The Pension consultants at Planmark regularly receive calls on a broad array of technical topics related to qualified retirement plans. A recent call with a plan sponsor in Norcross is a commonly asked question about Plan Audits. The plan sponsor asked:
“Who is considered a “key employee” and a “highly compensated employee” for purposes of plan testing?”
The definitions of highly compensated employees (HCEs) and key employees are used for nondiscrimination testing purposes in demonstrating the benefits that these employees receive in a plan are not disproportionately more favorable than those paid to rank-and-file employees.
The HCE definition is used in tests for minimum coverage, actual deferral percentage (ADP) and the actual contribution percentage (ACP) tests. The key employee definition is used in the “top-heavy” test.
To add to the confusion, there can be situations where an employee is an HCE but not a key employee and vice versa. When the plan testing requires contributions to non-HCEs or non-key employees you can have what seems to be contradictory results.
The following table provides a side-by-side comparison of HCE and key employee definitions. The salary amounts are subject to change each year as published by the IRS.
|Definition||· More than 5% owner during the determination year or look-back year1
· Receives compensation during the look-back year in excess of the annual threshold (An employee who earned more than $120,000 in 2016 will be considered an HCE in 2017)2
|For the plan year
· An officer with annual compensation greater than the threshold amount (($170,000 for 2016; $175,000 for 2017)
· A more than 5% owner
· A 1% owner having annual compensation of more than $150,000
|Test||Minimum coverage: Compares the percentage of HCEs benefiting under the plan to the percentage of non-HCEs benefiting under the plan||Top Heavy: Determines whether key employees own more than 60% of the total assets in the plan.|
|Test||Actual deferral percentage (ADP): Applies to salary deferrals; to pass the test the ADP of the HCE group may not exceed the ADP of the non-HCE group by 1.25% or 2 percentage points|
|Test||Actual contribution percentage (ACP): Applies to matching and after-tax contributions; To pass the test, the ACP of the HCE group may not exceed the ACP for the non-HCE group by 1.25% or 2 percentage points.|
- The determination year is the plan year; and the look-back year is the 12-months preceding the plan year.
- The employer could also require the subset of employees to be among the “top-paid group”, which is the top 20% of the highest paid employees.
The Resource Desk is staffed by the pension experts at Planmark Financial Group, Inc., a third-party plan administration firm. Any information provided is for informational purposes only. It cannot be used for the purposes of avoiding penalties and taxes. Planmark does not provide tax or legal advice.
Consumers consult with their tax advisor or attorney regarding their specific situation.