What are the consequences of failing nondiscrimination testing?

Failing nondiscrimination testing can lead to potential tax penalties and corrective actions for the retirement plan. Nondiscrimination tests, such as the Actual Deferral Percentage (ADP) test and the Actual Contribution Percentage (ACP) test, are designed to ensure that the benefits provided by a 401(k) plan do not disproportionately favor highly compensated employees over non-highly compensated employees.

If a plan fails these tests, it may be required to take corrective actions, which could include refunding contributions to highly compensated employees or increasing contributions for non-highly compensated employees to comply with the nondiscrimination requirements. Additionally, failing these tests can trigger tax penalties for both the employer and affected employees because the plan may lose its tax-qualified status. This could lead to significant financial repercussions for the plan sponsor, making it crucial to adhere to the nondiscrimination rules.

The other options, while they may seem relevant in some contexts, do not accurately capture the primary legal and financial ramifications associated with failing nondiscrimination testing.