Has your sponsored 401(k) plan recently failed an ADP or ACP test? If so, you're probably feeling frustrated, uncertain, and perhaps anxious. But rest assured, you're not facing these challenges alone. RPCSI understands the complexities and stress that come with managing retirement plan compliance, and we're here to help you! If your plan has failed ACP or ADP 401(k) testing, read on to gain our insights on the next steps to take to bring your plan back into compliance.
What Are ADP and ACP 401k Testing?
Before diving into the causes and consequences of testing failure, let's take a step back to understand what ADP and ACP 401(k) testing are and their significance in maintaining plan compliance.
ADP 401k Plan Testing
ADP (Actual Deferral Percentage) testing ensures that highly compensated employees (HCEs) do not disproportionately benefit from the plan's tax advantages through their elective deferrals.
ADP 401(k) Plan testing focuses on elective deferrals made by both HCEs and non-highly compensated employees (NHCEs). The goal is to prevent HCEs from significantly exceeding the elective deferral percentages of NHCEs. This testing ensures fair distribution of the plan's tax advantages among all participants.
ACP 401k Plan Testing
ACP 401(k) Plan testing involves comparing the actual contribution percentages for employee groups. This process ensures HCEs and NHCEs receive similar benefits from the employer's contributions to the plan.
Understanding the Causes of ADP and ACP 401k Testing Failures
When it comes to ADP and ACP 401(k) testing, there are two primary reasons why failures occur. They are:
Highly Compensated Employee Contributions: If HCEs contribute a significant amount to the plan compared to NHCEs, testing failures may occur.
Non-Discrimination Requirements: Plans must meet non-discrimination requirements to ensure equitable distribution of benefits. Failure to comply with these requirements can lead to testing failures.
To prevent future failures, be sure to conduct thorough analyses of your plan's demographics and contribution patterns to identify potential issues.
It is always a best practice to analyze your plan regularly to prevent ACP and ADP 401(k) testing failures.
The Consequences of ADP and ACP Testing Failures
When ADP and/or ACP testing failures occur, there are possible penalties and consequences that may affect both your company and plan participants.
Penalties Imposed by the IRS: Failing to correct an ADP and/or ACP test timely may result in penalties imposed by the Internal Revenue Service (IRS) or see your plan be disqualified. Either of these actions will bring substantial consequences and negative impacts on your company's retirement plan.
Impact on Employees: Testing failures may limit the contributions HCEs can make to the plan and result in the loss of tax benefits. This can negatively affect employee morale and retention.
Addressing testing failures promptly is crucial to mitigate these consequences and protect the qualified status of your plan and the well-being of your employees.
Steps to Correct ADP and/or ACP 401k Testing Failures
Corrective action is necessary when ADP and/or ACP testing fails. Implementing corrective measures helps bring your plan back into compliance and avoids future testing failures. Here are the steps involved:
Assess the Impact: Determine the extent of the failure and its potential consequences for your plan and participants.
Adjust Contributions: Make the required adjustments to the HCEs to meet the required compliance ratios and refund the amounts that must be returned to the HCEs to pass the test(s).
Improve Plan Design: Evaluating and adjusting the plan design can help minimize the risk of future testing failures.
Seek Professional Guidance: Engaging a qualified third-party administrator with expertise in retirement plan compliance can provide valuable assistance with plan design considerations and throughout the correction process if a failure occurs.
There are two primary methods to follow as you pursue these self-corrective actions:
Method 1: Revenue Procedure 2021-30, Appendix A, section .03 (based on Internal Revenue Code):
Determine the amount necessary to raise the ADP or ACP of the NHCEs to the percentage needed to pass the tests.
Make qualified non-elective contributions (QNECs) for the NHCEs to the extent necessary to pass the tests.
Method 2: One-to-One Method—Revenue Procedure 2021-30, Appendix B, section 2.0 (based on Internal Revenue Code):
Assign and distribute excess contributions (adjusted for earnings) to the HCEs.
Matching contributions (and earnings) related to the excess contributions to the extent vested must be distributed to the HCEs or if not fully vested they must be forfeited.
Using the IRS's methods for correcting ACP and ADP 401(k) testing failures will help re-establish compliance.
Prevent Future ADP or ACP 401k Testing Failure
To avoid future ADP and ACP testing failures, it is essential to implement preventive measures. Consider the following best practices:
Consider using Prior Year Testing Method so you know what the average deferral rate is allowed to be for the HCEs in the next plan year.
Regular Plan Monitoring: Monitor plan contributions and demographics regularly to identify any potential disparities.
Adjusting Contributions: If disparities are identified, adjust contributions to meet compliance requirements and ensure fairness among employees.
Partner with a Reliable Third-Party Administrator: Working with a trusted third-party administrator with expertise in retirement plan compliance can provide ongoing support and guidance.
Does Your Plan Pass the Test? Let RPCSI Help!
Addressing ADP and ACP testing failures promptly is crucial to maintaining plan compliance and ensuring the equitable distribution of benefits among all participants. Our team at RPCSI serves clients nationwide as they navigate retirement plan compliance. Contact RPCSI for personalized assistance and additional information on how we will help you achieve retirement plan success.
Remember, RPCSI is committed to providing industry-leading services and solutions to help your businesses create and administer the perfect retirement plan for your organization. Together, let’s ensure your next round of ADP and/or ACP 401(k) Plan testing is stress-free!