March 3, 2026 | 9-12 Minute Read
IRC §410(b) Coverage Testing is one of the required annual compliance tests for most 401(k) plans. If you’ve ever wondered why employee census data is needed every single year, even for those employees who don’t participate in the retirement plan, this article can help explain the reasons behind that requirement and how that data is used.
What’s the Point of Coverage Testing?
The point of Coverage Testing is to prove the plan is not unfairly benefiting Highly Compensated Employees, HCEs, over Non-Highly Compensated Employees, NHCEs.
For reference, HCEs include owners who own more than 5% of the company as well as employees who earn more than the annual threshold. For example, the threshold in 2025 is whether someone earned more than $155,000 in 2024. For the latest compensation limits, click here: https://www.benefits2llc.com/annual-limits-compliance-calendar/.
Coverage Testing is used to demonstrate that the plan covers a fair cross-section of employees by looking at who is eligible to participate and who is not, regardless of whether they choose to participate. An employee is considered “benefiting” based on the specific contribution type being tested. For elective deferrals and employer matching, an employee is benefiting if they are eligible to defer, and if a match is offered, receive that match. For non-elective contributions, an employee is benefiting only if they actually receive (or are allocated) that contribution. This is why it is so important for every employee to be on the census, even if they have never made or received contributions.
Who Might Be Excluded from Testing?
The following categories of employees can be excluded to help the plan pass testing more easily:
- Employees who have not met the eligibility requirements for the plan
- Nonresident aliens with no US income from the employer
- Employees subject to a good faith collective bargaining agreement
- Terminated employees who worked fewer than 500 hours during the plan year and are not otherwise required to be included under IRS regulations
Your dedicated analyst will determine whether excluding employees is advantageous for your plan or not.
How Does Coverage Testing Work?
The Coverage Test is run first for deferrals, then for Employer Matching, and then again separately for Employer Non-Elective contributions. Each money type must pass testing separately. A plan may pass coverage testing for elective deferrals but fail for employer contributions if those contributions are structured differently.
First is to determine whether the Ratio Percentage Test is satisfied. If not, the Average Benefit Test is used. The Ratio Percentage Test is more straightforward, but if the plan fails, the Average Benefits Test can be used to pass coverage testing.
Ratio Percentage Test
The Ratio Percentage Test compares the ratio of NHCEs benefiting with the ratio of HCEs benefiting from the plan. A passing test is a ratio of 70% or higher.
For Example: The plan has 10 NHCEs, 6 of which are benefiting. This ratio is 60%. The same plan has 5 HCEs, 4 of which are benefiting. This ratio is 80%. The coverage ratio is 60/80, or 75%. This is over 70% and passes the Ratio Percentage Test, and therefore 410(b) Coverage Testing. The Average Benefit Test would not be needed.
Now let’s assume only 5 of the 10 NHCEs are benefiting. Now the NHCE ratio is 50%, which changes the coverage ratio to 50/80, or 62.5%. The Ratio Percentage Test is no longer satisfied, and the Average Benefit Test could be used.
Average Benefit Test
The Average Benefit Test includes many steps:
- Nondiscriminatory Classification Test
- Employee Classifications: The plan must use reasonable, objective classifications to identify which employees benefit under the plan. These could be job categories or geographic location. Unreasonable classifications could be whether someone is a “valued contributor.” This is subjective and open to interpretation. Benefits² Administrators writes plan documents to ensure reasonable, objective classifications to ensure this portion of the test is satisfied.
- Numerical Nondiscrimination Test – One of two methods below must be used to pass:
- The Coverage Ratio must be equal to or greater than the Safe Harbor Percentage. The Safe Harbor Percentage is provided by the IRS based on the concentration percentage of NHCEs. Consider all nonexcludable NHCEs and divide that amount by the number of nonexcludable NHCEs. Using the same example above with 10 NHCEs and 5 HCEs, we have 10 NHCEs / 15 total employees. IRS Safe Harbor Percentages can be found here: https://www.law.cornell.edu/cfr/text/26/1.410(b)-4. Based on this, the Safe Harbor Percentage is 46.25%. The Coverage Ratio, 62.5%, was determined during the Ratio Percentage Test, and since the coverage ratio is equal to or greater than the Safe Harbor Percentage, the plan satisfies the Numerical Nondiscrimination Test.
