What Is 401(k) Non-Discrimination Testing? ADP, ACP, Top-Heavy Rules & Compliance Explained

Understand how 401(k) non-discrimination testing works and how it helps maintain IRS compliance and promote fair participation across employees.

Offering a 401(k) plan can be a valuable way to help employees prepare for retirement while supporting recruitment and retention goals. However, maintaining a qualified retirement plan comes with responsibilities — including complying with IRS non-discrimination testing rules.

For many plan sponsors, these tests can feel overly technical or intimidating. Yet the purpose behind them is fairly straightforward: ensuring that a retirement plan benefits employees broadly and does not disproportionately favor owners, executives, or highly compensated employees (HCEs).

Understanding how non-discrimination testing works — and what happens if a plan fails — can help sponsors avoid costly corrections, employee frustration, and potential compliance headaches.

Why 401(k) Non-Discrimination Testing Is Required

401(k) plans receive favorable tax treatment under IRS rules. In exchange, employers must demonstrate that the plan operates fairly for all eligible employees, not just leadership or top earners.

Non-discrimination testing is designed to measure whether rank-and-file employees are participating and benefiting from the plan at levels reasonably comparable to highly compensated employees. In general, an HCE is someone who:

• Earned above the IRS compensation threshold in the prior year, or
• Owns more than 5% of the company

Employees who do not meet those criteria are considered non-highly compensated employees (NHCEs).

The IRS updates compensation thresholds periodically, so sponsors should confirm current limits each year with their recordkeeper, TPA, or advisor.

Common Types of 401(k) Non-Discrimination Tests

While retirement plans may undergo several compliance tests, the most common non-discrimination tests for 401(k) plans are the ADP and ACP tests.

ADP Test (Actual Deferral Percentage)

The Actual Deferral Percentage (ADP) test compares the average salary deferral rates of HCEs versus NHCEs.

If highly compensated employees are contributing significantly more to the plan — percentage-wise — than other employees, the plan may fail the test. For example, if owners and executives are maximizing contributions while lower-paid employees participate minimally or not at all, the disparity could trigger a failed test result.

ACP Test (Actual Contribution Percentage)

The Actual Contribution Percentage (ACP) test focuses on employer matching contributions and after-tax employee contributions.

This test evaluates whether matching contributions disproportionately favor highly compensated employees relative to the participation levels of non-HCEs.

Top-Heavy Test (Ownership Concentration Test)

Plans may also be subject to Top-Heavy testing, which examines whether more than 60% of plan assets belong to key employees.

If a plan is deemed top-heavy, the employer may be required to make minimum contributions for eligible non-key employees, even if those employees are not contributing themselves.

What Happens If a 401(k) Plan Fails Non-Discrimination Testing?

A failed non-discrimination test does not necessarily mean the plan is in serious trouble. In fact, failures are relatively common — particularly in smaller businesses or organizations with uneven participation levels. However, failed testing results do require corrective action.

Corrective Distributions to Highly Compensated Employee (HCE Refunds)

One of the most common corrections involves distributing excess contributions back to highly compensated employees. While this resolves the compliance issue, it can create frustration among executives or owners who expected to maximize retirement savings through the plan. These refunds are taxable and may reduce confidence in the value of the plan.

Corrective Employer Contributions to NHCEs

Another correction option may involve making additional employer contributions to non-highly compensated employees in order to improve testing outcomes. Although this approach can preserve HCE contribution levels, it may increase employer costs unexpectedly.

IRS Penalties and Compliance Risks

If failures are not corrected within required timeframes, the employer could face:

• IRS penalties
• Additional administrative expenses
• Required amended filings
• Potential plan qualification concerns

The good news is that most testing failures can be corrected successfully when identified early.

Why 401(k) Plans Fail Non-Discrimination Testing

Several factors can contribute to failed testing results:

1. Low NHCE Employee Participation

When non-HCE participation is weak, testing results often suffer. Employees may not understand the plan, may feel they cannot afford contributions, or may simply fail to enroll.

2. Poor Employee Communication and Education

Complex enrollment materials or infrequent education campaigns can lead to lower engagement among employees.

3. High HCE Deferral Rates Relative to NHCEs

When owners or executives contribute at very high rates while employee participation remains modest, testing imbalances become more likely.

4. Workforce Composition and Compensation Disparities

Businesses with significant compensation disparities or high turnover may experience greater testing challenges.

How to Improve 401(k) Non-Discrimination Testing Results

Fortunately, there are several ways plan sponsors can reduce the likelihood of failed testing.

Increase NHCE Employee Participation

Improving participation among NHCEs is often the most effective solution. Sponsors may consider:

• Automatic enrollment features
• Automatic escalation
• Simplified enrollment processes
• Ongoing education campaigns
• Targeted communication efforts

Even modest increases in employee participation rates can significantly improve testing outcomes.

Optimize Employer Match Design

A well-structured matching formula may encourage broader participation and improve testing performance. In some cases, adjusting the match formula can create better incentives for lower-paid employees to contribute.

Consider a Safe Harbor 401(k) Plan Design

Many employers choose Safe Harbor 401(k) plan designs specifically to avoid ADP and ACP testing requirements.

Safe Harbor plans generally require mandatory employer contributions that meet specific IRS standards, but in exchange, highly compensated employees can often contribute up to annual IRS limits without concern about testing refunds.

For some organizations, the predictability and reduced administrative burden of Safe Harbor designs may outweigh the added employer contribution costs.

Why Ongoing 401(k) Plan Monitoring Matters

One common misconception is that non-discrimination testing only matters at year-end. In reality, monitoring participation trends throughout the year can help sponsors identify problems before they become more difficult or expensive to correct.

Regular reviews of the following can help plan sponsors make proactive adjustments before testing deadlines arrive:

• Participation rates
• Deferral percentages
• Match utilization
• HCE contribution activity

How a Retirement Plan Advisor Helps With Compliance and Testing

Non-discrimination testing involves technical rules, deadlines, and correction procedures that can be difficult for employers to navigate alone. A retirement plan advisor can help sponsors:

• Understand testing requirements
• Monitor plan health throughout the year
• Identify participation gaps
• Evaluate Safe Harbor alternatives
• Coordinate with TPAs and recordkeepers
• Develop employee education strategies

Perhaps most importantly, advisors can help sponsors take a proactive approach rather than reacting after testing problems occur.

Informational Resources: John Hancock: “Understanding Safe Harbor 401(k) Design” (April 20, 2026); IRS: “401(k) Plan Fix-it Guide — The Plan Failed the 401(k) ADP and ACP Nondiscrimination Tests” (accessed May 26, 2026); ADP: “Safe Harbor 401(k) Plans” (accessed May 26, 2026).