Nondiscrimination testing (ADP/ACP) explained

What is nondiscrimination testing?

Nondiscrimination testing is an annual process required for many traditional 401(k) plans to help ensure that retirement plan benefits are not disproportionately favoring Highly Compensated Employees (HCEs) over Non-Highly Compensated Employees (NHCEs).

The tests compare participation and contribution levels between these groups to determine whether the plan satisfies IRS requirements.

Not every retirement plan is required to complete ADP and ACP testing. Certain plan designs, such as many Safe Harbor 401(k) plans, may satisfy these requirements through alternative methods.

What is the ADP test?

The Actual Deferral Percentage (ADP) test compares the average salary deferral percentages of Highly Compensated Employees and Non-Highly Compensated Employees. In simple terms, the IRS wants to ensure that highly compensated employees are not contributing significantly more to the plan unless non-highly compensated employees are also participating at meaningful levels.

Example: Suppose Highly Compensated Employees contribute an average of 9% of their pay, while Non-Highly Compensated Employees contribute an average of 3%. Depending on the applicable IRS limits, the plan may not satisfy the ADP test because the difference between the two groups is too large.

The specific testing limits are established by the IRS and can change over time.

What is the ACP test?

The Actual Contribution Percentage (ACP) test focuses on employer matching contributions and employee after-tax contributions.

Rather than comparing employee salary deferrals, the ACP test compares the average contribution percentages received by Highly Compensated Employees and Non-Highly Compensated Employees from these sources.

Like the ADP test, the goal is to ensure that employer contributions are benefiting employees fairly across the organization.

Why do these tests matter?

Failing nondiscrimination testing can require corrective action to bring the plan back into compliance. Depending on the circumstances, corrections may include:

• Refunding excess contributions to Highly Compensated Employees
• Making additional employer contributions to Non-Highly Compensated Employees
• Adjusting future plan design or contribution strategies

Addressing testing failures promptly helps maintain the plan's tax-qualified status and keeps the plan operating in accordance with IRS requirements.

How can plan sponsors improve testing results?

While annual testing occurs after the plan year ends, there are several proactive steps plan sponsors can take throughout the year to improve the likelihood of passing. Strategies may include:

• Encouraging greater participation among Non-Highly Compensated Employees
• Increasing average employee deferral rates through education campaigns
• Implementing automatic enrollment
• Adding automatic escalation features
• Reviewing the employer matching formula
• Monitoring contribution trends before year-end

Improving participation across the workforce often benefits both employees and the plan's testing results.

Should testing be monitored during the year?

Yes. Waiting until the end of the year to review contribution data can limit your available options if the plan appears likely to fail testing.

Periodic reviews throughout the year allow plan sponsors to identify developing issues early and adjust before testing is completed.

Working with your recordkeeper, third-party administrator, or retirement plan advisor can help you monitor progress and reduce the likelihood of unexpected corrections.

The bottom line

ADP and ACP testing play an important role in ensuring that retirement plans provide equitable benefits to employees across the organization. By understanding how these tests work, monitoring contribution trends throughout the year, and encouraging broad employee participation, plan sponsors can improve compliance while helping more employees prepare for retirement. Whether through participant education, plan design enhancements, or ongoing compliance support, we're here to help keep your retirement plan on track.