16.2 Actual Contribution Percentage (ACP) Test: Matching & After-Tax Contributions

16.2 Actual Contribution Percentage (ACP) Test: Matching & After-Tax Contributions

[!NOTE] The Parallel Statutory Barrier for Matching and After-Tax Contributions While IRC §401(k)(3) prevents discrimination in employee salary deferrals, Congress recognized that employers could easily circumvent nondiscrimination mandates by pairing modest elective deferrals with generous employer matching contributions or voluntary after-tax savings mechanisms targeted toward highly compensated executives. To close this loophole, Congress enacted the Actual Contribution Percentage (ACP) Test under IRC §401(m) as part of the Tax Reform Act of 1986.

Interpreted under Treasury Regulation §1.401(m)-1 through §1.401(m)-5, the ACP test mirrors the mathematical structure of the ADP test, but focuses specifically on employer matching contributions and employee voluntary after-tax contributions. For ASPPA QKA candidates, mastering the distinct eligible populations, contribution components, forfeiture treatments, and anti-abuse disproportionate matching rules is vital for ensuring total plan compliance.

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Statutory Architecture of the ACP Test: IRC §401(m)(2)

Under IRC §401(m)(2)(A) and Treas. Reg. §1.401(m)-2, a defined contribution plan containing matching contributions or employee after-tax contributions satisfies nondiscrimination under IRC §401(a)(4) for a plan year if and only if the Actual Contribution Percentage (ACP) for the eligible HCE group satisfies either the 1.25 Test or the 2.0 / 2-Percentage-Point Spread Test relative to the ACP for the eligible NHCE group.

+---------------------------------------------------------------------------------------------------+
|                         THE THREE-STAGE ARCHITECTURE OF ACP TESTING                               |
+---------------------------------------------------------------------------------------------------+
|                                                                                                   |
|   STAGE 1: IDENTIFY THE ACP TESTING UNIVERSE (Treas. Reg. §1.401(m)-5)                            |
|   • Any employee eligible to receive an employer matching contribution (if they defer).          |
|   • Any employee eligible to make employee voluntary after-tax contributions.                     |
|   • Include non-deferring employees (they were eligible to receive match had they deferred!).      |
|                                                                                                   |
|   STAGE 2: CALCULATE INDIVIDUAL ACTUAL CONTRIBUTION RATIOS (ACRs)                                 |
|   • For each eligible employee:                                                                   |
|                                                                                                   |
|                   Employer Matching Contributions + Employee After-Tax Contributions              |
|          ACR  =  ────────────────────────────────────────────────────────────────────             |
|                          IRC §414(s) Testing Compensation (Capped by §401(a)(17))                 |
|                                                                                                   |
|   • Apply Disproportionate Matching Contribution limits (Treas. Reg. §1.401(m)-2(a)(6)(ii)).      |
|   • Round ACR to nearest hundredth of a percent (0.01%).                                          |
|                                                                                                   |
|   STAGE 3: COMPUTE GROUP ACTUAL CONTRIBUTION PERCENTAGES (ACPs)                                   |
|   • Calculate the UNWEIGHTED ARITHMETIC MEAN of ACRs separately for HCEs and NHCEs:               |
|                                                                                                   |
|                   Sum of Individual ACRs in Group                                                 |
|          ACP  =  ─────────────────────────────────                                                |
|                      Total Eligible Employees in Group                                            |
|                                                                                                   |
+---------------------------------------------------------------------------------------------------+

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Determining the Eligible Participant Population for ACP Testing

Under Treasury Regulation §1.401(m)-5, the definition of an "Eligible Employee" for ACP testing parallels the ADP definition, but is tailored to the specific contribution types governed by IRC §401(m):

1. Eligibility for Matching Contributions

An employee is an eligible employee for the matching portion of the ACP test if the employee is directly or indirectly eligible to receive an allocation of employer matching contributions at any time during the plan year, conditioned upon making an elective deferral or employee contribution.

[!IMPORTANT] The Non-Deferrer in the ACP Test: A foundational ASPPA QKA exam rule is that an employee who satisfies plan eligibility conditions to make elective deferrals—and who would have received an employer match had they deferred—is an eligible employee for the ACP test, even if they deferred $0 and received $0 match! Their ACR is 0.00%, and this zero must be included in the group ACP denominator.

