What is the purpose of the ACP nondiscrimination test in 401(k) plans?

• A. To ensure that after-tax contributions and employer matching do not disproportionately favor highly compensated employees.
• B. To limit the total elective deferrals from all employees.
• C. To set the vesting schedule for employer contributions.
• D. To evaluate investment diversification adequacy.

Answer: (A)

Nondiscrimination testing for 401(k) plans ensures the way contributions are allocated doesn’t give higher-paid employees a disproportionate share. The ACP test specifically compares actual contribution percentages between highly compensated employees and non-highly compensated employees, focusing on employer matching and any after-tax employee contributions. If the ACP for highly compensated employees is too high relative to non-highly compensated employees, the plan must correct it, often by adjusting contributions or refunds so the plan passes the test. This is why the best choice says that after-tax contributions and employer matching should not disproportionately favor highly compensated employees.

The other options describe different aspects of plan testing or features: limiting total elective deferrals relates to the ADP test, vesting schedules govern when contributions belong to employees, and investment diversification is about how the plan’s investment options are structured.