Passing the ADP Test
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 of the group of eligible highly compensated employees is not more than 125% of the ADP of the eligible nonhighly compensated employees or
- The ADP of the eligible highly compensated employees is not more than two percentage points greater than — and no more than two times — the ADP of the eligible nonhighly compensated employees
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||3.8%|
|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)