2. Eligibility for Voluntary After-Tax Contributions

An employee is an eligible employee for the after-tax portion of the ACP test if the employee is authorized under the terms of the plan document to make voluntary after-tax contributions at any time during the plan year.

3. Allocation Conditions and Mid-Year Events

• Allocation Conditions (e.g., 1,000 Hours or Last-Day Rules): Under Treas. Reg. §1.401(m)-5, if an employer matching contribution is subject to an allocation condition (such as completing 1,000 hours of service or being employed on the last day of the plan year), an employee who is eligible to defer is still treated as an eligible employee for the ACP test, even if they fail the allocation condition and receive no match! Their ACR is 0.00%.
• Mid-Year Terminations: An employee who enters the plan and terminates employment mid-year remains an eligible employee for the ACP test for that plan year.
• Suspensions: Employees suspended from deferring due to plan loan defaults remain eligible employees for ACP testing.

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Defining the Actual Contribution Ratio (ACR)

Under Treasury Regulation §1.401(m)-2(a)(2), the Actual Contribution Ratio (ACR) is computed individually for each eligible employee:

$\text{ACR}_i = \frac{\text{Employer Matching Contributions}_i + \text{Employee Voluntary After-Tax Contributions}_i}{\text{IRC Section 414(s) Testing Compensation}_i}$

Breakdown of ACR Numerator Components

1. Employer Matching Contributions

Includes any employer contribution made to the trust on account of an employee's elective deferrals (pre-tax or Roth) or employee after-tax contributions:

• Fixed Matching Contributions: Defined formulas in the plan document (e.g., 50% match on the first 6% of compensation deferred);
• Discretionary Matching Contributions: Ad-hoc percentage matches declared by the employer's board of directors for the plan year;
• Tiered Matching Formulas: Formulas offering different match percentages across successive deferral tiers (e.g., 100% on the first 3%, 50% on the next 2%).

2. Employee Voluntary After-Tax Contributions

Includes traditional voluntary after-tax employee contributions accounted for in a separate after-tax account under IRC §401(a)(4) and IRC §411(c)(2)(B).

[!WARNING] Roth Contributions Are NOT After-Tax for ACP: A dangerous exam trap is confusing designated Roth contributions with voluntary after-tax contributions. While Roth contributions are made with after-tax dollars, they are legally classified as elective deferrals under IRC §402A and are tested exclusively in the ADP test. In contrast, traditional voluntary after-tax contributions are non-elective employee contributions tested exclusively in the ACP test!

3. Excluded Contributions

• Safe Harbor Matching Contributions: Matching contributions satisfying the statutory safe harbor requirements of IRC §401(m)(11) (traditional safe harbor) or IRC §401(m)(12) (QACA safe harbor) are exempt from ACP testing (unless the safe harbor is lost or excessive discretionary matching is provided);
• Qualified Matching Contributions (QMACs) Shifted to ADP: If the plan sponsor elects under Treas. Reg. §1.401(k)-2(a)(6) to include QMACs in the ADP test to help pass the ADP test, those QMACs MUST be excluded from the ACP test to prevent double-counting;
• Employer Profit-Sharing Contributions: Tested under general nondiscrimination (IRC §401(a)(4)) unless shifted as QNECs.

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Treatment of Plan Forfeitures in the ACP Test

When non-vested participants separate from service, unvested employer matching account balances are forfeited under the terms of the plan document. Plan documents typically direct forfeitures to be utilized in one of three ways:

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|                         TREATMENT OF PLAN FORFEITURES UNDER IRC §401(m)                           |
+---------------------------------------------------------------------------------------------------+
|                                                                                                   |
|   METHOD 1: USED TO REDUCE EMPLOYER MATCHING CONTRIBUTIONS                                        |
|   • Forfeitures offset the employer's cash contribution liability dollar-for-dollar.               |
|   • Does NOT create an additional participant allocation.                                         |
|   • The actual allocated matching contributions are tested in the ACP test.                       |
|                                                                                                   |
|   METHOD 2: REALLOCATED AS ADDITIONAL MATCHING CONTRIBUTIONS                                      |
|   • Forfeitures are allocated among participants who made elective deferrals.                     |
|   • MUST BE INCLUDED in the ACP numerator as additional matching contributions!                   |
|   • Increases participant ACRs.                                                                   |
|                                                                                                   |
|   METHOD 3: REALLOCATED AS PROFIT-SHARING (NONELECTIVE) ALLOCATIONS                               |
|   • Forfeitures are allocated among all eligible participants pro-rata on compensation.           |
|   • EXCLUDED from the ACP test!                                                                   |
|   • Tested under general nondiscrimination rules of IRC §401(a)(4).                               |
|                                                                                                   |
+---------------------------------------------------------------------------------------------------+

