17.5 Switching Between Prior-Year and Current-Year Testing: Advantages, Limits & Anti-Abuse Rules

Two Ways to Draw the Comparison Line

The ADP and ACP tests compare an HCE average against an NHCE average. Which year's NHCE average is a plan election.

The Advantages of Each

Prior-Year Testing

1. Certainty before the year starts. In January 2027 the administrator already knows the 2026 NHCE ADP. If it was 4.10%, the HCEs' 2027 ceiling is 6.10%. The plan can cap HCE deferral elections proactively at 6.10% and never fail the test — no refunds, no excise tax exposure, no unpleasant conversation with the owner in March.
2. Predictable for owner tax planning. Owners can be told their maximum in advance rather than being refunded after they have filed.
3. Insulated from a bad current year. If NHCE participation collapses in 2027, the 2027 test still uses the healthier 2026 figure.

Current-Year Testing

1. Rewards improvement immediately. A plan that adds automatic enrollment and drives the NHCE ADP from 3.0% to 5.5% gets the benefit in that same year rather than waiting twelve months.
2. Required for certain corrections. A QNEC or QMAC contributed to fix a failure raises the NHCE percentage for the year it is allocated. Under prior-year testing, the QNEC affects the following year's test — so a plan wanting to fix the current year with a QNEC needs current-year testing.
3. Simpler for a plan with volatile demographics. Rapid growth or heavy turnover makes a stale prior-year figure a poor predictor.
4. Necessary for safe harbor plans to the limited extent testing applies.

The Switching Rules

Prior-Year → Current-Year: Freely Permitted

A plan may switch to current-year testing for any plan year. There is no waiting period. The change must be made by plan amendment before the end of the plan year to which it applies.

Current-Year → Prior-Year: Restricted

Under Treas. Reg. §1.401(k)-2(c)(1), a plan may switch from current-year to prior-year testing only if one of the following is true:

1. The plan used current-year testing for each of the five preceding plan years (or, if fewer, for all the years the plan has existed); or
2. The change results from a plan merger, acquisition, or similar transaction where the resulting plan adopts the method of one of the predecessor plans; or
3. The plan was using current-year testing because it was a safe harbor plan and is ceasing safe harbor status.

The five-year rule exists to stop annual method-shopping — picking whichever year's NHCE number happens to be higher. That anti-abuse purpose is the reason the restriction runs in only one direction.

The Double-Counting Rule

This is the trap that catches experienced administrators. When a plan switches from current-year to prior-year testing, the prior year's NHCE percentage must be recomputed to exclude any QNECs, QMACs, or shifted elective deferrals that were already counted in that prior year's current-year test.

Worked example. Kestrel Tooling used current-year testing for 2026 and failed, correcting with a QNEC of 1.20% allocated to NHCEs. Its 2026 NHCE ADP, including the QNEC, was 4.30%. For 2027 the plan (having satisfied the five-year requirement) switches to prior-year testing.

The 2027 test may not use 4.30%. The QNEC was already used to pass the 2026 test; counting it again in the 2027 prior-year figure would let one employer contribution pass two years of testing. The correct prior-year figure is 4.30% − 1.20% = 3.10%, and the 2027 maximum HCE ADP is 3.10% + 2.00% = 5.10% — not the 6.30% an administrator would compute by carrying the QNEC forward.

The same principle applies to shifted amounts: deferrals shifted into the ACP test in the prior year cannot also inflate the prior-year ADP figure used after a switch.

First Plan Year Rules

For a plan's first plan year, if prior-year testing is elected there is no preceding year to look at. IRS Notice 98-1 and Treas. Reg. §1.401(k)-2(c)(2) permit the plan to either:

• Deem the prior-year NHCE percentage to be 3%; or
• Use the actual first-year NHCE percentage (which is then the same figure a current-year test would use).

The choice must be stated in the document and is irrevocable for that year. The 3% deemed rule is generally favorable when NHCE participation is expected to be weak in year one — a very common situation in a startup plan.

Important limitation: the deemed-3% rule is unavailable to a successor plan — a plan that is a continuation of a prior plan of the same employer — because the predecessor supplies a real prior-year figure.

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Common ASPPA QKA Exam Traps

• Trap 1 — Believing switching is free in both directions. Moving to prior-year testing requires five preceding current-year years or a qualifying transaction.
• Trap 2 — Carrying a QNEC forward. The double-counting rule strips prior-year QNECs, QMACs and shifted amounts from the prior-year percentage on a switch.
• Trap 3 — Using the deemed 3% in a successor plan. Not available.
• Trap 4 — Using prior-year testing to fix the current year with a QNEC. Under prior-year testing a QNEC affects the following year's test.
• Trap 5 — Forgetting that aggregated plans must use the same method. Plans aggregated for coverage and testing must share the election.
• Trap 6 — Thinking prior-year testing prevents all failures. It only allows a proactive cap; if HCE elections are not actually limited, the plan still fails.