Qualified Plan Design, Coverage, and Nondiscrimination Testing
Design Choices
Plans vary by type (defined benefit, defined contribution, 401(k), 403(b), ESOP), contribution formula, vesting schedule, and distribution options. Design decisions drive testing outcomes. A safe harbor 401(k) avoids ADP and ACP testing but requires mandatory employer contributions and immediate vesting.
Coverage and Nondiscrimination
Section 410(b) coverage tests whether enough non-highly compensated employees benefit. The ratio percentage test requires 70 percent, or the average benefit test applies. Section 401(a)(4) requires nondiscriminatory benefits, often tested through ADP/ACP for deferrals and match, or through general testing for employer contributions. Top-heavy rules under 416 add minimum contributions when key employees exceed 60 percent of account balances.
Compensation and Highly Compensated Employees
HCE status is determined by the prior-year compensation threshold or ownership. Compensation must satisfy 414(s) for testing. Trap: using current-year compensation for HCE determination instead of the lookback year.
Traps to Watch
- Assuming safe harbor status eliminates top-heavy minimums; it generally does for the safe harbor contributions only.
- Forgetting that ADP testing uses prior-year deferral percentages.
- Missing that 410(b) coverage uses the plan year, not the calendar year, for non-calendar plans.
- Confusing ACP (match and after-tax) with ADP (elective deferrals).
Rule of Thumb
Test in order: coverage first, then nondiscrimination, then top-heavy. A plan that fails coverage cannot be rescued by passing 401(a)(4).