A highly compensated employee is a construct of retirement plans and it’s used to determine if a retirement plan is biased towards these highly compensated employees. Those plans that are biased lose favorable tax advantages for those retirement programs, those that demonstrate that they are not biased towards these highly compensated employees will qualify for tax breaks because of their retirement plan. What is a highly compensated employee? It is an employee that owns more than 5% of a company or whose income exceeds a predetermined amount specified by the Internal Revenue Service. Below is the schedule for the last few years:
Year: Income Level
The bias test, to determine if there is any bias, is that they compare the amount contributed by the company to the highly compensated employee 401(k) pool to the amount contributed by the company to the remainder of the company. Since companies usually match on a percentage basis, the more you make the greater the contribution. If the difference between the contributions is too great, then the company loses tax benefits. (The test is a little more complicated with that but I doubt most people care, if you do, read this document)
How does this affect you? Highly compensated employees are usually limited in how much they can contribute to their 401(k) plan so the amount the employer kicks in will be lowered if your contribution limit is lower. How can you get around that? That’s an issue for another post.