What Is 410(b) Coverage Testing and How Does It Work?

Section 410(b) coverage testing is the annual IRS check that confirms a qualified retirement plan benefits enough rank-and-file workers relative to the company’s highest earners. A plan needs to pass only one of three tests to satisfy the rule, but failing all three puts the plan’s tax-qualified status at risk, with the harshest tax consequences landing on the very executives the plan was designed to reward.¹

Who Counts as Highly Compensated

Every test begins by splitting the workforce into Highly Compensated Employees (HCEs) and Non-Highly Compensated Employees (NHCEs), using the prior plan year’s data rather than the current year.

An employee is an HCE if either of two things is true. They owned more than 5% of the employer at any point in the current or preceding year, regardless of pay. Or their compensation exceeded $160,000 in the look-back year, which is the threshold for plan years beginning in 2026.² Employers may also elect a top-paid group limitation, which restricts the compensation-based HCE group to employees who additionally rank in the top 20% by pay.³ Everyone else is an NHCE.

Who Gets Excluded from the Testing Population

Before you calculate anything, certain employees drop out of the testing population entirely:

Employees who haven’t met the plan’s minimum age or service requirements. A plan may require age 21 and one year of service (1,000 hours over 12 months); if it requires two years, participants must be 100% vested on entry.¹
Employees covered by a collective bargaining agreement where retirement benefits were subject to good-faith bargaining.⁴
Nonresident aliens with no U.S.-source income.⁴
Employees who terminated during the year with 500 or fewer hours worked. Those who terminated with more than 500 hours stay in the pool and are treated as not benefiting.⁵

Whoever remains after those exclusions makes up the HCE and NHCE groups the tests actually measure. Misclassifying a single person can flip the outcome, so this step deserves care.

When Related Businesses Get Combined

Owners of multiple companies often find that their real testing population is larger than they expected. Under IRC Section 414(b) and (c), all employees of corporations or trades and businesses in a controlled group are treated as working for one employer for 410(b) purposes, and the same aggregation applies to affiliated service groups under Section 414(m).⁶

A practical example: an owner runs a professional practice with 10 employees and also owns a staffing company with 80 lower-paid workers. All 90 people enter the testing pool, and a plan that covers only the practice can’t ignore the staffing company. Any employer unsure whether these rules apply should resolve that question before running the test, not after.

The Three Coverage Tests

Section 410(b) gives sponsors three ways to prove adequate coverage, and a plan needs to pass only one.¹ Administrators generally run them in order, stopping at the first pass.

The Percentage Test

The plan passes if it benefits at least 70% of all NHCEs in the testing population. HCE participation is irrelevant. If 100 NHCEs are in the group and 70 of them benefit, the plan clears the test.

In a defined contribution plan, an employee benefits by receiving an allocation of employer contributions for the year. For a 401(k), an employee counts as benefiting by being eligible to defer, even if they never contribute a dollar.⁷ That distinction is significant. A 401(k) open to everyone can pass coverage on eligibility alone, even when actual deferral participation among lower-paid workers is thin.

The Ratio Percentage Test

When the straight percentage test doesn’t work, the ratio percentage test compares the two groups. Calculate the percentage of eligible NHCEs who benefit, calculate the percentage of eligible HCEs who benefit, then divide the NHCE percentage by the HCE percentage. The result must be at least 70%.¹

Try it with numbers. A company has 10 eligible HCEs and 100 eligible NHCEs. Eight of the 10 HCEs benefit (80%), and 60 of the 100 NHCEs benefit (60%). Dividing 60% by 80% gives 75%, above the 70% threshold. The plan passes.

Change one number. Only 55 of the 100 NHCEs benefit (55%). Dividing 55% by 80% gives 68.75%. That fails, and the plan has to attempt the more complex average benefit percentage test.

This is where most plans either clear the bar or discover a problem. Plans with restrictive eligibility rules, long service requirements, or high turnover among lower-paid workers most often struggle here.

The Average Benefit Percentage Test

A plan that fails both prior tests has one last option, and it comes in two parts. Both parts must pass, or the plan has failed 410(b) for the year.

