What action must an employer take if they fail the ADP/ACP tests?

If an employer fails the Actual Deferral Percentage (ADP) or Actual Contribution Percentage (ACP) tests, the appropriate action is to either refund excess contributions to Highly Compensated Employees (HCEs) or make Qualified Nonelective Contributions (QNECs) or Qualified Matching Contributions (QMACs).

The ADP and ACP tests are designed to ensure that retirement plans do not disproportionately benefit HCEs compared to non-HCEs. When a plan fails these tests, it signifies that HCEs are contributing at a rate that exceeds the allowable limits based on the contributions of non-HCEs. To rectify this situation and bring the plan into compliance, the employer can return the excess contributions made by HCEs, thereby adjusting the overall balance of contributions to better reflect the intent of the nondiscrimination rules. Alternatively, the employer can opt to make QNECs or QMACs, which are contributions that do not depend on employee deferrals but rather provide benefits directly to non-HCEs, improving the plan's compliance status.

While increasing employer contributions or adjusting the vesting schedule might be potential strategies for improving plan participation or retention, they do not directly address the failure of the ADP/ACP tests. Similarly,