2

Within a 401k plan, there is a term called Highly Compensated Employee (HCE).

It looks like anyone is considered an HCE if they make $120k+ (in 2016) and/or has 5% company ownership.

I have had a hard time finding concrete and comprehensive definitions on what this is, resulting in a few questions.

  • Is $120k total compensation? Salary + bonus? Cash compensation?
    • Do things like stock options count towards the compensation process?
  • Is there a limit to the number of employees which must be considered HCE?
    • Imagine a company with 100 employees, where 99 of them make $120k+. Are those all considered HCE? Are they limited based on the 1 person who isn't an HCE?
  • Is this defined somewhere concisely by the IRS?
  • Important to note, the 5% rule is >5%, not >=5%. If a person owns EXACTLY 5%, they are not considered an HCE. – Chris Oct 10 '16 at 20:43
5

HCE is defined as being above 120k$ or in the top 20 % of the company. The exact cutoff point might be different for each company. Typically, only the base salary is considered for that, but it's the company's (and 401(k)-plan's) decision.

The IRS does not require HCE treatment; the IRS requires that 401(k) plans have a 'fair' distribution of usage between all employees. Very often, employees with lower income save (over-proportionally) less in their 401(k), and there is a line where the 401(k) plan is no longer acceptable to the IRS.
HCE is a way for companies to ensure this forced balance; by limiting the amount of 401(k) savings for HCE, the companies ensure that the share of all contributions by below-HCE is appropriate. They will calculate/define the HCE cutoff point so that the required distribution is surely achieved.

One of the consequences is that when you move over the HCE cutoff point, you can suddenly save a lot less in your 401(k). Nothing can be done about that.

See this IRS page: https://www.irs.gov/retirement-plans/plan-participant-employee/definitions

Highly Compensated Employee - An individual who: Owned more than 5% of the interest in the business at any time during the year or the preceding year, regardless of how much compensation that person earned or received, or For the preceding year, received compensation from the business of more than $115,000 (if the preceding year is 2014; $120,000 if the preceding year is 2015 or 2016), and, if the employer so chooses, was in the top 20% of employees when ranked by compensation.

  • I used to work at Amazon, and by default, I always maxed out my 401k contributions. At the end of every year, I had a forced distribution of a significant amount so that the company as a whole had "balance". It was really annoying to have an effective lower contribution limit and also for doing taxes. One of many reasons I am glad I no longer work at Amazon... – gaefan Oct 10 '16 at 18:27
  • Its not really Amazon's fault - it's the IRS rules and your position in the payscale of the company – Aganju Oct 10 '16 at 18:31
  • @Aganju - if I recall, my old company offered a high enough matching that they were exempt from the HC limits. Amazon can fix this problem by being more generous. – JoeTaxpayer Oct 10 '16 at 18:45
  • Those are ADP refunds. Really annoying from an admin standpoint to tell an upper level that they need to have money returned because they saved TOO MUCH for retirement. Amazon could have gotten around that by being a Safe Harbor plan. – Chris Oct 10 '16 at 21:07
0

There are some nuances with HCE definition. To answer your questions.

  1. It's compensation as defined by the plan. Usually it's gross comp, but it can exclude things like fringe benefits, overtime pay, commissions, bonuses, etc. The compensation test is also a look-back test, meaning that an EE is determined to be an HCE in the current year if their compensation in the previous year was over the limit. I'm not sure how stock options affect this, but I expect they would be counted. Probably have an ESOP plan at that point too which is a whole other can-o-woms. The 5% owner test applies to the current year and also has a one-year look-back period. If at ANY point, even for a day, an employee was more than 5% owner, they are HCE for that year and next.

  2. Yes there is a limit. A company may limit the amount of HCE's to the top 20% of employees by pay like Aganju said. They can also disregard employees that may otherwise have been excluded under the plan using statutory exclusions. Example, they can disregard employees under 21 years and with less than 1 year of service.

  3. Hahaha, the IRS does not like to concisely define things. You can look here, that's probably as concise as you'll get.

Hope this helps!

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.