The IRS issued Notice 2025-67 to announce updated limits reflecting retirement plan indexing. These updates include thresholds used to identify highly compensated employees (HCEs) under Internal Revenue Code (IRC) §414(q) and key employees under §416(i). These definitions are essential for the annual non-discrimination testing of retirement and certain non-retirement benefit plans.
Applies To
- Employers of any size offering employees pre-tax paycheck deductions under a §125 cafeteria plan (excluding a Simple Cafeteria Plan exempt from non-discrimination testing)
Employers of any size sponsoring a dependent care assistance program (DCAP) under §129 - Employers of any size sponsoring group-term life insurance under §79
- Employers of any size sponsoring other arrangements tested for discrimination based on a §414(q) definition, including §127(a) education assistance
Go Deeper: 2026 Indexing for Employee Benefit Plans
Annual non-discrimination testing ensures employee benefits do not disproportionately favor highly compensated or key employees. Several definitions of HCEs or key employees rely on income thresholds that are indexed annually:
- HCE definition (IRC §414(q)(1)(B)): Looks at last year’s income to determine if an employee is highly compensated for the current year.
- Key employee definition (IRC §416(i)(1)(A)(i)): Looks at last year’s income to determine if an employee is a key employee for the current year.
- New hires without prior-year income are evaluated based on projected annual income.
Common Benefits Subject to Non-Discrimination Testing
The most common benefit subject to testing is a §125 Plan, which allows employees to make pre-tax paycheck deductions for qualified health and welfare benefits.
Exceptions:
- §125 Plans offering only pre-tax premium deductions (not account-based plans like FSA, DCAP, or HSA) can generally pass the safe harbor percentage test and avoid further testing.
- Simple Cafeteria Plans for small employers meet strict eligibility requirements and do not require non-discrimination testing.
Other benefits commonly subject to annual testing include FSA, DCAP, group-term life insurance, and education assistance. The table below shows updated HCE and key employee thresholds:
| 2025 | 2026 | 2027 | |
| §125 Plan pre-tax paycheck deductions | |||
| Highly compensated individual (HCI) | $155K in 2024 | $160K in 2025 | $160K in 2026 |
| Other HCIs (officers, more-than-5% owner current or preceding year, and employed spouses and dependents of HCIs) | No income test | No income test | No income test |
| Key employee officer | $220K in 2024 | $230K in 2025 | $235K in 2026 |
| Key employee more-than-1% owner | $150K | $150K | $150K |
| Key employee more-than-5% owner current or preceding year | No income test | No income test | No income test |
| §129 DCAPs | |||
| Highly compensated employee (HCE) | $155K in 2024 | $160K in 2025 | $160K in 2026 |
| Other HCEs (more-than-5% owner current or preceding year, and employed spouses and dependents of HCEs) | No income test | No income test | No income test |
| §79 Group term life insurance | |||
| Key employee officer | $220K in 2024 | $230K in 2025 | $235K in 2026 |
| Key employee more-than-1% owner | $150K | $150K | $150K |
| Key employee more-than-5% owner current or preceding year | No income test | No income test | No income test |
| §127(a) Education assistance | |||
| Highly compensated employee (HCE) | $155K in 2024 | $160K in 2025 | $160K in 2026 |
Top 20% Paid Group Election
Some employers with a high number of HCEs may elect the top 20% paid group to reduce the number of HCEs. This requires amending all affected plans (both retirement and non-retirement benefits relying on a §414(q) threshold) and is a universal, written election for the year.
Employer Considerations
- Annual testing is required for nearly all employers offering employee benefits.
- Employers often rely on FSA or DCAP administrators to conduct testing, though third-party administrators for COBRA or 5500 filing can also assist.
- DCAP preliminary testing should be done early in the year, typically by April, to identify potential imbalances. If testing suggests an issue, employers may ask HCEs with large DCAP elections to reduce contributions to improve the likelihood of passing.
- IRS submission of test results is not required, but records must be retained for audits and may be requested in due diligence for mergers or acquisitions.