is any employee who does not meet the definition of an HCE.

The plan testing process

When the Program sends you the annual Employee and Contribution Census, be sure to complete and return it to the Program in a timely manner. The Employee and Contribution census data is used to determine HCEs and Key Employees and complete the top-heavy test and ADP/ACP nondiscrimination testing. In addition, this information is used to monitor the annual additions limit and prepare a contribution calculation if you request one.

If you do not return the information, the Program cannot complete these tests or calculate your employer contribution. If your plan fails the ADP or ACP test, you may be required to arrange for refunds of excess salary deferrals, matching or after-tax contributions, and earnings by two and a half months after the end of the plan year; otherwise, your firm incurs a 10% excise tax on the excess contribution amount. If your plan has an Eligible Automatic Contribution Arrangement (EACA) or a Qualified Automatic Contribution Arrangement (QACA), ADP/ACP test refunds must be distributed by six months after the end of the plan year; otherwise, your firm incurs a 10% excise tax on the excess contribution amount. Please note that any necessary refunds must be made by the end of the following plan year to avoid a disqualifying event.

Upon receipt of completed census information and request form, the Program will test your plan for the:

• Annual additions limit,
• Top-heavy status, and
• Nondiscrimination requirements, where applicable (ADP and ACP tests where applicable).

The Program will notify you if, as a result of these tests, there are any compliance issues or corrective measures you need to take. Generally, testing/calculation requests received in good order by the deadline indicated in our communication are handled within 15 business days.  Requests received in good order after the deadline are handled within 20 business days.

For more information on Compliance Testing, view the Program’s helpful webinar, which can be accessed here.