What Are Actual Deferral Percentage and Actual Contribution Percentage Tests?

What Are ADP and ACP Tests?

The Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests are two tests that companies must conduct to ensure that their 401(k) plans don't unfairly benefit highly paid employees at the expense of others.

Companies that offer 401(k) plans must conduct the tests in order to retain the qualified status of their plans under Internal Revenue Service (IRS) rules and the Employee Retirement Income Security Act (ERISA).

If the plan fails either test, the employer must take corrective action in the 12-month period following the close of the plan year in which the oversight occurred. Failure to do so can result in penalties, plan disqualification, and fiduciary liability on the part of the employer. 

How ADP and ACP Tests Work

The ADP test compares the average salary deferral percentages of highly compensated employees (HCEs) to those of non-highly compensated employees (NHCEs). An HCE is any employee who owns more than 5% interest in the company at any time during the current or previous plan year or earned more than $155,000 during the 2024 tax year. 

The ADP test takes into account both pre-tax deferrals and after-tax Roth deferrals, but no catch-up contributions, which may be made only by employees aged 50 and over. To pass the test, the ADP of the HCE may not exceed the ADP of the NHCE by more than two percentage points. In addition, the combined contributions of all HCEs may not be more than two times the percentage of NHCE contributions.

The ACP test uses a similar method as the ADP test, except that it uses matching contributions and employee after-tax contributions.

Correcting an ADP and/or ACP Test Failure

When employers fail the ADP test and/or the ACP test, they can remedy the failure by refunding excess contributions back to HCEs in the amount necessary to pass the test. However, these refunds will be liable for income tax for the HCEs. 

Some companies set buffer zones within their plan documents to steer plans away from potentially failing the ADP/ACP tests in the first place. One option is setting a cap on contributions by HCEs. Another option is to place a contribution limit on HCEs at the point where the plan would fail the ADP/ACP tests. Setting plan buffer zones may require employers to conduct ADP/ACP test projections, typically in the middle of the plan year, to determine if any restrictions need to be applied. 

Still, some companies use a safe harbor 401(k) plan to avoid the ADP/ACP tests entirely.

The Bottom Line

The Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests ensure that 401(k) plans don't favor higher-paid employees. Companies' retirement plans must pass these tests for the plans to remain qualified under the IRS. Failing these tests can lead to penalties and potential fiduciary liability. To avoid this, some companies choose to offer a safe harbor 401(k) instead.