The actual deferral percentage test requires that the Actual Deferral Percentage (“ADP”) of eligible highly compensated employees ( Q
3930) be compared to the ADP of all other eligible employees, and that it satisfy one of the following tests:
Test 1: The actual deferral percentage for eligible highly compensated employees ( Q
3930) for the plan year does not exceed the actual deferral percentage of all other eligible employees for the preceding plan year, multiplied by 1.25.
Test 2: The actual deferral percentage for eligible highly compensated employees for the plan year does not exceed by more than 2 percent that of all other eligible employees for the preceding plan year and the actual deferral percentage for highly compensated employees for the plan year is not more than the actual deferral percentage of all other eligible employees for the preceding plan year multiplied by two.
The IRC provides two methods of applying the ADP test: a prior year testing method, and a current year testing method. The method described above is the prior year testing method (as set forth in the IRC), but the current year method is available by election.
1 Under the current year testing method, the ADP results of nonhighly compensated employees for the current year (instead of the preceding year) are used in each test. The ability of plan sponsors to switch between the current and prior year testing methods is limited.
2 The plan document must reflect which testing method the plan is using for a testing year.
3 Qualified Matching Contributions (“QMACs”) and Qualified Nonelective Contributions (“QNECs”) are employer matching contributions and nonelective contributions, respectively, that are subject to the same nonforfeitability ( Q
3753) and withdrawal restrictions ( Q
3797) as elective deferral contributions. Under certain circumstances, elective contributions used to pass the ADP test may include QMACs and QNECs that are made with respect to employees eligible under the cash or deferred arrangement.
4 Specific requirements for such use are set forth in regulations.
5 QMACs and QNECs may be used only once. In other words, contributions that are treated as elective contributions for purposes of the ADP test may not be taken into account for purposes of the ACP test under IRC Section 401(m) and are not otherwise taken into account in determining whether any other contributions or benefits are nondiscriminatory under IRC Section 401(a)(4). Similarly, QNECs that are treated as matching contributions for purposes of the ACP test may not be used to satisfy the ADP test.
6 Calculation of Actual Deferral Percentage
The actual deferral percentage for a group of eligible employees is the average of the actual deferral ratios of employees in the group for the plan year as calculated separately for each employee and to the nearest 1/100 of 1 percent.
7 An employee’s actual deferral ratio is determined by dividing the amount of elective contributions (including amounts treated as elective contributions) made to the trust on his or her behalf for the plan year by his or her compensation for the plan year, calculated to the nearest 1/100 of 1 percent.
8 Only contributions allocated to the employee’s account for the plan year and related to compensation that, but for the election to defer, would have been received during the plan year (or, if attributable to services performed during the plan year, within 2½ months after the close of the plan year) are considered in applying the ADP test. Designated Roth contributions ( Q
3779) are treated as elective deferral contributions for purposes of the
ADP test.
9 Compensation, for purposes of calculating actual deferral percentages, generally means compensation for services performed for an employer, which is includable in gross income
( Q
3867). An employer may limit the period taken into account to that portion of the plan year (or calendar year) in which the employee was an eligible employee, provided that this limit is applied uniformly to all eligible employees.
10 Miscellaneous Provisions
Although a plan must, by its terms, provide that the ADP test will be met; it may incorporate by reference the 401(k) nondiscrimination provisions of the IRC and regulations.
11
1. IRC § 401(k)(3)(A).
2. IRC § 401(k)(3)(A); Treas. Reg. § 1.401(k)-2(c)(1)(ii).
3. Treas. Reg. § 1.401(k)-1(e)(7).
4. IRC § 401(k)(3)(D)(ii).
5. Treas. Reg. § 1.401(k)-2(a)(6).
6. Treas. Reg. § 1.401(k)-2(a)(6)(vi).
7. Treas. Reg. § 1.401(k)-2(a)(2)(i).
8. Treas. Reg. § 1.401(k)-2(a)(3).
9. Treas. Reg. § 1.401(k)-1(f)(4).
10. Treas. Reg. § 1.401(k)-6.
11. Treas. Reg. § 1.401(k)-1(e)(7).