What Are the Minimum Coverage Test Requirements?

Employer-sponsored retirement plans, like 401(k)s, must undergo annual nondiscrimination testing required by the Internal Revenue Service (IRS). A part of this process is the minimum coverage test, governed by Internal Revenue Code (IRC) Section 410(b). The test ensures a plan benefits a broad cross-section of a company’s workforce and does not unfairly favor those with high incomes or significant ownership stakes. Passing this evaluation is required for a retirement plan to maintain its tax-qualified status.

The test confirms that the plan provides fair access to retirement savings for rank-and-file employees. Each type of contribution, such as employee deferrals, employer matching funds, and profit-sharing, must be tested separately to verify each component is equitable. This prevents a scenario where all employees can make 401(k) contributions, but only top executives receive employer-funded profit sharing. Failure to satisfy these requirements can lead to financial penalties and plan disqualification.

Identifying Employee Groups for Testing

Before performing calculations, a company must categorize its workforce into specific groups as defined by the IRS. The counts within these groups form the basis of the required mathematical tests.

The first group is Highly Compensated Employees (HCEs). An employee qualifies as an HCE for the current year by meeting either an ownership or compensation test in the preceding year. The ownership test is met if the individual owned more than 5% of the business at any point during the current or prior year. For the 2025 testing year, the compensation test is met if an employee earned more than $155,000 in 2024; this IRS threshold increases to $160,000 for determining 2026 status.

Non-Highly Compensated Employees (NHCEs) are all employees who do not meet the HCE criteria. This group represents the general workforce, and the tests are designed to ensure a sufficient number of these individuals benefit from the retirement plan. The ratio of benefiting NHCEs to benefiting HCEs is the focus of the coverage analysis.

A third category, excludable employees, consists of individuals who are legally omitted from testing calculations. These include employees who have not yet met the plan’s minimum age and service requirements, which cannot exceed age 21 and one year of service. Other excludable groups are unionized employees whose retirement benefits were subject to good-faith collective bargaining and non-resident aliens with no U.S. source income.

The Ratio Percentage Test

The most direct way to satisfy the minimum coverage requirement is the ratio percentage test. This straightforward mathematical calculation compares the rate at which NHCEs benefit from the plan to the rate at which HCEs benefit.

The test’s formula requires that the percentage of benefiting NHCEs be at least 70% of the percentage of benefiting HCEs. A company first determines the percentage of its non-excludable HCEs benefiting from the plan. It then performs the same calculation for its non-excludable NHCEs, and the resulting ratio must meet or exceed the 70% threshold.

For example, consider a business with 10 HCEs and 50 NHCEs who are all eligible. If all 10 HCEs (100%) are benefiting, the plan must also benefit at least 70% of the NHCEs. This means a minimum of 35 NHCEs must benefit for the plan to pass. If the ratio falls below 70%, the plan fails this test and must proceed to the average benefit test.

The Average Benefit Test

If a plan fails the ratio percentage test, it has a second opportunity to comply through the average benefit test. This alternative is composed of two separate sub-tests, and the plan must satisfy both to pass. It allows plans with lower coverage ratios to qualify, provided the benefits are fair across the different employee groups.

The first component is the nondiscriminatory classification test. This part ensures the criteria used to determine which employees are covered by the plan are reasonable and not discriminatory. The IRS provides safe harbor percentages based on the concentration of NHCEs in the workforce. A plan’s coverage ratio is compared against this safe harbor percentage; if it meets or exceeds it, the classification is considered nondiscriminatory.

If the plan passes the nondiscriminatory classification test, it must then satisfy the average benefit percentage test. This part compares the average benefit provided to NHCEs with the average benefit for HCEs. To pass, the average benefit percentage for the NHCE group must be at least 70% of the average for the HCE group. Calculating an employee’s benefit percentage involves summing all employer contributions, employee deferrals, and allocated forfeitures, then dividing by the employee’s compensation. These individual percentages are then averaged across the HCE and NHCE groups.

Correcting a Failed Test

Failing both tests does not immediately result in plan disqualification. The IRS provides methods for an employer to correct the failure within a defined timeframe. The standard deadline for correction is 9 ½ months after the close of the failed plan year.

One correction method is a retroactive plan amendment. An employer can amend the plan’s terms for the prior year to expand coverage to more NHCEs, increasing the coverage ratio to a passing level. For example, an employer could amend the plan to retroactively include a previously excluded department for the failed year.

Another correction involves making Qualified Nonelective Contributions (QNECs). A QNEC is an employer contribution made to the accounts of specific NHCEs to correct a testing failure. These contributions are required even if the employee did not contribute and must be 100% vested immediately. If these corrective actions are not completed on time, the employer may face penalties and be required to use the IRS’s Voluntary Correction Program (VCP).