What is the benefit of using the prior year testing method?

The benefit of using the prior year testing method primarily lies in the predictability of the Average Deferral Percentage (ADP) and Average Contribution Percentage (ACP) results for non-highly compensated employees (NHCEs). By applying the prior year’s data, plan sponsors can more accurately forecast whether their plan will meet the nondiscrimination tests required under the Internal Revenue Code. This predictive capability enables employers to make informed decisions about their plan designs and employee communication strategies, reducing the risk of failing the tests and facing penalties or required corrective measures.

In using the prior year data, employers can conduct their testing based on stable historical contributions rather than on potentially volatile current year information, which might be influenced by changes in employee behavior or external economic factors. This stability can significantly simplify the compliance process, as it serves as a reliable benchmark when evaluating current year contributions against set thresholds.

While the other options may have their own merits, they do not specifically highlight the primary advantage of using the prior year method. For instance, increased employee contribution limits pertains to plan design rather than testing methodology, administrative cost reductions are more dependent on the overall plan structure and operation rather than the testing method, and stability in economic downturns addresses broader financial considerations rather than the mechanics of testing.