Primer Article: ADP/ACP Non-Discrimination Testing Explored
Last Updated: August 5, 2020
Non-Discrimination Testing
Non-Discrimination testing is required for qualified retirement plans. Uniglobal provides you with all the required nondiscrimination testing your plan needs as part of our services to you and the plan. Generally speaking, a plan must prove that it is not discriminatory.
How does a plan prove it does not discriminate?
Whether or not a provision in the plan is discriminatory has little do with what we think of as "discrimination." A plan provision is discriminatory if it favors HCEs (Highly Compensated Employees) over the NHCEs (Non-Highly Compensated Employees).
What happens if the plan provisions are discriminatory?
For this article, we'll focus on nondiscrimination as it relates to the ADP (Average Deferral Percentage) and ACP (Average Contribution Percentage) tests.
If the ADP test "fails" it is due to the average deferral rate (the percentage of pay being contributed) of the pool of HCEs (owners, highly paid employees, etc.) being higher than allowed. The allowed average is based on the NHCEs average deferral rate.
Example #1:
2 HCEs - 1 defers 10% of compensation, the other 5% | the average is 7.50%
10 NHCEs - each defer different percentages | the average is 5.00%
The spread between the HCE and NHCE averages is greater than 2.00%, therefore, the ADP test will fail.
A correction must be done to satisfy the test. There are 2 options:
- Some or all of the HCEs receive a refund equal to some or all of their deferrals, or
- The company provides a QNEC (Qualified Non-Elective Contribution) that is 100% vested to some or all of the Non-Highly Compensated Employees to pass testing.
For some small employers (those under 100 employees), it might sting a bit to get back all or some of the deferrals contributed for failing this test.
How can our retirement plan avoid being discriminatory and failing testing?
Your plan can be designed in such a way that the ADP and, if applicable, the ACP non-discrimination tests automatically pass, or are "deemed satisfied." One of the ways this is accomplished is by utilizing Safe Harbor contributions. These are either an employer Match or a Non-Elective contribution allocated to eligible participants each plan year and that is 100% vested immediately.
Learn more about the major types of Safe Harbor Plans in our Focus Article Top 3 Safe Harbor Plan Designs.