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

• A. To ensure that pre-tax deferrals do not disproportionately favor highly compensated employees.
• B. To ensure after-tax contributions are equal among all employees.
• C. To guarantee a minimum employer match for all employees.
• D. To set vesting schedules for highly compensated employees.

Answer: (A)

The main idea tested here is nondiscrimination in how employees defer compensation into a 401(k). Elective deferrals are the pre-tax contributions employees choose to take from their pay and put into the plan. To keep a 401(k) qualified, the IRS requires that these deferrals aren’t biased toward highly compensated employees. The ADP test compares the average deferral rates of highly compensated employees with those of nonhighly compensated employees. If the highly compensated group defers at a higher rate on average, the plan fails the test and must be corrected, often by refunds or adjustments so that nonhighly compensated employees aren’t disadvantaged. This preserves fair participation and the plan’s tax-qualified status.

The other options don’t fit because the test isn’t about equalizing after-tax contributions, guaranteeing a minimum employer match, or setting vesting schedules. It specifically focuses on ensuring pre-tax (elective) deferrals don’t disproportionately favor higher-paid employees.