Understanding NDT
Many companies offer 401(k) plans for contributions into retirement investment plans. Frequently, the company provides a partial or matching contribution for the amount that the employee contributes to the plan up to a specified amount. The government defers the taxes due for the amounts contributed to and earned by 401(k) plans until the employee withdraws money from the plan.
The tax advantages that are available for a qualified plan are contingent upon the plan covering an adequate cross-section of the sponsoring employer's employees. To determine whether a plan meets this requirement, you can perform a number of objective tests that measure the extent to which a plan benefits employees.
This table describes terms and concepts that apply to NDT:
Term or Concept |
Description |
|---|---|
Highly compensated employee (HCE) (also called key employee) |
An employee who meets at least one of the following criteria:
|
Non-highly compensated employee (NHCE) (also called non-key employee) |
An employee who does not meet at least one of the following criteria:
|
Average deferral percentage (ADP) |
The average amount of money deferred into a plan and allocated to the employees' accounts. This amount is expressed as a percentage of the employees' total compensation. |
Average contribution percentage (ACP) |
The average amount of employer-matching funds and employee post-tax contributions to a plan. This amount is expressed as a percentage of the employees' total compensation. |
Determination year |
The 12-month period from January 1 through December 31 of the current testing year. |
Look-back year |
The 12-month period from January 1 through December 31 of the year prior to the testing year. |
Testing year |
The plan year used to test the ADP and ACP for HCEs. |
Current year testing method |
The method of testing in which the plan uses data from the testing year in determining the ADP and ACP for NHCEs. |
Prior year testing method |
The method of testing in which the plan uses data from the previous year in determining the ADP and ACP for NHCEs. |
You use NDTs to compare the treatment of HCE to the treatment of employees who are not highly compensated. NDTs ensure that HCE do not take greater advantage of the tax savings of a 401(k) plan than NHCE employees. When you perform the compliance tests, you include all eligible employees, regardless of whether they actually contribute to the plan.
In NDTs for 401(k) plans, the first of two major components that determine plan status is the ADP, which is calculated per employee, per annum. The ADP test applies to employee 401(k) contributions only. A total ADP exists for both the HCE and NHCE groups. The ADP of the NHCE group determines the maximum ADP of the HCE group. In general, the HCE group can have a slightly higher ADP than the NHCE group, but if it is too high, the plan is discriminatory and excess deferrals must be returned to the HCE group.
The second major component is the ACP, which is calculated per employee, per annum. The ACP test applies to non-401(k) contributions, the employer matching contributions, and employee after-tax contributions. A total ACP exists for both the HCE and NHCE groups. You apply the ACP test in the same manner as the ADP test to measure the amounts that the employer contributed and allocated to employees' accounts.
Before January 1, 1997, the contribution limits for HCEs were based on the amount deferred or contributed by NHCEs during the current plan year. Beginning with the 1997 plan year, employers were given an additional testing option that enables them to use previous year percentages for the NHCEs. The contribution percentages for HCEs are still based on payroll data from the current plan year in this testing method. The prior year testing method enables employers to determine HCE average contribution limitations well in advance of the year-end, and to take corrective measures that reduce the chances of a failed test.
An employer may choose to switch from the prior year testing method to the current year testing method at any time, but some limitations apply when the employer switches from the current year to the prior year testing method. The plan document specifies the testing method used each year.
A plan might be disqualified if it is discriminatory. When a plan is disqualified, the following events occur:
Some or all of the employer's income tax deduction for contributions made to the plan are disallowed.
The employee's income and tax deferrals are lost.
The interest earned on employer and employee contributions loses its tax deferral.
In addition to the 401(k)-related tests, you can review the NDT - 415 Nondiscrimination Testing report (R083676). This report identifies all employees, on a pay-period by pay-period basis, who have withheld more on a pretax basis than the government allows.
The NDT - Definition and Setup program (P083600) groups all of the tasks associated with NDT and provides access to these tasks through a centralized point of entry. This work area also provides a visual representation of current and historical test scenarios, the results of the tests, and the various stages of a current testing process. You can use the link to the JD Edwards EnterpriseOne Payroll system to review and verify the test results that relate to employee- and employer-related plan contributions and employee compensation.
This implementation guide is not intended as a replacement for the legal requirements of NDT. A federal statute called the Employee Retirement Income Security Act (ERISA) governs NDT. You should be familiar with the regulations and mandates provided through ERISA in administering NDT. The U.S. Department of Labor's Pension and Welfare Benefits Administration, together with the Internal Revenue Service (IRS), provides statutory regulation for ERISA.