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.
6 responses to “What Is A Highly Compensated Employee?”
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[…] by the IRS and DOL. This testing is to ensure that plans are not in place only to benefit the highly compensated employees (HCE). A highly compensated employee is somebody who makes $100,000 a year, is a 5% owner, or is the […]
[…] If you are curious as to the rules regarding HCE’s, please read this page that discusses what a highly compensated employee means. Related Posts Highly Compensated Retirement Contribution OptionsWhat Is A Highly Compensated […]
Thank you for this information – it was extremely helpful! Just one question – I went to the IRS Alert Guidelines, etc site…can you please tell me which Alert would be used for the HCE bias test?
Alicia – I believe Form 5627 is the one you’ll want.
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