My plan failed the coverage test; what happens next?
A 401(k) coverage test is performed each year to confirm that the highly compensated employees ("HCEs") are not the only individuals eligible to receive a benefit from the plan. The goal is for at least 70% of the non-highly compensated employees ("NHCEs") to benefit from the plan.
Review Test
Review the coverage test results on the sponsor portal by logging in & going to My Plan > Annual Testing > Test Results. Review the test results and make sure you are satisfied with the following:
- First, check that the test identifies the correct employees as highly compensated employees.
- Note: To understand the difference between HCEs and NHCEs, please visit our "What is Compliance Testing?" article.
- Next, confirm that the test shows the correct contributions. Each contribution type is considered its own “plan”. Therefore, the coverage test might be applied for three different sources, such as employee deferrals, employer match, and employer profit sharing. It's important to consider which source is failing.
- Finally, this is a great time to determine if the exclusions that are in the plan are necessary and still a good provision for the plan. Excluding certain classes of employees makes them ineligible to receive a benefit; therefore, the test might fail if more than 30% of the workforce is excluded and they are all non-highly compensated employees.
The accuracy of the compliance tests is dependent on the above items being correct. If our records contained inaccurate data, the test results may change once the data is updated. If you notice any errors or updates, please email us, and we can update the records and revise the test. There will be a charge of $250 per hour for revised testing based on data changes. Therefore, it is in your best interest to ensure all information provided to us is accurate when submitting the census and year-end questionnaire.
How do I correct a failed test?
A corrective amendment is required within 9½ months of the close of the plan year. Employers with a failed coverage test will also require corrective action. This can be done in two ways:
- Making an additional contribution, or
- Returning excess HCE contributions (with applicable adjustments)
If corrective actions are not taken in a timely manner, the IRS may impose penalties, taxes, or disqualify the plan. Once it is past the deadline, the plan will need to go through the IRS’s Voluntary Compliance Program, in which additional fees apply.