ADP, ACP, and Top-Heavy Non-discrimination Tests
The ADP, ACP, and Top-Heavy tests determine whether a company's 401( k ) plan disproportionately favors certain employees.
The ADP Test
The average deferral percentage (ADP) of all HCEs, as a group, can be no more than 2 percentage points greater (or 125% of, whichever is more) than the NHCEs, as a group. This is known as the ADP test. If a plan fails the ADP test, it essentially has two options to come into compliance.
- It can have a return of excess done to the HCEs to bring their ADP to a lower, passing, level.
- Or it can process a "qualified non-elective contribution" (QNEC) to some or all of the NHCEs to raise their ADP to a passing level.
Any reimbursements made to employees will be subject to tax, thus results in losing money/the advantage of contributing to a fund with pre-tax money. Employers with safe-harbor plans are typically exempt from the ADP test.
The ACP Test
The Actual Contribution Percentage (ACP) test is similar to the ADP test, only it tests the employer contributions rather than employee contributions.
The Top-Heavy test
The Top-Heavy test looks at how much Key Employees contribute to the plan compared to everyone else. If Key Employee balances exceed 60% of the entire plan balance at the end of the plan year, the employer is required to make a 3% contribution to the non-key employees to be non-discriminatory.