401k Discrimination Testing

401k discrimination testing is necessary to make sure that employers do not give more benefits to highly compensated employees then to non-highly compensated employees.

The plan must be tested at least once annually. And it must pass two 401k Discrimination Tests.

1. ADP

The actual deferral percentage (ADP) will look for the amount deferred by each group in the company. The amount deferred by highly compensated employees cannot exceed 2% of that deferred by non highly compensated employees.

2. ACP

Average Contribution Percentage (ACP) is relevant only if the company matches employee contributions or after tax contributions. It can limit the amount of money that highly compensated Employees are able to contribute.

If the company does not meet these tests then they may have to refund money that was invested into the 401k by their employees. These employees must then pay taxes on the money that was refunded to them.

Safe Harbor 401k Plan

The Safe Harbor Plan can be used to satisfy both ADP and ACP. It involves contributing 3% of compensation to all eligible employees who have been employed at some point within the year.

For it to work all employees that are eligible must receive the contribution and it must be 100% vested.

If the company is not top heavy and the company is matching contributions they may consider using an alternative plan called the safe harbor match.

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