Does the election of the prior year testing method affect the HCE data used in ADP/ACP tests?

The election of the prior year testing method does not impact the Highly Compensated Employee (HCE) data used in the Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests. Under the prior year testing method, a plan uses HCE data based on the prior year’s compensation to evaluate the current year’s compliance with the ADP and ACP tests. This approach maintains consistency in testing, allowing employers to better predict contributions and plan for compliance.

The primary focus of the ADP and ACP tests is to ensure that the contributions made by HCEs do not disproportionately exceed those made by non-highly compensated employees (NHCEs). Since the testing looks back to the previous year for HCE status, the current year's election of testing method remains unaffected.

In contrast, the other options suggest varying implications for the HCE data based on the testing method, plan status, or employer preferences, but the established rules dictate that using the prior year’s HCE data effectively removes those considerations in relation to the election of the testing method.

Therefore, understanding that the prior year testing method relies solely on historical HCE data is crucial for mastering the compliance requirements within 401(k) plans.