The Importance of ADP and ACP Testing Within Your Employee Benefit Plan
Published on by Mike Balzano in Benefit Plan Audits, Consulting
Have you ever thought about whether your 401(k) benefits are the same as other employees within your Plan? Are you getting the same benefits as someone who is more highly compensated? Luckily for you, Employee Benefit Plans are required to go through compliance testing to ensure that benefits within your 401(k) plan are not being skewed towards certain employees.
What are the ADP and ACP Tests?
The Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) compliance tests are performed each plan year. Specifically, the test is geared to identify Highly Compensated Employees (HCE) and their average rates of contributions compared to that of Non-Highly Compensated Employees (NHCE). The ADP test takes an employee’s elective deferrals and divides this by their compensation to get to their Actual Deferral Ratio (ADR). Similarly, the ACP test takes an employee’s matching and after-tax contributions and divides this by their compensation.
How they are done
The first step is to divide all employees who are eligible for the plan into two groups: HCE and NHCE. An HCE can be identified as any employee who owns more than 5% interest in the company at any time during the current or previous year, or someone who earned more than $130,000 during the 2020 tax year (also the same rate for 2021).
Next, perform the ADP and ACP test for all HCE’s and NHCE’s
| ADP | ACP | |||||
| Elective Contributions | = ADR | Matching/After-Tax Contributions | = ADR | |||
| Compensation | Compensation |
How to interpret the results
The ADP/ACP test passes if the average for the HCE group is within a certain range of the average for the NHCE. This “range” is broken out into 3 separate categories:
- If the NHCE average is less than 2%, the maximum HCE average can be the NHCE average multiplied by 2 (ex. NHCE average = 1.5%, maximum amount of HCE average = 3%)
- If the NHCE average is between 2% and 8%, the maximum HCE average can be the NHCE average plus 2 (ex. NHCE average = 5%, maximum amount of HCE average = 7%)
- If the NHCE average is greater than 8%, the maximum HCE average can be the NHCE average multiplied by 1.25 (ex. NHCE average = 9%, maximum amount of HCE average = 11.25%)
Should the plan fail the ADP/ACP test, a correction is made by providing additional contributions to the NHCE’s or refunds to the HCE’s in the amount necessary to pass the test.
Overall, compliance testing such as the ADP/ACP test should provide comfort that all eligible employees within your employee benefit plan are receiving similar benefits.
Get started
Planning to conduct an ADP or an ACP test, or have questions about what you’re reading? Contact our team of EBP professionals – we’re happy to answer your questions and help you ensure you’re on the right path. We’re here to help.
