Highly Compensated Employees and Key Employees

“Highly Compensated Employees” (HCEs) and “Key Employees” (Keys) are terms used to describe employees for testing purposes in the annual compliance testing of a retirement plan.

Let’s start with the definition of each:

Highly Compensated Employees:   (for plan years beginning in 2013)

• An employee who owns more than 5% of the company in the current or preceding year;
• An employee who received over $115,000 (indexed) in the preceding year;
• Certain family members of more than 5% owners due to constructive stock ownership rules.
  • Spouses, parents, grandparents, children, or grandchildren are treated as owning stock owned by their spouse, lineal ascendants (parents) or lineal descendants (children/grandchildren).

Key Employees are, at any time during the year:  (for plan years beginning in 2013)

• An officer with annual compensation in excess of $165,000 (indexed);
• A more than 5% owner;
• A more than 1% owner with annual compensation in excess of $150,000;
• Certain family members of more than 1% owners are also considered to be key employees.           

Each year it is necessary to conduct nondiscrimination and coverage testing on a plan to show the plan does not favor the HCEs or Keys over the non-Highly Compensated Employees (NHCEs) or non-Key employees.

Because of the annual testing, HCEs may find they cannot contribute as much to their 401(k) plan as they would like.   In general, the average deferral percentage of all HCEs cannot be more than 2% greater than the average deferral percentage of all NHCEs.  The “deferral percentage” is determined by dividing the employee deferrals by the employee compensation. The plan must also demonstrate that the coverage rate for the non-HCEs is at least equal to 70% of the coverage rate for the HCEs.

The Key employee definition comes into play in the “top heavy” test.  Each year, it must be determined if the plan is top heavy.  A top heavy plan is one in which the Key employees own more than 60 percent of the plan’s assets.   If the plan is determined to be top heavy, the general rule is the employer must make a minimum 3% contribution to all non-Key eligible employees employed on the last day of the plan year.    There are exceptions to this rule and we will be happy to discuss your individual plan with you.

As you can see, being able to determine the HCEs and Key employees for your plan is very important.  We rely on you, or your advisors, to report accurate and complete data to us for the plan year.   When we follow up with relationship questions, we aren’t just being nosy.  We really need to know!

If you should have questions regarding the HCEs or Keys for your plan, please contact a member of your RMS team.