For many employers, annual ADP and ACP testing is one of the most stressful parts of administering a traditional 401(k) plan. A failed test can mean corrective distributions to highly compensated employees, additional employer contributions, unexpected administrative work, and questions from leadership about what went wrong.

The good news is that most ADP and ACP test failures are preventable. With proactive monitoring, thoughtful plan design, and ongoing participation tracking, employers can identify potential issues well before year-end testing begins.

At Basic Capital, we believe retirement plan compliance should be proactive—not reactive. This guide explains why ADP and ACP tests fail, what corrective actions may be required, and how employers can reduce compliance risk year-round.

What Are ADP and ACP Tests?

Traditional 401(k) plans are generally required to complete two annual nondiscrimination tests:

• The Actual Deferral Percentage (ADP) Test, which compares employee salary deferral rates between highly compensated employees (HCEs) and non-highly compensated employees (NHCEs).

• The Actual Contribution Percentage (ACP) Test, which evaluates employer matching and after-tax employee contributions across those same employee groups.

The purpose of both tests is to ensure retirement plan benefits are distributed fairly and do not disproportionately favor owners or highly compensated employees.

Why Do Plans Fail ADP and ACP Testing?

Most failures are not caused by calculation errors—they result from participation patterns within the workforce.

Common causes include:

Low Participation Among Non-Highly Compensated Employees

When fewer rank-and-file employees contribute to the plan, the gap between HCE and NHCE contribution rates widens, increasing the likelihood of an ADP test failure.

Encouraging broader participation through automatic enrollment, employee education, and simplified enrollment can often improve testing results.

Highly Compensated Employees Max Out Contributions

Business owners and executives frequently contribute up to IRS limits.

If participation among other employees remains low, the plan may exceed the allowable testing thresholds.

Matching Contributions Create ACP Issues

Generous employer matches are a valuable benefit, but uneven participation across employee groups can create ACP testing failures if matching contributions disproportionately benefit HCEs.

Reviewing participation trends throughout the year can help identify potential problems before annual testing is completed.

Rapid Company Growth

Hiring activity, organizational restructuring, and changes in workforce demographics can significantly affect testing outcomes.

Companies experiencing rapid growth should periodically review participation data instead of waiting until year-end.

Incorrect Employee Classification

Improperly identifying highly compensated employees or excluding eligible participants can lead to inaccurate test results.

The IRS recommends reviewing employee classifications and plan data annually before testing begins.

What Happens If Your Plan Fails?

A failed ADP or ACP test does not automatically jeopardize your retirement plan, but corrective action is required within IRS correction timeframes.

Depending on your plan document and the circumstances, corrections may include:

Returning Excess Contributions

One of the most common correction methods is distributing excess elective deferrals or matching contributions back to highly compensated employees.

While effective, this outcome is rarely popular with executives who expect to maximize retirement savings.

Making Qualified Nonelective Contributions (QNECs)

Instead of reducing HCE contributions, employers may contribute additional funds to eligible non-highly compensated employees.

QNECs are fully vested employer contributions that help increase NHCE averages and may allow the plan to satisfy testing requirements.

Adjusting Future Plan Design

Recurring testing failures often indicate a structural issue rather than a one-time event.

Many employers respond by reviewing:

• Employer matching formulas

• Automatic enrollment features

• Employee education programs

• Safe Harbor plan options

A proactive redesign can significantly reduce future compliance risk.

IRS Deadlines Matter

Corrective action should not be delayed.

Generally, employers have 2½ months after the end of the plan year (or up to **6 months for certain Eligible Automatic Contribution Arrangements) to correct excess contributions without triggering additional excise tax consequences. If corrections are delayed, employers may face a 10% excise tax and more complex correction requirements.

How to Reduce the Risk of ADP and ACP Test Failures

Rather than treating testing as a year-end exercise, employers should monitor plan health throughout the year.

Track Participation Rates Regularly

Monitor employee participation by:

• Department

• Compensation level

• Eligibility group

• Overall workforce participation

Early visibility makes it easier to address trends before annual testing begins.

Review Highly Compensated Employee Contributions

If HCE contribution rates increase significantly while NHCE participation remains flat, employers may wish to evaluate plan communication or enrollment strategies before year-end.

Encourage Early Enrollment

Employees who begin contributing earlier in the year have a greater impact on overall testing outcomes than employees who wait until later in the plan year.

Simple enrollment processes and ongoing education can improve participation rates.

Evaluate Your Employer Match

Employers should periodically assess whether their matching formula continues to support both employee participation and compliance objectives.

In some cases, modest adjustments can improve testing outcomes without significantly increasing employer costs.

Consider Whether a Safe Harbor Plan Makes Sense

For some employers, repeated failures of ADP and ACP indicate that a traditional 401(k) design may no longer be the best fit.

Safe Harbor 401(k) plans generally eliminate the annual ADP and ACP testing requirements by meeting specific employer contribution and notice requirements.

Although Safe Harbor plans require mandatory employer contributions, many growing businesses find the simplified compliance process worthwhile.

The right choice depends on company size, workforce demographics, participation rates, and long-term retirement goals.

Why Real-Time Compliance Monitoring Matters

Traditional compliance often focuses on year-end testing.

Modern retirement platforms increasingly provide ongoing visibility into plan health throughout the year.

Rather than discovering problems after testing is complete, employers can monitor:

• Participation trends

• Deferral percentages

• Highly compensated employee contribution patterns

• Matching utilization

• Potential compliance risks before annual testing

At Basic Capital, we believe compliance should be continuous rather than reactive. Better visibility helps employers make informed decisions before issues require corrective action.

Companies looking to strengthen ongoing retirement plan oversight can also explore our Basic Capital AI Compliance Agent, which helps employers simplify compliance monitoring and gain greater visibility into retirement plan administration.

Turning Compliance Into a Competitive Advantage

ADP and ACP testing doesn't have to become an annual scramble.

Employers that actively monitor participation, review plan performance throughout the year, and make informed plan design decisions are often better positioned to avoid costly corrections and administrative surprises.

At Basic Capital, we believe modern retirement plans should provide employers with the tools and insights needed to manage compliance confidently—not just react to year-end test results.

Companies evaluating retirement plan solutions can also explore our For Employers resources to learn how modern retirement infrastructure supports compliance, administration, and employee engagement.

Ready to simplify retirement plan compliance? Get started with Basic Capital to learn how our platform helps employers monitor plan health, streamline administration, and build retirement programs designed for long-term success.