What is the overall purpose of the ADP test in a 401(k) plan?

The overall purpose of the ADP test, or Actual Deferral Percentage test, in a 401(k) plan is to evaluate deferrals of highly compensated employees compared to non-highly compensated employees. This test is designed to ensure that the plan does not disproportionately favor higher-paid employees when it comes to contributions.

The ADP test measures the average deferral rates of both groups and is a critical part of maintaining the plan’s qualified status under Internal Revenue Code regulations. If highly compensated employees are contributing significantly more than their non-highly compensated counterparts, the plan may fail the test, which could require corrective actions, such as refunding excess contributions to highly compensated employees or increasing contributions for non-highly compensated employees.

While evaluating employer match contributions, assessing employee eligibility, and ensuring compliance with tax regulations are all important aspects of 401(k) plan administration, they do not specifically address the primary function of the ADP test. The focus of the ADP test is solely on the deferral rates of employees, which is crucial for maintaining the balance needed for compliance with nondiscrimination requirements.