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401(k) plans offer meaningful tax advantages — employees defer income taxes, employers deduct contributions, and investment earnings grow tax-deferred. In exchange, the IRS requires that plans not disproportionately favor owners or highly paid employees. Annual testing enforces that balance.
If you sponsor a 401(k) plan, annual testing is part of your compliance responsibilities. Your 401(k) provider will handle the calculations, but understanding the basics can help you avoid surprises before year-end.
At a high level, annual 401(k) testing falls into three categories:
- Nondiscrimination testing
- Top-heavy testing
- Annual contribution limits
Let’s walk through each.
Nondiscrimination Testing
Nondiscrimination testing ensures the plan does not favor highly compensated employees (HCEs) over non-highly compensated employees (NHCEs).
Under IRS rules, an employee is an HCE if they meet either:
- Compensation Test – The employee earned more than the IRS compensation threshold in the prior year (the threshold is indexed annually for inflation), or
- Ownership Test – The employee owned more than 5% of the business (directly or indirectly) during the current or prior year.
For the 2026 plan year, an employee is an HCE if they earned more than $160,000 in 2025, or meet the 5% ownership test. All others are NHCEs.
Depending on plan design, up to four nondiscrimination tests may apply to a 401(k) plan each year:
- Coverage (IRC 410(b)) Testing
- Actual Deferral Percentage (ADP) Testing
- Actual Contribution Percentage (ACP) Testing
- 401(a)(4) General Nondiscrimination Testing
Not every plan is subject to all four tests. Understanding which tests apply to your plan is the first step toward avoiding year-end surprises.
Among these tests, coverage testing is foundational.
Coverage Testing (IRC 410(b))
All 401(k) plans must pass coverage testing. This test checks whether enough NHCEs are included (covered) by each contribution type.
Passing the Coverage Test
Each contribution type (deferrals, match, profit sharing) is tested separately.
Under the most common method — the Ratio Percentage Test — the following must be at least 70%:
(NHCEs covered ÷ Total NHCEs) ÷ (HCEs covered ÷ Total HCEs)
Correcting a Failed Coverage Test
If too many NHCEs were excluded from a contribution, the correction requires retroactively expanding coverage to include enough NHCEs to pass the coverage test.
What that involves depends on the contribution type:
- Employer contributions: Fund the contribution the excluded NHCEs should have received, plus earnings.
- Elective deferrals: If employees were improperly excluded from deferring, the employer may need to contribute on their behalf and make up any related missed matching contributions and earnings.
Preventing Future Coverage Issues
Coverage failures often result from ownership changes, acquisitions, or misunderstandings about related companies. Review ownership annually and evaluate eligibility before making structural changes.
Actual Deferral Percentage (ADP) Testing
Traditional 401(k) plans must pass the ADP test. Safe harbor plans are exempt if they meet required contribution and notice rules.
The ADP test compares average salary deferral percentages between HCEs and NHCEs.
Passing the ADP Test
The ADP of the HCE group cannot exceed the greater of:
- 125% of the NHCE group ADP, or
- The lesser of:
- 200% of the NHCE group ADP, or
- The NHCE group ADP plus 2 percentage points.
The NHCE group ADP can be based on current or prior year contributions.
Example: If the NHCE ADP is 4%, the maximum allowable HCE ADP is 6%:
- 125% test: 4% × 125% = 5%
- 2% spread test: lesser of 8% (200% of 4%) or 6% (4% + 2%)
- The rule allows the greater of 5% or 6% → 6%
Correcting a Failed ADP Test
To fix a failure, you have three options:
- Refund excess deferrals (plus earnings) to HCEs. For calendar-year plans, this must generally occur by March 15 to avoid a 10% excise tax.
- Make a qualifying employer contribution (called a QNEC) to NHCEs to raise their ADP.
- Retroactively adopt safe harbor status and fund a 4% nonelective contribution to (at least) NHCEs by the end of the following plan year.
Preventing Future ADP Issues
Low NHCE participation — not excessive HCE deferrals — usually drives failures. Automatic enrollment and escalation are often the most effective long-term solutions. If failures become routine, a safe harbor design may be appropriate.
Actual Contribution Percentage (ACP) Testing
The ACP test mirrors the ADP but applies to matching and after-tax contributions. Traditional 401(k) plans must pass; safe harbor plans are generally exempt.
