What Is a Highly Compensated Employee (HCE)?

An HCE is not simply an employee with a large paycheck.

Federal retirement-plan law uses two separate tests:

1. ownership
2. prior-year compensation

Meeting either test can make an employee a highly compensated employee, or HCE, for retirement-plan purposes.^[3][4]

That creates results that often surprise people.

A 6% owner earning $55,000 can be an HCE.

A newly hired executive earning $300,000 in 2026 can fail the ordinary compensation test for 2026 because that test generally looks backward to compensation from the employer in 2025.

The classification is technical because it has a technical job: separating HCEs from nonhighly compensated employees, or NHCEs, for nondiscrimination testing.

Key Takeaways

• HCE status generally arises under either:
• the more-than-5% ownership test
• the prior-year compensation test.^[3][4]
• Ownership can make an employee an HCE regardless of compensation.^[3]
• The ownership test generally looks at the current year and preceding year.^[3]
• For a calendar-year 2026 plan, the compensation test generally starts with 2025 compensation.
• The HCE threshold was $160,000 for 2025 and remains $160,000 for 2026.^[1][2]
• The statute uses compensation in excess of the threshold. At a $160,000 threshold, $160,000 and $160,001 are not equivalent.
• An employer can elect a top-paid group limitation so the compensation test generally reaches only employees in the highest-paid 20% group, subject to the applicable rules and plan terms.^[3]
• Compensation for HCE classification uses the applicable Section 415 compensation framework, which can differ from compensation used to calculate a match or other plan contribution.^[3]
• Family attribution can make certain relatives of owners HCEs even when the relative owns no stock directly.^[4]
• HCE status is not the same as key employee status used for top-heavy testing.
• HCE status does not create a separate federal elective-deferral ceiling. A plan may still have to limit or refund HCE deferrals to pass nondiscrimination testing.^[4][6]
• HCE status is also different from the 2026 mandatory Roth catch-up wage test, which uses a separate $150,000 prior-year FICA-wage threshold.^[7][8]

The Two Tests

The cleanest HCE analysis is:

Ownership test OR compensation test

An employee does not have to satisfy both.

That matters because many employers begin with payroll.

Payroll is enough for the compensation test.

It is not enough for the ownership test.

Test 1: More Than 5% Ownership

An employee is generally an HCE if the employee was a more-than-5% owner at any time during:^[3]

• the current year, or
• the preceding year.

Compensation does not rescue the employee from this rule.

An owner can draw a modest salary and still be an HCE.

More Than 5% Means More Than 5%

This wording deserves precision.

5.00% ownership

Does not satisfy a rule requiring ownership of more than 5% on direct percentage alone.

5.01% ownership

Can satisfy the ownership threshold.

Ownership attribution can change the calculation, so direct ownership percentage is not always the final number.

Still, the basic statutory line is more than 5%, not 5% or more.

Example: Low Salary, 6% Owner

Employee owns:

6%

Annual compensation:

$55,000

The employee can be an HCE under the ownership test.

The $160,000 compensation threshold is irrelevant because the employee already satisfies the other route.

This is why a census containing salary but no ownership field is incomplete for HCE classification.

Ownership Can Matter in Either Year

Assume an employee owned:

8% in 2025

The employee sold the interest on:

December 31, 2025

Ownership during 2026:

0%

The 2025 ownership can still cause HCE status for 2026 because the ownership test looks at the current and preceding year.^[3]

Selling stock does not necessarily remove HCE status immediately.

Family Attribution

Direct ownership is not the only ownership that can matter.

Federal attribution rules can treat certain family ownership as belonging to another individual for retirement-plan testing.^[4]

IRS specifically warns plan administrators to identify owners' relatives because family members can have different last names and still be affected.^[4]

The practical lesson:

Do not build the HCE list from a shareholder spreadsheet alone.

The ownership analysis can require family relationships.

