🇺🇸United States

Refunded HCE Contributions and Missed Executive Deferrals Reduce Retention Value of Plans

3 verified sources

Definition

When ADP/ACP tests fail, employers must refund elective deferrals and/or matching contributions to HCEs to bring their average percentage in line with NHCEs. These refunds lower HCEs’ effective annual deferral capacity and can discourage executive participation, reducing the perceived value of the plan as a key retention and compensation tool.

Key Findings

  • Financial Impact: Commonly 5–15% of total HCE contributions for failing plans are refunded each year, which for a mid‑size insurance or benefit fund plan can mean $50,000–$250,000 in lost tax‑deferred savings value to executives and reduced long‑term retention benefit.
  • Frequency: Annually in each year the plan fails ADP and/or ACP testing; roughly 30% of small‑business plans subject to ADP/ACP fail in a typical year.
  • Root Cause: Plan designs that favor high HCE deferral percentages without sufficient NHCE participation, combined with lack of proactive modeling of testing results and failure to adopt safe harbor designs. Many sponsors view testing as an after‑the‑fact compliance exercise rather than managing it as a strategic benefits design issue, so HCEs repeatedly bump into the refund ceiling.

Why This Matters

This pain point represents a significant opportunity for B2B solutions targeting Insurance and Employee Benefit Funds.

Affected Stakeholders

Highly Compensated Employees and executives in insurance carriers, brokers, and benefit funds, CFOs and CHROs responsible for total rewards strategy, Benefits committee members and trustees, Financial advisors serving the plan

Deep Analysis (Premium)

Financial Impact

$50,000–$250,000 in lost tax-deferred savings and reduced retention value per year • $50,000–$250,000 in refunded HCE contributions and lost tax-deferred savings • $50,000–$250,000 in refunded HCE contributions and lost tax-deferred savings annually

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Current Workarounds

Complex Excel models for HCE/NHCE projections and correction scenarios • Manual calculations and tracking of HCE vs NHCE contribution percentages in spreadsheets • Manual Excel aggregation from multiple contributing employers

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Methodology & Sources

Data collected via OSINT from regulatory filings, industry audits, and verified case studies.

Evidence Sources:

Related Business Risks

Recurring ADP/ACP Test Failures Trigger Corrective Contributions, Excise Tax, and Disqualification Risk

Unplanned corrective contributions often run into tens or hundreds of thousands of dollars per year for mid‑size plans, plus a 10% excise tax on late corrections and potentially multi‑million‑dollar liabilities if disqualification occurs (per IRS correction framework and industry practice).

High Recurring Administrative and Professional Fees to Fix ADP/ACP Errors

$5,000–$50,000+ per year in extra professional fees for mid‑size plans that repeatedly fail or have testing errors, depending on complexity and legal involvement.

Data and Setup Errors Cause Mis‑Testing and Costly Rework of ADP/ACP Results

Rework can add thousands to tens of thousands of dollars per year in additional administrative fees and staff time, and may trigger further corrective contributions or clawbacks that change cash flows.

Delayed ADP/ACP Testing and Corrections Extend Refund and Contribution Cycles

Primarily opportunity cost: HCEs lose months of tax‑deferred investment time on refunded amounts and employers delay deductible contributions to NHCEs; late corrections further risk 10% excise taxes.

Manual ADP/ACP Testing Consumes HR/Finance Capacity and Crowds Out Strategic Work

Commonly tens to hundreds of staff hours annually across HR, payroll, and finance, equating to $5,000–$25,000+ in internal labor cost per year for mid‑size organizations, not counting opportunity cost of delayed strategic initiatives.

Testing and Correction Complexity Creates Window for Abusive Contribution Patterns

Potentially significant but highly case‑specific: abusive patterns can shift tens or hundreds of thousands of dollars of annual contribution benefit toward favored HCEs while under‑funding NHCEs, creating fiduciary breach exposure and future restitution costs if detected.

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