What is non-discrimination testing?

Non-discrimination testing (NDT) is an annual evaluation of an organization's benefits program, particularly focusing on ensuring that highly compensated employees (HCEs) do not receive preferential treatment or greater access to benefits compared to other employees. This practice is mandated under the Employee Retirement Income Security Act (ERISA), which requires that qualified retirement plans do not exhibit selective or discriminatory behavior. All eligible employees must have equal access to benefits, including investment options, employer match amounts, and tax deductions, under ERISA.

Purpose and Scope of NDT

The Internal Revenue Service (IRS) oversees non-discrimination testing to maintain the qualified status of retirement plans and adhere to safe harbor provisions outlined in ERISA. While initially instituted to regulate 401(k) plans, NDT now extends its purview to include other plans under IRC Section 125, such as health savings accounts (HSAs), health reimbursement accounts (HRAs), and flexible spending accounts (FSAs). NDTs should occur annually, with reports submitted to the IRS by the last day of the plan year. Failure to pass NDTs necessitates corrective actions by employers to ensure plan compliance.

Ensuring Financial Equality

NDT ensures that employers maintain parity in benefits contribution rates between HCEs and non-highly compensated employees (NHCEs). Additionally, it verifies that employers do not gain unfair tax advantages from their 401(k) contributions, thereby safeguarding financial equality in the workplace. Different types of benefits necessitate distinct NDTs, including the Actual Deferral Percentage (ADP) test, the Actual Contribution Percentage (ACP) test, and the Top-Heavy Test, among others.

Conducting ADP and ACP Tests

Actual Deferral Percentage (ADP) Test: Compares the average salary deferrals of HCEs and NHCEs for their 401(k) contributions. Employers calculate the Annual HCE Contribution Rate and the Annual NHCE Contribution Rate, ensuring that the former does not exceed prescribed limits set by the IRS. Actual Contribution Percentage (ACP) Test: Assesses both employer-matched contributions and after-tax employee contributions in addition to employee deferrals for each group (HCEs and NHCEs). Employers calculate the ACP for each group, ensuring compliance with IRS regulations.

Compliance and Adaptation

Employers must stay abreast of current laws and regulations governing NDT and consult with experts to maintain compliance in various benefits plans. The specific testing procedures and requirements may evolve with regulatory changes, necessitating ongoing vigilance and adaptation to ensure plan compliance and financial equity within the organization.