Table of Contents
- What Is a Highly Compensated Employee (HCE)?
- Key Takeaways
- Understanding Highly Compensated Employees
- Nondiscrimination Test
- Important Note on Compensation
- Other Considerations
- 401(k) Contribution Limits for Highly Compensated Employees
- Other Retirement Savings Options for Highly Compensated Employees
- What's a Highly Compensated Employee?
- Why Is It Important to Know If I'm a Highly Compensated Employee?
- Why Does the IRS Limit Contributions for Highly Compensated Employees?
- The Bottom Line
What Is a Highly Compensated Employee (HCE)?
Let me explain what the IRS means by a highly compensated employee, or HCE. You're considered an HCE if you meet one or both of these criteria: you owned more than 5% of the business at any point in the current or previous year, no matter your pay, or you earned over $155,000 in 2024 and ranked in the top 20% of your company's earners. That threshold goes up to $160,000 in 2025.
Key Takeaways
As an HCE, your 401(k) contributions face IRS limits. The goal here is to make sure pre-tax benefits don't favor you over others. Every 401(k) plan must pass an annual nondiscrimination test to check for equal treatment in tax perks. How much you can put in depends on how much non-HCEs participate.
Understanding Highly Compensated Employees
Being labeled an HCE means restrictions on your 401(k) contributions, and that's a downside. The IRS sets this up to prevent high earners from getting outsized tax breaks on pre-tax savings. That 5% ownership rule factors in voting power or share value, and it includes what your spouse, parents, kids, or grandparents own—but not siblings or grandkids.
For instance, if you own exactly 5%, you're not an HCE, but 5.01% pushes you over. Or if you have 3% and your spouse has 2.2%, that's 5.2% total, so you're in. Tax-deferred plans like 401(k)s aim for equality. Originally, anyone could contribute up to the max, matched by employers—$23,000 in 2024, $23,500 in 2025. But high earners benefited more from deductions, so the IRS capped them to level the field.
Nondiscrimination Test
Your company's 401(k) has to run a nondiscrimination test each year. It splits employees into HCEs and non-HCEs, then checks if contributions treat everyone fairly for tax advantages. These rules stop HCEs from hogging the benefits. If HCE average contributions exceed non-HCEs by more than 2%, or if HCEs contribute over twice the percentage of others, the plan fails.
Important Note on Compensation
If your 2025 pay tops $160,000 and you're in the top 20% by compensation, your employer might classify you as an HCE. That's up from $155,000 in 2024. This includes overtime, bonuses, commissions, and deferrals to cafeteria or 401(k) plans.
Other Considerations
When companies base contributions to defined benefit or contribution plans on pay, the IRS demands minimal gaps between HCE and non-HCE benefits. Fail to fix it, and the plan could lose tax-qualified status, forcing returns of all contributions with big tax hits for the employer. To correct, add to non-HCE accounts or distribute to HCEs, who then pay taxes on those amounts.
401(k) Contribution Limits for Highly Compensated Employees
You as an HCE can contribute up to $23,000 in 2024, rising to $23,500 in 2025, plus $7,500 catch-up if you're 50 or older.
Other Retirement Savings Options for Highly Compensated Employees
Beyond your 401(k), consider a traditional IRA for up to $7,000 pre-tax in 2024 and 2025, with $1,000 catch-up at 50+. Deductions phase out based on income if you have a work plan, but you still build tax-deferred savings.
If you have a high-deductible health plan, open an HSA. Contribute pre-tax, grow earnings tax-deferred, invest in stocks or bonds, and withdraw tax-free for medical costs.
A brokerage account isn't tax-advantaged, but you can invest unlimited amounts in things like Treasury or municipal bonds and withdraw anytime.
Deferred compensation lets you postpone salary and taxes until retirement, with no deferral limits and 401(k)-like investments. But remember, it's company-owned, so if they go under, you lose access.
What's a Highly Compensated Employee?
Per the IRS, it's you if you owned over 5% of the business in the current or prior year, regardless of pay, or if you made over $155,000 in 2024 (top 20% earners), jumping to $160,000 in 2025. These figures get updated yearly.
Why Is It Important to Know If I'm a Highly Compensated Employee?
If you are, your 401(k) contributions are capped. Exceed them, and you'll likely get a refund that's taxable.
Why Does the IRS Limit Contributions for Highly Compensated Employees?
It's to keep tax benefits fair, so high earners don't slash their taxable income more than others through bigger contributions.
The Bottom Line
If you're unsure, check with your benefits department about HCE status and your 401(k) limits. Be ready for taxes on any prior over-contributions. For example, if you're an HCE who maxed out and the plan fails the test, expect a taxable refund of the excess.
Other articles for you
Price to tangible book value (PTBV) is a ratio that compares a company's stock price to its tangible assets, offering a conservative estimate of its net value in liquidation.
The gold standard is a historical monetary system linking currency value to gold, now replaced by fiat money in all countries.
The troy ounce is a unit of measurement for precious metals, equivalent to 31.103 grams, distinct from the standard ounce and still used today in metal trading.
Variance Inflation Factor (VIF) is a statistical measure used in regression analysis to detect multicollinearity among independent variables.
An umpire clause in insurance policies allows for dispute resolution through appraisers and an umpire when the insurer and insured disagree on claim amounts.
Blockchain is a decentralized, immutable ledger technology used for secure data storage and transactions beyond just cryptocurrencies.
White-collar jobs refer to office-based administrative or managerial roles that contrast with manual blue-collar labor and often involve higher education and pay.
Private equity real estate involves pooled investments in managed funds for acquiring and owning properties, offering high returns but with significant risks and capital requirements.
A monopsony is a market dominated by a single buyer that exerts control over prices and suppliers, leading to inefficiencies similar to a monopoly but on the demand side.
Earnings per share (EPS) is a key metric that measures a company's profitability by dividing net income by outstanding shares.