Example: Owner's Spouse

Founder owns:

100% of company

Founder's spouse:

• owns no shares directly
• earns $70,000
• works for company

Applicable family-attribution rules can cause the spouse to be treated as an owner for HCE analysis.^[4]

The spouse's modest compensation does not prevent HCE classification.

That can materially change the ADP or ACP testing population.

Ownership Information Must Reach the TPA

A TPA can calculate ownership attribution only from facts it has.

The employer should disclose:

• direct ownership
• indirect ownership
• spouses
• relevant family relationships
• ownership changes
• acquisitions
• related entities

INV-083 explains why a technically perfect test can still be wrong when the employer supplied an incomplete census.

Test 2: Prior-Year Compensation

The second route is compensation.

An employee can generally be an HCE for the current plan year if the employee received compensation from the employer in the preceding year above the indexed HCE threshold.^[3][5]

That timing rule is the source of many mistakes.

The threshold published for a year is generally used as a lookback threshold when that year's compensation becomes the preceding-year compensation for the next determination year.

2026 Calendar-Year Example

For a calendar-year plan determining HCE status for:

2026

look first to compensation paid in:

2025

The HCE threshold for 2025 was:

$160,000.^[1]

So an employee who received more than $160,000 in applicable 2025 compensation can satisfy the compensation component for 2026, subject to the plan's top-paid group election if one applies.

The separately published 2026 HCE threshold is also $160,000.^[1][2]

Because the number did not change, the lookback issue is easy to miss this year.

The rule still matters.

The Threshold Is "More Than"

Assume no top-paid group election.

2025 compensation:

Employee A

$160,000

Employee B

$160,001

With a $160,000 threshold, Employee B exceeds the threshold.

Employee A does not exceed it on compensation alone.

That one-dollar distinction rarely changes an executive's economics.

It can change the technical classification.

The Threshold Is Not a Salary Cap

Calling $160,000 the "HCE limit" can create the wrong impression.

It is not:

• maximum salary
• maximum plan compensation
• 401(k) contribution limit
• tax deduction limit

It is an indexed threshold used in the HCE definition.

Other retirement-plan limits use different numbers.

For 2026, for example, the annual compensation limitation for many qualified-plan purposes is:

$360,000.^[1][2]

That is a different rule.

Compensation Has Its Own Definition

An employee's payroll "salary" is not automatically the HCE compensation amount.

IRS states that HCE compensation is based on the applicable Section 415(c)(3) compensation framework.^[3]

That can differ from a plan's contribution compensation definition.

A plan might exclude bonuses when calculating a match.

That does not automatically mean bonuses are ignored when determining HCE status.

This is a recurring source of bad classification.

Example: Match Compensation vs. HCE Compensation

Plan document says:

Bonuses excluded from match compensation

Employee receives in 2025:

• salary: $150,000
• bonus: $25,000

Match compensation might be:

$150,000

HCE compensation can be determined under a different required framework.

A payroll extract that sends only "match compensation" to the TPA can therefore be insufficient for HCE analysis.

Same employee.

Two compensation questions.

The Top-Paid Group Election

The compensation test has an optional refinement.

If the employer has made the permitted election, an employee who exceeds the compensation threshold generally also must be in the:

top-paid 20% group

for the applicable lookback year to be classified as an HCE under the compensation route.^[3]

This can materially shrink the HCE population at employers with many well-paid employees.

The Election Is Not Automatic

Suppose 30 employees earned more than $160,000 in the lookback year.

Without the top-paid group election, the compensation test can classify all 30 as HCEs.

With a valid top-paid group election, only employees who also fall in the applicable top-paid group are reached through that route.^[3]

The employer cannot decide after seeing an unfavorable ADP result:

"Let's use the top 20% this year instead."

The election has plan-document and consistency rules.

IRS says election changes should be evidenced in the written plan documentation.^[3]

Once Elected, Consistency Matters

IRS guidance states that the top-paid group election generally continues for subsequent years until revoked.^[3]

That prevents opportunistic classification.