- If the plan’s Coverage Ratio does not meet the IRS Safe Harbor Percentage, the plan may still pass by satisfying the Unsafe Harbor Percentage and meeting the additional facts-and-circumstances requirements described in IRS guidance. https://www.law.cornell.edu/cfr/text/26/1.410(b)-4. For our example, the Unsafe Harbor Percentage is 36.25. In addition to meeting the Unsafe Harbor Percentage, the Facts and Circumstances Test must also be satisfied. The Facts and Circumstances questions are outside the scope of this article, but more information can be found here: https://www.irs.gov/pub/irs-tege/epch702.pdf.
The more NHCEs are covered in the plan, the easier it is to pass testing.
- Average Benefit Percentage Test: The Average Benefit Percentage for NHCEs must be at least 70% of the Average Benefit Percentage for HCEs:
NHCE Average Benefit Percentage / HCE Average Benefit Percentage = Average Benefit Percentage Ratio
The Benefit Percentage is determined:
Employer Contributions Allocated to the Employee / Employee Compensation = Employee Benefit Percentage
The Benefits Percentage for NHCEs and HCEs are calculated using this formula, then the NHCE Average Benefit Percentage is divided by the HCE Average Benefit Percentage. If the resulting Coverage Ratio is at least 70%, the plan passes testing.
Because Coverage Testing has so many variables and calculations involved, your dedicated Analyst will assist throughout this process. The plan sponsor just needs to be sure they are providing accurate and timely census information for all their employees so testing can be completed properly.
Can Anyone Automatically Pass Coverage Testing?
A plan can automatically pass Coverage Testing if one of the following is satisfied:
- The plan has no includable NHCES
- No HCEs benefited from the plan
- The plan only benefits union employees, or
- The employer recently went through a merger or acquisition and takes advantage of the temporary IRS transition rule to waive testing. See more information on this here: https://ferenczylaw.com/article-the-elusive-irc-section-410b6-transition-rule/
What If the Plan is Part of a Control Group?
If the plan is part of a control group, the entire group is tested as if it were one employer. We need census data for every employee in the entire control group each year to properly complete Coverage Testing. Your dedicated analyst will help determine whether the entities associated with your plan constitute a Control Group. For more information on Control Groups, see here: https://www.asppa-net.org/news/2017/11/who-employer-it-makes-big-difference/#:~:text=Controlled%20Group,-The%20parent%2Fsubsidiary&text=If%20a%20business%20owns%20at,for%20qualified%20retirement%20plan%20purposes.
What If the Plan Fails Coverage Testing?
If the plan fails coverage testing and does not make required corrections, the plan can be considered noncompliant and be disqualified.
To correct failed Coverage Testing, the plan can bring more NHCES into the plan, or alternatively adjust employer contribution allocations to increase benefits for NHCEs. The plan document may need to be amended to allow more NHCES into the plan or to change the formula for allocating employer contributions.
Benefits² Administrators works with our plan sponsors to design plans in such a way that they are likely to pass, but we will perform the testing every year to ensure continued compliance.
Benefits² Administrators clients: If you have questions about coverage testing, we encourage you to reach out to your dedicated Retirement Analyst. They can help you determine what information is required and what steps to take next.
For non-clients or plan advisors seeking guidance: Feel free to contact Leslie Wood (lwood@benefits2llc.com) for additional information and support. Leslie can provide an overview of annual requirements and strategies to ensure compliance with these guidelines.
Whether you are a current client or not, our goal at Benefits² Administrators is to ensure every plan sponsor has the knowledge and support to remain compliant and help participants succeed in saving for retirement.
MJ Lewis, QKC, QKA
MJ Lewis, QKS, QKA is a Retirement Benefits Analyst at Benefits² Administrators. She has more than 7 years of experience working with qualified retirement plans.