Home / NEWS LINE / Actual Deferral & Actual Contribution Percentage Tests Definition

Actual Deferral & Actual Contribution Percentage Tests Definition

What Are the Existing Deferral Percentage (ADP) & Actual Contribution Percentage (ACP) Tests?

The Actual Deferral Percentage (ADP) and Actual Contribution Interest (ACP) tests are two tests that companies must conduct to ensure that their 401(k) plans don’t unfairly forward highly-paid employees at the expense of others.

If the plan fails either test, the employer must take corrective exertion in the 12-month period following the close of the plan year in which the oversight occurred. Failure to do so can result in the IRS imposing pecuniary mulct fees, plan disqualification, and fiduciary liability on the part of the employer. 

Understanding ADP and ACP Tests

The ADP test compares the average emolument deferral percentages of highly compensated employees (HCE) to that of non-highly compensated employees (NHCE). An HCE is any employee who owns multitudinous than 5% interest in the company at any time during the current or previous plan year or earned more than $120,000 during the 2018 tax year. 

The ADP investigation takes into account both pre-tax deferrals and after-tax Roth deferrals, but not catch-up contributions, which may be made just by employees age 50 and over. To pass the test, the ADP of the HCE may not exceed the ADP of the NHCE by more than 2 percentage points. In addition, the connected contributions of all HCEs may not be more than two times the percentage of NHCE contributions.

Correcting an ADP/ACP Test Failure

When outfits fail the ADP/ACP tests, they can remedy the failure by refunding excess contributions back to HCEs in the amount necessary to antiquated the test. However, these refunds will be liable for income tax for the HCE individuals. 

Some companies set buffer zones within their arrange documents to steer plans away from potentially failing the ADP/ACP test in the first place. One option is setting a cap on contributions by HCEs. Another choice is to place a contribution limit on HCEs at the point where the plan would fail an ADP/ACP test. Setting plan buffer zones may command employers to conduct ADP/ACP test projections, typically in the middle of the plan year, to determine if any restrictions need to be applied. 

Check Also

Blockchain-as-a-Service (BaaS) Definition

What Is Blockchain-as-a-Service (BaaS)? Blockchain-as-a-Service (BaaS) is the third-party beginning and management of cloud-based networks …

Leave a Reply

Your email address will not be published. Required fields are marked *