The ADP and ACP Tests - What You Need to Know

Each year, the IRS requires 401(k) plans that don’t meet the safe harbor provision to undergo certain tests to make sure the plan doesn’t unfairly discriminate for Highly-Compensated Employees (HCEs) over non-HCEs. The Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests are two of the main ones.

Here's what you need to know about them.

Who is Considered a Highly-Compensated Employee (HCE)?

For 2024, an HCE is defined as an individual who meets one of the following two criteria: 

• They own more than 5% of the employer (directly or by family attribution) at any time during 2024 or 2023
• They received compensation in excess of $150,000 during 2023. A plan can limit this group to the top 20% of employees, ranked by compensation

The ADP Test

The ADP tests pre-tax and Roth elective deferrals - not including catch-ups - for nondiscrimination.  To pass the ADP test, the average contribution rate of HCEs for the year cannot exceed the greater of:

• 125% of the non-HCE average rate, or
• the lesser of: 
• 200% of the non-HCE average rate, or
• the non-HCE average rate plus 2%.

The non-HCE average can be based on current or prior year contribution rates.

ACP Test

The ACP test uses the same methodology as the ADP to test matching and voluntary after-tax contributions for nondiscrimination.

Most Safe Harbor 401(k) Plans Automatically Pass

Safe harbor 401(k) plans automatically pass the ADP/ACP tests UNLESS one or more of the following conditions apply:

• The safe harbor contribution is subject to longer eligibility requirements than employee deferrals.
• A match that’s not exempt from the ACP test is made during the year.
• Voluntary (non-Roth) after-tax contributions are made during the year.

How to Correct a Failed Test

The most common correction method is refunding the contributions made to HCEs in the amount necessary to pass the ADP or ACP test (as applicable).

A 10% excise tax will usually apply to contribution refunds made later than 2 1/2 months following the close of the year (March 15 for calendar-based 401(k) plans).

The final deadline for refunding excess contributions is 12 months following the close of the year.  

Thanks to the SECURE Act, a 401(k) plan can adopt safe harbor status up to the last day of plan year following the year in which the plan failed the ADP test by making a 4% nonelective contribution.

Don’t Settle for a Failed ADP/ACP Test!

If you are a 401(k) fiduciary, you don’t need to settle for annual ADP/ACP test failures – there are steps you can take to avoid or mitigate returns. You just need to know your options. Once you do, you’ll be ready to discuss these options with your 401(k) provider.