The 401(k) plan is one of the most common employer-sponsored retirement savings options today. It allows participants to save on a tax-deferred basis, thereby lowering taxable income and deferring taxes on contributions and earnings until retirement. Employers benefit, too, by receiving tax deductions for contributions they make to the plan.

It’s a win-win for everyone involved.

But just when you think everything's under control, here comes Uncle Sam with his compliance tests.

To maintain those tax advantages, 401(k) plans must meet certain requirements under the Employee Retirement Income Security Act of 1974 (ERISA). ERISA governs private sector retirement plans, ensuring employee benefits are protected and employers meet their fiduciary responsibilities. Plans must also conform to IRS regulations, which include annual compliance tests to ensure they operate fairly and equitably.

A key requirement is that a 401(k) plan must benefit all employees — not just executives and owners. To ensure the rules are followed, plans must conduct annual compliance tests. These tests compare contributions and benefits for different employee groups, proving the plan doesn’t unfairly favor highly paid employees.

Why Compliance Testing Matters

The main reason for compliance testing for 401(k) plans is quite simple – to ensure the plans are fair and that they continue to meet their legal responsibilities to discourage discrimination and safeguard plan benefits. Here’s why it matters:

Promotes Fairness: 401(k) plans are intended operate fairly and equitably for all employees, regardless of their job title or how much money they make. Testing prevents discrimination against non-highly paid employees by ensuring a plan doesn’t disproportionately favor one group over another. Failing these tests could jeopardize the plan’s tax-qualified status.

Ensures Legal Compliance: 401(k) plans must adhere to IRS-approved plan documents and regulations. Staying compliant protects both the plan's status and the tax benefits tied to it.

Accurate Administration: Compliance testing confirms the plan is being administered correctly according to its plan document and IRS rules. This reassures employees that they are treated fairly and strengthens trust in the plan.

Maintains Tax-Qualified Status: Failure to pass compliance tests could result in the loss of tax-deferral benefits for both employee contributions and investment growth, as well as the employer's tax deductions.

Reduces Risk: Plans are required to pass the tests to stay in compliance. Passing the tests minimizes the risk of incurring penalties and fines from the IRS. Failed compliance tests can lead to costly corrections, or, in extreme cases, plan disqualification.

While these tests can seem "pesky," they ultimately protect employers and employees. Far beyond satisfying IRS requirements, they ensure plan integrity, build employee trust, and encourage greater participation.

Introduction to Key Tests

Different 401(k) plan types have different rules, but most companies run three key tests annually to confirm their plan’s compliance.

But first, let's review two key employee categories in 401(k) testing:

• Highly Compensated Employees (HCEs): Employees earning more than an IRS-specified amount or who own more than 5% of the company. The threshold is $160,000 for 2025. Employees in the top 20% salary range may also qualify as HCEs.

• Non-Highly Compensated Employees (NHCEs): Employees who don’t meet the HCE criteria.

Key Compliance Tests

ADP (Actual Deferral Percentage) Test: Compares deferrals made by HCEs and NHCEs. Ensures HCEs aren’t contributing significantly more of their salary to the plan than NHCEs. Deferrals include pre-tax and Roth, but not catch-up contributions.

• Applies To: Traditional 401(k) plans with employee deferrals.

• Be On the Lookout For: Significant gaps between HCE and NHCE deferral rates.

• Key Tip for Passing: Encourage widespread NHCE participation through education or automatic enrollment.

ACP (Actual Contribution Percentage) Test: Similar to the ADP test except it focuses on employer matching contributions instead of deferrals. Ensures matching contributions don’t disproportionately favor HCEs.

• Applies To: Traditional 401(k) plans with employer matching or voluntary after-tax contributions.

• Be On the Lookout For: Disparities in employer match contributions.

• Key Tip for Passing: Consider a Safe Harbor plan design to automatically meet ACP requirements automatically.

Top-Heavy Test: Ensures key employees (owners, officers, and certain highly compensated employees) don’t control more than 60% of total plan assets.

• Applies To: All 401(k) plans and other qualified plans.

• Be On the Lookout For: High plan asset concentrations among key employees.

• Key Tip for Passing: For plans approaching the 60% threshold, consider offering a minimum employer contribution to NHCEs to maintain compliance.

Beyond the Basics: Additional Compliance Tests to Know

While the ADP, ACP, and Top-Heavy tests are the most familiar, they’re not the only compliance tests that matter. Some plans require additional tests to ensure fairness in specialized plan designs:

• Coverage Test: Ensures a plan covers a broad cross-section of employees and doesn’t exclude too many NHCEs. Common in plans with restricted eligibility or complex organizational structures.

• 410(b) Test: A specific type of coverage test that confirms NHCEs are fairly represented in the plan. Crucial for plans with complex employee classifications or divisions.

• 401(a)(4) Nondiscrimination Test: Ensures employer contributions and benefits don’t disproportionately favor HCEs. Often required in Profit-Sharing Plans, New Comparability Plans, or those with customized contribution formulas.

These tests are less familiar because they’re often required for more complex plan designs. While ADP, ACP, and Top-Heavy tests apply to most traditional 401(k) plans, coverage and other nondiscrimination tests are critical for ensuring fairness in specialized plans or those with unique contribution formulas.

The Role of Those Pesky Compliance Tests – We Need Them

It’s no surprise that the ADP, ACP, and Top-Heavy tests get the most attention — they address the most critical aspects of plan operation and are often the only tests required for small to mid-sized plans. However, other tests are equally important for certain designs.

For plans with discretionary contributions, specialized formulas, or strict eligibility rules, tests like the Coverage Test, 410(b), and 401(a)(4) are equally important. Each test ensures your plan meets IRS requirements and protects its tax-advantaged status.

The Value of Proactive Testing

Proactive compliance testing can save time, stress, and costly corrections. Monitoring contributions, participation rates, and asset balances throughout the year — rather than waiting until year-end — helps the plan sponsor identify potential issues early and make timely adjustments before problems arise. Proactive testing not only helps maintain compliance but also promotes plan integrity and builds employee trust.

Those Pesky Compliance Tests – Uncle Sam Requires Them

Each test plays a distinct role in maintaining fairness, ensuring access for all employees, and protecting the plan’s tax-advantaged status. By understanding which tests apply to which type of plan — and conducting regular compliance checks — plan sponsors can avoid costly corrections and better support their employees' financial future.

Let Stax.ai Help

Stax.ai offers powerful tools to support plan sponsors with their nondiscrimination testing needs. By ensuring participant data is accurate, comprehensive, and accessible, Stax.ai simplifies compliance management and helps plan sponsors administer their plans with greater confidence.

Stax.ai is dedicated to helping TPAs manage administrative challenges — including compliance testing — required by the IRS. Interested in a demo? Contact Stax.ai and learn how we can help you keep your participant data accurate and up to date.