Separate HCE and key employee definitions, compensation years and ownership rules. Improve census accuracy before nondiscrimination and top-heavy testing.

January 19, 2026 · Financial Forte Staff

Historical article: prepared retrospectively using information available as of January 19, 2026.

An owner may describe a department leader as a key employee because the business depends on that person's expertise. Retirement-plan testing uses the same words much more narrowly. Confusing a business description with a tax definition can put the wrong people into the wrong testing groups.

Highly compensated employee and key employee are separate classifications. They serve different tests and use different compensation and ownership rules. The employer's first responsibility is to provide accurate underlying facts, with the appropriate years identified, so the administrator can apply those rules correctly.

Start with the question each test asks

The highly compensated employee, or HCE, definition is used in various nondiscrimination rules. Broadly, it considers certain owners and employees whose preceding-year compensation exceeds the applicable threshold. The employer may also have a valid election that limits the compensation-based group to the top-paid group. [1]

For a calendar-year 2026 determination, the basic compensation lookback generally asks whether 2025 compensation exceeded $160,000. Ownership is a separate route: more-than-5% ownership during the current or preceding year can establish HCE status without reaching that compensation amount. Attribution rules can affect who is treated as an owner. [1][2]

Key employee status is used for top-heavy testing. It generally includes an officer whose compensation exceeds the applicable indexed threshold, a more-than-5% owner, or a more-than-1% owner with compensation above $150,000. The officer category also has limits on the number of officers counted. Job titles alone are not a complete classification method. [3]

The indexed officer threshold is $230,000 for 2025 and $235,000 for 2026. Those are officer thresholds for key employee classification, not general salary cutoffs for every employee or the HCE thresholds. Nor should an administrator substitute the newest dollar figure into an older determination period simply because the testing work is being completed now. [2][4]

Keep the years attached to the data

January often involves two jobs at once: completing the prior year's testing and preparing the current year's administration. A spreadsheet headed only “compensation” invites mistakes when those jobs are mixed together.

For example, a calendar-year 2025 HCE review generally looks back to 2024 compensation above $155,000, while a 2026 review generally looks back to 2025 compensation above $160,000. The ownership route and any valid top-paid-group election still need to be considered. [1][2]

Top-heavy analysis has its own determination-date framework. For an ongoing calendar-year plan, the determination date for 2026 is generally December 31, 2025; a first plan year has a different rule. The administrator needs to establish the relevant key employee determination period and account data rather than borrow the HCE lookback mechanically. [3]

That is why a useful census identifies the compensation year, ownership dates, family relationships, officer duties and employment changes. It should also disclose related businesses for the administrator's aggregation review. A payroll export alone may not contain enough information.

See how the classifications can diverge

Suppose an employer is reviewing 2025 classifications with its administrator. Maya is a nonowner, nonofficer employee who earned $180,000 in 2024 and $190,000 in 2025. Assume there is no top-paid-group election and no attributed ownership.

Maya is an HCE for 2025 through the preceding-year compensation test. She is not a key employee merely because she earns more than other staff. Under the stated facts, she does not meet the owner or officer categories.

By comparison, Luis owns 6% of the company during 2025 and earns $80,000. His lower salary does not keep him out of the ownership-based classifications. Subject to the applicable determination rules, his ownership can make him both an HCE and a key employee. [1][3]

If HR labels everyone earning above $155,000 as “key,” Maya's balance could be placed in the wrong top-heavy group while Luis could be missed. The error would not be cured by having correct total assets. The allocation of those assets among correctly classified participants matters.

For a simplified defined contribution example, assume all required adjustments and aggregation have been considered. Key employee accounts of $600,000 out of $1 million equal exactly 60%. The statutory test is more than 60%, so exactly 60% does not cross it. At $620,000 out of $1 million, the ratio is 62% and crosses that threshold, absent an applicable exception. [3]

Turn the distinction into a review control

Top-heavy status can affect minimum contributions and vesting requirements. It does not justify a blanket instruction to deposit 3% for every person without checking eligibility, exceptions, other contributions and the plan's facts. Certain arrangements can qualify for exceptions, and an additional contribution can affect that analysis. [3]

Request separate HCE and key employee reports, each showing its determination period, compensation year and classification basis. Have an authorized employer contact review ownership and officer facts. Ask the administrator to identify uncertain relationships before testing is finalized.

These tax classifications also do not determine who is an ERISA fiduciary. Fiduciary status depends on the relevant functions and authority. For an ERISA-covered plan, prudent provider selection and monitoring remain important even when a third party performs the calculations. [5]

A clear census process can reduce correction expenses, repeated payroll requests and unwelcome contribution surprises. It can also improve communication with employees whose contributions or benefits are affected by testing. Put the definitions in separate columns, document the administrator's resolution of exceptions and keep the approved version and the evidence supporting any changed classification with the year's plan records.

Related reading

Have more questions about retirement plan testing and employee classification? Email Dave at dave@financialforte.com to discuss your questions and next steps.

The contact invitation is current; it does not imply this contact path existed on the historical reference date.

Educational information, not personalized investment, tax, legal or benefits advice. Examples use hypothetical assumptions. Verify current rules and your circumstances before acting.

Sources

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