This guide explains the ADP, ACP, top-heavy, and coverage tests, the deadlines for correcting failures, and how safe harbor plan design can reduce testing requirements. This content is for informational purposes only and is not tax, legal, or financial advice.
What Is 401(k) Nondiscrimination Testing?
401(k) nondiscrimination testing checks whether a retirement plan meets IRS rules that limit benefits favoring highly compensated employees over other eligible employees. The rules cover employee deferrals, employer matching contributions, and whether the plan benefits enough non-highly compensated employees.
Two employee classifications matter: highly compensated employees (HCEs) and key employees. They serve different purposes under IRS testing rules.
Highly compensated employees (HCEs) generally include employees who owned more than 5% of the business during the current or preceding year, including ownership attributed under IRS family rules. Employees may also qualify based on prior-year compensation. For the 2026 plan year, the compensation threshold is $160,000. An employer may elect to limit this compensation-based group to employees in the top 20% by compensation.
Key employees are identified under the separate top-heavy rules. They include employees who own more than 5% of the business, employees who own more than 1% and earn over $150,000, and certain officers whose compensation exceeds the applicable threshold. For 2026, the officer compensation threshold is $235,000. IRS ownership attribution rules also apply.
These categories are not interchangeable. The Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests compare contribution rates for HCEs and non-highly compensated employees. The top-heavy test checks whether key employees hold more than 60% of the plan’s relevant account balances. Coverage testing under Internal Revenue Code Section 410(b) checks whether the plan covers enough non-highly compensated employees under an applicable IRS test.
Correctly classifying employees is a necessary first step. If the employer or plan administrator uses the wrong compensation figures or misses an owner’s family member, the plan’s test results may be incorrect.
The ADP Test
The Actual Deferral Percentage (ADP) test compares the average compensation deferral rates of highly compensated employees (HCEs) and non-highly compensated employees (NHCEs). If owners defer too much relative to other eligible employees, the plan may fail this part of 401(k) nondiscrimination testing.
How the ADP test works
The plan administrator calculates each eligible employee’s deferral rate and averages the results for HCEs and NHCEs. Eligible employees who defer nothing must be included. Pre-tax and Roth deferrals generally count, but catch-up contributions do not.
The HCE average must not exceed the greater of these limits:
- 125% limit: The NHCE average multiplied by 1.25.
- Two-times limit: The lesser of twice the NHCE average or the NHCE average plus two percentage points.
The plan document determines whether the test uses current-year or prior-year NHCE data. See the IRS 401(k) Plan Fix-It Guide for testing and correction rules.
Worked example: Two owners and eight staff members
Assume a traditional 401(k) plan has two HCE owners and eight NHCE staff members. These group averages illustrate how the ADP test for a 401(k) works; actual results depend on the plan’s testing data and rules.
Scenario A: The plan passes
| Employee group | Average deferral rate |
|---|---|
| Two owners (HCEs) | 6% |
| Eight staff members (NHCEs) | 5% |
125% limit: 5% × 1.25 = 6.25%
Two-times limit: The lesser of 10% or 7% = 7%
The permitted HCE average is 7%, the greater of the two limits. The owners’ 6% average is below that limit, so the plan passes.
Scenario B: The plan fails
| Employee group | Average deferral rate |
|---|---|
| Two owners (HCEs) | 8% |
| Eight staff members (NHCEs) | 3% |
125% limit: 3% × 1.25 = 3.75%
Two-times limit: The lesser of 6% or 5% = 5%
The permitted HCE average is 5%. The owners’ 8% average exceeds that limit, so the plan fails.
A failed test may require refunds to HCEs or another correction permitted by IRS rules and the plan document. IRA Club SBS offers Traditional 401(k) plans with compliance testing, recordkeeping, government filing, and payroll integration. Businesses can also explore its Safe Harbor 401(k) option, which can help eligible plans avoid ADP testing.
The ACP Test
The Actual Contribution Percentage (ACP) test compares employer matching contributions and eligible employee after-tax contributions for highly compensated employees (HCEs) and non-highly compensated employees (NHCEs). Unlike the ADP test, which measures salary deferrals, the ACP test measures these matching and after-tax contributions as a percentage of compensation.
How the ACP test works
The plan administrator calculates each eligible employee’s contribution percentage and averages the results for HCEs and NHCEs. The HCE average must not exceed the greater of:
- 125% limit: The NHCE average multiplied by 1.25.
