Q: What does the ”ADP” in ADP Test stand for?
A: Average Deferral Percentage – WRONG!
A: Always Discriminate Properly – NOPE
It stands for ACTUAL DEFERRAL PERCENTAGE, because we are a boring industry and we like to use lame Acronyms. The IRS requires Plan Sponsors to perform various tests each year to ensure that 401(k) Plans are not discriminating in favor of business owners or other high paid employees. One of the required tests is the Actual Deferral Percentage test.
The ADP Test can be a pain in the you know what, but it is there for a reason. The test helps make sure that the plan is balanced and treating the NHCEs (Non Highly Compensated Employees) fairly.
Quick Fun Advice: try referring to your clients that fail the ADP test as “ADP Test Challenged” it’s a far friendlier approach. 🙂
The fact is that nobody likes a failed ADP test. It is a time-sucking, negative event. Nothing more fun than calling your highly paid executives and explaining to them that a portion of the money that they thought they socked away for retirement will now be coming back to them as taxable income in the form of a corrective distribution….so fun!
The solution to this horrible atrocity can be so simple. The Safe Harbor design is one of the magical elements of the 401k world…..a regular Marvel Superhero of retirement plans. Yes, the Safe Harbor comes at a cost as the key ingredient to its magical power is an Employer Contribution of some kind, but if you are a fan of retirement readiness (and who isn’t) then you know that Employer Contributions can go a long way in moving the needle of successful saving. You are killing two birds with one stone! (it should be noted that I am vegetarian and do not condone killing animals or throwing stones of any kind)
Check out this advice (video below) from one of my favorite retirement plan Professionals Nerdy Chad. Nerdy Chad loves him some retirement plans and gets real excited when people mention Safe Harbor options. Granted he is a little creepy but he is not afraid to show his love for 401(k) and you gotta love him for that.
Of course, there are other ways to fix a failed ADP test, but the Safe Harbor is the only sure fire way to solve this problem. Increasing plan participation through better education and adding auto features can be easier said than done.
Plan Sponsors should revisit the Safe Harbor concept as it can be a real win-win scenario. The deadline to establish a new Safe Harbor 401(k) plan is October 1st and the deadline to add a Safe Harbor to an existing plan is December 1st for the following year. Unleash your inner Nerdy Chad and leverage the magical powers of the Safe Harbor plan.
Sales Plug: Check out the newly released KIC(k)START program from Plan Design Consultants. It’s a low cost solution (Free Install and $1000 Flat Annual Fee) that utilizes the Safe Harbor concept and other simple provisions to minimize the admin/compliance work necessary. Making it easier for small companies to set-up and run their first 401(k) plan.
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