Every year, plan sponsors of traditional 401(k) plans must perform non-discrimination testing. The testing is performed to ensure that the Highly Compensated Employees (HCE’s) are not receiving contributions that are significantly greater than the Non-Highly Compensated Employees’ (NHCE’s) contributions. One of the non-discrimination tests is referred to as the Actual Deferral Percentage (ADP) Test.
WHAT IS THE ADP TEST?
The IRS website explains the ADP test as follows:
“The ADP test counts elective deferrals (both pre-tax and Roth deferrals, but not catch-up contributions) of the HCEs and NHCEs. Dividing a participant’s elective deferrals by the participant’s compensation gives you that participant’s Actual Deferral Ratio. The average ADR for all NHCEs (even those who chose not to defer) is the ADP for the NHCE group. Do the same for the HCEs to determine their ADP.
The ADP test is met if the ADP for the eligible HCEs doesn't exceed the greater of:
• 125% of the ADP for the group of NHCEs, or
• the lesser of:
• 200% of the ADP for the group of NHCEs, or
• the ADP for the NHCEs plus 2%.
You may base the ADP percentages for NHCEs on either the current or prior year contributions. The election to use current or prior year data is contained in the plan document. Under limited circumstances, the election may be changed.”
MORE THOUGHTS TO PONDER:
To say that this is the depth of non-discrimination testing would over simplify the concept and leave you with the following questions:
1. Is my plan subject to ADP Testing?
2. How do I determine who is an HCE versus a NHCE?
3. Do I need to consider the top paid group plan design option?
4. Should I use current year testing or prior year testing when performing the ADP test?
5. What if my plan fails the ADP test?
6. What are my options to correct an ADP test failure?
7. The ADP test addresses deferral contributions to the plan, but what about the ACP test (Actual Contribution Test) used for testing match contributions?
SUMMARY
Would a plan design change allow your plan to pass testing more easily, or avoid the tests altogether? Is your current TPA offering a retirement plan that meets your business needs? Are you failing non-discrimination testing year after year and not receiving proactive solutions to pass testing?
Let the experts review your plan and discuss your options – there are a plethora of options! Click here for a complimentary hour of expert advice to review your plan and discuss plan design alternatives.
You might also like:
Guide to Safe Harbor 401k Plans (getting a free pass on the ADP/ACP tests and the Top Heavy minimum contributions.)
Top Heavy Plan Questions (For Safe Harbor) - Part 2
6 ways to save money on your company retirement plan
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