Qualified retirement plans must pass several nondiscrimination tests designed to ensure the plan does not favor owners and other Highly Compensated Employees (HCEs) over the rest of the workforce. One of the most important of these is the Actual Deferral Percentage (ADP) test, which measures how much employees contribute to the plan through salary deferrals. This test compares the average of salary deferral rates of HCEs to the average of salary deferral rates of the NHCEs.

Who Is a Highly Compensated Employee (HCE)?

Employees are classified as HCEs if they meet either of the following criteria:

  1. Ownership Test: The employee owns more than 5% of the company at any time during the current or prior plan year. Attribution applies, so spouses, parents, children, and grandparents of a more-than-5% owner are also treated as HCEs.
  2. Compensation Test: The employee earned more than the IRS compensation limit in the prior plan year ($160,000 for 2025 – subject to cost of living adjustments for subsequent years). Employers may also elect to use the optional top-paid group election, which limits HCE status based on compensation to those who exceed the limit and are in the top 20% of employees ranked by pay.

How the ADP Test Works

The ADP test compares the average salary deferral percentage of HCEs to that of NHCEs. To pass the test, the average deferral rate for eligible HCEs cannot exceed:

  • The greater of 125% of the NHCE average deferral rate, or
  • The lesser of:
    • 200% of the NHCE average deferral rate, or
    • The NHCE average deferral rate plus 2 percentage points.

If the ADP test fails, the plan must correct the imbalance. The two basic correction methods are:

  • Refund excess deferrals (plus earnings) to certain HCEs, or
  • Make Qualified Non-Elective Contributions (QNECs) to NHCEs

Refunds must generally be issued within 2½ months after the close of the plan year to avoid a 10% excise tax. However, plans with certain Eligible Automatic Contribution Arrangement (EACA) features have an extended deadline of 6 months. Refunds are taxable to HCEs in the year they are distributed.

Closing Thoughts

The Actual Contribution Percentage (ACP) test functions similarly to the ADP test but applies to employer matching contributions and employee after-tax contributions. Also, it is important to note that plans designed with Safe Harbor 401(k) features can automatically satisfy both the ADP and ACP tests, as long as a required Safe Harbor contribution is made and the annual participant notice requirements are met. For additional information on ADP/ACP testing or safe harbor plan designs, please contact your Blue Ridge Associates Plan Consultant.