Highly Compensated Employees

"Highly compensated employee" (HCE) is a key concept in nondiscrimination testing. A retirement plan is discriminatory if HCEs are unduly favored in terms of contributions, optional forms of benefits, or other plan rights and features.

For plan years beginning after December 31, 1996, no employee is considered to be an HCE unless he or she received compensation of $80,000 or more (adjusted for cost of living) in the prior plan year. For 2007 plan years, only employees with compensation of more than $100,000 in 2006 are treated as HCEs. For employers with many highly paid employees, only the top-paid 20 percent need to be treated as HCEs for testing purposes — even if more than 20 percent exceeded the dollar limit in the prior year.

A plan covering only non-highly compensated employees (NHCEs) automatically meets all nondiscrimination requirements.

For testing purposes, you can disregard some types of employees, such as part-timers and student employees who work fewer than 20 hours a week, if no employees in the group are benefiting from the retirement plan. For an employee to be considered as benefiting from a noncontributory plan, an employer contribution must be made on his/her behalf. Under a contributory plan, an employee benefits as long as he/she is eligible for the plan, whether or not actually participating. A retirement plan is contributory if employees must contribute to the plan in order to receive a matching employer contribution.