All 401(k) plans without a safe harbor provision need to undergo Actual Deferral Percentage (ADP) testing each year. Plans with a discretionary matching contribution also need to run the Actual Contribution Percentage (ACP) test. This article explains how each test is calculated, what triggers a failure, how to correct one, and the deadlines involved.
All 401(k) plans without a safe harbor provision need to undergo ADP testing each year. Plans with a discretionary (non-safe harbor) matching contribution also need to run the ACP test each year. Both tests compare 401(k) contributions of highly compensated employees (HCEs) against the contributions of non-highly compensated employees (NHCEs).
Learn who is considered an HCE or NHCE.
Note: When “compensation” is referenced in these tests, it means compensation as defined by your plan document.
The ADP and ACP tests use different formulas, though both compare contributions of HCEs and NHCEs.
The ADP test compares the average deferral percentage of HCEs against the average deferral percentage of NHCEs. Each participant's ADP is calculated by dividing their total deferrals for the calendar year (excluding catch-up contributions) by their compensation for the same year.
The ACP test compares the average employer matching contribution percentage of HCEs against the average matching contribution percentage of NHCEs. Each participant's ACP is calculated by dividing the employer-matching contributions received during the year by the participant's compensation for the year.
HCEs are limited to an average deferral or match rate determined by the average NHCE rate, as shown in the table below.
Average NHCE rate
Maximum average HCE rate
Less than 2%
2× the NHCE rate
2% – 8%
NHCE rate + 2 percentage points
More than 8%
1.25× the NHCE rate
Example: If NHCEs deferred an average of 1%, HCEs are limited to an average of 2% (1% × 2). If HCEs deferred more than 2% on average, the plan fails the ADP test.
If your plan falls outside permissible ADP or ACP limits, Gusto Retirement will give you correction options and steps to take in the first quarter of the following year, as long as you provide compensation data in a timely manner. You will see a task on your Gusto Retirement dashboard and get an email notification that corrective action is needed.
Refund excess HCE contributions — To bring the HCE ADP ratio to the applicable limit, you can refund excess deferrals to HCEs. The IRS specifies the method that needs to be used to determine which HCEs get refunds and in what amounts — HCEs who contributed the largest dollar amounts get larger refunds. For a failed ACP test, you can refund vested employer matching contributions to bring the HCE ACP ratio to the applicable limit. Unvested matching contributions are also forfeited in this scenario.
Make employer contributions to NHCEs — As an alternative, you can make qualified non-elective contributions (QNECs) to NHCE accounts, which increases the deferral or match percentage of NHCEs and brings the plan within ADP or ACP limits.
Most plans choose to refund excess contributions because it is the less expensive option. However, refunding excess contributions has stricter timing requirements than making employer contributions.
Refunds distributed after the deadline are subject to a 10% excise tax. Deadlines depend on your plan's automatic enrollment setup:
No auto-enrollment or Automatic Contribution Arrangement (ACA): Mar. 15 of the following year
Eligible Automatic Contribution Arrangement (EACA) or Qualified Automatic Contribution Arrangement (QACA): Jun. 30 of the following year
QNECs need to be contributed to the plan by Dec. 31 of the year following the test year.
To prevent possible excise taxes, Gusto Retirement needs to get compensation information about your plan in a timely manner.
If you choose to refund excess contributions to HCEs, those refunds are taxable as ordinary income for the affected individuals in the year they are distributed — not the year of the original contribution. Any gains or losses are also calculated and included in the refund amounts.
ADP and ACP refunds do not affect the W-2 income of employees getting a refund. Affected employees will get a 1099-R the following January to report the taxable amount when filing their tax return for the year they got the refund.
Example: If excess contributions need to be returned for the 2024 plan year, these funds will typically be refunded in early 2025. The employee will get a 1099-R in early 2026 and report the amount on their 2025 tax return.
Unlike other cash distributions, excess contribution refunds are not subject to early distribution penalties. Federal tax of 10% is withheld by default.
The most effective way to avoid ADP and ACP testing is to adopt a safe harbor plan provision. Safe harbor plans are exempt from both tests.
Safe harbor matching contributions generally need to be added at least 30 days before the start of the calendar year. If you missed the matching contribution deadline, the SECURE Act allows plans to add a safe harbor nonelective contribution of at least 3% up until Dec. 1 of the applicable year (applying to the entire year), or at least 4% after Dec. 1 and up until Dec. 31 of the following year.