Safe harbor plans can be a big advantage for plan sponsors, specifically for small businesses.
Employers that sponsor a ROBS 401k can avoid the potential ADP or ACP testing failures by converting their 401k plan to a traditional safe harbor 401(k) plan. If operated properly, the safe harbor design would exempt the 401k plan from having to perform ADP/ACP tests.
What Are ADP and ACP Tests?
ADP and ACP tests are used to determine the maximum amount that plan participants may receive as contributions, including pretax and Roth deferrals, matching contributions, and employee after-tax (nondeductible) contributions. The ADP test compares the salary deferral contributions of HCEs and nonHCEs to make sure that HCEs do not receive a disproportionate amount of deferrals. Pretax and Roth deferrals are included in the ADP test. The ACP test is conducted in the same way as the ADP test, but the ACP test measures employer matching contributions and employee after-tax contributions. Completing the ADP/ACP tests accurately and timely is vital for employers maintaining 401(k) plans.
The ADP and ACP tests are satisfied by passing either a “1.25 test” or a “2 times/2 percent test.” An employer may use whichever test yields the best result. If a plan fails testing, the employer must take corrective measures.
For the 1.25 test, the HCE group’s ADP (or ACP if performing that test) may not exceed 125 percent of the nonHCE group’s ADP (or ACP).
2 Times/2 Percent Test
For the 2 times/2 percent test, the HCE group’s ADP (or ACP if performing that test) must not exceed the lesser of
· 2 times the nonHCE group’s ADP (or ACP), or
· the nonHCE group’s ADP (or ACP), plus 2 percentage points.
Satisfying the Safe Harbor minimum Contribution Requirements
Lastly, when a plan is deemed a safe harbor plan, an annual safe harbor notice is given to each eligible employee.