Table of Contents

Are Catch-Up Contributions Included in Actual Deferral Percentage Testing?

By

Updated December 18, 2023

Fact checked by

When it comes to tax-deferred retirement savings plans, like 401(k) plans, the Internal Revenue Service (IRS) carefully scrutinizes the contributions of highly compensated employees (HCEs) to ensure they do not benefit unfairly. To do so, it uses a method called actual deferral percentage 澳洲幸运5官方开奖结果体彩网:(ADP) testing. But catch-up contrib🔴utions by employees of a certain age are not included🙈 in the measure, because they can skew testing results.

Key Takeaways

Employer-sponsored retirement plans must meet certain stringent non-discrimination tests to retain their tax-qualified status.
One of the tests it must pass is the Actual Deferral Percentage (ADP) test, which seeks to prove that higher earners do not benefit more from the plan than the average wage earner.
The test stipulates that the average salary deferral made by high earners may only exceed the average contribution of regular employees by a certain percentage.
Only regular contributions are included in the testing, not catch-up contributions, because catch-up contributions are only available to those 50 and older.

What Is ADP Testing?

For an employer-sponsored retirement plan to retain its tax-qualified status, it must meet certain stringent non-discrimination tests to ensure wealthier employees are not benefiting more from the plan than the average wage earner. The IRS uses Actual Deferral Percentage (ADP) testing to verify that plan participation remains relatively equal for employees across all income levels.

Under the requirements of ADP testing, the average salary deferral made by HCEs may only exceed the average contribution of regular employees by a certain percentage. If HCEs are found to have exceeded the contribution limit required by ADP testing, the plan must return excess 澳洲幸运5官方开奖结果体彩网:contributions or risk losing its tax-qualified status.

Catch-Up Contributions

The IRS imposes strict 澳洲幸运5官方开奖结果体彩网:limitations on the amount that may be contributed to a qualified plan in any given year. For 2023, the maximum employee contribution for those under age 50 is $22,500, with a maximum total contribution limit (including employer participation) of $66,000. The maximum contribution increases to $23,000 for 2024, with a maximum total contribution limit of $69,000.

However, to encourage those nearing retirement to ramp up their savings, the IRS allows plan participants 50 and over to make annual 澳洲幸运5官方开奖结果体彩网:catch-up contributions that exceed these limits. For 2023, eligible employees may contribute an additional $7,500, increasing the total limit to $30,000 for employee contributions, and $73,500 overall. For 2024, the catch-up contributions are also $7,500, meaning the total limit for employee contributions is $30,500, and $76,500 overall.

Important

♓Be mindful not to contrib⭕ute over the allowed limit or you may incur penalties.

Why Are Catch-Up Contributions Excluded?

Catch-up contributions are excluded because not all employees are eligible to make them in any given year. Including them in ADP testing risks skewing the results.

If several non-highly compensated employees (NHCEs) over the age of 50 maximize their contribuꦗtions, fo♒r example, their aggressive participation increases the average contribution of all NHCEs, even if their peers are not yet eligible to make catch-up contributions.

Though this scenario may be good news for HCEs who would enjoy increased contribution limits, the opposite would be true if it were they were over age 50. If catch-up contributions made by HCEs were included in testing, the average HCE contribution might exce⛎ed the ADP limit more quickly🥃, requiring the plan to return contributions.

What Is a Catch-Up Contribution?

Catch-up contributions relate to retirement accounts. Most retirement accounts have a set limit for how much you can contribute to them annually. In 2024, for a 401(k), you can only contribute up to $23,000 annually. For an IRA, the amount is $7,000. Catch-up contributions, however, 澳洲幸运5官方开奖结果体彩网:allow you to cꩲontribute more than🍨 those amounts if you are 50 and over. In 2024, the catch-up amount allowed in a 401(k) is $7,500. For an IRA, it is $1,000. Catch-up contributions allow for those closer to retirement to contribute more so they can "catch up" with their retirement savings.

How Much Can You Contribute to a 401(k)?

In 2023, the amount you can contribute to a 401(k) is $22,500. This increases to $23,000 in 2024. If you are 50 and older, you can contribute an additional $7,500 in both years.

Is a 401(k) or IRA Better?

Generally, a 401(k) is better because it allows you to contribute more money to your retirement account every year. Additionally, many employers that offer 401(k)s also offer matching contributions, which is essentially free money. However, many people don't have access to 401(k)s. IRAs are available to everyone and are particularly helpful to those who don't have access to 401(k)s.

The Bottom Line

💙 The Actual Deferral Percentage (ADP) is used by the IRS to ensure that wealthier employe🦩es are not benefitting more than the average worker in order to grant an employer-sponsored plan tax-qualified status.

Article Sources

Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in our editorial policy.

Internal Revenue Service. "."
Internal Revenue Service. "." Page 1.
Internal Revenue Service. “.”
Internal Revenue Service. "."

Compare Accounts

The offers that appear in this table are from partnerships from which Investopedia receives compensation. This compensation may impact how and where listings appear. Investopedia does not include all offers available in the marketplace.

澳洲幸运5官方开奖结果体彩网