All qualified plans have a variety of regulations to follow. 401(k) and 403(b) plans have some unique testing requirements to test for non-discrimination in the amount of elective deferrals and/or matching contributions made to the plan.
Understanding the mechanics of the 401k compliance test called the Actual Deferral Percentage (ADP) test itself is fairly rudimentary. If the test fails there are two options:
To correct a failed test using the distribution option includes some extra steps that can be very confusing. This article discusses the process required for correcting an ADP test using the corrective distribution option
Step 1 – Determine the testing population
Step 2 – Split testing population into separate/allowable groups. Employees who are in one of the two categories below, may be tested separately (statutory exclusions)
Step 3 – Determine catch up contributions for HCEsParticipants who have attained age 50 or more during the testing period may have their catch-up contribution excluded from testing if they deferred the maximum contribution limit under §402(g) plus catch up
Step 4 – Compute the maximum contribution percentage for the HCE group based on the average of the NHCE group
NHCE deferral |
Maximum HCE deferral |
0.1%-2% |
200% of NHCE deferral |
2%-8% |
NHCE deferral plus 2% |
8% or more |
125% of NHCE deferral |
Step 5 – Determine the total amount needed to be refunded to HCE group to bring their percentage down to meet testing limits
Step 6 – Reduce deferral from HCE with highest contribution amount first. Continue until total refunded amount is reached
Step 7 – Allocate investment gain or loss to deferral accounts
Step 8– If additional catch up contributions remain after the amounts used in Step 3. Those additional amounts may be used to reduce the corrective distribution for those participants.
Example –corrective distributions for this HCE group based on NHCE group average deferral of 2.1%
Name |
Compen-sation |
Deferral |
Ratio |
Excess amt |
Distrib leveling |
Catch up to reduce distrib |
Corrective distrib |
Abel |
270,000 |
6,800 |
2.52% |
0 |
|
|
0 |
Baker# |
270,000 |
24,000 |
6.67%* |
7,827 |
6,822 |
@ |
6,822 |
Charlie# |
230,000 |
18,000 |
7.83% |
4,223 |
6,822 |
-6,000 |
822 |
Delta |
160,000 |
16,000 |
10.00% |
6,416 |
4,822 |
|
4,822 |
Echo |
120,000 |
0 |
0.00% |
0 |
|
|
0 |
TOTALS/AVG |
|
58,800 |
5.40% |
18,466 |
18,466 |
-6,000 |
12,466 |
# = catch-up elig. |
|
|
*excluding catch up |
5.99% max. defrl |
|
@catch up used in ratio calc |
|
The same process is performed on 401k matching contributions for the ACP test, except that catch up contributions do not apply to match. 403(b) plans have to pass the ACP test only; they are not subject to the ADP test.
There are a variety of nuances to ADP and ACP testing. We can include or exclude elective deferrals from the compensation used in the denominator of the ratios. In some cases we can include HCEs that would otherwise be excluded under the statute in the test with the main testing group. At Benefit Resources we look at every option available to our clients to give them the best testing result. If your plan has testing problems, let us take a look at it for you. We may have a solution that can help!