Highly Compensated Employee: 401(k) Limits and Testing Rules

A highly compensated employee (HCE) in a 401(k) plan is someone the IRS treats as a top earner or owner, and the label matters because it can quietly cap how much you actually get to defer each year. Under Internal Revenue Code Section 414(q), you’re an HCE for a given plan year if you earned more than $160,000 from the employer in the prior year, or if you owned more than 5% of the company at any point during the current or prior year.¹ You still get a tax-advantaged account. What changes is that your plan has to pass annual tests proving it doesn’t tilt toward high earners, and those tests can force refunds of contributions you thought were locked in.

Who Counts as a Highly Compensated Employee

The IRS uses two independent tests. Meeting either one makes you an HCE.

The Compensation Test

You’re an HCE for 2026 if you earned more than $160,000 from the employer during 2025.² The same $160,000 threshold applied for the 2025 plan year, measured against 2024 earnings.³ Because the test always looks backward, you don’t know your status for a given year until the prior year has closed.

Compensation here follows the broad definition in Section 415(c)(3). That means regular wages plus elective deferrals to a 401(k), 403(b), or similar plan, and amounts excluded through a cafeteria plan or qualified transportation benefit.⁴ Contributing more to your 401(k) will not push your compensation figure back under the threshold.

An employer can also add a top-paid group election to the plan document. When that election is in place, you’re only an HCE under the compensation test if you cleared $160,000 and ranked in the top 20% of employees by pay during the look-back year.¹ Someone earning $165,000 at a company with many people clustered above that line can end up outside the HCE group entirely.

The Ownership Test

Own more than 5% of the employer at any time during the current or prior plan year and you’re an HCE regardless of what you earn.⁵ The top-paid group election doesn’t relax this test. A part-time owner making $40,000 who holds 6% of the business is still an HCE.

Ownership also passes through the family. Under IRC Section 318, you’re treated as owning stock held by your spouse, children, grandchildren, and parents; legally adopted children count the same as biological children, and a spouse legally separated by court decree is excluded.⁶ If your parent owns 8% of the company and you work there, the IRS treats you as owning that 8%. You’re an HCE even without a paycheck near the compensation threshold.

How HCE Status Limits Your 401(k) Contributions

The label exists because of nondiscrimination testing. Every traditional 401(k) has to run two tests each year to confirm HCEs aren’t benefiting out of proportion to everyone else, called non-highly compensated employees, or NHCEs.

The ADP test (Actual Deferral Percentage) compares the average salary deferral rate of HCEs against NHCEs. Pre-tax and Roth deferrals both count; catch-up contributions do not.⁷
The ACP test (Actual Contribution Percentage) does the same for employer matching contributions and any after-tax employee contributions.

To pass the ADP test, the HCE average deferral rate cannot exceed the greater of two limits: 125% of the NHCE average, or the NHCE average plus 2 percentage points capped at double the NHCE rate.⁸ The ACP test uses the same two-prong formula.

The doubling cap is where the squeeze happens. If NHCEs average 6%, HCEs can go up to 8%, well under the double. If NHCEs average only 1%, the doubling cap holds HCEs to 2% rather than the 3% the additive rule would suggest. The less rank-and-file employees contribute, the tighter the ceiling on your deferrals.

What Happens If the Plan Fails Testing

A failed ADP or ACP test doesn’t disqualify the plan on its own, but the employer has to correct it. The most common fix is refunding excess contributions to HCEs. You may find that money you deferred throughout the year comes back to you as a check the following spring.

The plan has 2½ months after the plan year ends to distribute the excess without a penalty. For calendar-year plans that’s roughly March 15. Plans with an eligible automatic contribution arrangement get 6 months.⁹ Miss that window and the employer owes a 10% excise tax on the excess.⁷

For you as the HCE, the refunded amount and any earnings on it are taxable in the year of the distribution, not the year of the original deferral.⁷ The deferral you were counting on to reduce taxable income essentially unwinds, and you owe tax on the money now.

