Generously Remunerated Workers' 401(k) Plans (HCE)

High-Earnings Employees' (HIE) 401(k) Retirement Plans

One of the factors that make 401(k)s appealing is their substantial contribution limits, but these accounts might be more restrictive for certain employees than others. If you're among the highest-paid individuals at your organization, you might be classified as a highly compensated employee (HCE), which could impact the amount you're allowed to contribute to your 401(k). Here's a closer look at who constitutes an HCE and how this affects your retirement savings.

Who is considered an HCE?

An HCE is an individual who fulfills one of the following criteria:

They owned more than 5% of the company at any point during the year or the preceding year, regardless of their actual income.
They earned more than $155,000 from the business in the previous year (2024), or $160,000 in the preceding year (2025), and, if the employer makes a top-paid election, they fall within the top 20% of employees when ranked by compensation.

The first rule is relatively easy to understand, but the second rule can be somewhat complex. In many organizations, exceeding the income threshold for a given year automatically makes you an HCE. However, in other corporations, you become an HCE only if your income surpasses the limit and you are also among the top 20% of employees in terms of income.

Let's imagine a 10-person company for example:

Adam, the CEO, earns $500,000 and owns 90% of the company.
Betty earns $350,000.
Charles earns $200,000.
Danielle owns 10% of the company but earns only $70,000 annually.
Lastly, there are six other employees who earn less than $40,000 each.

In this scenario:

Adam is undoubtedly an HCE, given his ownership of more than 5% of the company and his earnings surpassing the threshold.
Danielle will also be considered an HCE due to her ownership of more than 5% of the company, despite her lower salary.
Betty and Charles will be considered HCEs only if the company chooses to make a top-paid election. In this case, the top 20% of the 10-person company would consist of Adam and Betty. Therefore, Betty remains an HCE, while Charles does not, even though his income exceeds the annual threshold.

Becoming an HCE is typically not a concern for most employees, but companies must conduct annual nondiscrimination tests to ensure that their 401(k) plans do not disproportionately favor HCEs over non-HCEs.

401(k) contribution limits for HCEs

In 2024, the maximum 401(k) contribution for individuals under 50 is $23,000, while those aged 50 and above can contribute up to $30,500. In 2025, the contribution limits for adults under 50 increase to $23,500, while those aged 50 to 59 as well as those aged 64 or older are permitted to contribute up to $31,000.

However, HCEs might not be able to contribute the maximum amount, depending on how much the non-HCEs contribute to their accounts. The company's annual nondiscrimination tests must ensure that HCE average contributions do not exceed the average contributions of non-HCEs by more than 2 percentage points. Furthermore, total HCE contributions should not exceed double the total contributions of non-HCEs.

If a 401(k) fails the nondiscrimination tests, the company must promptly address the issue, or risk losing the plan's tax-qualified status. The company can restore compliance by making additional contributions to the non-HCEs' 401(k)s or by requiring HCEs to withdraw some of their contributions.

Consider alternative retirement accounts

If your income classifies you as an HCE and you want to make the most of your retirement savings, you may consider different types of retirement accounts. Alternatively, you can open an individual retirement account (IRA), with 2024 contribution limits of $7,000 or $8,000 for individuals aged 50 or older. These contribution limits remain the same in 2025.

Additionally, you can utilize a health savings account (HSA) if you possess a high-deductible health insurance plan with a minimum deductible of $1,600 for an individual, or $3,200 for a family (2024), or $1,650 for an individual, or $3,300 for a family (2025).

Although technically not retirement accounts, HSAs offer several benefits, such as reduced taxable income, tax-free medical withdrawals, and tax-free withdrawals after age 65 for nonmedical purposes, albeit subject to income taxes.

In 2024, individuals can contribute up to $4,150 to an HSA, while families can contribute up to $8,300. For those aged 55 and older, additional contributions of $1,000 are permitted for both 2024 and 2025.

If you're out of alternatives, contemplate a tax-deductible investment account. You'll be liable to pay taxes on your deposits and profits, but if you maintain your assets for a year or more, your profits shift from income tax to long-term gains tax, which potentially saves you money.

The classification of a Highly Compensated Employee (HCE) might slightly change each year, so if you're teetering on the edge, ensure you clarify your annual 401(k) contribution limit before you start accumulating funds. Consult with your company's HR department if you're uncertain about your HCE status or permitted contribution level.

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Despite the high income, Betty might still need to contribute less to her 401(k) due to the nondiscrimination tests, as she could be classified as an HCE and her contributions may need to align with the average contributions of non-HCEs.

In light of the restrictions on 401(k) contributions for HCEs, it might be beneficial for individuals classified as HCEs to explore alternative retirement savings options, such as individual retirement accounts (IRAs) or health savings accounts (HSAs), to maximize their retirement savings.