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Business owners who sponsor a qualified retirement plan for employees may hear their provider mention “plan testing.” What does this mean and why does it matter?

A 401(k) plan is one of the most popular retirement savings tools and can be a powerful way to attract talent. However, to maintain the plan’s tax-advantage status and ensure it benefits employees fairly, the IRS requires annual compliance testing.

The purpose is to maintain fairness to prevent business owners and executives from receiving excessive tax-deferred benefits while lower-paid employees receive little to no benefit from the plan.

Plan testing refers to a series of non-discrimination tests to ensure that the company’s plan does not disproportionately favor highly compensated employees (HCEs) over non-highly compensated employees (NHCEs).

Who is an HCE? This is an employee who owns more than 5% of the company, is related to a more than 5% owner in a certain capacity, or earns over a certain compensation threshold (e.g., $160,000 in 2025). The status of each employee should be reviewed each year by the provider performing the tests.

Types of 401(k) Compliance Testing

1. Actual Deferral Percentage (ADP) Test. This test compares the average percentage of compensation that HCE’s defer into their 401(k) accounts with that of NHCEs. If HCEs defer too much more than the NHCEs, the plan may fail this test.
2. Actual Contribution Percentage (ACP) Test. This test looks at employer matching contributions and after-tax contributions, comparing the average percentage contributed for HCEs and NHCEs.
   • If either the ADP or ACP tests fail, the employer must take corrective action. Common remedies include refunding the excess contributions to the HCEs, making additional contributions to the NHCEs, or recharacterizing contributions, if eligible.
   • If a plan continues to fail testing year after year, employers may consider changing to a safe harbor plan design. This plan design requires employers to make minimum contributions to employees’ accounts and in return, the plan is exempt from the ADP and ACP testing.

Other 401(k) Plan Testing

1. Top-Heavy Test. This test ensures that Key employees (owners or officers earning above a compensation threshold) don’t hold more than 60% of the plan’s total assets. If a plan is “top-heavy”, employers must generally make minimum contributions to Non-Key employees’ accounts, which is typically 3% of compensation. The determination of which employees are considered Key employees should be reviewed yearly by the provider performing the tests.
2. Deduction / Contribution Limit Reviews. The dollar limit that an employee can defer annually out of their own payroll is limited, as well as the total amount of contributions into the plan, which combines deferrals with employer contributions received by an employee during the year. These annual dollar limitations are adjusted each year by the IRS and can vary based on the employee’s age. It is important to do periodic reviews throughout the year to ensure that no employee exceeds these limitations.
3. Coverage Test. This test ensures the plan covers a fair cross-section of employees and focuses on who is benefiting from the plan. The plan must provide meaningful benefits to NHCEs, not just executives and owners. An employee is considered benefiting if they are eligible and participating / receiving employer contributions. There are a couple of different tests that can be run to see if coverage is sufficient. Failing coverage testing is a serious compliance issue and a plan could lose its tax-qualified status.

Plan testing is an essential part of maintaining a compliant and fair plan. The process can become very complex, and the limits are ever-changing, so it is important that the plan sponsor hires a trusted and experienced provider to perform these tests. At Greenleaf Trust, our current staff within the retirement plan division that perform these tests have a combined 108 years of experience!