Do you understand the term Highly Compensated Employee, or Non-Highly Compensated Employee?

It’s important to understand these concepts in order to understand the different types of contribution limits that are set in 401k plans.

Since these are a mouthful to say, you can simply say HCE or NCHE instead. What’s the difference between these two and why does it matter?

First, the difference: If you made $110,000 or more in 2011 you will be considered a highly compensated employee (HCE) for 401k testing purposes in 2012. If you made $109,999.99 or less in 2011, you are considered a non-highly compensated employee (NHCE) for testing purposes in 2012 (plans always “look back” at your previous year’s salary to determine which group you fall into for the current year-this is also known as the look-back year. How original, huh?).

This distinction matters tremendously.

Remember that we said 401k plans are supposed to be fair and equitable for everyone, regardless of how much they make (see the 401k contribution limits overview for a refresher).

Obviously someone who is a HCE will be able to contribute more to the plan than someone who is a NHCE. But the testing that plans go through each year ensures that a HCE cannot benefit from the plan disproportionately to the NHCE’s. In other words the testing provides assurance that the plan is not discriminating in favor of highly compensated employees (hence the name non-discrimination testing).

As such, employees are divided into these two separate groups when the plan goes through testing. It is important to understand the distinction between the Highly Compensated Employee group and the Non-Highly Compensated Employee group as it will help you make sense of the various 401k contribution limits we discuss in this section of the website.

One more thing regarding highly compensated employees: even if you don’t make enough to cross the threshold level for a highly compensated employee, you can still be considered one if you are either a)an officer of the company you work for, or b)you own 5% or more of the business.

Generally, of course, if you are either one of these, you probably do make more than $110,000. However, if you work for a small company, you may not.

In any case, remember the term HCE is not only reserved for those making the big bucks.