What a Failed ADP/ACP Test Means | Watkins Ross

401k plan nondiscrimination testing is complex (for a review of the ADP/ACP tests, please read our 401k Plan Nondiscrimination Testing article). Many financial advisors and plan sponsors want to maximize retirement plan deferrals for the Highly Compensated Employee (HCE) group, yet feel stressed (and even panicked!) at the thought of failing ADP/ACP testing. 

Does a Failed ADP/ACP Test Actually Indicate Success?

Failure is defined as a lack of success and we understand no one likes to fail. But, it’s important to remember the goal of a 401k retirement plan is to provide your employees with an opportunity to save the maximum amount legally allowed for retirement. 

When your retirement plan passes ADP/ACP testing, it indicates your HCE group probably could have contributed more than they did and consequently missed out on deferring those additional savings. A failed test, on the other hand, means your HCE group was able to defer the maximum amount legally allowed. It pays to view this excess as an overage and not a failure, as the “failed” test means you succeeded in maximizing HCE deferrals into the retirement plan that year.

It’s also important to remember a failed test does not signal your retirement plan for an IRS/DOL audit. It merely indicates that HCE group contributions were disproportionately larger than the Non-Highly Compensated Employee (NHCE) group. As long as you correct the failure in a timely manner, your retirement plan remains in good standing with the IRS/DOL. 

Why ADP/ACP Tests Fail

Before you toast to a failed test, it’s important to analyze why the test failed. For example, if the ADP test failed due to poor participation from the NHCE group, then retirement plan strategies can be discussed with your Third Party Administrator (TPA) to increase NHCE participation, such as implementing an automatic enrollment feature. By increasing the NHCE participation, you will increase the amount the HCE group can defer.

A mid-year test can also be helpful and used to estimate if the retirement plan is going to pass or fail ADP/ACP testing for the year. The mid-year snapshot provides an opportunity to discuss the results with your TPA to determine if your retirement plan is optimized for your participants or if changes should be considered. You can also discuss adding a safe harbor feature to the retirement plan, which eliminates the need for ADP/ACP testing.

Contact the experienced Retirement Plan Administrators at Watkins Ross to discuss retirement plan testing solutions specifically designed to optimize your employee retirement savings. Together let’s evaluate your current retirement plan goals and discover ways to improve your administration so you can avoid penalties, missed deferrals, and expensive fees.

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