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What is a Highly Compensated Employee?

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Are you a highly compensated employee? No matter what you make, you probably don’t feel like a highly compensated employee (what’s that old saying – happiness is making a dollar more than you’re wife’s sister’s husband? :) ), but you might just be one. Whether or not you’re a highly compensated employee has an impact on your employer’s retirement benefits package. The retirement program has to prove that there is no bias towards highly compensated employees or it could lose the tax breaks it gets for having a retirement package.

A highly compensated employee is someone who owns more than a 5% interest in your business at any time during the year. Or, they could be considered highly compensated if they, in the preceding year, received compensation in excess of a specified amount (see the list below) and, if you choose to add this criteria, be in the top 20% of employees when ranked by compensation.

Highly compensated employee compensation limits:

  • 2006-2007: $100,000
  • 2008: $105,000
  • 2009-2011: $110,00
  • 2012-2013: $115,000

So if you earned more than $115,000 last year (2012) then you could be considered a highly compensated employee. Congratulations!

The bias becomes a factor because many companies contribute to a defined benefit or defined contribution plan based on the employee’s salary. Those earning more will naturally get a bigger benefit from the employer’s retirement package and the IRS wants to avoid this bias towards more richly compensated employees. They compare the amount the company contributes to the pool for highly compensated employees to the amount the company contributes to the remaining employees. if the difference is too great, as fined in this document, then the company could lose its tax benefits.

OK so what? If you are a highly compensated employee, you might be limited in how much you can contribute to your retirement plans. While the typical 401(k) plan limits employee contributions at $17,000, your employer may drop that limit to account for potential pension (defined benefit) contributions they are making on your behalf because of your salary. So if you are like my friend, who just recently received this letter, now you know what it means to be highly compensated.

Congratulations! :)

{ 52 comments, please add your thoughts now! }

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52 Responses to “What is a Highly Compensated Employee?”

  1. Luckily my wife’s sister isn’t married.

  2. cdiver says:

    I imagine this happened to many companies as pay cuts roll through people cut back on their contributions and then Highly Compensated folk get their notices.

  3. Becky says:

    This happens to me every year at my current company so my max contribution to our 401K is limited to 6%. I wish I could save more in a 401K but I had to go outside work and open an IRA. I guess there are worse problems to have.

    • cubiclegeoff says:

      I wish I had this problem.

    • NCTaxPro says:

      Becky:

      Is your company’s 401(k) a defined benefit plan – or do you have another defined benefit retirement plan for which you are eligible? If either is the case, you are considered to be covered by the plan even if you decline to participate, and your IRA contributions may not be deductible under those circumstances.

  4. zapeta says:

    I’m definitely not highly compensated…darn.

  5. brooklyn money says:

    I got lucky this year and only got like $200 of my maxed out contribution returned. This is NOT a good problem to have (i know it’s all relative and in reality this is not a horrible problem). There are so few places to save money that are tax-deferred, especially for HCEs.

  6. Interesting. For some reason my wife’s employer doesn’t have this issue (law firm). 80% of her company’s employees fall into the highly compensated bucket. I assume they pile extra money into the non-highly compensated folks’ accounts to make sure they don’t get fined.

    • freeby50 says:

      Jake, If you look at the $110,000 figure as the test they also have to be in the top 20% of employees at the company. So if most of the people make over $110,000 (like at a successful law firm) then the real test is if the salary is in the top 20% for the firm.

  7. Becky says:

    Brooklyn money- Agree. there are not enough tax deferred options available outside the 401K. I used to work in a law firm and they don’t have that problem because the majority of the employees there are HCE’s. It all depends on the percentage of HCE’s to non-HCE’s in determining how much can be contributed.

  8. Cap says:

    huh. I actually didn’t know there’s set criteria (in terms of compensation #) to define “highly compensated employee” and figured it was a per business basis — since a law firm may have a high % of “highly compensated employee” ratio to non-highly compensated employees.

  9. Cap says:

    woops just noticed that the law firm angle was already mentioned.

    whats unfortunate is if you’re just at the borderline and you’re being subjected to the contribution limit match etc. its always a bit stupid if you make a little bit less, you may actually reap more benefit (such as the working poor that may get screwed out certain assistance because they make $1k more per year vs. qualifying poverty level).

    different type of ‘making too much’ problems, of course.

  10. jsbrendog says:

    yeah not even close to a highly compensated employee. le sigh

  11. Bill says:

    I have got this email the last 5 years. Once it got so bad I got a check where they returned money I had put in. In my company the problem seems to have been such a small percent of the lower wage earners joined the plan. They changed the plan to automatically enroll people and then you had to opt out. I’ve never gotten a check since.

    I’m grateful the first real job I had. After I didn’t sign up for the 401(k) the CEO called me to his office and took 20 minutes of his time to educate me.

  12. Ron says:

    Any word on highly compensated employees for an ESOP?

  13. Josh says:

    I’m not married, so what’s the adage for me? If it’s the girlfriend, her sister is way too young to be married! :)

  14. I am not highly compensated nor do I feel that I am compensated enough in my company…

  15. Josh says:

    I have a question re 401K contribution – I have heard that IRS limit for 2009 yr for 401K was 16500 if u filed married file jointly. Say if i have 401K at work and do 16500 pre tax contribution already fm my paycheck – does that mean my wife can not put any money in her employer offered 401K?

    if she also puts some money away, we as couple would go above 16500, will that be a problem?

