NEC Contributions: What They Are and Why You Use Them

A Non-Elective Contribution (NEC) is an employer contribution made to an employee’s retirement plan. Its defining characteristic is that it is not dependent on an employee contributing their own money to the plan. Employers use these contributions to enhance their retirement plan design and ensure compliance with regulatory requirements.

Understanding Non-Elective Contributions

A Non-Elective Contribution is made by an employer to the retirement accounts of all eligible employees, regardless of whether those employees make their own contributions. This feature distinguishes NECs from employer matching contributions, which are only made if an employee first defers a portion of their own salary.

NECs vs. Employee Elective Deferrals

Employee elective deferrals are funds an employee chooses to have deducted from their paycheck and contributed to their 401(k) account. These are the employee’s own savings, subject to annual IRS limits. For 2025, this limit is $23,000, with an additional $7,500 catch-up contribution for those age 50 and over. In contrast, an NEC is funded entirely by the employer and does not reduce an employee’s take-home pay.

NECs vs. Employer Matching Contributions

Employer matching contributions are conditional, as an employer will only contribute if that employee is also contributing. A common matching formula might be 50 cents for every dollar an employee contributes, up to a certain percentage of their salary. NECs, however, are provided to all eligible employees, even those who have not contributed from their own salary.

An “eligible employee” for an NEC is defined by the 401(k) plan document, with eligibility often based on factors like age and service time. Compensation, which is the basis for calculating the NEC amount, is also defined in the plan document and includes W-2 wages, though some forms of pay like bonuses might be excluded. Vesting schedules for NECs can vary, but they are often 100% immediately vested, giving the employee full ownership of the funds.

NECs in Safe Harbor 401(k) Plans

A Safe Harbor 401(k) plan is a retirement plan that automatically passes certain annual nondiscrimination tests in exchange for mandatory employer contributions. These tests are designed to ensure a plan does not unfairly favor highly compensated employees. By satisfying Safe Harbor requirements, employers avoid complex testing and potential costly corrections if the plan were to fail.

One of the primary ways to achieve Safe Harbor status is through a non-elective contribution. Under this option, the employer is required to contribute a minimum of 3% of compensation to every eligible employee’s account. This contribution must be made for all eligible employees, regardless of whether they decide to defer any of their own salary into the plan.

The alternative for achieving Safe Harbor status is an employer match, but the NEC is often favored for its simplicity. The NEC calculation is a straightforward percentage of each employee’s pay. This contrasts with a matching formula, where the employer’s cost depends on employee participation rates and is less predictable for budgeting.

Employers who adopt a Safe Harbor plan must follow specific employee notification requirements. Annually, the employer must provide a written notice to all eligible employees explaining the plan’s Safe Harbor provisions. This notice details the employer’s contribution formula and other features of the plan.

Using NECs to Correct Failed Nondiscrimination Tests

Retirement plans not designed as Safe Harbor must undergo annual testing to ensure they do not disproportionately benefit certain employees. The two main tests are the Actual Deferral Percentage (ADP) test and the Actual Contribution Percentage (ACP) test. The ADP test examines elective deferrals of Highly Compensated Employees (HCEs) versus Non-Highly Compensated Employees (NHCEs), while the ACP test reviews employer matching and employee after-tax contributions.

When a plan fails one of these tests, it means the contribution rates of HCEs have exceeded the rates of NHCEs by more than the margin permitted by the IRS. The employer must take corrective action. A common method for correcting a failed test is to make a Qualified Non-Elective Contribution (QNEC), which involves the employer making an additional contribution to the accounts of the NHCEs.

The purpose of the QNEC is to retroactively increase the average contribution rate for the NHCE group. By depositing these funds, the employer raises the group’s overall percentage, bringing the plan back into compliance with testing limits. The amount of the QNEC is calculated to be just enough to pass the failed test, making it a targeted solution.

QNECs have specific conditions. A QNEC must be 100% vested immediately, giving employees instant ownership of the funds. These contributions are also subject to the same withdrawal restrictions as an employee’s elective deferrals and cannot be distributed until events like termination of employment, disability, or reaching age 59½.

Administrative and Tax Considerations

Administering non-elective contributions requires careful attention to data. To calculate the contribution, an employer needs a complete employee census with precise compensation data for every eligible employee for the plan year. For a standard 3% safe harbor NEC, the calculation is a direct multiplication of each employee’s eligible compensation by 0.03.

The deadlines for depositing NECs depend on their purpose. For a Safe Harbor NEC, the contribution must be deposited no later than the due date, including extensions, of the employer’s federal income tax return for that year. In contrast, a QNEC used to correct a failed test must be deposited within 12 months after the end of the plan year that failed. The employer works with their plan’s administrator to transfer the funds for allocation to participant accounts.

NECs offer tax benefits to both employers and employees. For the business, the entire contribution is a tax-deductible business expense for the year it is made. For the employee, the NEC is not included in their gross income and is not subject to income tax at the time of contribution, allowing the funds to grow tax-deferred until withdrawal.