401(k) ACP Test: Why Your Employees’ Actual Contribution Percentage Matters

401(k) ACP Test: Why Your Employees’ Actual Contribution Percentage Matters

If you have been offering a company 401(k) for more than a year, then you know your plan requires a lot of testing to stay compliant.

That’s because one of the primary duties of employers offering a 401(k) is to ensure that it’s designed to benefit all employees, not just owners and highly paid employees.

In 401(k) language, a plan with widespread benefits is non-discriminatory. That is, the benefits are not skewed toward certain employees.

A series of annual tests is used to decide whether or not a plan discriminates. If the plan fails a test, the company must take corrective action until the plan is no longer discriminatory.

Four Measures of Plan Fairness

There are four tests to measure 401(k) plan fairness.

  1. Actual Contribution Percentage (ACP) Test
  2. Actual Deferral Percentage (ADP) Test
  3. Coverage Test
  4. Top-Heavy Test

Each test compares how two groups of employees are benefiting from the plan.

The first three tests compare the benefits of highly compensated employees (HCEs) versus non-highly compensated employees (NHCEs).

The remaining test is called the top-heavy test and compare the plan benefits of NHCEs to those of key employees. Key employees are employees who fall into any of these categories at any time during the plan year being reviewed:

  • 5% Owner: owns more than 5% of the company
  • 1% Owner: owns more than 1% of the company and receives more than $150,000 in compensation for the year
  • Company Officer: Is an officer of the company and receives $170,000 or more in compensation for the year

An HCE can be defined as an employee who owned more than 5% of the company at any time during the year (or the year before). Or, regardless of ownership, if an employee earned more than $120,000 in 2016, that person would be considered an HCE for the 2017 plan year. Also certain family members of those who are 5% owners are considered HCEs.

Alternatively, the plan can choose to define HCEs as the top 20% highest paid employees. This type of categorization can help some plans pass the ADP/ACP tests.

An NHCE is – you guessed it – anyone who is not an HCE.

What’s On the Tests?

Coverage is a measure of plan participation by the two groups. Generally, the ratio of the participation rate of eligible NHCEs to the participation rate of the HCEs must be at least 70%.

The ADP and ACP tests are concerned with the ratio of contributions by HCEs to NHCEs.

The top-heavy test looks at the total accumulated assets of key employees as a percentage of the total assets in the plan.  A plan is top-heavy if more than 60% of plan assets are those of key employees.

There is an alternative to much of this testing. By adopting a type of plan called a Safe Harbor, the 401(k) generally gains exemption from the ADP, ACP and top heavy tests.

This blog post is most concerned with the ACP test. Both the ADP and the ACP tests measure the ratio of HCE contributions to NHCE contributions.

The ACP test is based on the same premise, but is concerned with  employer contributions and any after-tax contributions made by participants.

Grading the 401(k) ACP Test

For a plan to be nondiscriminatory it must achieve one of the following:

  1. Produce a ratio of the average HCE to NHCE contribution rate of no more than 125%. For example, if NHCEs contribute an average 4% of salary then the HCE average contribution can be no more than 5%.


2. The average HCE contribution rate must not exceed the average NHCE contribution rate plus 2%, or is no more than twice the NHCE rate, whichever is less. For example, if the NHCE average contribution rate is 4%, to pass the test, the HCE contribution rate can be no more than 6%. That’s because 4% + 2% = 6% and 4% x 2 = 8%. Because 6% is less than 8%, 6% is the maximum HCE contribution rate allowed under this option. (We never said this wasn’t confusing.)

There’s More Than Math to These Tests

There are even more options when it comes to 401(k) ADP/ACP testing. There are different testing methods that can be applied. The plan can elect to compare the HCE group contribution rate in the current year against the current year rate of NHCEs, or against the NHCEs’ rate from the prior year.

The prior year method can add some predictability to the testing process.  That’s because the NHCE figures are known in advance, meaning the maximum allowable HCE contribution rate can be known in advance as well, and HCEs can plan accordingly.

Another option is to “disaggregate” employees if a plan’s eligibility requirements are more liberal than required by law. Participants that are allowed in the plan – even if the plan is not legally required to include them – can be tested separately. But if this approach is taken, it must also be taken with coverage tests.

About Those After-Tax Contributions

If the plan allows them, the after-tax contributions included in the ACP test are not the same as Roth contributions. (Roth contributions are included in the ADP test.) These after-tax contributions are often made by employees who want to contribute more than the employee deferral limit of $18,500 (in 2018). Such contributions are allowed as long as the Section 415 annual limit is not exceeded. For 2018, the limit is $55,000 and includes all contributions including pre-tax employee deferrals, Roth deferrals, after-tax contributions and all employer contributions.

Fixing a Failed ACP Test

If a plan fails an ACP or ADP test, the plan must “fix” the failure within 12 months. The remedy can be implemented in one of two ways. The employer can make contributions to NHCEs sufficient to result in a passing grade, or the plan can distribute excess contributions back to the HCEs. If a correction is made within 2 ½ months of the end of the plan year, the employer can avoid a 10% excise tax on the amount of excess contributions. If the testing corrections are not made within 12 months the plan can lose its tax-qualified status. Corrections can still be made, but under a far more onerous process.

We noted earlier that adopting a Safe Harbor 401(k) exempts the plan from the ADP and ACP tests. However, at ForUsAll, we have found that a Safe Harbor approach is not always necessary to ensure that a plan is nondiscriminatory. The key is getting employees to join the plan and save at high rates. And the best recipe for that kind of employee engagement is to make the plan user friendly, low hassle, accessible by mobile device, and to offer automated features.

High employee engagement not only helps your plan pass the ADP and ACP tests, but also gets your employees on the path to meaningful retirement savings.

Talk to us today to find out how to pass compliance tests without the high cost of a Safe Harbor Plan. We’re always happy to walk you through the details of ACP testing and chat about keeping your plan in the passing lane.