Retirement plan sponsors sometimes request projected discrimination testing during the year to determine whether their 401(k) plan is on track to pass its annual compliance tests.
While projected testing can provide useful information in certain circumstances, it is important to understand its limitations before relying on the results to make contribution decisions.
Why Projected Discrimination Testing May Not Be Reliable
Annual 401(k) discrimination testing, including the Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests, is generally based on information for the entire plan year.
Projected testing uses year-to-date data and assumptions about what may happen during the remainder of the year. However, several factors can change before year-end:
- Employees may be hired, terminate employment, or become eligible to participate.
- Employee compensation and contribution amounts may change.
- Participants may increase, decrease, or stop their contributions.
- Bonuses may affect annual compensation, and employees may choose to defer or not defer from those bonuses, potentially changing testing results.
- The participation and contribution rates of highly compensated employees (HCEs) and non-highly compensated employees (NHCEs) may change.
As a result, a plan that appears to pass projected testing could ultimately fail at year-end. Conversely, a plan that appears to fail projected testing could ultimately pass.
For these reasons, RPG Consultants encourages plan sponsors to proceed with caution when relying on projected ADP/ACP discrimination testing, as the results may not reliably predict year-end outcomes.
What If Projected Testing Indicates a Failure?
A projected testing failure does not necessarily mean that highly compensated employees should reduce or stop their 401(k) contributions.
First, the final results may change as the year progresses.
Second, even if the plan ultimately fails its annual discrimination testing, correction methods will be available. Depending on the circumstances and plan provisions, these may include qualified nonelective contributions (QNECs) or corrective distributions to highly compensated employees.
For these reasons, we encourage plan sponsors to consult with RPG before making changes based on projected testing results.
When Projected Testing Is Beneficial
Projected testing can be valuable for plans with advanced profit-sharing designs, including plans using new comparability or cross-tested allocation methods.
These designs may require more detailed projections to help employers evaluate potential contribution amounts, allocation strategies, and financial planning opportunities.
For these plans, projected testing can help employers assess different contribution scenarios and plan for their anticipated year-end funding obligations.
RPG includes projected testing for plans with advanced profit-sharing designs as part of our administration services.
Although these projections remain estimates and final results may change, they can provide meaningful information for financial and retirement planning purposes.
Projected Testing Fees
For plans without an advanced profit-sharing design, projected testing is available upon request for a fee of $750 per testing request.
Because of the limitations discussed above, we encourage plan sponsors to consider whether projected testing would provide meaningful value before requesting this service.
Our Recommendation
Our goal at RPG Consultants is to help plan sponsors make informed decisions, not simply produce additional reports that may not provide actionable information.
For most traditional 401(k) plans, projected ADP/ACP discrimination testing provides limited predictive value and should be interpreted with caution. For plans with advanced profit-sharing designs, however, projected testing can be an important financial planning tool.
If you are considering projected testing, please contact your RPG representative. We would be happy to discuss your plan’s design, your objectives, and whether testing would be beneficial in your particular circumstances.