The Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests are compliance tests that must be performed on 401(k) and other defined contribution retirement plans to ensure that the plan does not discriminate in favor of highly compensated employees (HCEs) at the expense of non-highly compensated employees (NHCEs). These tests are required under the Employee Retirement Income Security Act (ERISA) and the Internal Revenue Code (IRC) in the United States.

1. **Actual Deferral Percentage (ADP) Test:**
– The ADP test evaluates the elective deferrals made by highly compensated employees in a 401(k) plan compared to those made by non-highly compensated employees.
– The ADP for each group (HCEs and NHCEs) is calculated as a percentage of their compensation that is deferred into the plan.
– The test compares the ADP of highly compensated employees with the ADP of non-highly compensated employees to ensure that the ratio does not exceed certain limits set by the IRS.

– **Formula for ADP:**
\[
\text{ADP} = \frac{\text{Total Elective Deferrals for HCEs or NHCEs}}{\text{Total Compensation for HCEs or NHCEs}}
\]

– The ADP limit is generally the greater of:
– 125% of the ADP of NHCEs, or
– The lesser of 200% of the ADP of NHCEs or the ADP of NHCEs plus 2%.

2. **Actual Contribution Percentage (ACP) Test:**
– The ACP test examines employer matching contributions and employer nonelective contributions (such as profit-sharing contributions) made to the plan on behalf of HCEs and NHCEs.
– Like the ADP test, the ACP test compares the contribution percentages for the two groups and ensures that the ratio does not exceed certain limits set by the IRS.

– **Formula for ACP:**
\[
\text{ACP} = \frac{\text{Total Matching Contributions + Total Nonelective Contributions for HCEs or NHCEs}}{\text{Total Compensation for HCEs or NHCEs}}
\]

– The ACP limit is generally the greater of:
– 125% of the ACP of NHCEs, or
– The lesser of 200% of the ACP of NHCEs or the ACP of NHCEs plus 2%.

These tests are important for maintaining the tax-qualified status of the retirement plan. If the plan fails the ADP or ACP test, corrective actions may need to be taken, such as returning excess contributions to highly compensated employees or making additional contributions on behalf of non-highly compensated employees. Plan sponsors and administrators work closely with third-party administrators or consultants to perform these tests and ensure compliance with the relevant regulations.