Highly Compensated Employee (HCE) vs. NHCE: What It Means for Your 401(k)

For 2026, you are a highly compensated employee (HCE) if you earned more than $160,000 in compensation in 2025, or if you own more than 5% of the business at any time in 2025 or 2026. Ownership counts regardless of pay. A non-highly compensated employee (NHCE) is simply everyone who doesn’t meet either test. The distinction exists so the IRS can test whether a 401(k) plan unfairly favors its higher-paid employees.

By the About401K editorial team · Facts verified against IRC §414(q) and IRS Notice 2025-67 · Updated September 25, 2026

What is an NHCE?

A non-highly compensated employee, usually shortened to NHCE, is any employee who is not an HCE under IRC §414(q). That means someone who earned $160,000 or less in the lookback year and owns 5% or less of the company. There is no separate NHCE test to pass, because the category is purely what is left over after the HCE tests run.

NHCEs matter more than the dull name suggests. In compliance paperwork, their average savings rate sets the ceiling for what the HCEs in the same plan are allowed to defer under nondiscrimination testing. When rank-and-file participation is strong, the high earners get more room.

Am I an HCE for 2026?

• ☐ Test 1, compensation. Did you earn more than $160,000 from this employer in 2025? That prior year is what the rules call the lookback year, and 2025 pay is what determines your status for the 2026 plan year.
• ☐ Test 1, the fine print. “Compensation” here means the plan’s definition, which is usually W-2 pay plus deferrals. Check your summary plan description if you are close to the line.
• ☐ Test 2, ownership. Did you own more than 5% of the business at any time during 2025 or 2026? Pay is irrelevant to this test, so a part-time owner earning $40,000 is still an HCE.
• ☐ Test 2, family attribution. Count stock owned by your spouse, children, parents, and grandparents as though it were yours. This is what makes family businesses full of unexpected HCEs.
• ☐ Check for the top-paid group election. If your employer made this election, only the top 20% of employees by pay are HCEs under the compensation test, which can pull you back out. The plan document says whether the election is in place.
• ☐ New hires, check the lookback year. If you had no pay from this employer in 2025, the compensation test cannot catch you for 2026, no matter what you earn now.

If you answered yes to either test, you are an HCE for 2026. That status is not a penalty and it is not something you did wrong. It simply puts your contributions inside the group the plan has to test each year.

Why HCE status matters: the ADP and ACP tests

Every year, traditional 401(k) plans have to pass nondiscrimination tests that compare the two groups. The tests exist to make sure the tax break the plan enjoys reaches ordinary workers and not only the corner offices.

• The ADP test (actual deferral percentage) compares the average deferral rate of HCEs against the average deferral rate of NHCEs.
• The ACP test (actual contribution percentage) does the same job for matching contributions and after-tax contributions.

Roughly speaking, if NHCEs defer 4% of pay on average, HCEs as a group are held to about 6%. The general rule allows 1.25 times the NHCE rate, or 2 percentage points more, depending on which branch of the statutory formula the plan uses.

The point of the design is structural rather than personal. HCEs can only benefit heavily from the plan if the rank-and-file employees actually use it too, which gives the employer a real incentive to make the plan worth joining.

Consequences of a failed test

When a plan fails, it has to correct the imbalance, and the most common correction is a refund of deferrals to HCEs. This is called a corrective distribution, or an ADP refund, and it usually goes out within 2½ months after year end. Money you thought was safely saved comes back to you as taxable income for the year you receive it.

The employer has other options besides refunds. It can make qualified contributions to NHCEs, known as QNECs, to raise their average and pull the plan into compliance. It can also adopt a safe harbor design, which is a mandated employer contribution formula that exempts the plan from ADP and ACP testing altogether.

If you are an HCE who received a refund, nothing went wrong with your account and you did not make a mistake. Your plan failed its test, and the refund is the plan’s compliance fix.

What to do if your plan fails testing

• ☐ Read the notice carefully and confirm the refund is a corrective distribution rather than a different kind of distribution. The plan should tell you the amount and the tax year.
• ☐ Set aside the tax. The refund is taxable income in the year you receive it, and the plan may not withhold enough to cover your bracket.
• ☐ Do not try to roll it back in. A corrective distribution is not eligible for rollover, so putting it into an IRA would create a new problem.
• ☐ Ask HR whether the plan will impose an HCE deferral cap for the coming year, for example a limit of 8% of pay. If it will, adjust your election in January rather than discovering the cap in June.
• ☐ Ask whether the plan offers after-tax contributions. They are ACP-tested, but where they are available they can take money the deferral cap will not.
• ☐ Redirect the refunded money into a backdoor Roth IRA or a taxable brokerage account so the savings do not simply evaporate into spending.
• ☐ Raise safe harbor with HR or the plan committee if refunds have happened more than once. Repeat failures are a plan design problem, and safe harbor is the standard cure.

HCE status and your contribution limit

HCE status does not reduce your legal limit at all. The 402(g) limit of $24,500 for 2026 is exactly the same for everyone in the plan.

What changes is what your plan will let you do in practice. In a plan that fails testing or comes close to failing, HCEs are often capped by the plan below the legal limit, for example at 8% of pay, or hit with refunds after year end. That is a plan-imposed ceiling rather than an IRS one, which is why two people at different companies can face very different realities on the same salary.

Two other limits touch high earners specifically, and the IRS contribution-limits page covers the full set.

• The compensation limit of $360,000 in 2026 caps how much salary the plan may consider when it runs contribution formulas.
• The Roth catch-up mandate for 2026 says that if your prior-year FICA wages exceeded $150,000, which is a lower bar than HCE status, your catch-up contributions must be Roth. Different threshold and different test, so try not to conflate the two.

HCE threshold by year

If you are working out your status for an earlier year, here is the compensation threshold for each determination year back to 2021.

The mechanics trip people up, so read the table carefully. The dollar figure published for a year applies to that year’s pay when determining your status for the following plan year. The $160,000 threshold announced in IRS Notice 2025-67 tests your 2025 compensation to set your status for 2026. The threshold announced for 2025 also happened to be $160,000, since the number held flat.

The top-paid group election

Employers may elect to treat as HCEs, by compensation, only the employees who are also in the top 20% by pay. It is an optional election, and it changes who lands in each group.

In a company where a great many people earn six figures, such as a law firm, a hospital system, or a technology company, this election can pull a large slice of $160,000-plus earners back into NHCE status and help the plan pass testing. Whether your employer has made the election appears in the plan document. It changes your classification for testing, not your rights under the plan.

If you’re an HCE getting squeezed, your options

Being capped below the legal limit is frustrating, but there are several places the money can still go.

• Max what you’re allowed, including the catch-up if you are 50 or older. Catch-up contributions are not limited by ADP testing, so that room stays open to you.
• Use after-tax contributions if your plan offers them. They are ACP-tested but often still available, and they can be converted through the mega backdoor route. Our page on after-tax contributions explains the mechanics.
• Fall back on a backdoor Roth IRA and a taxable brokerage account, which will absorb whatever the plan will not take.
• Advocate for safe harbor. If refunds arrive every single year, the real fix is plan design rather than personal tactics. A safe harbor match ends the testing problem for everyone in the plan at once.

Related reading

• All 2026 contribution limits
• The $360,000 compensation limit
• After-tax contributions and the mega backdoor Roth

Sources: IRC §414(q) · IRS Notice 2025-67 · IRS: ADP/ACP fix-it guide