What is it that you mean by be an high-paying employees (HCE)? It is a matter of interpretation since being an HCE is different to different individuals and organizations.
To you:
You’ve put in the effort throughout your career, aiming to climb on the corporate ladder. You are now earning a better compensation because of your expertise as well as your contribution to the success of the company and your overall knowledge.
To your employer:
Your contributions and talents are appreciated and valued enough to warrant a higher salary that will keep you in the fold.
You (and maybe your entire family) are considered the owners of over 5percent of the company.
To the Internal Revenue Service (IRS):
As is the norm like every other time, the IRS develops rules and definitions around everything financial. Below is the IRS definition of an Highly Compensated Employee (HCE):
“An person who:
* owned over 5% stake in the business at any point during the previous year regardless of the amount of the compensation that was paid or earned.
* In the previous year they received payment from the company of greater than $125,000 (if the previous year was 2019, or 130,000 if the prior year was either 2020 or 2021, and $135,000 if it was the previous year 2022) and if the employer chooses to it, ranked placed in one of the highest 20% of workers ranking in terms of pay.”
Note: There’s an exception to the 5percent ownership rule. If you and an immediate family member have a joint venture and are owned by over 5% of the property, you’re an HCE. The definition of family member is your spouse, children, and your grandchildren.
WHY DOES THIS MATTER?
The IRS is interested in keeping the track of HCEs since they want to make sure that tax-qualified employer benefits benefit everyone. They also strive to avoid bias in favor of high-paying employees. If you satisfy the requirements to be an HCE the employer will label you an HCE. This might limit the amount you are able to make contributions to the 401(k).
The tax advantages of the tax benefits of a 401(k) is so advantageous for long-term wealth building that the IRS would like to ensure everyone with any income are able to benefit from these advantages. Every conventional 401(k) plan must be able to pass a series of tests every year to ensure that plans don’t get too “top-heavy” by benefitting the HCEs owners, HCEs, as well as other employees.
WHAT’S THE LIMIT?
The HCE label isn’t meant to function as the equivalent of a “feather in your cap.” It’s more of an instrument to determine the participation rates of the pretax 401(k)s. This is important in the context of non-discrimination testing. These metrics and formulas can become complex and it’s the job of your employer to track the details when managing the traditional 401(k) for their employees.
In 2022 in 2022, for 2022, the 401(k) contribution limit for employees of $20,500 (plus $6,500 for those who are 50 or over). For an HCE the contribution amount can’t generally be higher than 2% above the amount other employees of non-HCE contribute. If the non-discrimination test is unsuccessful, amounts that are above the threshold of 2% will usually be transferred to HCE which is then taxed as earnings in the case of an HCE.
WHAT YOU CAN DO AS AN EMPLOYEE
If you’re not able to make the full amount of the 401(k) plan because of the rules against discrimination you can follow our recommended plan of savings hierarchy.
There are other savings vehicles that are tax-deductible through individual retirement plans (IRAs) or Health savings accounts (HSAs).
Pro Tips:If you’re in the position that your employer is returning a portion or all of your 401(k) contribution, think about the backdoor Roth IRA contribution strategy. The maximum contribution for 2022 is $6,000 with an additional $1,000 if you’re older than 50.
OTHER CREATIVE SOLUTIONS
Contributions to catch-up: If you’re older than 50 this catch-up benefit is available to you regardless whether you’re an HCE or a non-HCE designation. In 2022, you’ll be able to make an additional contribution of $6,500 each calendar year into the 401(k) you have. 401(k).
Concentrate on your spouse’s retirement plan: In the event that your family has a separate retirement plan from your employer that is available, you should make an effort to reach the maximum you can in your plan by registering it as an HCE and then redirect the rest of your savings to the plan of your spouse. So, your family will be able to reach the limit of $20,500 in the minimum one of your employer-sponsored retirement accounts.
Plans for deferred pay: Some companies offer deferred compensation plans, which offer similar investment options to the 401(k). The concept is to delay receiving a portion of your salary by deciding to transfer the money to be put in a deferred pay program. Then, you will be able to be paid and recognized for that amount in the years to come, as per the payout rules in your plan.
The plans are not without potential risks. In particular, the company might not be able to follow through with the plan if it encounters financial difficulties. If your employer has the option of deferred compensation make sure you review the options thoroughly.
AVOIDING DISCRIMINATION TESTING ISSUES
In order to ensure that the plan is in charge of the employees of the organization, you could continue to be an HCE however, you can contribute the entire portion to retirement account by encouraging non-HCEs into their 401(k)s. In this way, the total contribution of non-HCEs will are increased. It is hoped that the majority of your employees will increase their retirement savings, and you’ll be able to contribute more money towards the 401(k). To encourage other employees to take part and enroll every employee and educational materials to encourage participation are readily available.
SWITCHING TO A SAFE-HARBOR 401(K) PLAN
If you’re a highly paid employee, you could have some power of decision-making within your workplace. In order to be exempt from tests for compliance of an employer’s 401(k) plan the employer is able to implement what’s called safe-harbors. This means that your employer must to keep track of and offer certain match contributions to employees who are eligible.
For more information on safe-harbor plans, 401(k) providers can provide you with the pros, negatives, and the costs that come with a possible change. When you are considering bringing the idea with your boss, it’s crucial to be aware that, regardless of the size the business, there are some additional expenses are associated with safer-harbor 401(k) plans because of employer contributions that are mandatory. However administration burdens for safer-harbor 401(k) programs are easier as traditional 401(k) plans because of elimination of the requirement for discrimination tests.
STILL CONFUSED ABOUT WHERE TO SAVE?
If you’re still struggling determine the best savings vehicle, here’s an strategy guide to apply to your personal savings hierarchy.
