To retain their tax-favored status, 401(k) plans have to demonstrate that they don’t discriminate in favor of highly compensated employees. Actual deferral percentage (ADP) nondiscrimination testing is an annual ritual for 401(k) plans that do not have a safe harbor design or a qualified automatic contribution arrangement and that are not SIMPLE 401(k) plans.
The ADP test compares the average rate at which highly compensated employees defer salary with the average deferral rate for nonhighly compensated employees. The difference between the averages for the highly paid and lower paid employees must be within certain limits:
The ADP test is met if the ADP for the eligible highly compensated employees doesn’t exceed the greater of:
- 125% of the ADP for the group of nonhighly compensated employees, or
- the lesser of:
- 200% of the ADP for the group of nonhighly compensated employees, or
- the ADP for the nonhighly compensated employees plus 2%.
If an ADP test does not meet the requirements, there are several correction methods. For example, excess contributions can be returned to the highly compensated employees after year-end.
How Plans Pass the ADP Test
|% of Plans|
|Excess Contributions Returned to Participants After Plan Year Ended||16.7%|
|Elections of Highly Paid Participants Limited by Plan Design||8.9%|
|Elections of Highly Paid Participants Limited When Contributions
Reached the Maximum Allowed by the Test
|Excess 401(k) Amounts Deposited into a Nonqualified Arrangement||0.6%|
|Passed Because of Safe Harbor Plan Design||38.8%|
|Non-safe Harbor, Passed with No Corrective Action||35.4%|
Source: 57th Annual Survey of Profit Sharing and 401(k) Plans, Plan Sponsor Council of America, 2014 (reflecting 2013 plan experience)
To learn more about ADP nondiscrimination testing, contact a Lumin Financial advisor.
Disclosure: Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific investment, or investment strategy. Investments involve risk and are not guaranteed. Information has been gathered from sources believed to be reliable, but cannot be represented as accurate or complete. Before investing, you should consult your investment, tax, or legal advisor.