Glossary

Nondiscrimination testing

Apr 6, 2024

What is nondiscrimination testing?

Nondiscrimination testing is a process for determining whether the benefits of a qualified retirement plan are being offered on a fair basis to rank-and-file employees and highly compensated employees. If a plan fails nondiscrimination testing, it will be subject to IRS penalty taxes.

Why should you care about nondiscriminatory testing?

What is nondiscrimination testing for companies? Іs a requirement for qualified retirement plans. Without it, your plan would not be qualified and therefore you could not offer it to employees.

When you choose a qualified retirement plan, such as a 401(k) or 403(b), your organization must be able to show that the benefits offered are available to all employees in like situations. For example, if you have a retirement plan that allows employees who work part-time to participate, then this benefit should also be available to part-time workers throughout your organization (such as full-time employees). If it’s not offered equally across all units of the company, then that could put your plan at risk for IRS scrutiny and penalties.

Nondiscrimination testing is an important part of any employer's retirement plan. You can't afford to ignore it or hope that it will just go away. The consequences are too severe, and the process for correcting problems isn't easy. 

How do companies comply with non-discriminatory testing requirements?

Companies must ensure that their plans are nondiscriminatory. When a plan is discriminatory, it means that it provides more generous benefits to higher-paid employees than to lower-paid ones.

The IRS and the Pension Protection Act require companies to perform plan-wide tests and benefit allocation tests for each plan annually. These tests are performed by a qualified actuary to ensure that the benefits provided under the plan are equal among all participants who have similar service or compensation histories.

When nondiscrimination testing fails, the consequences vary depending on the type of plan. If you have a 401(k) plan, you may need to make corrective distributions to highly compensated employees.

How to conduct non-discriminatory testing?

There are various steps involved in nondiscrimination testing for retirement plans. These include:

  • defining the data set and setting up a test table;
  • identifying the column that needs to be tested, which can be done by using a discriminant function or using a linear regression model with dummy variables;
  • creating the sampling plan that includes how many records should be drawn from each group, how large the groups should be, and what percentage of records should belong to each group.

How often should non-discriminatory testing be conducted?

When is nondiscrimination testing due? Each testing frequency has its own pros and cons.

Annual testing is the most comprehensive, but also the most costly. Depending on how many employees you have, it may be difficult to keep track of every individual's race and gender year after year. Moreover, if an employee changes job title or department within a small company (say from an administrative assistant in one department to a manager in another), then annual non-discriminatory testing might not be the best option for you because it's hard to track these changes over time.

If you want to ensure your company is making strides toward equal opportunity employment practices, quarterly nondiscrimination testing for health plans might be right up your alley! They're less expensive than annual tests, but still offer thorough information about how people are being treated at work over time — not just what they look like when they walk through your door on day one! While this type of testing doesn't give as much insight into each employee's personal experience with discrimination on a daily basis as does annual testing does; if done correctly, it'll still provide valuable insight into whether or not there are systemic issues within your organization that need addressing before things get out of hand.

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