A 401(k) plan must meet certain nondiscrimination tests to ensure that highly compensated employees cannot elect to defer a disproportionately higher amount of their salary than the non-highly compensated employees are deferring. If the 401(k) plan does not meet these special nondiscrimination requirements, it may be disqualified.
Nondiscrimination testing applies separately to non-elective contributions, elective contributions, employer matching and employee after–tax contributions.
Non-elective contributions must satisfy the nondiscrimination standards set forth in Section 401(a)(4) of the Internal Revenue Code.
Elective contributions must satisfy one of the limit tests set forth in Section 401(k)(3)(a)(ii) of the Code. For the purpose of meeting the actual deferral percentage test, all or part of the qualified non-elective contributions and qualified matching contributions may be treated as elective contributions.
NOTE: Disqualification can be prevented if the contributions in excess of the limitation are distributed to the contributing employees or are re-characterized as after–tax contributions.
Highly Compensated Employees
A qualified plan cannot discriminate in favor of highly compensated employees (HCEs). An HCE is any individual, who during the year or the preceding year:
- Was a 5 percent owner of the employer; or...