Certified Plan Sponsor Professional (CPSP) Practice Exam

What action should be taken if the ADP test fails?

1. Increase the contributions of HCEs

2. Decrease the contributions of NHCEs

3. Return excess contributions to HCEs

4. Stop all contributions to the plan

The correct answer is: Return excess contributions to HCEs

When the Actual Deferral Percentage (ADP) test fails, it indicates that the contributions made by Highly Compensated Employees (HCEs) exceed the allowable limits compared to the contributions of Non-Highly Compensated Employees (NHCEs). To rectify this situation, a common corrective action is to return excess contributions made by HCEs. This return of excess contributions helps ensure compliance with the nondiscrimination rules set forth by the IRS, which aim to prevent disproportionately benefiting HCEs over NHCEs. The act of returning excess contributions effectively reduces the HCEs' contributions to a level that passes the ADP test, allowing the plan to maintain its qualified status without additional penalties. This adjustment protects both the plan sponsors and participants by adhering to federal regulations, encouraging equitable participation among all employees. Other options, while they might initially seem appealing as corrective actions, won't directly resolve the failure of the ADP test in the manner required by regulatory standards. Therefore, the most appropriate action in response to a failed ADP test is to return excess contributions to HCEs.