If your company’s 401(k) plan fails nondiscrimination testing every year, you’re probably tired of the same cycle: frustration from leadership, refund checks issued to your highest earners, and awkward conversations with employees who don’t understand why their contributions got kicked back. It’s a problem, but it’s also a sign that your plan design isn’t keeping up with your team’s needs.

Sure, you can tweak some basics, such as auto-enrolling more people, adding contribution escalation, or sweetening the match. Those are a good start. But if the testing failures keep coming, those moves may not be enough.

That’s where nonqualified deferred compensation (NQDC) plans can truly make a difference. They’re often thought of as a “nice to have” for executives, but in the right situation they can play a key role in solving the problem of failed testing and avoiding frustrations for your leadership team.

Why do 401(k) tests commonly fail?

The Internal Revenue Service wants to make sure retirement plans benefit all employees, not just the ones earning the most. In practice, it means that if your lower-paid employees aren’t contributing enough to their 401(k) plans, your higher-paid folks can get capped or even refunded.

What happens after they fail?

  • Savings goals take a hit. Executives can’t contribute as much as they’d planned.
  • Surprise tax bills show up. Refunds are taxed as regular income, and they’re often unexpected.
  • Retention gets harder. If your leadership team feels like their benefits don’t match their pay, that frustration can build—especially if it happens year after year.

What is an NQDC plan, and how can it help?

NQDC plans don’t follow the same rules as a 401(k). With an NQDC plan, there’s no nondiscrimination testing or contribution caps, freeing up resources to fix the bigger picture.

How NQDC retirement plans work:

  1. It reduces pressure on the 401(k). If some of your top earners shift their savings into the NQDC plan instead, they’re no longer skewing the 401(k) test results. That means your plan has a better shot at passing.
  2. It keeps tax deferral in play. If highly compensated employees are refunded 401(k) contributions, they lose the tax benefit. But if they’re using an NQDC plan to defer income, they stay on track with their savings—and avoid that unexpected tax hit.
  3. It offers a more complete benefit. Due to their earnings, your top talent probably can’t save as much as they’d like within 401(k) limits. With NQDC retirement plans, they can defer against bonuses and incentive pay, bringing them more in line with actual compensation.

Elements of NQDC plans to consider

NQDC plans give you a lot of flexibility, but they’re not plug and play. You’ll need to make a few key decisions:

  • Who is eligible?
  • What types of pay can be deferred?
  • When and how do distributions happen?
  • How will you educate participants so they actually use it?


Also keep in mind that this isn’t just about executives. When your 401(k) plan passes testing, everyone benefits. There’s less rework, fewer surprises, and a benefits package that does what it’s supposed to do: recruit, engage, and retain.

When it makes sense to explore an NQDC plan

If your 401(k) plan is failing nondiscrimination testing year after year, consider an NQDC plan—especially if you’re refunding contributions to highly compensated employees, adjusting the 401(k) design has shown little improvement, retaining executives is a priority, and you want your benefits to scale with compensation levels.

You don’t need to overhaul everything overnight. But if your current setup is falling short, it might be time to rethink the approach. Our retirement plan consultants work with companies to address these issues and are here to assist you as well.

Fixing 401(k) failures isn’t just a compliance task, it’s an opportunity to build a better benefits strategy that makes sense for your company now and in the future. Learn more about our Retirement Plan Consulting capabilities.

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