    • Matt says:

      Josh, I work for a 401k/pension third party administrator. The $16,500 is an individual limit and your spouse’s contribution has no bearing on it. You both can contribute $16,500 to 401k plans.

  16. lkern says:

    Does anyone know if the $110K refers to an employee’s actual salary, or if that dollar amount includes other benefits, such as health insurance? My husband doesn’t make anywhere near $110K in salary/bonus (if he gets a bonus), but the company pays a big portion of our health insurance. They also pay for accidental death insurance, life insurance, etc.

  17. Roderick says:

    Hi guys… my name is roderick from the philippines and currently working in dubai UAE.

    I was hired last July 2008 at Emirates Flight Catering-Linencraft in a Grade 2 position which is a Team Member. but i was working at administration department handling with customer service calls from Cabin crew & pilot staff/hotel clients and also doing with accounts job.
    It has been 2 years now that my salary is only about 1,200 UAE Dirhams including overtime that is 12 hours a day from 7am to 19pm.

    With this, i would like to ask if am i compensated with my work?

  18. Lee says:

    I recently received a package from my company regarding the HCE. The problem I have is that I am a ‘modified full-time employee’ and in reality I do not make the $110K, but on paper it appears as though I make more than the $110K. Since my overall salary is less than $110K do I need to participate in the Deferred Compensation Plan or can I continue to contribute the max to my 401k?

  19. Bob says:

    My 401K plan states:

    An Employee is considered a highly compensated Employee if (i) at anytime during the current or prior year you own, or are considered to own, at least five percent of your Employer, or (ii) received compensation from your Employer during the prior year in excess of $110,000, as adjusted.

    I am not sure what “as adjusted” means.
    Is this your previous years Gross, minus pretax contributions like medical and even 40K for that matter. So is it an adjusted Gross.

    • Zoey says:

      It’s gross compensation, including any type of pretax contribution. The easiest way to look at it is, whatever is reported on box 3 of your W-2.

      “as adjusted” has to do with increases (if applicable) due to COLA (cost of living adjustments). For 2011, there was no increase. It remains the same as 2010.

  20. Bob says:

    The reason I ask is because my plan would limit me at 7% and my gross is right on the border. I just turned 50 and would like to participate in the catch up program but if I am HCE, I am still limited to 7%. My company can not seem to tell me if I am or not. If I was would I receive a letter. I received a letter around 5 years ago, but no since and like someone mentioned, my company also auto-enrolled ALL new employees into the plan at a starting rate of 3%. This may have also made a difference.

    • Zoey says:

      Well, the compensation used to determine whether you are a HCE (highly compensated employee) may not be the same compensation the plan uses for contribution purposes. There are several different types of compensation allowed in a plan. For instance, a plan may exclude bonuses, overtime, commissions, etc.

      Unfortunately, there will probably be no letter stating that you are a HCE. Some employees don’t find out until they have to take money back (i.e., refund). Look at your W-2 from last year.

      There is much controversy over auto-enroll. Personally I think it ticks off employees. The fact that they are thrown into the plan and then have to go through the hassle to “opt out” if they never wanted in, in the first place. However, employers do it because it helps the testing. And failing the ADP and/or ACP test(s) is what causes the HCE’s to have to take some of their contributions back.

  21. Bob says:

    Ok, so 2009 Box-3 wages states 106800, which takes out pretax contributions, but not 401K. It also includes bonus’s, so it would apear I am not an HCE. 2010 W2 has not come out yet but should be around 100000 so again I should be ok and can take advantage of the catch up contributions this year. Thanks.

  22. adeyemi sobowale says:

    It is sad that you are discriminated against for being highly compensated. It is OK for non-highly compensated to contribute $16,500 while highly compensated cannot do so because of unfair law. The government workers are not discriminated against getting their pension reduced because of high compensation.

  23. trey says:

    I’m in the union and the pension plan we participate in says “because my dad is primary share holder of one of the electrical contractors i cant contribute more than 4% to my 401K” regardless of what contractor i work for. I dont think this is right!!!

  24. brenda says:

    what happens if I am a “highly” compensated employee and my company does NOT contribute to my 401K? are theses “rules” still in effect? I contribute 3800 last year to my 401K They are sending me back a check for $2200.00 WHY??????

    • Jules says:

      Brenda – Really, 2200? This is something you need to ask your HR department or your 401k administrator. Doesn’t sound right to me, I’ve never given a non-HC employee money due to discrimination testing.

  25. KMB says:

    I’m getting nailed by this for 2009. I received a letter and a disbursement check, which apparently means I’ll need to cough up several thousand dollars in 2011 in additional income taxes, as opposed to saving that money for retirement. The company I work for, a very large IT contracting company, has no matching contribution. I am in my 50s and was finally in a position to start plowing some money into retirement, but apparently what I do with _my_ money is restricted by what thousands of nameless fellow employees fail to do with _theirs_. How does this law in its current form do anything about “top heavy” compensation plans? Since there is no matching contribution, its not like they’re deliberately rewarding top management at the expense of low-level employees. All this law does is shift the burden to an insolvent social security system.


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