The IRS issued Notice 2025-67 to announce updated limits reflecting retirement plan indexing.
These updates include thresholds used to identify highly compensated employees under Internal
Revenue Code Section 414(q) and key employees under §416(i), which are used for annually required non-discrimination testing for both retirement and several non-retirement benefit plans.
Applies To:
- All size employers allowing employees to make pre-tax paycheck deductions under a §125
plan (except for a Simple Cafeteria Plan exempt from non-discrimination testing) - All size employers sponsoring a dependent care assistance program (DCAP) subject to §129
- All size employers sponsoring group term life insurance subject to §79
- All size employers sponsoring other arrangements that test discrimination against a §414(q)
definition, including but not limited to §127(a) education assistance
Go Deeper:
2026 indexing is now complete for employee benefit plans. Several employee benefits require annual testing under various sections of the Internal Revenue Code (IRC) to ensure benefits do not overly favor highly compensated or key employees. Some highly compensated or key employee definitions rely on individuals exceeding certain income thresholds which are indexed annually.
- One highly compensated definition used in non-discrimination testing is found in IRC
§414(q)(1)(B). It looks back at last year’s income to determine if someone is highly
compensated for the current year. - One key employee definition used in non-discrimination testing is found in IRC
§416(i)(1)(A)(i). It looks back at last year’s income to determine if someone is a key employee
for the current year. - In both cases, a new hire will not have income from the prior year so the projected annual
income is evaluated instead.
Common Benefits Subject to Non-Discrimination Testing
The most common benefit employers sponsor is a §125 Plan that allows employees to make pre-tax paycheck deductions for qualified health and welfare benefits. These plans are subject to annual non-discrimination testing with a couple of exceptions:
- A §125 Plan that only allows employees to make pre-tax paycheck deductions for premiums
and not for account-based plans like FSA, DCAP, or HSA, can typically pass just the safe
harbor percentage component of the eligibility test and avoid running the rest of the §125
tests. - A Simple Cafeteria Plan has such strict requirements for small employers to meet that it
avoids the need to run non-discrimination testing.
Other common benefits which run annual non-discrimination testing include FSA, DCAP, group term
life, and education assistance. The table below provides a description of where definitions of highly
compensated or key employees are utilized:
Note that some employers have enough highly compensated employees that they consider whether
to exercise the top 20% paid group election to make it a smaller group of HCIs. Doing this requires
amending each impacted plan (including the §125 Plan) and any qualified retirement plan, as it is a
universal election they commit to in writing for the year for both retirement and non-retirement
benefits that rely on a §414(q) compensation threshold.
Employer Considerations
Non-discrimination testing is required annually of almost every employer sponsoring employee
benefits. Employers with an FSA or DCAP administrator will often rely on that administrator to run
their annual testing, but there are other third-party administrators that can help if needed, including
COBRA or 5500 filing administrators.
A DCAP in particular needs to run preliminary testing early in the year, usually by April, to ensure it
appears as though it might pass testing at the end of the year. If preliminary testing indicates an
imbalance, the employer will want to reach out to highly compensated employees with large DCAP elections to lower election amounts that make it more likely for the employee to pass testing at the
end of the year.
Submitting test results to the IRS is not required, but they must be kept on file and provided in an
audit to demonstrate the plans did not overly favor highly compensated or key employees. These
tests are also requested in due diligence audits for a merger or acquisition.
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