Part one is the nondiscriminatory classification test. The group the plan covers has to be defined by reasonable, objective business criteria: job categories, geographic locations, divisions, salaried versus hourly. The classification also has to meet a numerical threshold. Start with the NHCE concentration percentage (NHCEs divided by total non-excludable employees). That percentage points to a safe harbor and an unsafe harbor from an IRS table. For example, with an NHCE concentration between 0% and 60%, the safe harbor is 50% and the unsafe harbor is 40%. As NHCE concentration rises, both thresholds fall; at 99% NHCE concentration, the safe harbor is 20.75% and the unsafe harbor is 20%.⁸ If the plan’s NHCE coverage ratio hits the safe harbor, part one is met. If it lands between the two harbors, the IRS applies a facts-and-circumstances review. Below the unsafe harbor, the classification is treated as discriminatory automatically.

Part two compares the average benefit percentage of all NHCEs against the average benefit percentage of all HCEs. The NHCE average must be at least 70% of the HCE average. Each employee’s benefit percentage is the employer-provided contribution or benefit accrual as a percentage of compensation. Employers may elect to average over up to three consecutive plan years ending with the current year.¹

One detail catches many employers: this calculation pulls in all non-excludable employees across every qualified plan the employer maintains, not only the plan being tested. An employee who doesn’t participate in the tested plan but receives benefits under another qualified plan still contributes a benefit percentage. That scope is why administrators typically run the ABPT through specialized software or actuarial consultants.

Fixing a Failed Test

A failed test doesn’t disqualify the plan instantly, but the correction window is short. The standard fix is a retroactive amendment that expands coverage or increases contributions for enough NHCEs to bring the plan into compliance. That corrective action, including any required contributions, generally has to be completed within 9½ months after the end of the plan year in which the failure occurred.⁹ For a calendar-year plan, that’s around October 15 of the following year.

Correction usually means additional employer contributions to NHCE accounts. If the failure came from restrictive eligibility, the sponsor may need to amend eligibility retroactively and fund contributions for the newly covered employees. The cost scales with how far the plan missed the mark.

Miss the 9½-month window and the failure becomes a demographic failure that can’t be self-corrected. The sponsor then has to use the Voluntary Correction Program (VCP) under EPCRS, which requires an application, a user fee, and IRS approval of the correction method.⁹ VCP user fees for 2026 are tied to plan assets: $2,000 for plans up to $500,000, $3,500 for plans between $500,000 and $10 million, and $4,000 for plans over $10 million.¹⁰ Those fees cover the IRS application only; they don’t include the corrective contributions or the professional cost of preparing the filing.

If the failure surfaces during an IRS audit, the sponsor enters the Audit Closing Agreement Program instead, with a negotiated sanction that runs at least as high as the corresponding VCP fee and often higher.⁹

What Happens If the Plan Is Disqualified

An uncorrected coverage failure can cost the plan its qualified status under Section 401(a), and the tax consequences are severe.¹¹

When disqualification stems from a 410(b) failure specifically, every HCE has to include the full previously untaxed amount of their vested account balance in gross income for the year of disqualification. An HCE sitting on $500,000 of previously untaxed vested benefits could see that entire balance land on a single year’s return. NHCEs include only the employer contributions made during the disqualified years, and only to the extent vested.¹²

The trust also loses its tax exemption, so investment earnings inside the trust become taxable, and the employer loses the deduction for contributions. For a company running close to the coverage thresholds, the cost of disqualification is far larger than the cost of expanding coverage or making corrective contributions in time.

1
Office of the Law Revision Counsel. 26 USC 410 – Minimum Participation Standards
2
IRS.gov. 2026 Amounts Relating to Retirement Plans and IRAs, as Adjusted for Changes in Cost-of-Living (Notice 2025-67)
3
Internal Revenue Service. Identifying Highly Compensated Employees in an Initial or Short Plan Year
4
Internal Revenue Service. A Guide to Common Qualified Plan Requirements
5
eCFR. 26 CFR 1.410(b)-6 – Excludable Employees
6
Office of the Law Revision Counsel. 26 USC 414 – Definitions and Special Rules
7
GovInfo. 26 CFR 1.410(b)-3 – Employees and Former Employees Who Benefit Under a Plan
8
GovInfo. 26 CFR 1.410(b)-4 – Nondiscriminatory Classification Test
9
Internal Revenue Service. EPCRS Overview
10
Internal Revenue Service. Voluntary Correction Program (VCP) Fees
11
Office of the Law Revision Counsel. 26 USC 401 – Qualified Pension, Profit-Sharing, and Stock Bonus Plans
12
Internal Revenue Service. Tax Consequences of Plan Disqualification