What is a Highly Compensated Employee?
Highly compensated employees are usually limited in the amount of money they can set aside in their 401(k) plans and other retirement plans. Specifically, the federal government limits the amount of money that the HCEs at a company can contribute to 125% of the average that the non-HCE's contribute to a plan. This is to ensure that companies don't implement retirement plans solely to benefit the executives. In turn, how much HCEs can contribute to their own retirement plans is dependent on how much non-HCEs participate in the plan. Any funds that HCEs contribute in excess of that limit do not have the same tax advantages.
How Does a Highly Compensated Employee Work?
Let's say John Doe is the CFO of Company XYZ. He makes $175,000 a year. Because that compensation is over the federal threshold, John is considered a highly compensated employee.
Why Does a Highly Compensated Employee Matter?
A highly compensated employee is a person who owns 5% or more of a company, or earns more than a federally stated compensation limit (it was $115,000 in 2012). Highly compensated employees can also be those whose compensation is in the top 20% of the company.