Testing is a comparison of benefits, not a personality test.

Nondiscrimination testing sounds like a compliance product. It is a comparison. The tax law will let a professional practice fund a much larger retirement promise for an owner than a 401(k) deferral can hold. It will not let that promise exist, in a plan that covers employees, unless the benefits for everyone else are in a relationship the statute accepts. The tests are how that relationship is measured. They are not a vibe check on whether you are a generous employer, and they are not optional because the staff already have a match they seem to like.

This briefing is the comparison in plain language, for an owner who has to decide whether a cash balance credit is affordable once the staff are included. It is not the regulation, and it will not teach anyone to run the general test. Sterling Pension Group is a third-party administrator in West Hartford. We run and coordinate the tests from the census. An independent Enrolled Actuary certifies the defined benefit valuation that feeds them. We are not an actuarial firm. Nothing here is tax, legal, or actuarial advice, and a passed test from last year is not a promise about this year's census.

Who has to be in the plan at all

The first comparison is coverage. A plan may not cover only the people the owners like if the mathematics of coverage fail. The question is what fraction of the non-highly compensated employees benefit, compared with the highly compensated employees. Who counts as highly compensated is not a job title. A person who owned more than 5 percent at any time this year or last year is highly compensated because of the ownership. Everyone else is measured on pay in the lookback year.

For the 2025 plan year, that lookback is generally 2024 compensation, and the threshold that applies to 2024 compensation is $155,000. The $160,000 figure in the 2025 COLA announcement is the threshold that will be applied to 2025 pay when the following year's determination is made. An associate who earned $155,000 or less in 2024 is not highly compensated for 2025 on account of pay. An associate who earned more than that is. The owner of the practice is highly compensated by ownership even when the W-2 is modest. Getting this backwards is how a firm "tests" the wrong groups and likes the result.

Employees who are too new, too young, or too part-time under the document's eligibility rules may be excludable. The exclusion has to be the one the document wrote and the statute allows. Calling someone part-time when the hours say otherwise is not an exclusion. Related employers are pulled in before the fraction is computed. A staffing company, a second clinic, or a management company under common control can add people to the denominator who have never heard of the pension. The test is an employer test. The letterhead is not the employer if the statute says otherwise.

Coverage is passed, or it is not, before anyone admires the size of the owner credit. A design that fails coverage does not get saved by a generous contribution for the three employees who happened to enter the plan. More people have to benefit, or the group has to be restructured in a way the rules allow. Restructuring is a technical project. It is not a relabeling of departments over a weekend.

Dollars are the wrong unit

The second comparison is nondiscrimination in the amount of the benefit. A defined contribution plan naturally speaks in dollars and percentages of pay. A defined benefit plan speaks in accrued benefits. A cash balance plan speaks in hypothetical accounts that are a form of defined benefit. The law allows, under stated conditions, a comparison that converts those forms into a common unit. Practitioners call the conversion cross-testing. The point is simple even when the arithmetic is not. A dollar given to a 35-year-old employee is a larger retirement benefit than a dollar given to a 62-year-old owner, because it has longer to grow before retirement. The test knows that. So an owner can receive a larger dollar credit than an employee and still pass, if the employee's smaller dollar, projected forward, is a comparable benefit, and if the other gates are met.

The gate that owners actually feel is a minimum allocation to non-highly compensated employees in the defined contribution plan. Before the test is allowed to compare benefits instead of dollars, those employees generally have to receive a gateway allocation. The rate depends on how large the owners' own allocation rates are. It is often described in shorthand as a few percent of pay. The shorthand is not the rule, and it is not a number to type into a budget from this paragraph. What you should take from it is that staff receive employer money, every year the design relies on cross-testing, and that the money is a condition of the owner's credit rather than a holiday bonus. Staff cost is that condition written as a business fact. A proposal that quotes an owner deposit and is silent on the gateway is not finished.

The gateway is not the safe harbor 401(k) match, and it is not the elective deferral. Safe harbor is a design that can satisfy the actual deferral test. It does not, by itself, satisfy the general test for a cash balance credit. A match the employee must contribute to receive is not the same as an employer allocation the gateway requires even if the employee contributes nothing. Firms get into trouble by counting the match twice in their heads and once in the test.

A 401(k) and cash balance combination exists largely so this comparison can be done with both plans on the table. The cash balance credit and the profit-sharing allocation are tested together, in the way the regulations permit, instead of each plan having to look fair in isolation. The combination is not a discount. It is a structure. If the profit-sharing piece is too thin, the structure fails even though the cash balance document was signed. If the profit-sharing piece is written as discretionary and then not funded, the test that was illustrated will not be the test that happened.

