If you own more than 5% of your employer or earned more than $160,000 from that employer in the prior year, you’re a highly compensated employee, and the 401(k) rules that apply to highly compensated employees don’t lower your contribution limit directly. They do something less obvious: they tie your maximum deferral to how much your lower-paid coworkers save, and if the plan fails its annual tests, money comes back out of your account.1Internal Revenue Service. COLA Increases for Dollar Limitations on Benefits and Contributions
The $160,000 figure applies to both the 2025 and 2026 plan years. Anyone who earned more than $160,000 in 2025 is classified as an HCE for 2026.
Who Counts as a Highly Compensated Employee
IRC Section 414(q) sets two independent paths to HCE status. Meeting either one is enough.2Office of the Law Revision Counsel. 26 USC 414 – Definitions and Special Rules
The ownership test looks at whether you owned more than 5% of the business at any point during the current or prior year. For corporations, that means more than 5% of outstanding stock or combined voting power. For partnerships and LLCs, it’s more than 5% of capital or profits interest. Salary is irrelevant here: an entry-level worker holding 6% of the company’s stock is an HCE.
The compensation test uses a look-back. Earn more than the IRS dollar threshold from your employer in the prior year and you’re an HCE for the current plan year. For 2026, the threshold is $160,000, up from $155,000 for 2024 and $150,000 for 2023.1Internal Revenue Service. COLA Increases for Dollar Limitations on Benefits and Contributions The look-back approach gives administrators time to classify everyone before the plan year begins.
Family Attribution
The 5% ownership rule reaches beyond your own name on the shareholder list. Under IRC Section 318, stock owned by your spouse, children, grandchildren, and parents is treated as yours.3Office of the Law Revision Counsel. 26 USC 318 – Constructive Ownership of Stock If your spouse owns 4% and you own 2%, you’re a 6% owner in the eyes of the IRS. A legally separated spouse under a divorce or separate maintenance decree is excluded from this attribution. This rule catches family businesses off guard: a relative who never appears on the cap table can still be swept into HCE status through attributed ownership.
The Top-Paid Group Election
Employers can shrink the compensation-test pool with a top-paid group election, limiting HCEs to employees who both exceeded $160,000 and ranked in the top 20% of the workforce by pay.4Internal Revenue Service. Identifying Highly Compensated Employees in an Initial or Short Plan Year At larger companies, this can substantially narrow the HCE group. Certain workers can be excluded when calculating the top 20%: those under age 21, those with less than six months of service, part-timers who normally work fewer than 17½ hours per week or fewer than six months per year, collectively bargained employees (with some restrictions), and nonresident aliens with no U.S.-source income.
Two boundaries matter. The election only affects the compensation test; anyone meeting the 5% ownership test remains an HCE regardless of pay rank. And the election must be written into the plan document to hold up on audit.
What HCE Status Actually Does to Your Contributions
Your statutory deferral limit is the same as everyone else’s: $24,500 for 2026.5Internal Revenue Service. 401(k) Limit Increases to $24,500 for 2026; IRA Limit Increases to $7,500 What changes is that your plan must pass two annual nondiscrimination tests, and if it fails, your deferrals get trimmed.
The ADP and ACP Tests
The Actual Deferral Percentage (ADP) test compares the average salary deferral rate of HCEs against that of non-highly compensated employees. The Actual Contribution Percentage (ACP) test does the same for employer matching and after-tax contributions.6Internal Revenue Service. 401(k) Plan Fix-It Guide – The Plan Failed the 401(k) ADP and ACP Nondiscrimination Tests
The HCE average passes if it doesn’t exceed the greater of:
- 125% of the NHCE average, or
- The lesser of: 200% of the NHCE average, or the NHCE average plus 2 percentage points.
Both tests use the same formula. In practice, when rank-and-file participation is low, HCEs get squeezed. If NHCEs defer an average of 2%, the formula caps HCEs at roughly 4%. If NHCEs average 6%, HCEs can go up to 8%. A plan design change that lifts NHCE participation, such as automatic enrollment, can meaningfully increase the room HCEs have to defer.
What Happens When the Plan Fails
The most common fix is a corrective distribution: the plan refunds the excess amounts HCEs contributed above what the test allows, along with any earnings on those amounts. The refund is taxable income in the year received and is reported on Form 1099-R.7Internal Revenue Service. Instructions for Forms 1099-R and 5498 For an HCE who thought they had maxed out, the practical result is a lost year of tax deferral and lost compounding on those dollars. Corrective distributions generally must be completed within 2½ months after the plan year closes to avoid a 10% excise tax on the excess.8eCFR. 26 CFR 54.4979-1 – Excise Tax on Certain Excess Contributions
2026 Contribution Limits
If the plan passes testing or uses a safe harbor design, the 2026 caps are:5Internal Revenue Service. 401(k) Limit Increases to $24,500 for 2026; IRA Limit Increases to $7,500
- Standard employee deferral: $24,500
- Catch-up contribution at age 50 and older: an additional $8,000, for a total of $32,500
- Enhanced catch-up at ages 60 through 63: an additional $11,250, for a total of $35,750
- Total annual additions including employer contributions: $72,000 under IRC Section 415(c)1Internal Revenue Service. COLA Increases for Dollar Limitations on Benefits and Contributions
Mandatory Roth Catch-Up in 2026
A SECURE 2.0 provision takes full effect in 2026 that directly affects most HCEs. Employees who earned $150,000 or more in W-2 wages from the same employer in the prior year must make all catch-up contributions on a Roth (after-tax) basis. Pre-tax catch-ups are no longer available for this group. Because nearly every HCE clears the $150,000 line, HCE catch-up dollars are effectively Roth-only going forward. The trade-off is tax-free growth on those contributions inside the Roth account.
Ways HCEs Recover Contribution Room
Safe Harbor Plans
Employers can bypass the ADP and ACP tests entirely by adopting a safe harbor 401(k). In exchange for making mandatory, immediately vested employer contributions, the plan is exempt from annual nondiscrimination testing.9Internal Revenue Service. 401(k) Plan Overview HCEs can then defer up to the full statutory limit without regard to what coworkers contribute.
Two contribution formulas are typical:
- Basic match: 100% of the first 3% of pay deferred, plus 50% of the next 2%.
- Nonelective contribution: 3% of pay for every eligible employee, whether or not they defer.
Employers must give eligible employees written notice at least 30 days and no more than 90 days before the plan year begins, describing the contribution method and election rules.
Roth IRAs and After-Tax 401(k) Dollars
HCEs whose deferrals get trimmed by testing often use other tax-advantaged accounts to close the gap. A backdoor Roth IRA involves making a nondeductible traditional IRA contribution, capped at $7,500 for 2026, then converting it to a Roth, which bypasses the direct Roth income limits.5Internal Revenue Service. 401(k) Limit Increases to $24,500 for 2026; IRA Limit Increases to $7,500
If your plan permits after-tax 401(k) contributions and in-plan Roth conversions, the “mega backdoor Roth” strategy lets you route additional dollars into a Roth account, up toward the $72,000 annual additions ceiling minus your pre-tax deferrals and employer match. Not every plan offers this. Ask your plan administrator before assuming it’s available. A health savings account paired with a qualifying high-deductible health plan is another tax-advantaged bucket that HCEs commonly use alongside the 401(k).