- Two-times limit: The lesser of twice the NHCE average or the NHCE average plus two percentage points.
For example, if the NHCE average is 3%, the permitted HCE average is 5%. That is the greater of 3.75% and 5%.
A plan can pass the ADP test but fail the ACP test because the tests measure different contributions. A failed ACP test may require corrective distributions of excess aggregate contributions or additional employer contributions for eligible NHCEs, depending on the plan terms and IRS correction rules.
See the IRS 401(k) Plan Fix-It Guide for failed ADP and ACP tests. Employers reviewing plan design can also explore IRA Club SBS’s Safe Harbor 401(k) plans. Qualifying safe harbor matching arrangements can receive ACP test relief when they meet applicable requirements.
The Top-Heavy Test
A 401(k) plan is top-heavy when key employees hold more than 60% of the total account balances included in the IRS calculation.
For 2026, key employees include:
- Business owners: Employees who own more than 5% of the business.
- Certain smaller owners: Employees who own more than 1% and earn over $150,000.
- Certain officers: Officers whose compensation exceeds $230,000 for 2026.
Family ownership rules can also affect these classifications. See the IRS top-heavy plan rules.
When a plan is top-heavy, the employer generally must contribute at least 3% of compensation for eligible non-key employees. A lower minimum may apply when the contribution rate for key employees is lower.
Employee deferrals do not count toward this required employer contribution.
Passing the ADP and ACP tests does not remove this obligation. Top-heavy testing uses account balances, not deferral or matching contribution percentages.
Certain Safe Harbor plans qualify for an exemption. Additional employer contributions can affect whether the exemption applies.
Employers can review the IRS 401(k) Plan Fix-It Guide for top-heavy plans for details on required contributions and corrections.
Coverage Testing (Section 410(b))
IRS Section 410(b) checks whether a 401(k) plan covers enough non-highly compensated employees (NHCEs). Unlike the ADP and ACP tests, which compare contribution percentages, coverage testing examines which employees benefit from the plan.
Under the ratio percentage test, the percentage of NHCEs who benefit must be at least 70% of the percentage of highly compensated employees (HCEs) who benefit. For example, if 100% of HCEs benefit, at least 70% of NHCEs must benefit to pass this test.
A plan that fails the ratio percentage test may still qualify under the IRS average benefit test. That test requires a nondiscriminatory employee classification and an NHCE average benefit percentage of at least 70% of the HCE percentage. Employers should review plan eligibility rules and employee classifications to determine whether their plan meets either permitted test. See the IRS Guide to Common Qualified Plan Requirements for details.
What Happens If Your Plan Fails?
A failed ADP or ACP test requires corrective action under the plan document and IRS rules. Depending on the failure, the correction may reduce HCEs’ retirement contributions or require additional employer contributions.
Refund excess contributions: The plan may distribute excess contributions, adjusted for allocable earnings, to affected highly compensated employees (HCEs). These distributions are generally taxable in the year received and are not eligible for tax-free rollover.
Make corrective employer contributions: Qualified nonelective contributions (QNECs) can increase the contribution percentages for nonhighly compensated employees (NHCEs). Qualified matching contributions (QMACs) may also count when plan terms and IRS rules permit. QNECs must be fully vested and meet applicable distribution restrictions.
Meet correction deadlines: Employers generally have 12 months after the end of the plan year to correct an ADP or ACP failure. Correcting excess contributions within the first 2½ months generally avoids the 10% excise tax under IRC Section 4979. A special exception may apply when qualifying corrective QNECs are made within 12 months under IRS rules.
For a calendar-year plan that fails its 2026 test, the usual 2½-month deadline is March 15, 2027, and the 12-month correction period generally ends December 31, 2027. Missing the applicable deadline can put the plan’s tax-qualified status at risk.
Review the IRS 401(k) Plan Fix-It Guide for failed ADP and ACP tests and work with your plan administrator to confirm the appropriate correction method and deadlines.
When Is 401(k) Compliance Testing Due?
A failed ADP or ACP test requires corrective action under IRS rules. Depending on the failure, the employer may need to refund excess contributions to highly compensated employees (HCEs) or make additional employer contributions.
Corrective refunds: Excess contributions, adjusted for allocable earnings, may be distributed to affected HCEs. These refunds are generally taxable in the year received and cannot be rolled over tax-free.
