Passing ADP and ACP Testing and Avoiding Refunds to Highly Compensated Employees
If you own your business, your rank-and-file employees help decide how much of your own pay stays in your 401(k). The ADP (actual deferral percentage) and ACP (actual contribution percentage) tests compare what highly compensated employees save with what everyone else saves. When a plan fails that comparison, it has to correct the excess, and one correction is a refund to the highly paid participants. Owners of more than 5% of a company are in that group.
Who counts as a highly compensated employee
For 401(k) testing, the IRS treats an employee as highly compensated in either of two cases. The employee was a 5% owner at any time during the current or prior year, or the employee was paid more than $160,000 in the prior year. For the 2026 plan year, the pay threshold is $160,000, as of October 6, 2026, according to IRS Notice 2025-67. For the pay test, an employer can also elect to count only employees in the top 20% by pay, per the Instructions for Form 5330.
The IRS also treats a spouse, child, parent, or grandparent of a 5% owner as a 5% owner. Those family members on your payroll are highly compensated for the plan year, regardless of pay.
What the ADP and ACP tests measure
The ADP test covers employee deferrals, both pre-tax and Roth. The ACP test covers matching and after-tax contributions, so a match is tested too. Each test divides a participant’s contributions by that participant’s pay, averages the results for the highly compensated group and for the other eligible employees (the rank-and-file group), and compares the two averages.
As of October 6, 2026, the IRS 401(k) plan Fix-it Guide says the highly compensated average passes when it does not exceed the greater of 125% of the rank-and-file average, or the lesser of 200% of the rank-and-file average or the rank-and-file average plus 2 percentage points.
The guide includes an illustrative example from a 2020 plan year. The rank-and-file group averaged 4% and the highly compensated group averaged 7%. The highest passing average for the highly compensated group was 6%, so the plan failed. The same formula applied to a rank-and-file average of 5% sets the ceiling at 7%, so a 7% average would pass.
Every eligible rank-and-file employee counts in the average, including employees who never enroll, who count as zero. Low participation pulls the rank-and-file average down, and a lower average lowers the ceiling for the highly compensated group.
Why a failed test leads to refunds
A plan that fails must take the corrective action in its plan document during the statutory correction period. One correction is a refund. The plan distributes the excess contributions, meaning the amount above what the test permits, along with the income earned on them, to the highly compensated participants for whom they were made.
The refund has a deadline. As of October 6, 2026, a plan generally has 2½ months after the plan year ends to correct excess contributions, which is March 15 of the next year for a calendar-year plan. If the employer does not distribute them by then, it owes a 10% excise tax on the excess contributions, with one exception covered below, according to the IRS Fix-it Guide. The outside deadline is 12 months after the plan year ends. Past that point, the IRS says the plan’s cash or deferred arrangement (the 401(k) feature) is no longer qualified and the entire plan may lose its tax-qualified status.
Levers that prevent or fix a failure
* Raise rank-and-file participation. A higher rank-and-file average lifts the ceiling for the highly compensated group, as the 4% and 5% example shows.
* Check classification before testing. The IRS advises reviewing prior-year pay and ownership records, including family members of owners, who often have different last names.
* Consider a safe harbor design. Safe harbor plans that meet the IRS requirements, which include notices, are generally exempt from ADP and ACP testing, per the IRS Fix-it Guide and the IRS safe harbor notice page.
* Make corrective employer contributions. Qualified nonelective contributions, which are employer contributions that are always 100% vested, raise the rank-and-file percentage when made for those employees. The IRS says the excise tax does not apply when a plan that uses current year testing makes enough of them within 12 months after the plan year ends to pass.
* Distribute refunds on time. A plan that allows catch-up contributions can also recharacterize a refund as a catch-up contribution for a participant who is 50 or older and has not used the catch-up limit for the year.
Where Asure 401(k) Plans fits
Whether you run a practice, a contracting firm, a plant, a hotel, or a restaurant, passing these tests depends on plan design and on what employees choose to defer each year. No design choice guarantees a result.
Asure 401(k) Plans are payroll-integrated retirement plans with automatic contributions through payroll, plan monitoring, required filings, and compliance support to offer competitive benefits for smaller employers. They are sold as an add-on to AsureCentral or AsureWorks. AsureCentral is a unified payroll and HR platform with one login and personalized dashboards, supporting payroll, HR, tax, benefits, recruiting, time, and employee self-service. The employer remains responsible for plan compliance decisions, so testing and correction choices are worth reviewing with a CPA or ERISA attorney.
If you are adding or modernizing a retirement plan, schedule a conversation with us about Asure 401(k) Plans and AsureCentral. To go further, read How to Offer a 401(k) Plan to Employees.
This article is general information, not tax or legal advice. Rules and figures are as of October 6, 2026.
