What Is IRC Section 410(b)?
IRC Section 410(b) is a regulatory provision that dictates how retirement plans must be structured to remain tax-qualified. Its primary goal is to prevent discrimination in favor of HCEs, ensuring that all eligible employees—regardless of income level—have equitable access to the plan’s benefits. Employers must demonstrate compliance with these rules annually to maintain the plan’s favorable tax status.
Key Components of IRC Section 410(b)
- Coverage Tests To meet the requirements of IRC Section 410(b), a retirement plan must pass at least one of the following tests:
- Ratio Percentage Test: This test requires that the percentage of NHCEs benefiting from the plan is at least 70% of the percentage of HCEs who benefit. For example, if 80% of HCEs are covered, then at least 56% (70% of 80%) of NHCEs must also be covered.
- Average Benefits Test: This more complex test involves two parts:
- Nondiscriminatory Classification Test: The plan’s classification of employees must be reasonable and based on objective business criteria.
- Average Benefits Percentage Test: The average benefit percentage for NHCEs must be at least 70% of the average benefit percentage for HCEs.
- Highly Compensated Employees (HCEs) vs. Non-Highly Compensated Employees (NHCEs)
- HCEs: Employees who earned more than a specified compensation limit in the prior year ($150,000 in 2024, adjusted annually for inflation) or own more than 5% of the business.
- NHCEs: Employees who do not meet the criteria to be classified as HCEs.
- Excludable Employees Certain employees can be excluded from the coverage tests, such as:
- Employees who have not met the plan’s minimum age (e.g., 21 years) and service (e.g., one year) requirements.
- Union employees covered by a collective bargaining agreement, provided retirement benefits were negotiated separately.
- Nonresident aliens with no U.S. income.
- Testing Period Coverage tests are typically conducted annually. Employers must evaluate the demographics of their workforce and adjust their plans if necessary to remain compliant.
- Plan Aggregation and Disaggregation Employers may combine or separate plans for testing purposes, depending on their organizational structure and ownership relationships. Aggregation is often necessary for businesses with multiple entities or related operations.
Why Compliance Matters
Maintaining compliance with IRC Section 410(b) is essential to preserving the tax-qualified status of a retirement plan. If a plan fails the coverage tests:
- The plan could lose its tax advantages, resulting in adverse tax consequences for both the employer and employees.
- Employers may need to make corrective contributions or amend the plan’s design to address deficiencies.
Final Thoughts
IRC Section 410(b) plays a critical role in ensuring retirement plans are inclusive and equitable. By adhering to these rules, employers not only maintain their plans’ tax-favored status but also foster a sense of fairness and inclusion within their workforce. For employees, this means greater confidence that their financial futures are being safeguarded, regardless of their compensation level.
Navigating the nuances of IRC Section 410(b) can be challenging, but with the right strategies and support, compliance is achievable. If you’re an employer, taking proactive steps today can save you from potential complications tomorrow—and demonstrate your commitment to equitable benefits for all employees. Contact Accelus to know more!