When HCE Status Doesn’t Restrict You: Safe Harbor Plans

The straightforward way around all this is a safe harbor 401(k). Safe harbor plans are exempt from ADP and ACP testing in exchange for guaranteed employer contributions to eligible employees. If your employer runs one, your HCE status essentially doesn’t matter for how much you can defer.

To qualify, the employer must make one of these contributions for eligible non-highly compensated employees:¹⁰

A nonelective contribution of at least 3% of each eligible employee’s compensation, whether or not they defer.
A basic match: 100% of the first 3% deferred, plus 50% of the next 2%.
An enhanced match at least as generous as the basic match at every deferral rate, commonly 100% on the first 4% deferred.

Safe harbor contributions vest immediately. If you’re not sure whether your plan is safe harbor, ask your plan administrator. In a safe harbor plan you can generally contribute up to the full IRS deferral limit without watching for a corrective refund in the spring.

2026 Contribution Limits and Catch-Ups

The standard 401(k) elective deferral limit for 2026 is $24,500, and it applies to everyone.¹¹ In a plan that isn’t safe harbor, ADP results can bring your effective HCE limit well below that figure, depending on what NHCEs put in.

Catch-ups help. Participants age 50 and older can add $8,000 in 2026, and catch-up contributions are excluded from the ADP test.³ Even if testing squeezes your regular deferrals, the catch-up stays available on top.

SECURE 2.0 added a higher catch-up limit for participants who turn 60, 61, 62, or 63 during the plan year. For 2026 that enhanced amount is $11,250 rather than $8,000.¹¹ An HCE in that age band could defer up to $35,750 if the plan’s testing allows the full regular deferral.

The Roth Catch-Up Rule Coming in 2027

Section 603 of SECURE 2.0 will require higher earners to make catch-up contributions on a Roth basis rather than pre-tax. The rule applies to employees whose prior-year FICA wages from the employer exceeded $145,000, indexed for inflation. The IRS finalized regulations with an effective date for taxable years beginning after December 31, 2026, which means the rule first bites on 2027 catch-ups.¹²

The $145,000 threshold sits close to the HCE compensation line, so most HCEs age 50 and up will feel this. The catch-up money still lands in your 401(k) and still grows tax-free, but you lose the upfront deduction on those dollars. And if your plan doesn’t offer a Roth 401(k) option by 2027, employees over the wage threshold won’t be permitted to make catch-up contributions at all until the plan adds one.

For 2026, pre-tax catch-ups remain open to everyone. If you’ve been leaning on them to trim taxable income, it’s worth thinking now about how the switch will land on your 2027 return.

1
Office of the Law Revision Counsel. 26 USC 414 – Definitions and Special Rules
2
Internal Revenue Service. COLA Increases for Dollar Limitations on Benefits and Contributions
3
Internal Revenue Service. IRS Notice 2025-67 – 2026 Amounts Relating to Retirement Plans and IRAs
4
Office of the Law Revision Counsel. 26 USC 415 – Limitations on Benefits and Contribution Under Qualified Plans
5
Internal Revenue Service. Identifying Highly Compensated Employees in an Initial or Short Plan Year
6
Office of the Law Revision Counsel. 26 USC 318 – Constructive Ownership of Stock
7
Internal Revenue Service. 401(k) Plan Fix-It Guide – The Plan Failed the 401(k) ADP and ACP Nondiscrimination Tests
8
eCFR. 26 CFR 1.401(k)-2 – ADP Test
9
Office of the Law Revision Counsel. 26 USC 4979 – Tax on Certain Excess Contributions
10
eCFR. 26 CFR 1.401(k)-3 – Safe Harbor Requirements
11
Internal Revenue Service. 401(k) Limit Increases to $24,500 for 2026, IRA Limit Increases to $7,500
12
Internal Revenue Service. Treasury, IRS Issue Final Regulations on New Roth Catch-Up Rule, Other SECURE 2.0 Act Provisions