Employer contributions: Qualified nonelective contributions (QNECs) and qualified matching contributions (QMACs) may help correct a failure when IRS rules and plan terms permit. QNECs must be fully vested and meet applicable distribution restrictions.
Correction deadlines: Employers generally have 12 months after the plan year ends to correct an ADP or ACP failure. Correcting excess contributions within 2½ months generally avoids the 10% excise tax under Internal Revenue Code Section 4979. A limited exception applies to qualifying corrective QNECs made within 12 months.
For a calendar-year plan that fails its 2026 test, the usual 2½-month deadline is March 15, 2027, and the 12-month correction period ends December 31, 2027.
How a Safe Harbor 401(k) Helps You Skip Testing
A Safe Harbor 401(k) can eliminate ADP testing when the plan meets IRS requirements. It can also avoid ACP testing if matching contributions meet the applicable safe harbor rules.
Which tests can a safe harbor plan avoid?
- ADP test: A qualifying safe harbor plan is deemed to pass this test.
- ACP test: ACP testing relief applies when the plan meets the requirements for matching contributions and other applicable conditions.
- Top-heavy test: A plan funded solely with qualifying safe harbor contributions generally receives an exemption from top-heavy minimum contribution rules. Certain additional employer contributions can remove that exemption.
Safe harbor status does not eliminate all compliance duties. Employers must still meet applicable coverage requirements and follow the plan document.
Compare IRA Club SBS’s Safe Harbor 401(k) plans and Safe Harbor 401(k) rules and contribution structure. A traditional 401(k) generally requires annual ADP and applicable ACP testing.
How IRA Club SBS Handles Compliance Testing
IRA Club SBS provides ongoing nondiscrimination testing and handles required corrections for its retirement plans. Its administration services also cover recordkeeping, government filings, and employee onboarding.
For business owners, this means less manual work managing plan requirements. Payroll integration automates retirement deductions and deposits through supported providers.
IRA Club SBS can help employers review plan options, including traditional and Safe Harbor 401(k) plans. The right design affects which tests apply and whether corrective contributions or refunds may be needed.
Talk to IRA Club SBS about compliance testing for your plan. Review plan pricing to compare available options.
Frequently Asked Questions
Is nondiscrimination testing required for every 401(k)?
No. Traditional 401(k) plans generally require annual ADP and ACP testing, as applicable. Qualifying Safe Harbor 401(k) plans can avoid certain tests if they meet IRS requirements. Other compliance rules may still apply.
What happens if my employer fails the 401(k) nondiscrimination test?
The plan must correct the failure under IRS rules. Depending on the test, this may mean refunding excess contributions to highly compensated employees (HCEs) or making corrective employer contributions. HCE refunds are generally taxable in the year received.
Who counts as a highly compensated employee?
For 2026 testing, an employee generally qualifies as an HCE if they owned more than 5% of the business during the current or preceding year, or earned more than $160,000 in 2026. An employer may also elect to limit the compensation-based category to employees in the top 20% by pay. HCE status differs from key employee status under top-heavy rules.
Does a Safe Harbor 401(k) need nondiscrimination testing?
A qualifying Safe Harbor 401(k) is deemed to pass the ADP test. It may also qualify for ACP testing relief when IRS requirements are met. Coverage testing and other plan rules may still apply. Top-heavy relief depends on the plan’s contributions and structure.
Do solo 401(k) plans need nondiscrimination testing?
A one-participant 401(k) covering only a business owner, or the owner and their spouse, generally does not require employee nondiscrimination testing. If the business hires employees who meet plan eligibility rules, testing and coverage requirements may apply unless the plan qualifies for an exemption. See IRA Club SBS’s Solo 401(k) options.
When is 401(k) compliance testing due?
Testing usually takes place after the plan year ends, once the administrator has the required contribution and employee data. For ADP and ACP failures, the general correction period is 12 months after the plan year ends. Correcting excess contributions within 2½ months generally avoids the 10% excise tax, subject to exceptions. Confirm the deadlines with your plan administrator.
Talk to IRA Club SBS About Compliance Testing
Your 401(k) should support your business without adding unnecessary administrative work.
Talk to IRA Club SBS about compliance testing for your plan. Review your testing requirements and explore retirement plan options for your business.
Explore IRA Club SBS pricing or schedule a call with a 401k expert.
This content is for informational purposes only and is not tax, legal, or financial advice.