A sponsor should know whether its plan uses the election before the annual census is tested.

The answer should not live only in the TPA's software settings.

Example: High Earner Outside the Top Group

Assume:

• employee earned $205,000 in 2025
• employer uses a valid top-paid group election
• employee falls outside the applicable top-paid 20% group
• employee is not a more-than-5% owner

The employee can avoid HCE classification under the compensation route because the top-paid group condition is not satisfied.

High salary alone does not always decide the result.

New Hires Produce a Counterintuitive Result

Assume an employee joins the company on:

January 2, 2026

2026 salary:

$300,000

2025 compensation from this employer:

$0

The ordinary compensation test for the 2026 determination year generally looks to the preceding year.

That employee may therefore be an NHCE for 2026 under the compensation test, assuming the ownership test does not apply.

The result feels wrong only if HCE is mistaken for a description of current salary.

It is a statutory classification with a lookback structure.

Ownership Can Override the New-Hire Result

Change one fact.

The new employee also acquires:

10% ownership

during 2026.

Now the ownership test can make the employee an HCE despite having no prior-year compensation from the employer.^[3]

This is why the two tests should always be run separately.

Initial and Short Plan Years Need Separate Analysis

New plans and short plan years can create timing questions because the ordinary lookback structure may not fit neatly.

IRS has specific guidance for identifying HCEs in:

• initial plan years
• short plan years
• certain employer-history situations.^[3]

Do not force a normal calendar-year example onto those cases.

For a new business or plan-year change, use the special timing rules.

HCE Does Not Mean Key Employee

INV-083 introduced this distinction because it affects which test uses which population.

HCE

Used prominently in:

• ADP testing
• ACP testing
• other nondiscrimination rules

Key employee

Used for:

top-heavy testing

The definitions overlap.

They are not interchangeable.

2026 Key-Employee Threshold Is Different

For 2026, the indexed compensation threshold for the officer component of the key-employee definition is:

$235,000.^[1][2]

The HCE compensation threshold is:

$160,000.^[1][2]

Key-employee status also includes ownership tests different from the HCE definition.

An employee can be:

• HCE and key
• HCE but non-key
• NHCE but key in some ownership-driven situations
• neither

Use the correct definition for the test being run.

HCE Status Does Not Reduce the Federal Deferral Limit

A common employee reaction is:

"I became an HCE, so my 401(k) contribution limit dropped."

Not exactly.

For 2026, the general employee elective-deferral limit for a traditional 401(k) is:

$24,500.^[6]

HCE status does not create a separate lower Section 402(g) ceiling.

The practical restriction can arise from the plan's nondiscrimination testing.

How HCE Status Affects ADP Testing

The ADP test compares elective-deferral behavior between:^[4]

• HCEs
• NHCEs

At a simplified level, the plan calculates each eligible participant's deferral percentage and averages the percentages by group.

If HCE deferrals are too high relative to NHCE deferrals, the plan can fail the test.^[4]

The problem is not that an HCE violated the $24,500 federal deferral limit.

The plan failed a group nondiscrimination test.

Example: HCE Contributes Within Federal Limit but Gets Refund

HCE contributes:

$24,500

The amount is within the 2026 elective-deferral ceiling.

Plan fails ADP test.

A corrective distribution of excess contributions may be required under the applicable correction method.^[4]

The employee can therefore receive money back despite never exceeding the individual federal deferral limit.

That distinction explains many "Why did my 401(k) refund me?" questions.

ACP Testing Uses the Same Classification for Different Money

The ACP test focuses on specified:

• employer matching contributions
• employee after-tax contributions

rather than ordinary elective deferrals.^[4]

It still depends on correct HCE classification.

One wrong owner or family attribution can affect both ADP and ACP testing.

Safe Harbor Changes the Testing Consequence

A properly designed and operated safe harbor 401(k) can avoid the regular ADP test and, when applicable requirements are met, the ACP test.^[4]

That is one reason safe harbor design is attractive to employers with:

• owners
• executives
• low NHCE participation

Safe harbor does not erase HCE status.

