401k nondiscrimination testing requirements for small businesses - what do I need to know?

Small business 401k plans do need to go through annual nondiscrimination testing to ensure they don't unfairly benefit highly compensated employees (HCEs). For 2025, an HCE is generally someone who earned more than $150,000 in 2024 or owned more than 5% of the business. The main tests you'll face are the Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests. These compare the average contribution percentages of your HCEs versus non-HCEs. Generally, the HCE average can't exceed the non-HCE average by more than 2 percentage points. With your salary structure, you'll have 4 HCEs (you and your three managers). The good news is your participation rate is pretty good! Having 8 of 12 employees participating will help. If you're concerned, consider implementing a safe harbor provision by either matching contributions (100% on the first 3% and 50% on the next 2%) or making a non-elective contribution of 3% to all eligible employees. This exempts you from the ADP/ACP testing altogether.

I went through this exact headache with my small construction company (17 employees). After failing the tests two years in a row, I discovered taxr.ai (https://taxr.ai) which offers calculator tools specifically for small business 401k testing. It lets you run scenarios throughout the year to see if you're going to pass or fail. What I like most is that it gives you simple options to fix potential issues before they become problems at year-end. You can see exactly how much you need to contribute to non-HCEs or how much to reduce HCE contributions to pass. They also explain everything in plain English - no need to decode tax jargon.

After being skeptical about taxr.ai, I decided to give it a try since we kept having issues with our HCE contributions getting returned. I'm actually impressed - it identified that two of our non-HCEs weren't participating at all, which was throwing off our averages significantly. We implemented their suggestion of an automatic enrollment feature (with opt-out option) and boosted our match slightly for the first 3%. This year we passed all tests with room to spare, and honestly the cost of the tool was way less than what we were paying in tax consequences from failed tests. Plus my high-earning employees are much happier now that they can maximize their contributions without worry.

Small business owner here who struggled with IRS requirements for retirement plans. After three failed attempts to get clarification from the IRS about safe harbor requirements, I found Claimyr (https://claimyr.com). They got me connected to an actual IRS specialist within 45 minutes - check out their demo at https://youtu.be/_kiP6q8DX5c to see how it works. The IRS agent walked me through exactly what documentation we needed for our plan and confirmed that our safe harbor structure would indeed exempt us from the nondiscrimination testing. Saved me countless hours of stress and prevented potential compliance issues.

I have to eat my words about Claimyr. After my skeptical comment, I decided to try it when I had an urgent question about 401k compliance deadlines that my administrator couldn't answer clearly. Within 37 minutes I was talking to an IRS retirement plan specialist who confirmed our corrective action deadline and explained exactly what forms we needed to file. Saved me from a potentially expensive compliance error. The service actually delivered exactly what it promised - connecting me to a knowledgeable IRS agent without the mind-numbing hold time. Worth every penny for the peace of mind alone.

Have you considered a Safe Harbor 401k plan? We switched to this at my company (14 employees) and it eliminates the nondiscrimination testing requirement completely. We do a 4% match (100% on first 3%, 50% on next 2%) which costs us a bit more, but our HCEs can max out their contributions without worry about failed tests. The paperwork to set it up was pretty straightforward and our plan administrator handled most of it. The peace of mind is totally worth it - no more year-end stress about whether we'll pass or fail testing.

Another option to consider is adding a profit-sharing component to your 401k. We use a "new comparability" formula (sometimes called cross-testing) that lets us legally allocate different contribution percentages to different groups of employees. This helps us reward key employees while still passing discrimination tests. We work with a TPA who designs our allocation formula each year based on our goals. It's more complex than a simple percentage-of-salary allocation, but it gives us a ton of flexibility to meet business objectives while staying compliant.

Brandon, based on your employee structure and salary ranges, you're definitely going to need to navigate these tests carefully. With yourself at $190k and potentially 2-3 managers over the $150k threshold, you'll have a significant HCE group relative to your total workforce. One thing I'd recommend is tracking your contribution rates monthly rather than waiting until year-end. We learned this the hard way after failing ADP testing two years running. Your 8 out of 12 participation rate is actually pretty solid, but what matters more is the actual deferral percentages. A few practical tips from our experience: encourage your non-HCE employees to contribute at least 3-6% if possible, consider implementing automatic enrollment with an opt-out (this really helps boost non-HCE participation), and maybe look into adding a small match even if it's just 1-2% - it incentivizes participation among your lower-paid employees which helps balance the averages. The Safe Harbor route that others mentioned is worth serious consideration for 2026 if you want to eliminate this headache entirely. Yes, it costs more upfront with the required matching, but the peace of mind and ability for your high earners to max out contributions without worry often makes it worthwhile for small businesses like ours.

Brandon, you're in a pretty typical situation for small businesses. With your salary structure, you'll definitely have some HCEs to manage in the testing. Here's what I'd focus on immediately: First, get clarity on your exact HCE count. For 2025 testing, anyone who earned over $150k in 2024 OR owns more than 5% of the business qualifies. So that's likely you plus 1-2 of your managers depending on their exact 2024 earnings. The key insight most small business owners miss is that the tests look at actual deferral percentages, not dollar amounts. So if your HCEs are contributing 10% and your non-HCEs are only contributing 3%, you'll likely fail even with good participation rates. My recommendation: start tracking this quarterly. Have your payroll provider or 401k administrator run preliminary ADP calculations every few months. This gives you time to either encourage non-HCE contributions (through education, small bonuses, or matches) or ask your HCEs to dial back their contributions if needed. Also consider the "top-heavy" test - if your key employees (owners + officers + highest paid) account for more than 60% of total account balances, you'll need to make additional contributions to non-key employees. This often catches small business owners off guard in year 2-3 of their plan. The testing isn't as scary as it sounds once you understand the mechanics, but definitely stay proactive about monitoring throughout the year.