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ADP & ACP Testing Deadlines

We are quickly approaching the deadline for making any corrections to plans that fail nondiscrimination testing. What follows is a discussion of what these tests are and how failed tests can be corrected, both for the plan year being tested and going forward.

Nondiscrimination Testing
401(k) plans are subject to nondiscrimination testing, specifically the Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests.

The ADP test is administered to determine if a plan's average deferral rates for the highly compensated employee (HCE) group are discriminatorily higher than the average deferral rates for the non-highly compensated employee (NHCE) group. The purpose of the ADP test is to set a limit on the deferrals for the HCE group as they can only exceed the average deferral rate for the NHCE group by a certain amount.

The ACP test is administered to determine if a plan's average match contribution rates for the highly compensated employee (HCE) group are discriminatorily higher than the average match contribution rates for the non-highly compensated employee (NHCE) group. The purpose of the ACP test is to set a limit on the match contributions for the HCE group as they can only exceed the average match contributions for the NHCE group by a certain amount.

If a plan fails the ADP test, there are two common ways to correct the failure for that plan year. The first is to distribute the HCE deferrals that caused the plan to fail the ADP test. In other words, return the portion of the deferrals that caused the average deferral rates of the HCE's to be considered discriminatorily higher than that of the NHCE's. These corrective distributions must be processed no later than March 15th for plan years that end on December 31. The employer could also make a Qualified Non-elective Contribution (QNEC) to the NHCE's so the plan passes the ADP test. In essence, this correction increases the deferral rate for the NHCE group to a point where their average deferral rate is not significantly less than the HCE's.

If a plan fails the ACP test, there are two common ways to correct the failure for that plan year. The first is to distribute the HCE match contributions that caused the plan to fail the ACP test. In other words, return the portion of the HCE match contributions that caused the average match contributions rates of the HCE's to be considered discriminatorily higher than that of the NHCE's. These corrective distributions must be processed no later than March 15th for plan years that end on December 31. The employer could also make a Qualified Matching Contribution (QMAC) to the NHCE's so the plan passes the ACP test. In essence, this correction increases the match contributions for the NHCE group to a point where their average match contribution rate is not significantly less than the HCE's.

Safe Harbor
One long-term solution for a plan that consistently fails ADP/ACP testing is for an employer to amend the plan document to allow for Safe Harbor contributions. Depending on the nature of the Safe Harbor contributions made, the plan will be deemed to pass nondiscrimination testing regardless of the actual outcome of the tests. Generally speaking, the aforementioned corrections are not necessary for Safe Harbor plans.

If a Plan Sponsor consistently makes matching contributions, they may benefit by adding a Safe Harbor match feature to their plan. If a Plan Sponsor consistently makes Profit Sharing contributions, they may benefit by adding a Safe Harbor non-elective feature to their plan. Note that this contribution is not dependent on a participant deferring in order to receive it. In other words, this contribution will be made to all eligible plan participants regardless if they are deferring or not.

Both Safe Harbor match and non-elective contributions are 100% vested regardless of the participant's length of service. There are also similar withdrawal restrictions as those that apply to deferrals. The plan will also be required to provide an annual Safe Harbor notice to all eligible employees that describes the employees' rights and obligations under the Safe Harbor arrangement. As your plan's TPA, we will handle the generation of these annual notices.

Automatic Enrollment
Another long-term solution for plans that repeatedly fail the ADP/ACP test is for the Plan Sponsor to amend the plan document to allow for automatic enrollment. This is a feature in a retirement plan that allows an employer to enroll an eligible employee in the employer's plan at a specified deferral rate unless the employee affirmatively elects otherwise. The logic behind adding this feature is that it will increase the average deferral rates of the NHCE group, thereby allowing the HCE group to defer at a higher average rate.

Conclusion
Please contact your Client Service Manager to discuss your plan's ADP/ACP testing outcomes and whether amending your plan to add the Safe Harbor and/or automatic enrollment features is something you may be interested in.