HCE Compensation—Which Year?

The compensation test for determining HCEs for a year is based on the lookback year. Therefore, if a person had compensation greater than $160,000 in 2025, they would be an HCE for 2026.

Welcome to the Retirement Learning Center’s (RLC’s) Case of the Week. Our ERISA consultants regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, Social Security and Medicare. This is where we highlight the most relevant topics affecting your business. A recent call with a financial advisor in Minnesota is representative of a common question on highly compensated employees.

“Is the 2025 cost of living adjustment (COLA) to the highly compensated employee (HCE) compensation amount used for actual deferral percentage (ADP) testing in the 2025 testing year or the 2026 testing year?”

Highlights of the discussion

For calendar year plans, the amount the IRS posts for the 2025 HCE dollar threshold is used for testing in the 2026 determination, or testing, year. For 2026 testing, if a person had compensation greater than $160,000 in 2025, they would be considered an HCE. See the chart below.

Employer Plan Limits Source: Notice 2024-80

2025

2024

Elective Deferral Limit (401(k), 403(b), 457(b) and SARSEP)

$23,500

$23,000

Age 50 Catch-Up Contribution Limit

$7,500

$7,500

Ages 60-63 Catch-Up Limit

$11,250

N/A

Annual Defined Benefit Limit

$280,000

$275,000

Annual Defined Contribution Limit

$70,000

$69,000

Annual Compensation Limit

$350,000

$345,000

Highly Compensated Employee Dollar Threshold

$160,000

$155,000

SIMPLE Standard Contribution Limit

$16,500

$16,000

SIMPLE Small Employer Special Contribution Limit

$17,600 (1)

$17,600

SIMPLE Standard Age-50 Catch-Up Contribution Limit

$3,500

$3,500

SIMPLE Small Employer Special Age-50 Catch-Up Contribution Limit

$3,850 (2)

$3,850

SIMPLE Age 60-63 Catch-Up Contribution Limit

$5,250

N/A

SEP Coverage Minimum Comp.

$750

$750

SEP Compensation Limit

$350,000

$345,000

Top-Heavy Key Employee Comp.

$230,000

$220,000

Social Security Taxable Wage Base

$176,100

$168,600

ESOP maximum amount subject to a 5-year distribution period

$1,415,000

$1,380,000

ESOP maximum amount for lengthening of the 5-year period

$280,000

$275,000

As background, the determination of which participants are HCEs is necessary for several nondiscrimination tests, including the ADP test. There are two basic tests to determine whether a person is an HCE:

  1. The ownership test and

  2. The compensation test.

An employee is an HCE if he or she satisfies either of the two tests. Additionally, an employer can elect to limit the number of HCEs by defining employees as HCEs if they are among the top-paid 20 percent of all employees when ranked by compensation.

The ownership test is based on whether a person is a more than five percent owner at any time during the current plan year (also known as the determination, or testing year) or the 12-month period immediately preceding the determination year (also known as the lookback year) [See IRC §414(q)(2)].

The compensation test, which is based strictly on compensation, is always determined based on the lookback year [See IRC § 414(q)(4)].

Conclusion

When focusing on the compensation test for determining HCEs, compensation is always determined based on the lookback year. Therefore, if a person had compensation greater than $160,000 in 2025, they would be an HCE for 2026. If they had compensation greater than $155,000 for 2024, they would be an HCE for 2025.

(1) For SIMPLE plans with 25 or fewer employees and SIMPLE plans with 26-100 participants if 4% match or 3% nonelective employer contribution provided

(2) For SIMPLE plans with 25 or fewer employees and SIMPLE plans with 26-100 participants if 4% match or 3% nonelective employer contribution provided

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