3844 / What is the average benefit test that can be used to determine whether a qualified plan satisfies the minimum coverage requirement?

A plan that cannot satisfy the ratio percentage test ( Q 3843) still may satisfy the coverage requirement by passing the average benefit test.¹ The average benefits test may allow a plan with a ratio percentage of less than 70 percent to satisfy minimum coverage. It has two parts: the “non-discriminatory classification” test and the “average benefit percentage” test. Both of these requirements must be met for a plan to satisfy the average benefit test.² Note that the non-discriminatory classification test has two separate requirements that must be met.

A plan passes the non-discriminatory classification test when the plan benefits “such employees as qualify under a classification set up by the employer and found by the Secretary not to be discriminatory in favor of highly compensated employees.”³ Regulations state that this requirement has two parts: (1) the classification of employees must be reasonable and established under objective business criteria identifying the category of employees who benefit under the plan; that is, it must reflect a bona fide business classification of employees,⁴ and (2) the classification must be non-discriminatory based on a threshold of coverage specified in regulations. Theoretically it is possible to demonstrate that a classification not satisfying the mathematical threshold of part (2) may satisfy the requirement through a facts and circumstances demonstration or a safe harbor percentage test as explained below.⁵

To determine whether a classification is non-discriminatory, the plan’s ratio percentage (as defined above) is compared to a table (described below) that is set forth in the regulations. This table contains a range of “safe harbor” and “unsafe harbor” percentages determined based on the percentage of non-highly compensated employees participating in the plan (a concentration level).⁶ This comparison produces one of three results: (1) if the plan’s ratio percentage falls below the unsafe harbor percentage, it is discriminatory; (2) if the plan’s ratio percentage falls between the safe harbor and unsafe harbor amounts, it must satisfy a facts and circumstances test; or (3) if the plan’s ratio percentage falls at or above the safe harbor amount, the classification is non-discriminatory.⁷