2025 Guide: Actual Deferral Percentage (ADP) & Actual Contribution Percentage (ACP) Tests Explained

Julia Kagan, an expert financial journalist and former senior editor at ZAMONA, breaks down the essentials of ADP and ACP tests.

Understanding ADP and ACP Tests in 2024

The Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests are critical compliance checks that companies must carry out to ensure 401(k) plans are fair and nondiscriminatory. These tests prevent highly compensated employees (HCEs) from disproportionately benefiting over non-highly compensated employees (NHCEs).

Maintaining these tests is mandatory for 401(k) plans to retain their qualified status, adhering to IRS regulations and ERISA standards.

Failing either test requires employers to implement corrective measures within a year following the plan year with the failure, or face penalties, plan disqualification, and fiduciary liabilities.

Key Insights

• The ADP test evaluates pre-tax and Roth deferrals from employees.
• The ACP test reviews employer matching and employee after-tax contributions.
• Both tests aim to ensure equitable retirement benefits across all employee compensation levels.

How ADP and ACP Tests Operate

The ADP test measures the average deferral percentages of HCEs versus NHCEs. In 2024, an HCE is defined as someone owning more than 5% of the company or earning over $155,000.

It includes both pre-tax and Roth contributions but excludes catch-up contributions for employees 50 and older. To pass, the ADP of HCEs cannot exceed NHCEs by more than two percentage points or be more than double the NHCEs' average.

The ACP test mirrors this approach but focuses on employer matches and after-tax employee contributions.

Addressing Test Failures

If a plan fails the ADP or ACP test, employers can refund excess contributions to HCEs to regain compliance. However, these refunds are taxable income for the recipients.

Some companies proactively set contribution limits or buffer zones within their plans to avoid failures. Mid-year projections help determine if restrictions are necessary.

Alternatively, many employers opt for safe harbor 401(k) plans to bypass these tests entirely.

What Is a Safe Harbor 401(k) Plan?

Safe harbor plans exempt companies from ADP and ACP testing by committing to mandatory employer contributions, such as a 100% match on the first 3% of salary deferrals plus a 50% match on the next 3%, or a 3% nonelective contribution for all eligible employees.

The Role of ADP and ACP in Fair Retirement Planning

The ADP test focuses on employee salary deferrals, ensuring high earners don’t overshadow others in 401(k) participation.

The ACP test evaluates employer match and after-tax contributions to maintain fairness.

Conclusion

In 2024, ADP and ACP tests remain essential for ensuring 401(k) retirement plans promote equity between high- and lower-paid employees. Compliance protects companies from penalties and fiduciary risks. Utilizing safe harbor plans is a popular strategy to simplify compliance and foster inclusive retirement savings.

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