Failing 401(k) nondiscrimination testing can create stress for HR teams, finance leaders, and business owners, especially when it happens unexpectedly after year-end planning is already complete.

For many companies, failed testing leads to questions like:

• What needs to be corrected?

• How quickly do corrections need to happen?

• Will executives receive contribution refunds?

• Are there penalties involved?

• How can the company avoid this happening again next year?

At Basic Capital, we believe retirement plan compliance should feel more transparent and manageable. Understanding the correction process can help employers respond more confidently while improving the long-term health of the plan.

Why 401(k) Plans Fail Nondiscrimination Testing

Nondiscrimination testing is designed to ensure retirement plans do not disproportionately benefit highly compensated employees (HCEs) over non-highly compensated employees (NHCEs).

The two most common tests are:

• ADP (Actual Deferral Percentage) testing

• ACP (Actual Contribution Percentage) testing

Plans often fail testing when highly compensated employees contribute significantly more than the broader employee population.

This can happen when:

• Employee participation rates are low

• Lower-paid employees contribute very little to the plan

• Executives maximize retirement contributions

• Matching structures create imbalances

• Workforce demographics shift over time

For growing companies, these issues can become more common as compensation structures and participation behavior evolve.

Option 1: Refunding Excess Contributions

One of the most common correction methods is refunding excess contributions to highly compensated employees.

Under this approach, the plan returns a portion of retirement contributions to executives or other highly compensated participants in order to rebalance contribution averages across the workforce.

While this method is relatively straightforward operationally, it can create frustration for:

• Business owners

• Executives

• Highly compensated employees who expected to maximize annual retirement contributions

Refunds can also create:

• Unexpected taxable income

• Additional payroll coordination

• Participant communication challenges

• Administrative correction work

For many employers, repeated refunds become a signal that the current plan design may no longer fit the organization effectively.

Option 2: Making QNEC Contributions

Another correction option involves Qualified Non-Elective Contributions, commonly referred to as QNECs.

Under this approach, the employer contributes additional funds to eligible non-highly compensated employees in order to improve overall testing results rather than refunding contributions to highly compensated employees.

Many employers prefer this option because it:

• Preserves executive contribution levels

• Supports employee retirement balances

• Improves participation fairness

• Avoids corrective refunds

However, QNECs also increase employer retirement plan costs and require careful contribution calculations.

For HR and finance teams, the decision often becomes a balance between:

• Administrative simplicity

• Employer contribution costs

• Executive retirement goals

• Long-term plan strategy

Option 3: Restructuring the Plan

For companies experiencing repeated testing failures, correcting the issue year after year may not be the best long-term solution.

At some point, many employers begin evaluating whether the retirement plan itself should be redesigned.

Common restructuring approaches include:

• Moving to a safe harbor 401(k) structure

• Adjusting employer match formulas

• Improving employee participation initiatives

• Implementing automatic enrollment features

• Modernizing participant communication and onboarding

Safe harbor 401(k) plans are especially common because they generally eliminate ADP and ACP testing requirements when employers meet qualifying contribution rules.

For many growing businesses, that tradeoff creates:

• More predictable compliance outcomes

• Simpler administration

• Better contribution consistency for owners and executives

• Improved retirement participation behavior

Why Participation Often Becomes the Root Issue

In many cases, failed nondiscrimination testing reflects broader participation challenges within the workforce.

Employees may not fully understand:

• The value of the retirement plan

• How much to contribute

• Employer match opportunities

• Long-term retirement benefits

Outdated enrollment experiences and fragmented retirement systems can also reduce engagement.

At Basic Capital, we believe modern retirement infrastructure should help employers create stronger participant experiences through:

• Simplified onboarding

• Better visibility into retirement progress

• Modern retirement technology

• Transparent plan management

• More personalized retirement experiences

Stronger engagement often leads to healthier participation rates over time, which can help reduce future testing failures.

How Technology Can Help Reduce Compliance Risk

Many HR teams still manage retirement compliance through disconnected systems, manual reporting, and reactive year-end reviews.

Modern retirement platforms can help employers proactively monitor:

• Contribution trends

• Participation rates

• Compliance risks

• Payroll integration accuracy

• Testing exposure throughout the year

At Basic Capital, we believe better visibility leads to better retirement plan management.

Companies exploring proactive compliance monitoring may also want to review our Basic Capital AI Compliance Agent, which helps employers monitor retirement plans for potential ADP failures, top-heavy violations, and other compliance risks before they become larger administrative issues.

How Employers Can Reduce Future Testing Failures

Employers that consistently pass nondiscrimination testing often focus on improving overall plan health throughout the year rather than reacting after failures occur.

That may include:

• Increasing employee participation rates

• Simplifying enrollment

• Reassessing employer contribution structures

• Exploring safe harbor plan options

• Improving retirement education

• Modernizing retirement administration systems

For many growing businesses, nondiscrimination testing failures become a catalyst for broader retirement plan modernization.

Looking Ahead

Failed nondiscrimination testing can feel disruptive, but it also creates an opportunity to reevaluate whether a retirement plan is still aligned with the company’s workforce, participation trends, and long-term goals.

At Basic Capital, we believe retirement plans should help employers balance:

• Compliance simplicity

• Employee engagement

• Administrative efficiency

• Transparent plan management

• Long-term retirement readiness

As retirement plans become more complex, employers with stronger visibility into participation behavior and compliance trends may be better positioned to reduce correction work, improve employee outcomes, and build more scalable retirement programs over time.

Ready to modernize your retirement plan administration and reduce compliance friction? Get started with Basic Capital to learn how our platform helps employers improve retirement outcomes, simplify compliance management, and create better participant experiences.