If a plan is more generous, some shorter service employees who become eligible often choose not to contribute, which hurts the test results. When a plan fails the ADP/ACP test, correction is made by either refunding amounts to the HCEs or providing additional company contributions to NHCEs or some combination of the two. As long as the correction is made on a timely basis, there are no penalties. As a result, failing is not necessarily a negative event in that it confirms the HCEs have obtained the maximum benefit available to them based on the plan’s design. Another nondiscrimination test for 401 plans is the Actual Contribution Percentage test, which takes into account matching employer contributions and after-tax employee contributions. Typical Safe Harbor allocation methods are pro rata based on wages (i.e. same % of compensation for all participants) or integrated with Social Security Taxable Wage Base.

If the https://adprun.net/ fails the ADP or ACP test, corrective action must be taken to protect the tax qualified status of the plan. The statutory correction period is the 12-month period following the close of the plan year in which the failure occurs. Typically, the correction involves issuing a refund for the amount of the excess deferrals or contributions, plus earnings. If corrective distributions are made later than 2 ½ months after the applicable plan year, the employer is liable for an excise tax. Another option for correction of a failed test is for the employer to deposit additional fully vested contributions into the accounts of the NHCEs, in order to increase the average percentage for that group.

Resources for small business owners looking to offer a retirement benefit to their employees

The calculation includes all employees eligible to make a deferral, even if they don’t contribute. The ratio of the two average deferral rates drives the test results. Return excess retirement plan contributions, including earnings, to HCEs. The distributions are first made to HCEs who deferred the highest dollar amounts, not the highest percentage, consequently lowering the average percentage contribution until the test passes.

• Another option is to make a 3% “non-elective” contribution to each eligible employee even if not in the plan.
• The ACP test includes the employer match contributions, employee voluntary after-tax contributions and certain forfeitures allocated on the basis of deferrals or matching contributions.
• Family attribution rules treat an employee who is a spouse, child, grandparent or parent of someone who’s a 5% owner, as a 5% owner.
• Return the excess contributions, including earnings, to HCEs.
• And, those lower paid employees should be contributing to the plan as well.
• In the example above, the maximum amount that HCEs can now defer is limited to just 6%.

Actual Deferral & Actual Contribution Percentage Tests Definition amounts must be returned within 2½ months of the close of the plan year to avoid an IRS excise tax of 10%. The corrective distribution amount returned is taxable to the participant in the calendar year in which the distribution is received and a Form 1099-R is issued for tax reporting. In order to ensure a 401 plan is not favoring owners or highly paid employees, the IRS requires the 401 nondiscrimination testing is performed. The Actual Deferral percentage Test measures the employee deferral contributions and the Actual Contribution Percentage Test measures the employer matching contributions.

PASSING ADP/ACP TESTING

Plan sponsors that select safe harbor and automatic enrollment plan designs can limit testing headaches and mitigate the risk of having to take corrective measures to be in compliance, Droblyen says. A Safe Harbor may not be the least expensive way to pass testing, but it’s definitely the easiest. If you cannot afford to pay 3% of all employees’ salaries, you may consider the other methods mentioned.

When the employer reran the ADP test with the corrected classification, HCEs had an ADP of 7% and NHCEs had an ADP of 4%. The maximum passing ADP for the HCE group is 6%; and the plan failed the ADP test. There were no matching or other employee contributions for the 2017 plan year. A safe harbor 401 plan ensures all eligible plan participants receive an employer contribution. In exchange, employers get a “pass” on the ADP and ACP tests, and no longer have to restrict contributions from HCEs . This means that all plan participants—owners, HCEs, and NCHCEs alike—can max out contributions.

More Definitions of Actual Contribution Percentage (ACP

Dividing a participant’s elective deferrals by the participant’s compensation gives you that participant’s Actual Deferral Ratio . The average ADR for all eligible NHCEs is the ADP for the NHCE group. It requires that the average annual contribution rate which is the employers contribution together with the employer matching for HCEs should not surpass the set limit in the 401 Nondiscrimination Testing. The Actual Deferral Percentage/Actual Contribution Percentage simply refers to two separate 401 nondiscrimination plan tests. ERISA and the IRS require that a 401K pass these tests to maintain its qualified status.

Testing ensures that businesses are compliant with federal regulations and that non-highly-compensated employees have the same access to tax advantage as the owners and key executives. SCP and VCP are generally only available if the plan identifies the error before the IRS discovers it. Most plans are eligible for Audit CAP, which allows the plan sponsor to correct the mistake and pay a negotiated sanction, even if the IRS discovered the error first. This sanction would bear a reasonable relationship to the nature, extent and severity of the mistake, considering many factors, including the extent to which correction occurred before audit. Sanctions under Audit CAP are a negotiated percentage of the maximum payment amount.