Mary Beth’s Corner

Understanding ADP and ACP Testing: Key Differences and Why They Matter

Administration, ERISA Services, General
March 20, 2025

When it comes to managing a 401(k) plan, ensuring compliance with federal regulations is critical. Two essential compliance tests—Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP)—play a pivotal role in maintaining fairness and preventing discrimination in retirement savings plans. Here’s a breakdown of what these tests are, how they differ, and why they should matter to you and your business owner clients.

What Are ADP and ACP Tests?

The ADP and ACP tests are annual nondiscrimination evaluations required for traditional 401(k) plans. Their primary purpose is to ensure that the plan does not disproportionately favor Highly Compensated Employees (HCEs) over Non-Highly Compensated Employees (NHCEs). These tests are mandated by the IRS under the Employee Retirement Income Security Act (ERISA) to maintain the plan’s tax-advantaged status.

ADP Test: Focuses on employee salary deferrals, including pre-tax and Roth contributions, but excludes catch-up contributions for employees aged 50 or older.

ACP Test: Examines employer matching contributions and employee after-tax contributions to ensure equitable treatment.

Key Differences Between ADP and ACP Testing

For both tests, the allowable difference between HCEs and NHCEs is limited. For example, the HCE average cannot exceed either:

The NHCE average plus 2%, or
125% of the NHCE average.

Why These Tests Matter

Ensures Fairness: The ADP and ACP tests prevent retirement plans from disproportionately benefiting HCEs, fostering equity among all employees.
Maintains Tax Advantages: Passing these tests is crucial for the plan to retain its tax-qualified status, which benefits both employers and employees.
Encourages Participation: By tying HCE contribution limits to NHCE participation rates, these tests incentivize employers to promote plan participation among all employees.

What Happens If a Plan Fails?

Failing an ADP or ACP test can have significant consequences:

Employers must take corrective actions within 12 months, such as refunding excess contributions to HCEs or making additional contributions for NHCEs.

Failure to correct can lead to penalties, loss of tax-qualified status, or fiduciary liability for employers.

Safe Harbor Solution

For your business owner clients looking to simplify compliance and automatically pass ADP/ACP testing, implementing a safe harbor 401(k) plan is an excellent option. This approach offers numerous benefits, including guaranteed passing of nondiscrimination tests and potential relief from top-heavy requirements.

For a comprehensive overview of safe harbor plan benefits, please refer to our Safe Harbor Retirement Plan one-pager, which details the advantages and implementation strategies for safe harbor 401(k) plans.

Let Us Bring It All Together for You!

Compliance testing is a critical aspect of 401(k) plan management that shouldn’t be overlooked. With complex regulations and potential consequences for non-compliance, it’s essential to partner with experts in this field. My Benefits specializes in compliance testing and can provide the guidance needed to keep your client’s retirement plan compliant with government regulations.

Don’t leave your business owner client’s plan’s compliance to chance – reach out to My Benefits today for answers to your testing questions and ensure their 401(k) plan remains in good standing with the IRS.