What happens if the 1.25% limit is exceeded?
Generally, the plan must return some salary deferrals to highly compensated participants. If the plan does not satisfy either the 1.25 ration test or the alternative test, the plan must either distribute excess deferrals to highly compensated participants sufficient to reduce the highly compensated ADP to an acceptable level or special contributions must be made by the employer on behalf of non-highly compensated participants sufficient to raise their ADP to an acceptable level. This type of contribution is called a QNEC, (Qualified Non-Elective Contribution). Either approach can be expensive or result in unfavorable tax impact on highly compensated employees.
