When you have a 401(k) plan it can get a little overwhelming at times, especially when you start to worry about passing all the non-discrimination tests. These tests ensure a plan does not favor highly compensated employees (HCE) over non-highly compensated employees (NHCE) and mandates that corrections be made if one of these tests are failed. Two of these tests are the ADP and the ACP tests.
ADP stands for “actual deferral percentage”. This test is a comparison between the average deferral percentages of HCE with those of NHCE. Essentially, you take the total amount deferred for each employee and divide it by that employee’s compensation. Then you average all the HCE’s results and compare them with the NHCE average.
ACP stands for “actual contribution percentage”. This test is like the ADP test except instead of using the amount deferred you use the employer matching contributions of the HCE against the NHCE.
The tests are passed individually if the spread between the HCE group and NHCE is within acceptable ranges. The spread is generally two percentage points, but varies based on the NHCE percentage
|NHCE Average||Maximum HCE Average|
|Less than 2%||NHCE Average % x 2|
|Between 2% and 8%||NHCE Average % + 2|
|More than 8%||NHCE Average % x 1.25|
These two tests are performed every year and are an important part of ensuring your plan is following the law. If your plan fails either of these tests, corrections will have to be made. This consists of either refunding deferrals made by highly compensated employee’s or by providing additional employer contributions in an amount to meet the percentages above. If you decide to make your plan a Safe Harbor plan, your plan automatically passes these tests and they don’t need to be performed. There are certain requirements that must be met to make your plan a Safe Harbor plan. It could be worth asking your third-party administrator or recordkeeper if a Safe Harbor plan is right for your company.