401k Nondiscrimination Testing Explained

📝 The government requires companies offering 401k plans to keep things fair for all employees. This ensures that highly paid employees (like executives) don’t get much better retirement benefits than regular employees.

Each year, companies must run tests to prove that the retirement benefits and contributions are relatively equal between these two groups of employees: 

If a company fails these fairness tests, they must either give more money to lower-paid employees’ retirement accounts or return some money from higher-paid employees’ accounts to make things more equal.

The IRS updates the qualifications for each group each year. For 2025, an employee qualifies as an HCE if they:

Here are some examples:

Any other employee who does not meet these criteria is classified as an NHCE.

What is Nondiscrimination Testing?

The Employee Retirement Income Security Act (ERISA) requires all  employers who sponsor a 401k plan to conduct nondiscrimination testing each year. These tests  make sure retirement benefits don’t disproportionately favor owners or HCEs over NHCEs. 

To pass, companies must prove that all employees get fair access to:

✅ Contribution limits
✅ Investment options
✅ Employer matches
✅ Other plan benefits

HCEs can receive slightly higher retirement benefits, but only within the IRS limits. These are calculated using the nondiscrimination tests, which we’ll explain below.

The Three Main Types of 401k Nondiscrimination Tests

There are the three annual nondiscrimination tests a 401k sponsor must pass:

✅ Compares the percentage of salary HCEs contribute vs. NHCEs.

✅ Ensures HCEs aren’t saving at a much higher rate than NHCEs.

✅ Compares employer contributions received by HCEs vs. NHCEs.

✅ Prevents HCEs from getting significantly higher employer matches.

✅ Ensures that key employees (like owners or executives) don’t hold more than 60% of the plan’s total assets.

✅ If they do, the company must make extra contributions to NHCEs.

The Actual Deferral Percentage (ADP) test

The Actual Deferral Percentage (ADP) test measures how much of their salary HCEs contribute to their 401(k) compared to NHCEs. It ensures that highly paid employees aren’t deferring significantly more than everyone else. The ADP is calculated by dividing an employee’s 401(k) deferrals by their total W-2 income (the total taxable income an employee earns from their employer) and then averaging the results for each group.

✏️ For example:

If NHCEs, on average, defer 5%, but HCEs defer 10%, the company may fail the test because HCEs are saving at a much higher rate.

📌 Related: Can A W-2 Employee Contribute To A SEP IRA?

The Actual Contribution Percentage (ACP) Test

The Actual Contribution Percentage (ACP) test checks whether employer contributions (such as matching or profit-sharing) favor HCEs over NHCEs. It compares the average employer contributions each group receives as a percentage of their W-2 income.

The ACP is calculated by dividing the employer contributions to an employee’s plan by their W-2 income.

✏️ For example:

If the NHCE average is 3%, HCEs must stay within the allowable limit based on IRS rules. If HCEs receive too high a match, the company fails the test and must take corrective action.

The Top Heavy Test

The top heavy test checks whether key employees (owners and certain high-ranking employees) hold more than 60% of the total 401(k) plan assets.

A key employee meets any of the following:

✅ Owns more than 5% of the business.

✅ Owns more than 1% of the business and earns over $150,000.

✅ Earns over $230,000 in 2025.

Both HCEs and NHCEs can be key employees.

Unlike the ADP and ACP tests, which focus on HCEs, the top heavy test looks specifically at key employees to prevent them from dominating the plan’s benefits.

✏️ For example:

Since key employees hold more than 60%, the plan fails the test, and the company must make additional contributions to NHCE accounts to restore balance.

How Often Are Nondiscrimination Tests Conducted?

Companies are legally required to conduct nondiscriminatory tests annually, typically at the end of the plan year or the first day of the next plan year. Internal tests should be run at least once, or even multiple times, a year to make sure that the plan stays compliant and there are no surprises on test day.

Passing the ADP and ACP Tests

Companies are legally required to conduct nondiscriminatory tests annually, typically at the end of the plan year or the first day of the next plan year. Internal tests should be run at least once, or even multiple times, a year to make sure that the plan stays compliant and there are no surprises on test day.

NHCEs percentage	Maximum percentage allowed for HCEs
2% or less	2x the NHCE percentage
Over 2% but under 8%	2% above NHCE percentage
Over 8%	1.25% above NHCE percentage

What if I Fail the Nondiscrimination Tests?

Failing is common, but you must fix it to avoid IRS penalties.

If You Fail the ACP or ADP Test:

If You Fail the Top-Heavy Test: 

Safe Harbor 401k Plan Exemption

A company can choose to set up a Safe Harbor 401k plan to automatically pass the nondiscrimination tests.

To qualify, employers must:

✅ Match 100% of employee contributions up to 4% (not exceeding 6%).

✅ Match 100% of employee contributions up to 3%, and 50% of the next 2%.

✅ Contribute 3% of employee compensations,even if they don’t participate.

A Safe Harbor 401k not only exempts you from nondiscrimination testing, but also encourages employees to save for retirement. Plus, the employer match can be a great way to attract top talent to your company.

Disclaimer: This article provides general information about 401(k) nondiscrimination testing and is intended for educational purposes only. It should not be considered financial or legal advice. The rules and regulations governing 401(k) plans and nondiscrimination testing are complex and subject to change. This article simplifies certain concepts for clarity and may not cover all aspects of these regulations.

For specific guidance related to your 401(k) plan or compliance with IRS regulations, it is essential to consult with a qualified financial advisor, tax professional, or legal counsel. The information provided herein does not substitute for professional advice, and reliance on this information is solely at your own risk.

While we strive to ensure the accuracy of the information presented, laws and regulations change frequently. Always refer to the official IRS publications and resources for the most current and detailed information. We are not responsible for any errors or omissions, or for any actions taken based on the information provided in this article.

Remember that the specific circumstances of your company’s 401(k) plan may significantly impact the application of these rules. Do not make decisions about your plan based solely on this information.