Discrimination testing 101 - Determining if each of the retirement plan contribution types meets the coverage test of 410(b)

Tip of the Day

By Stephanie Reagan


Step-by-step guidance on how to determine if each retirement plan contribution type meets the coverage test of Code Sec. 410(b):

Step 1.  To perform the testing for the whole controlled group, input the following data on an Excel spreadsheet in columnar format:

Company designation, SS#, Name, Birth Date, Hire Date, Eligibility Date, Termination Date, Rehire Date, Highly Compensated Employee (HCE) or Non-Highly Compensated Employee (NHCE) [generally determined from the prior year's data], Gross Compensation, Plan Compensation, Elective Deferrals, Roth Deferrals, Catch-up Contributions, After-Tax Employee Contributions, Match, and other Employer Contributions.

Step 2.  Split the plan into contribution types for testing each type separately, i.e., elective deferrals, matching contributions, employer nonelective contributions.

Step 3.  Determine who is benefiting from each type of contribution:

  • Elective deferrals - employees eligible to elect to defer
  • Matching contributions - employees eligible to receive a match whether or not the person defers
  • Employer nonelective contributions - employees who have received any nonelective contributions during the year

Step 4.  Now, determine from each type of contribution whether it passes one of the two types of coverage tests: the Ratio Percentage Test or the Average Benefit Test. First, try the Ratio Percentage Test because it is the simplest.

Ratio Percentage Test (RPT):

NHCE ratio = # of benefiting non-excludable NHCEs / # of all non-excludable NHCEs in the controlled group

HCE ratio =  # of benefiting non-excludable HCEs / # of all non-excludable HCEs in the controlled group

Coverage ratio percentage = NHCE ratio / HCE ratio

Pass Ratio Percentage test if the Coverage ratio percentage is equal to or greater than 70%.

Average Benefit Test (ABT):

To pass the ABT the plan must meet the Nondiscrimination Classification Test and the Average Benefit Percentage Test.

Nondiscrimination Classification Test

The NHCE Concentration Percentage = total NHCEs of the controlled group / total employees of the controlled group (do not include excludable employees and round the % down to the nearest whole %).

Determine where the NHCE Concentration Percentage falls on the chart found in 1.410(b)-4(c)(4)(iv).

Determine if the Coverage ratio calculated above in the RPT section is at least above the unsafe harbor %.  It is better if it is above the safe harbor % so you don't have to analyze the facts and circumstances.

Average Benefit Percentage Test (ABPT)

This test takes into account all benefits from all plans of the employer controlled group.

Determine the benefit % for each NHCE and each HCE. All non-excludable employees in the controlled group are taken into account even if they are not benefiting from any plan. The employees not benefiting are counted as a zero in the average.

Each employee's benefit % is determined either on an allocation-rate basis or an accrual-rate basis consistently applied.  First, try passing the test on an allocation-rate basis.

Allocation rate = amount of contributions / nondiscriminatory 414(s) Compensation
The following types of contributions are included in the numerator of the allocation-rate fraction:

  • Elective deferrals (after tax contributions or catch-up contributions are not included)
  • Reallocated forfeitures
  • Employer matching contributions
  • Employer contributions, e.g., profit-sharing contributions, ESOP contributions, money purchase pension contributions

Accrual rate (Equivalent Benefit Rate or EBR) = the Allocation rate / present value factor in the 8.5% column from the IRS-Approved UP-1984 Table Without Setback.  For determining the present value factor in the table, you will need to know the number of years the employee has before he or she reaches retirement age.  Note: In calculating the years, use the age the employee is at the end of the plan year.  If the employee is already at or over retirement age, use the factor for 0 years.

If the NHCE average of benefit %s  / HCE average of benefit %s (determined on either an allocation or accrual rate basis) is equal to or greater than 70%, the plan passes the ABPT.

If it passes you are done!  If not, we have other posts on the subject that you may find helpful.


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