If your 401(k) plan fails annual ADP/ACP non-discrimination testing, corrective action must be taken to bring the plan into compliance with IRS regulations. Plans that do not operate under a Safe Harbor provision or remove Safe Harbor mid-year are subject to this testing. The goal of corrective action is to ensure that highly compensated employees (HCEs) are not contributing significantly more to the plan than non-highly compensated employees (NHCEs).

Who This Applies To

This information is for 401(k) Plan Sponsors and Plan Administrators responsible for monitoring annual compliance testing results and taking corrective action if needed.

When Corrective Action Is Required

Corrective action is required any time your plan fails annual ADP (Actual Deferral Percentage) or ACP (Actual Contribution Percentage) testing. This occurs when:

  • The average deferral rates of HCEs are too far above those of NHCEs (ADP failure).
  • The average employer match or after-tax contribution rates of HCEs are too far above those of NHCEs (ACP failure).
  • Testing results show that the plan does not meet IRS limits, even after considering allowable adjustments.

In other words, corrective action is required whenever the test indicates that the plan provides a disproportionate benefit to HCEs compared to NHCEs. The goal of the correction is to restore balance so that the plan complies with IRS fairness rules.

What Does a "Deemed to Pass" Test Result Mean?

Sometimes, your test results may show as “Deemed to Pass.”

This means that, although the plan technically failed testing, the failure was resolved by recharacterizing certain HCE contributions as catch-up contributions.

  • Catch-up contributions are additional deferrals employees age 50 or older can make above the standard IRS contribution limit.
  • These contributions are excluded from non-discrimination testing.
  • When HCE contributions that caused the failure are reclassified as catch-up contributions, the plan is treated as having passed the test.

If your plan receives a “Deemed to Pass” result:

  • No corrective refunds or additional contributions are required.
  • No further action is needed from the Plan Sponsor or Administrator.

Corrective Options for Failed Testing

If your plan fails, corrective action must be taken by IRS deadlines. The options available depend on whether your plan uses the current-year or prior-year testing method (check your Adoption Agreement to confirm).

  1. Corrective Refunds to HCEs (Most Common)
    • Refund excess contributions to HCEs until the plan passes the test.
    • Refunds are taxable in the year distributed.
    • Cost-neutral for the employer.
    • Must be completed by March 15th (or June 30th if your plan has automatic enrollment).
  2. Qualified Non-Elective Contributions (QNECs) to NHCEs
    • Only available for current-year tested plans.
    • Employer makes an additional contribution to NHCEs to raise their average contribution rate.
    • QNECs are 100% vested and cannot be withdrawn until a qualifying event.
    • Can be made by December 31, 2025 to avoid issuing refunds to HCEs.
    • To request, email compliance@myubiquity.com.
  3. 4% Safe Harbor Non-Elective Contribution (SHNEC) – Retroactive Application
    • Available for both current-year and prior-year tested plans.
    • Applies retroactively to January 1 of the failed plan year.
    • Must be contributed to all eligible employees (you may exclude HCEs to reduce cost).
    • Useful when required QNECs would cost more than 4%.

      How to Correct Failed Non-discrimination Testing (step-by-step)

      1. Review your test results email from Ubiquity.
      2. Confirm that the data used during testing is accurate. The results of your testing are based on the employee census you verified on MyUbiquity.com. If you did not verify your census online, Ubiquity compiles your annual payroll data to perform the test. Please verify your census to ensure accuracy. If you made changes after the submission deadline, ensure that the updated information was used. Email compliance@myubiquity.com to notify us of updated census verification submission after the deadline.
      3. Decide on your preferred correction method.
      4. Reply to the test results email with your selection by the applicable deadline.

      Correction Deadlines for 2024 Testing Failures

      • Refunds (non–auto-enrollment plans): March 15, 2025
      • Refunds (plans with auto-enrollment): June 30, 2025
      • QNEC contributions (current-year tested plans): December 31, 2025

      Missing these deadlines may result in plan disqualification, IRS penalties, and required taxable refunds with additional excise taxes.

      Refund Processing Details

      • Refund amounts are shown in your test results but are subject to market gains/losses, so the final refund may vary.
      • Refunds do not affect 2024 employee W-2s. Impacted employees will receive a 2025 Form 1099-R by January 31, 2026.
      • If a refund involves employer match contributions that are subject to vesting, only the vested portion is refunded. Non-vested amounts are forfeited and added to the plan forfeiture account to offset plan fees or future contributions.

      Example: Jonathan, an HCE, is due a $500 corrective refund. He is only 40% vested in the discretionary match. He will receive $200 (40% of $500), and the remaining $300 will be forfeited back to the plan.

      Need Help?

      If you’re unsure which method applies to your plan or need help deciding on a correction, please contact us.