Business 401(k) Services / Plan Administration

The Keys to 401(k) Compliance Testing Success

In the 15 years I’ve worked at Fisher Investments, I’ve spent a lot of time helping individuals plan for a secure financial future. Working with 401(k) plans gives me ample opportunity to meet with individuals and their employers and help those people understand their plans, make good decisions, and work to make their retirement dreams a reality. Sometimes, that means helping individuals to take all the right steps between today and their last day of work through counseling and education. Other times, I’m working with employers to make sure that their plans are providing a real and legally compliant benefit to those employees who count on them.

During the first quarter of the year, a lot of our focus is on helping to keep these plans compliant. Each year, employers and their service providers are required to test their 401(k) plans for compliance to the government’s rules. It’s a confusing time for many employers, and can be downright frustrating sometimes, but it’s important to make sure plans are working properly (and fairly) for everybody involved.

To help keep your ducks in a row, you may want to request a “preview” of how your plan is doing heading into testing season—something known as a mid-year compliance test. And to help you ready your business for the Q1 compliance test, let me walk you through the basics of compliance testing and mid-year tests—the who, what, why, and when—and give you my three best pieces of advice to make sure when the time comes for testing, you’re ready.

What Is Mid-Year 401(k) Compliance Testing?

A mid-year compliance test applies the same yearly 401(k) nondiscrimination testing structure to your plan, but it’s more like a preview of what you can expect during your “real” test the following year if no changes are made. A mid-year test can help you get ahead of making necessary changes to keep the plan compliant, because you get a projection of how you’ll fare on the test based on your plan’s current data. That way, you can check in to make sure your plan is performing properly and, if it is not, make changes early to avoid a failed test next year.

Many (but not all) employer-sponsored retirement plans must go through compliance testing each year to make sure they’re in line with rules and regulations from the U.S. Department of Labor and the IRS. Mid-year compliance testing is often the tool that business owners use to create a strategy to maximize savings for their highly-compensated employees (more on that below).

Some plans don’t require as much testing; Safe Harbor Plans, for example, avoid most testing by committing to a minimum benefit that’s offered to all employees across the board. For the rest, the rules apply. In a nutshell, those rules are in place to make sure that employers are contributing the right amount of money in plans for all eligible employees, that nobody is contributing more than they are allowed by law, and that plans aren’t discriminating against certain classes of employees.
Much of the regulations focus on “highly compensated employees,” or HCEs for short.

What Is a Highly Compensated Employee (HCE)?

A Highly-Compensated Employee is an employee, usually an executive or partial owner of a company, who makes more than $125,000 for the 2019 tax year or has a 5% stake or greater in the company. An HCE is defined by the IRS as any employee who, at any point during the tax year:

  • Owned 5% or more of the company (family members included), regardless of how much they were compensated otherwise, or;
  • Received more than a certain amount of income in a given year. Note that the income threshold is based on the prior year.

The rules regulate how much can be contributed by an HCE compared to the rest of the employees of the plan. This is in large part to make sure that management and those with an interest in a company do not somehow benefit more than the rank-and-file workers at a company (called non-highly compensated employees, or NHCEs, by the IRS). Plans that don’t meet these criteria typically must make adjustments to their plan in order to pass the test, which usually translates to distributing excess contributions to HCEs or making additional contributions to NHCEs for the year in question.

3 Keys to 401(k) Compliance Testing Success

There’s plenty you and your provider can do before, during, and after your compliance test happens to make it more manageable now, and into the future.

Tip #1: Maintain Accurate Census Data Throughout The Year

There’s no reason to scramble when compliance testing season comes around. When your provider completes your test, they’re going to rely on the census data you’ve kept in your payroll files, HR records and entered into the record keeping system. If you put garbage in, you’ll get garbage out, and that can lead to problems. Avoid the fire drill at the end of the year by reviewing your employee census data throughout the year for accuracy, and look into allowing your payroll provider to give data directly to your plan provider’s recordkeeper to make sure they always have the most up-to-date information.

Tip #2: Review Test Results In Detail with Your Service Provider

When it comes to reviewing the results of your compliance tests, there are a couple of key things you want to do: First, make sure your provider used the correct data to run your test, and second, make sure you fully understand whether you failed or passed, and why. The best way to do this is by specifically requesting a full walkthrough of your test results from your service provider. This way, you can triple-check the work, verify your pass/fail status, and also catch small inconsistencies or inaccuracies in your employee census information that may be lost on your service provider.

Tip #3: Make a Game Plan for The Coming Year

Pass or fail, you’ll want to make the most of what you learned during your compliance testing process. If you did have to take corrective action in order to pass, talk with your service provider and discuss ways you can update your plan in order to pass next year. Alternately, you could also convert your plan to a Safe Harbor Plan to automatically pass some of these tests. Another method of improving test results that is very near and dear to my own heart is in-person, one-on-one education for your employees to help improve participation and savings rates across the board. Whatever action seems best for your plan, the common thread is to not wait until next year to improve your plan and shore up your chances of a passing test next time around.

That third tip really brings everything together for me when it comes to compliance testing. More than a burden or a pain, I think it’s a great time for employers to really get a good look at their plans, to learn what is working and what isn’t, and to ultimately improve those plans for the benefit of their employees. It’s one more important step along the way to a comfortable retirement for each employee, and in the end, that makes it well worth the time and effort.

What Are The 401(k) Nondiscrimination Testing Deadlines?

Plans that are subject to compliance testing tend to follow a set schedule:

  • January: Review complete payroll and employee data for the previous year. Clean up and validate the information by the end of January.
  • February to March: This is typically when service providers perform compliance tests and share the results.
  • March 15: Non-discrimination testing corrective distributions or additional contributions have to happen before this date to avoid penalties.
  • April 15: This is the deadline for any required corrective distributions for those that contribute over the IRS limit, based on the results of your test.
  • July 31: This isn’t a hard deadline, but generally you will want to engage your adviser for a mid-year checkup on your plan by this date in order to have a reasonable amount of time to make any necessary changes.


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