Passing the ACP Test
The HCE average contribution percentage must fall within the same 125% / 200% / +2% limits used for ADP testing.
Correcting a Failed ACP Test
Excess match may be refunded or forfeited, or QNECs may be made to NHCEs.
Preventing Future ACP Issues
Increasing match participation is often more effective than changing formulas. Automatic enrollment can materially improve results.
401(a)(4) General Nondiscrimination Testing
Plans that allocate different contribution percentages to different groups — such as cross-tested or tiered profit-sharing plans — must satisfy 401(a)(4) testing. Uniform contribution formulas generally pass automatically.
Passing the 401(a)(4) Test
Employer allocations must be nondiscriminatory in amount. This is typically demonstrated through rate group testing, performed on either:
- A contribution basis, or
- A benefits (cross-tested) basis.
Under cross-testing, contributions are converted into projected retirement benefits so employees of different ages can be compared fairly. This approach works particularly well when older HCEs receive higher contribution rates than younger NHCEs, since younger employees’ contributions have more time to grow.
Correcting a Failed 401(a)(4) Test
Corrections generally require increasing allocations to NHCEs and re-testing.
Preventing Future 401(a)(4) Issues
Because results depend on workforce demographics, model allocations before finalizing contributions — especially after staffing or ownership changes.
Top Heavy Testing
Most defined contribution plans are subject to top heavy testing. The test compares key employee balances to total plan assets. Safe harbor plans are not exempt, although safe harbor contributions often satisfy minimum requirements automatically.
A key employee is generally:
- A more-than-5% owner
- A more-than-1% owner earning above an IRS threshold
- An officer earning above an indexed IRS compensation limit
Passing the Top Heavy Test
A plan passes if key employees hold 60% or less of total plan assets.
Correcting a Failed Top Heavy Test
If the plan is top-heavy, the employer must generally make a 3% minimum contribution to non-key employees (or a lower percentage if key employees receive less).
Preventing Future Top Heavy Issues
Monitor owner balance concentration, encourage participation, and budget for potential minimum contributions. Safe Harbor contributions may satisfy minimums automatically.
Compliance with Annual Contribution Limits
Annual limits apply individually rather than by comparing employee groups. All qualified defined contribution plans are subject to these limits.
Section 402(g) Limit for Elective Deferrals
Section 402(g) limits total elective deferrals (pre-tax + Roth) regardless of how many plans a participant contributes to.
For 2026, the 402(g) limit is $24,500.
Correcting 402(g) Failures
Excess deferrals must generally be distributed by April 15 of the following year to avoid double-taxation.
Preventing Future 402(g) Issues
- Coordinate payroll and plan records
- Review participation in multiple plans
Catch-up Limit for Elective Deferrals
Participants age 50 or older may contribute catch-up contributions above the 402(g) limit. Beginning in 2025 under SECURE 2.0, participants ages 60–63 may qualify for an enhanced catch-up limit.
For testing purposes, catch-up contributions are excluded from ADP testing.
For 2026:
Correcting Catch-Up Failures
Excess catch-up contributions are corrected using the same procedures that apply to excess elective deferrals.
Preventing Future Catch-Up Issues
Ensure payroll tracks age eligibility and proper classification, and confirm compliance with SECURE 2.0 Roth catch-up rules if applicable.
Section 415(c) – Annual Addition Limit
Section 415(c) limits total annual additions — deferrals, match, profit sharing, and after-tax contributions.
For 2026, the 415(c) limit is $72,000 (or 100% of compensation, if lower).
Correcting 415(c) Failures
Excess annual additions must be corrected through distribution or reallocation under IRS rules.
Preventing Future 415(c) Issues
Monitor cumulative contributions throughout the year, especially for owners and cross-tested plans.
Staying Out of Trouble is Easy with the Right Help!
Annual 401(k) compliance centers on nondiscrimination testing, top-heavy testing, and contribution limits. Each exists to ensure retirement benefits are shared fairly across your workforce.
Although your provider handles the technical calculations and corrections, proactive monitoring makes compliance far more predictable. Reviewing participation trends, monitoring contributions, and evaluating plan design before year-end can prevent most surprises — and make managing your 401(k) far less stressful.
