Coverage test (410(b) test)

What the coverage test is

The usual method is the ratio percentage test. Divide the percentage of non-highly compensated employees who benefit by the percentage of highly compensated employees who benefit; the result must be at least 70%. A plan that falls short can try the more complex average benefit test. Deferrals, matching contributions and nonelective contributions are each tested. Employees under 21 or with less than a year of service, union employees and nonresident aliens can be left out of the count.

Why it matters to employers

A plan that covers every employee passes automatically. Problems start when a plan excludes a division, a location or a job class, or when a related company in the same controlled group has no plan. Safe harbor status does not exempt a plan from coverage testing.

Example

A company has 10 highly compensated employees and 50 other employees who meet the age and service rules. Its plan excludes a warehouse with 20 of those 50. All 10 highly compensated employees benefit (100%), but only 30 of 50 others do (60%). The ratio is 60%, below 70%, so the plan fails unless it passes the average benefit test or is amended.

Common mistakes

• Forgetting employees of related companies.

• Excluding a class such as “temporary” or “part-time” employees that is really based on service.

• Missing the window to fix a failure with a retroactive amendment, which closes 9½ months after the plan year ends.