Demystifying Non-Discrimination Testing in Retirement Plans: What You Need to Know
Are you familiar with the term "non-discrimination testing" when it comes to retirement plans? It may sound a bit intimidating, but it gets a bit of a bum rap! We'll explore the goal of non-discrimination testing, how it works, and whether it should be a cause for concern for you as a Plan Sponsor.
What is the purpose of non-discrimination testing? Well, its main objective is to ensure that retirement plans do not favor highly compensated employees (HCEs) over non-highly compensated employees (NHCEs). An HCE is broadly defined as earning $150,000 in 2023, a big jump up from $135,000 in 2022. The goal is to maintain fairness and prevent the plan from becoming a tax shelter for the wealthy. Non-discrimination testing is a crucial part of upholding the integrity of retirement plans and ensuring they benefit all eligible employees, regardless of their compensation levels.
Now, let's get into the basics of how non-discrimination testing actually works. During the testing process, various factors are examined, such as employee contributions, employer contributions, and benefits provided by the plan. These factors are evaluated to determine if there are any significant discrepancies between the benefits received by HCEs and NHCEs. The main tests performed annually for 401(k) plans are the Actual Deferral Percentage (ADP) Test, the Actual Contribution Percentage (ACP) Test, and a Top-Heavy test. Specific tests, in follow up, can vary depending on the type of retirement plan, but the underlying principle remains the same: equitable treatment for all plan participants.
Now, you may be wondering, as a Plan Sponsor, if non-discrimination testing should be a cause for concern. Well, the short answer is not necessarily. While non-discrimination testing adds an extra layer of compliance responsibility, it shouldn't be feared. Instead, think of it as a valuable tool to ensure your retirement plan remains fair and inclusive.
"So, what happens if the testing results in a failure?" This is probably one of the most common questions I receive from Plan Sponsors. A non-discrimination testing failure is not like a failure in school. It should not define your plan, nor will your organization's plan be painted with a scarlet letter. A failure simply helps identify to a Plan Sponsor that the plan is currently weighted in favor of the HCEs. Most immediately, the failure needs to be corrected to bring the plan back into compliance. The most common method of correction is a refund to the identified HCEs. However, there are alternate options that can and should be considered.
Longer term, a qualified Retirement Plan Advisor can help you identify potential plan design levers that can work towards your organizations passing their non-discrimination tests in future years. The plan can also consider adopting Safe Harbor Provisions - there are some features the plan must implement including a stated employer contribution and generally shorter vesting schedules. In exchange for formalizing those into the plan provisions, the plan gets to disregard the results of the non-discrimination testing - they are rendered moot!
Non-discrimination testing in retirement plans serves an essential purpose: to ensure fairness and equal treatment for all plan participants. While it may seem complex, it's a crucial aspect of maintaining compliance and upholding the integrity of your retirement plan. As a Plan Sponsor, understanding the goal of non-discrimination testing, how it works, and its potential impact can help you navigate this aspect of retirement plan administration. Remember, it's an opportunity to create an inclusive retirement plan that benefits all employees, regardless of their compensation levels.
And remember! A failure does not paint you as a Plan Sponsor with a bad brush. By working with a Retirement Plan Advisor, you can explore the ways, within the goals and budget of the plan, you can move the needle on the testing that results in a future passing result. A qualified financial advisor can help you navigate the varying options and make an informed decision. If you're looking for a Retirement Plan Advisor to help you start or manage your retirement plan, email us today, Christina.Tunison@lpl.com.
This information is not intended as authoritative guidance or tax or legal advice. You should consult your attorney or tax advisor for guidance on your specific situation. In no way does advisor assure that, by using the information provided, plan sponsor will be in compliance with ERISA regulations.
#439232 May 2023