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A recent call with a financial advisor in Minnesota is representative of a common question on highly compensated employees.
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.
“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?”
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: | 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:
The ownership test and
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)].
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 is 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 is provided