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What Happens When Our ACP Test Fails

Matching contributions and after-tax employee contributions must be tested under the Actual Contribution Percentage (ACP) test. The test is similar to the ADP test discussed in the previous section. The ACP testing is based on each participant's contribution ratio: current year after-tax contributions and matching contributions divided by compensation. All participants who could have made salary deferrals are included in the ACP test IF they are eligible to receive a match. However, if the individual's ability to receive a match is conditioned on additional service (e.g., a 1,000 hours of service requirement in the current plan year) or employment at the end of the plan year, and the individual does not meet these conditions, the individual is excluded from the ACP testing. However, when such a condition applies to receipt of the match, the group of participants who are eligible to receive matching contributions (e.g., those not excluded because they were employed on the last day of the plan year) must satisfy the IRC 410(b) minimum coverage requirements. Basically, a participant so excluded is treated as not benefiting. [Treas. Reg. 1.401(m)-1(a)(2).]

A plan may not exclude participants from the ACP test who are not eligible to receive a match simply because they choose not to make a deferral. Such an individual will have a contribution ratio in the ACP test of "0." [Treas. Reg. 1.401(m)-1(f)(4)(i).]

After-tax employee contributions are also tested under the ACP test, even if the plan isn't a 401(k) plan. After-tax contributions cannot generally exceed 10% of the employee's taxable compensation. [Rev. Rul. 80-350, 1980-2 C.B. 133.] And remember that after-tax employee contributions are part of the employee's annual addition limitation under IRC 415(c). [IRC 401(m)(1) and (m)(4).]

Mathematics of the ACP test

Like the ADP tests, the actual contribution percentage (ACP) for the group of highly compensated employees (HCEs) must:

  • not be greater than 125% of the average contribution percentage of the group of Non-Highly Compensated Employees (NHCEs), (the general test), or

  • not be higher than the average contribution percentage of the NHCEs by more than 2 percentage points and not be more than 2 times the average contribution percentage of the group of NHCEs (sometimes called the alternate test). [IRC 401(m)(3)(A).]

These limits can be demonstrated in the chart below:

Average percentage of match and voluntary contributions for NHCEs Maximum percentage permitted for the HCEs  

 

0% 0%
1% 2% 2 times
2% 4% -----
3% 5% 2 plus
4% 6%
5% 7%
6% 8%
7% 9%
8% 10% -----
9% 11.25% 1.25 times
10% 12.5%
12% 15%

|Correcting a failed ACP test (current-year testing)

When a plan fails the ACP test, the plan is said to have "excess aggregate contributions." The excess aggregate contributions are the total matching contributions (and after-tax employee contributions) that must be distributed, or forfeited, to the HCEs to satisfy the ACP testing. The employer has several options with respect to correcting any "excess aggregate contributions" in the plan. They include:

  • To the extent matching contributions are vested, they are distributed (along with earnings) to the HCEs before the end of the next plan year.

  • To the extent matching contributions are not vested, they can be forfeited.

  • The employer can make qualified matching contributions (QMACs) to the accounts of some or all of the NHCEs in an amount sufficient to raise the average contribution percentage for the group of NHCEs to pass the ACP test. [Treas. Reg. 1.401(m)-1(e)(1)(i).]

Multiple use test

As noted earlier, a plan sponsor can satisfy the ADP test under the "alternate test" (the 2-plus/2-times rule) rather than the "general test" (the 1.25-times rule), and a plan sponsor can satisfy the ACP test under the "alternate test" (the 2-plus/2-times rule) rather than the "general test" (the 1.25-times rule). But if both the ADP and ACP tests are met using the "alternate test," the plan also must satisfy the "multiple use" test. [Treas. Reg. 1.401(m)(2)(a) and -2(b)(2).] Note: Multiple use test Not Applicable after 2001.

Example: Preparing the ADP and ACP test

Highly Compensated
Pay
Deferral
Deferral %
Average Ratio
Match
Contribution Ratio
M
N
O

$150,000
100,000
80,000

$9,000
6,500
5,200
6.0%
6.5%
6.5%

6.33
$4,500
3,000
2,400
3.0%
3.0%
3.0%
3%
Non-Highly Compensated
P
Q
R
20,000
20,000
20,000
600
800
1,200
3.0%
4.0%
6.0%

4.33
300
400
600
1.5%
2.0%
3.0%

2.17%

The ADP and ACP tests are passed because the average contribution percentage for the HCEs does not exceed 2% more than the average contribution percentage for the NHs or two times the average contribution percentage for the NHS

However, because both the ADP and ACP tests are passed under the alternate tests (i.e., the average for the HCEs met the 2% plus or 2 times limit) and neither test satisfied the 1.25 times threshold, this plan must next be tested under the multiple use test.

Where a plan uses prior-year testing, the multiple use test is prepared based on the theoretical deferral ratios (the percentages used to determine the dollar amount of any excess contributions to be distributed) and contribution ratios (the percentages used to determine the dollar amount of excess aggregate contributions to be distributed). Corrections to pass the test are made subject to the dollar leveling method discussed earlier.

Note: Multiple use test Not Applicable after 2001.

 

Plan Testing

Select this link Tests Overview

    Select this link ACP/ADP Tests

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    Select this link Multiple Use Test

    Select this link Minimum Coverage

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    Select this link Controlled Group

    Select this link Top-Heavy Test

    Select this link Covered Employees

    Select this link Part-time Employees

    Select this link Union Employees

    Select this link PEO Client Outside

    Select this link Deductible Limits

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Information is provided for review and consideration only. Please consult legal and tax advisors for practical advice pertaining to your business and personal situations.

This page was last reviewed and/or updated on Friday, July 03, 2015 05:22 PM

 

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