The employee can still be an HCE for other retirement-plan rules.

It changes which nondiscrimination testing burden applies.

INV-053 covers the safe harbor structure.

HCE Is Not the Roth Catch-Up Wage Test

This distinction became more important in 2026.

Beginning in 2026, certain participants with prior-year wages above:

$150,000

must make catch-up contributions on a Roth basis when the applicable plan and statutory rules apply.^[7][8]

That is not the HCE test.

The Two 2026 Thresholds

The underlying compensation concepts also differ.

The Roth catch-up rule uses specified prior-year FICA wages from the sponsoring employer under its own framework.^[7][8]

Do not reuse the HCE list as the Roth catch-up list.

Example: HCE but Not Subject to Roth Catch-Up Rule

Employee is a 10% owner.

2025 applicable wages:

$90,000

The ownership test can make the employee an HCE for 2026.

But the employee's prior-year wages are below the separate $150,000 Roth catch-up threshold.

HCE status alone does not trigger the Roth catch-up rule.

Example: Roth Catch-Up Threshold but HCE Analysis Still Separate

Employee has prior-year applicable wages:

$155,000

That can exceed the 2026 Roth catch-up wage threshold.

But the HCE compensation threshold used for the relevant lookback may be $160,000.

Assuming no ownership and the other HCE conditions are not met, the two classifications can diverge.

Same employee.

Different statute.

Different question.

HCE Classification Should Be Rebuilt Each Year

Do not copy last year's HCE list into this year's test.

Review:

• prior-year compensation
• current and prior-year ownership
• family attribution
• top-paid group election
• employee population
• related employers
• acquisitions and ownership changes

An owner can sell stock.

A new owner can appear.

Compensation changes.

Family relationships can become relevant.

The HCE population is an annual determination.

The Census Needs More Than Payroll Data

A reliable HCE review needs fields payroll often cannot provide.

If the annual census asks only for name, salary and deferral amount, the compliance process is missing material facts.

Example: Different Last Name, Same Ownership Problem

Owner's adult child works for the company after marriage and uses a different last name.

The TPA sees:

• compensation: $80,000
• direct ownership: 0%

Without the family relationship, the employee may appear to be an NHCE.

IRS explicitly warns that relatives can be missed because surnames differ.^[4]

A good census asks the question directly.

Controlled Groups Can Complicate Compensation

Related employers can change:

• which employees belong in testing
• whose compensation is considered
• ownership analysis
• coverage results

An HCE determination should not be isolated from the employer-group analysis.

If the owner controls several entities, send the ownership chart to the TPA.

Do not assume separate payroll accounts mean separate retirement-plan employers.

The Plan Document Still Matters

IRS tells administrators to review the plan document for:^[4]

• HCE definition
• compensation definition
• top-paid group election
• ADP method
• ACP method

Federal law supplies the framework.

The document records elections the employer was permitted to make.

An HCE report inconsistent with the signed plan terms can be wrong even when the software followed its default settings.

What Participants Should Ask When Classified as an HCE

A participant does not need the full testing workbook to ask useful questions.

Which test made me an HCE?

• ownership?
• compensation?
• family attribution?

Which compensation year was used?

For a 2026 calendar-year determination, normally look to 2025 for the compensation test.

Does the plan use the top-paid group election?

This can change compensation-based classification.

Is the issue HCE status or failed ADP/ACP testing?

Those are separate questions.

Is a contribution restriction temporary or permanent?

A plan can impose operational controls to avoid future correction problems.

The reason should be identifiable.

HCE Status Can Be Correct and Still Feel Arbitrary

A 6% owner earning $50,000 can be an HCE.

A new vice president earning $250,000 can initially be an NHCE under the ordinary compensation lookback rule.

That is not evidence the rules are malfunctioning.