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Disproportionate Matching Contribution Rules: Treas. Reg. §1.401(m)-2(a)(6)(ii)

To prevent sophisticated employers from "gaming" the unweighted ACP testing mechanics, the Treasury promulgated anti-abuse regulations governing disproportionate matching contributions.

The Gaming Strategy: Target Matching

Because the group ACP is an unweighted arithmetic average, an employer wishing to boost an executive's ACR could theoretically provide a massive match rate to a single, low-paid NHCE. For example, if an NHCE earning $20,000 defers $200 (1%), the employer could provide a 1,000% match ($2,000), giving that single NHCE an ACR of 10.00% ($2,000 / $20,000). In a small NHCE group, this artificial 10% ratio would dramatically inflate the group ACP, allowing HCEs to receive large matches without failing the test.

The Anti-Abuse Regulation: The Matching Cap

Under Treasury Regulation §1.401(m)-2(a)(6)(ii), an employer matching contribution allocated to an NHCE cannot be taken into account in the ACP test to the extent the match exceeds the GREATEST of the following three statutory benchmarks:

+---------------------------------------------------------------------------------------------------+
|                 TREAS. REG. §1.401(m)-2(a)(6)(ii) DISPROPORTIONATE MATCH LIMITS                   |
+---------------------------------------------------------------------------------------------------+
|                                                                                                   |
|   An NHCE matching contribution is INCLUDIBLE in the ACP test only up to the GREATEST of:        |
|                                                                                                   |
|   1. 100% of the employee's elective deferrals for the plan year;                                 |
|                                                                                                   |
|   2. TWO TIMES (2×) the plan's "representative match rate"; OR                                    |
|                                                                                                   |
|   3. The employee's elective deferrals multiplied by the plan's "representative match rate".       |
|                                                                                                   |
|   • Any matching contribution exceeding this cap is DISPROPORTIONATE:                             |
|     - Must be excluded from the ACP test!                                                         |
|     - Must independently satisfy IRC §401(a)(4) nondiscrimination testing.                        |
|                                                                                                   |
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Defining the "Representative Match Rate"

Under Treas. Reg. §1.401(m)-2(a)(6)(v), the Representative Match Rate is defined as the lowest match rate allocated to any eligible NHCE among a substantial group of NHCEs (specifically, the lowest match rate among NHCEs who make elective deferrals equal to at least a designated threshold, or half of all eligible NHCEs who defer). If a plan provides a basic match of 50% on deferrals up to 6% of compensation, the representative match rate is 50.00%.

Worked Example of Disproportionate Match Rule:

• An employer maintains a 401(k) plan with a standard match of 50% of deferrals (representative match rate = 50%).
• To boost the ACP test, the employer awards a special targeted match of $2,500 to NHCE Adams, who earns $25,000 and deferred $1,000 (a 250% match rate).
• Let's determine the maximum match for Adams that can enter the ACP test:
  1. $100%$ of Adams' elective deferrals = $100% \times $1,000 = \mathbf{$1,000}$
  2. $2 \times$ representative match rate multiplied by deferrals = $2 \times 50% \times $1,000 = 100% \times $1,000 = \mathbf{$1,000}$
  3. Representative match rate multiplied by deferrals = $50% \times $1,000 = \mathbf{$500}$
• The greatest of these three limits is $1,000.
• Testing Result: Only $1,000 of Adams' $2,500 match can be included in the ACP test (yielding an ACR of $1,000 / $25,000 = 4.00%). The remaining $1,500 is disproportionate, cannot be used in the ACP test, and must satisfy general nondiscrimination under IRC §401(a)(4).