The limits are not the test

It is possible to be inside every dollar limit and still fail. It is possible to pass with contributions far below the limits. The 2025 limits, from IR-2024-285 and the IRS COLA page, are these. Elective deferrals are capped at $23,500. The catch-up is $7,500, or $11,250 for a participant who attains age 60, 61, 62, or 63, and the higher figure replaces the lower one. Annual additions other than catch-up are capped at $70,000. Compensation taken into account is capped at $350,000. The defined benefit dollar limit is an annual benefit of $280,000, reduced for early commencement and for fewer than ten years of participation. The IRS explains that benefit limit on its benefit limits page.

An owner at the compensation cap is, for testing, an owner who earns $350,000, even if the practice produced more. An employee with $70,000 of pay is tested on $70,000, not on a theoretical full-time wage. Deferrals the owner makes from wages count in the defined contribution allocation that the gateway ratio looks at. They do not count as staff contributions. Catch-up contributions are generally kept outside the annual additions limit, which is a reason to identify who is 50 or older, and who is 60 through 63, before the test is run rather than after a failure.

Publication 560 describes qualified plans for small employers without running a general test. Use it to remember that the plan has to be for employees, including owner-employees, under rules. Do not use it as software. The comparison of plan types is the business version of the same reminder. A SEP or a straight profit-sharing plan can be simpler because the test, if it is a uniform percentage, is almost visible to the eye. The deduction is smaller. You are choosing the simpler comparison or the larger contribution. You are not choosing to skip the comparison.

Age sits inside the test the same way it sits inside the design. The briefing on partners of different ages is about the fact that a 62-year-old and a 40-year-old cannot honestly be given the same maximum. Testing is why a firm cannot respond to that fact by giving the older owner everything and the staff a token. The older owner's larger credit is defensible when the projected benefits line up. It is not defensible because the older owner built the firm. The statute is indifferent to originations.

What makes a test fail in August

Hours and last-day rules change who is in the test. A summer of turnover can remove employees the illustration relied on, or add employees it ignored. A participant who was going to receive the gateway and who terminated before the allocation conditions were met may receive nothing. The owner's credit, which assumed that gateway, is then being tested against a different group. This is the ordinary August surprise. It is not bad luck. It is the census.

Compensation definitions do the same thing. If the document excludes bonuses and the staff are paid in bonuses, the denominator moved. If the owner's illustration used K-1 income and the document uses W-2 wages, the owner's rate moved. The test is run on the document's pay, after the statutory cap, not on the pay the partners use in their own conversations.

Controlled groups do it at larger scale. Two practices that share ownership may be one employer in August even though they were marketed as separate in March. The employees of the second practice enter the fraction. A design that passed inside one clinic can fail across both. The repair is sometimes an amendment, sometimes a contribution for people you did not budget, and sometimes the recognition that the plan should not have been adopted at that size. Repairs are cheaper before the accrual is locked and before the deductible contribution has been spent in the owner's mind.

A failed test is not corrected by a narrative in the Form 5500. It is corrected by additional contributions, corrective amendments within the time the regulations allow, or, in the worst posture, by treating the plan as having a qualification problem. The time allowed for a corrective amendment is not indefinite, and it is not a reason to discover the failure after the return is filed. Run the test when the census is knowable. In a calendar-year plan with a last-day allocation, late autumn is the first honest run. August is when you find out whether the people you need in that run are still employed. Both dates matter. Neither is "after the CPA asks."

Illustrations that "pass testing" passed a census that was handed to the software. Change the census and the pass is historical. Treat every testing illustration as illustrative. It is not an IRS cap and not a determination letter. The dollar figures in it for staff contributions are estimates of a formula, not a quote you can take to payroll without the year-end data.

How we talk about a pass

We will tell you the test passed or did not, on a stated census, under a stated formula. We will tell you the gateway that formula required. We will not tell you the plan is "safe" as a permanent condition, and we will not hide a near miss inside a green checkmark. A pass with two employees who are about to hit a year of service is a pass with an expiration date. The Enrolled Actuary's defined benefit certification and the defined contribution test have to agree on who was a participant and what they accrued. When those files disagree, the disagreement is the work, not a rounding difference.

The owner does not need the internal rate of return or the normalization assumptions in order to make the business decision. The owner needs the staff dollars, the owner dollars, and a sentence about what would break the result. If we cannot say that sentence, the test is not ready to rely on, even if a printout says it passed.

What to do in the next two weeks

List every employee who is eligible or who will become eligible by year-end, with 2024 pay, 2025 year-to-date pay, hours, and date of hire. Mark who owned more than 5 percent. Do not mark people as highly compensated from memory.

Ask whoever ran the last illustration which census it used and what employer contribution the non-highly compensated employees must receive for that result to hold. Put that contribution on the same page as the owner's credit. If the page has only one number, the page is a sales sheet.

If you have a second entity, a new hire, or a termination since that illustration, say so before you fund the amount on the sheet. Then send us the list. We will tell you whether the comparison still has the same shape. We will not call a stale pass a current one.