Definition of Actual Contribution Percentage
Actual Contribution Percentage (ACP) and Actual Deferral Percentage (ADP) tests are two of many nondiscrimination tests which a plan must meet to prove compliance with Internal Revenue Service (IRS) rules. These tests are performed to make sure that undue benefits are not provided in a plan to highly compensated employees and owners at the cost of other employees. If either test is failed by the plan then necessary corrective actions must be taken by the employer to defend its qualified status for the twelve-month period succeeding the end of the plan year in which the non-compliance occurred.
Brief Explanation of Actual Contribution Percentage
There are various steps involved in application of ACP and ADP tests. For performance of ADP test.
- Find the testing group, which contains all employees who are qualified for the plan. As per the rules, the participants are:
- Anyone qualified to be a participant whether he is actually contributing in the plan or not.
- All the participants should be divided into two groups –the highly compensated employees (HCEs) and the non-highly compensated employees (NHCEs).
- Compute the deferral rate for every participant by dividing total salary deferrals by compensation.
- Find the average rate of deferral for the NHCE group and the HCE group.
The ADP test for the plan passes when the HCE group average is under a certain range of the average used for the NHCE group. The below given chart explains the spread in averages of the two groups.
NHCE Average Maximum HCE Average
- Less than 2% NHCE average x2
- Between 2% and 8% NHCE average +2