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Side-by-Side Comparison: ADP Test vs. ACP Test

The following matrix illustrates the precise statutory boundaries and operational distinctions between the ADP and ACP tests under the Internal Revenue Code:

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Step-by-Step Multi-Participant ACP Census Worksheet

To see the complete mechanics in action, examine the 2024 calendar year census for Summit Financial Partners. Summit sponsors a 401(k) plan offering pre-tax deferrals, Roth deferrals, voluntary after-tax contributions, and an employer match of 50% on deferrals up to 6% of compensation (maximum regular match = 3.00% of pay). In addition, Summit declared a discretionary year-end matching allocation for select participants.

Summit Financial Partners 2024 Plan Census & Contribution Data

Detailed Calculation Notes:

1. Partner 1 (HCE): Compensation capped at $345,000. Received $10,350 in employer matching contributions and made $10,000 in voluntary after-tax contributions. Total numerator = $20,350. $\text{ACR} = $20,350 / $345,000 = 5.8986% \rightarrow \mathbf{5.90%}$.
2. Partner 2 (HCE): Compensation $250,000. Received $7,500 match, no after-tax. Total numerator = $7,500. $\text{ACR} = $7,500 / $250,000 = \mathbf{3.00%}$.
3. Manager 3 (HCE): Eligible to defer and eligible to receive match, but deferred $0 and contributed $0 after-tax. Total numerator = $0. $\text{ACR} = \mathbf{0.00%}$.
4. Associate 4 (NHCE): Compensation $90,000. Received $2,700 match and contributed $1,800 after-tax. Total numerator = $4,500. $\text{ACR} = $4,500 / $90,000 = \mathbf{5.00%}$.
5. Associates 5 & 6 (NHCEs): Deferred 6% of compensation, received full 3% match ($2,100 and $1,800). $\text{ACRs} = \mathbf{3.00%}$.
6. Associates 7 & 8 (NHCEs): Did not defer and made no after-tax contributions. Because they were eligible to participate, both are included in the ACP test with $\text{ACR} = \mathbf{0.00%}$.

Group ACP Computations:

HCE Group ACP (3 Eligible HCEs):

$\text{HCE ACP} = \frac{\text{ACR}_1 + \text{ACR}_2 + \text{ACR}_3}{3} = \frac{5.90\% + 3.00\% + 0.00\%}{3} = \frac{8.90\%}{3} = \mathbf{2.97\%}$

NHCE Group ACP (5 Eligible NHCEs):

$\text{NHCE ACP} = \frac{5.00\% + 3.00\% + 3.00\% + 0.00\% + 0.00\%}{5} = \frac{11.00\%}{5} = \mathbf{2.20\%}$

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Common ASPPA QKA Exam Traps

• Exam Trap 1: Excluding Non-Deferring Participants from the ACP Test: Candidates assume that because an employee did not make elective deferrals, they are not eligible for matching contributions and can be excluded from the ACP test. If the employee would have received a match had they deferred, they are an eligible employee for ACP with an ACR of 0.00%. Omitting them inflates the NHCE ACP.
• Exam Trap 2: Mixing Roth Deferrals into the ACP Test: Questions frequently list employee contributions labeled 'Designated Roth 401(k) Contributions' alongside 'Voluntary After-Tax Contributions'. Candidates erroneously place both into the ACP numerator. Roth contributions are elective deferrals tested exclusively in the ADP test! Only non-Roth voluntary after-tax contributions enter the ACP test.
• Exam Trap 3: Testing Safe Harbor Matching Contributions: A question describes a plan providing the basic safe harbor match (100% on first 3%, 50% on next 2%) and asks for the ACP test calculation. Safe harbor matching contributions under IRC §401(m)(11) and §401(m)(12) are completely exempt from ACP testing!
• Exam Trap 4: Overlooking Disproportionate Matching Limits: An employer provides a 300% match on the first 1% of pay to low-paid NHCEs. Candidates include the entire match in the ACP numerator. Matching contributions in excess of statutory disproportionate match limits (Treas. Reg. §1.401(m)-2(a)(6)(ii)) cannot enter the ACP test.
• Exam Trap 5: Confusing Forfeiture Offsets with Reallocations: Forfeitures used to reduce the employer's cash matching contribution do not create additional allocations for participants. Only forfeitures reallocated as additional matching contributions increase participant ACRs.