The tax code governing 401(k) plans was written to prevent qualified retirement plans from overly favoring highly compensated employees (HCEs). A series of non-discrimination tests were devised to measure whether a plan’s design or operation tends to favoring the HCEs over the nonhighly compensated employees (NHCEs). In our last installment we discussed how the Average Deferral Percentage (ADP) test is calculated. In this article we dive into the different methods of correcting for an ADP test failure.

The tax code governing 401(k) plans was written to prevent qualified retirement plans from overly favoring Highly Compensated Employees (HCEs). A series of non-discrimination tests were devised to measure whether a plan’s design or operation lends to favoring the HCEs over the Non-Highly Compensated Employees (NHCEs). All year end testing begins with the coverage test in accordance with IRS Code section 410(b). Once the coverage test is passed or, if not passed, once steps have been taken to pass coverage, then the average deferral percentage (ADP) test must be performed. The ADP test uses mathematical equations to compare the participation and contribution rates of the HCEs to the NHCEs in order to determine whether the plan is discriminating in favor of the HCEs.