Non-discrimination testing is the compliance gate that separates a qualified retirement or benefits plan from one the IRS will disqualify retroactively. Every plan that enjoys favorable tax treatment under the Internal Revenue Code (401(k)s, Section 125 cafeteria plans, HRAs, dependent care FSAs, and several others) has to prove annually that it doesn't disproportionately benefit the company's highest earners. The tests are mechanical once you know them, but they trip up fast-growing companies where headcount shifts between HCEs and non-HCEs year over year. A failed test rarely kills the plan, but the corrective actions (refunds, excise taxes, corrective contributions) land at exactly the moment payroll teams can least afford the distraction.
What the Tests Actually Check NDT asks three questions of every plan. Does a disproportionate share of the benefit flow to HCEs? Is a high-enough percentage of eligible non-HCEs participating? Is the plan design built to exclude people the IRS expects covered?
Who counts as an HCE is defined by the IRS and reset annually. For 2026, an HCE is anyone who earned more than $160,000 in the previous year or owned more than 5 percent of the company. Everyone else is a non-HCE for testing purposes.
The ADP and ACP Tests for 401(k) Plans The Actual Deferral Percentage (ADP) test compares the average salary deferral rate of HCEs against non-HCEs. The Actual Contribution Percentage (ACP) test does the same for employer matching and employee after-tax contributions. The HCE group's average can only exceed the non-HCE average by a set spread (1.25x or 2 percentage points, whichever is higher).
What Happens if a 401(k) Plan Fails ADP or ACP? The plan has until 2.5 months after the plan year ends to refund excess HCE contributions without penalty. Miss that window and the company owes a 10 percent excise tax on the refund. Some plan designs (safe harbor 401(k), QACA) sidestep the ADP and ACP tests entirely by committing to specific employer contributions, which is why safe harbor adoption has climbed sharply among mid-market employers.
Section 125 and Other Benefit Plan Tests Section 125 cafeteria plans face three tests: eligibility, contributions and benefits, and key employee concentration (no more than 25 percent of benefits going to key employees). HRAs and dependent care FSAs have their own versions. Self-insured medical plans under Section 105(h) get tested separately. Each test has different definitions and different failure consequences, which is why mid-sized employers typically outsource the actual testing to their benefits administrator or TPA.
Building a Non-Discrimination Testing Program That Passes Three habits separate plans that pass consistently from plans that scramble in February. Test early: run preliminary testing mid-year so any HCE adjustments can happen before the fourth quarter when deferrals are locked in. Consider a safe harbor 401(k) design if HCE concentration has historically caused ADP/ACP failures. And keep clean data: the most common source of testing errors is misclassified employees in payroll (wrong HCE status, wrong compensation definition, missed mid-year eligibility). Reference the IRS retirement plan definitions and the 401(k) Fix-It Guide for the official rules and correction procedures.
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