HCE and Key Employees in 401(k) Plans

Defining "HCE" and "Key" in a 401(k) plan is an important step towards keeping your plan compliant. When discussing a 401(k) plan, nondiscrimination testing, or compliance, these two terms most frequently used. They are integral in maintaining the 401(k) plans qualified status.

What is an HCE?

Technically, it's not a What, it's a Who. HCEs or Highly Compensated Employees are a classification of participants in a retirement plan. An HCE is any employee who satisfies at least one of the following criteria at any time during the Plan Year:

  • Owns more than 5% of the interest in the company at any time during the year or the prior year, or
  • Any spouse, child, parent, or grandparent of such more than 5% owner employed by the company, or
  • Earned compensation in excess of $120,000, during the prior year. If the prior year was 2015, 2016, 2017 or 2018 the limit is $120,000; if the prior year is 2019, the limit is $125,000. For 2020, the earned compensation limit is $130,000. Top Paid grouping is an option within the plans design. The Top Paid group will limit the HCE count to the top 20% of all employees when ranked by compensation in the prior year.

Who are Key Employees?

Key Employees are important in determining whether or not a retirement plan, like a 401(k), is Top Heavy. A plan with Key Employee balances in excess of 60% of the total plan assets will be Top Heavy. Regulations provided in IRC §416 (IRC = Internal Revenue Code) govern the Top Heavy rules.

A Key Employee is any employee meeting at least one of the following criteria at any time during the Plan Year:

  • Owns more than 5% of the interest in the company at any time during the year or the prior year, or
  • Any spouse, child, parent, or grandparent of such more than 5% owner employed by the company, or
  • Owns more than 1% of the interest in the company AND received compensation in excess of $150,000, or
  • An officer receiving compensation in excess of $180,000 in 2019 ($185,000 in 2020); the amount in prior years was $175,000 in 2018 and $170,000 in 2015, 2016 and 2017.

A 401(k) Plan must remain qualified. A 401(k) TPA analyzes the HCE and Key employees during advanced compliance testing. To maintain its qualified status and to demonstrate nondiscrimination a plan must be tested. Qualified plans enjoy tax-deferred status (exempt from taxation) when compliant.

Uniglobal is a 401(k) TPA. Uniglobal performs advanced compliance testing on all qualified plans. Plan sponsors work with our teams to keep their retirement plan running smoothly for the benefit of the plan participants and their beneficiaries.

Original Posting Date: February 5, 2019, updated for higher limits.