The HCE definition is not trying to rank social status or financial sophistication.

It identifies employee groups for tax-qualified plan testing.

Once that purpose is clear, the odd-looking cases become easier to understand.

Frequently Asked Questions

What is a highly compensated employee for a 401(k)?

An employee generally qualifies as an HCE by satisfying either the more-than-5% ownership test or the prior-year compensation test under IRC Section 414(q).^[3][4]

What is the HCE threshold for 2026?

The indexed HCE compensation threshold is $160,000 for 2026.^[1][2] For a 2026 calendar-year HCE determination, the compensation test generally looks at 2025 compensation, and the 2025 threshold was also $160,000.

Is someone earning exactly $160,000 an HCE?

Not under the compensation threshold alone when the applicable threshold is $160,000, because the statutory test uses compensation in excess of the threshold. Ownership or other applicable rules can still produce HCE status.

Does a 5% owner automatically count as an HCE?

The ownership test uses more than 5% ownership. Exactly 5% is not more than 5%, though attribution can change the ownership calculation.^[3]

Does an owner need to earn $160,000 to be an HCE?

No. A more-than-5% owner can qualify regardless of compensation.^[3]

Can an owner's spouse be an HCE?

Yes. Applicable family-attribution rules can cause certain relatives to be treated as owners even when they own no shares directly.^[4]

Is a highly paid new employee automatically an HCE?

Not necessarily. The ordinary compensation test generally uses compensation from the preceding year. A new employee can have no prior-year compensation from that employer and therefore fail that route, unless another rule such as ownership applies.^[3]

What is the top-paid group election?

It is an employer election that can limit compensation-based HCE classification to employees in the applicable top-paid 20% group, subject to the governing rules and plan documentation.^[3]

Is an HCE the same as a key employee?

No. HCE status is used in rules such as ADP/ACP testing. Key-employee status is used for top-heavy testing and has a different definition.

Does an HCE have a lower 401(k) contribution limit?

HCE status does not create a lower federal Section 402(g) deferral limit. A plan may restrict or refund HCE contributions if needed to satisfy nondiscrimination rules.^[4][6]

Does a safe harbor 401(k) eliminate HCE status?

No. Safe harbor design can remove certain ADP/ACP testing requirements when properly implemented. It does not erase the HCE classification.

Is the HCE threshold the same as the Roth catch-up wage threshold?

No. For 2026, the HCE threshold is $160,000, while the separate Roth catch-up rule uses a $150,000 prior-year wage threshold under its own rules.^[1][7][8]

The Classification Check That Matters

When an employee is labeled HCE, do not ask only:

"How much does this person earn?"

Ask in this order:

1. Did the employee own more than 5% during the current or preceding year?
2. Do family-attribution rules change that ownership result?
3. What was the employee's applicable compensation in the preceding year?
4. What threshold applied to that lookback year?
5. Does the plan use the top-paid group election?
6. Which employer entities and compensation were included?

That sequence catches the two biggest classification errors:

missing owners and using the wrong year's pay.

Sources & References

1. IRS: COLA Increases for Dollar Limitations on Benefits and Contributions
2. IRS: Notice 2025-67 — 2026 Cost-of-Living Adjustments
3. IRS: Identifying Highly Compensated Employees in an Initial or Short Plan Year
4. IRS: 401(k) Plan Fix-It Guide — Failed ADP and ACP Nondiscrimination Tests
5. IRS: Retirement Plans Definitions
6. IRS: Retirement Topics — 401(k) and Profit-Sharing Plan Contribution Limits
7. IRS: Retirement Topics — Catch-Up Contributions
8. IRS: Treasury and IRS Final Regulations on Roth Catch-Up Contributions

Educational Disclaimer

ROIStreet publishes educational content about retirement-plan classifications and compliance. This article is not legal, tax, fiduciary or plan-administration advice. HCE status depends on ownership, attribution, compensation, plan elections, employer structure and the rules applicable to the plan year being tested.

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