Highly Compensated Employees
Alex Howard
6 min read • Nov 10, 2024
Highly Compensated Employees (Definition for Employee Benefit Purposes)
Who is a Highly Compensated Employee?
A highly compensated employee (HCE) for purposes of retirement plan is defined based on two primary rules:
Ownership: The employee held 5% or more of the business at any time during the current or preceding year.
Compensation: The employee earned a compensation amounting to more than $150,000 in the previous year after inflation, and if selected by the employer, was in “top paid group” for that year.
The “top-paid group” includes employees who are among the top 20% when ranked by compensation. Certain employees can be excluded from this category including those with less than six month’s service, less than 17.5 hours per week have worked and are not below 21 years old and non-resident aliens without U.S. earned income.
Former employees who were HCEs at separation or at any time thereafter attaining age 55 are treated as HCEs.
Nondiscrimination in Benefits and Contributions
Qualified retirement plans must not favor HCEs in terms of benefits or employer contributions. Below is how to maintain balance:
Non-Discriminatory Formulas: Employ formulas that deliver equivalent benefits or contributions to HCEs as well as Non-HCEs. For instance, benefits could be tied to either compensation or service duration which promotes fairness across the board.
Testing Requirements: While defined contribution plans usually undergo contributions tests, defined benefit plans will use general testing procedures or one out of three safe harbors intended to prevent discrimination. ESOPs, 401(k) plans and plans having after-tax employee contributions or employer matching contributions have unique rules regarding nondiscrimination.
Balanced Approach: Competitive yet fair benefits should be extended to attract and retain HCEs but ensure compliance with anti-discrimination regulation for all other workers.
By following these rules, businesses can establish an equitable and compliant retirement plan for all their workers without regard to their levels of pay.