Non-Highly Compensated Employees (NHCEs): Definition and Importance in Retirement Plans

A comprehensive guide to understanding Non-Highly Compensated Employees (NHCEs), their role in retirement plans, and how they differ from Highly Compensated Employees (HCEs).

Non-Highly Compensated Employees (NHCEs) are employees who do not meet the criteria defined by the Internal Revenue Service (IRS) for Highly Compensated Employees (HCEs). Understanding NHCEs is essential for companies that sponsor retirement plans, as regulations require certain tests to ensure equitable benefits across all employee levels.

Historical Context

The concept of NHCEs was formalized through amendments to the Employee Retirement Income Security Act (ERISA) and subsequent IRS regulations to prevent discrimination in favor of HCEs in employer-sponsored retirement plans. This ensures fairness and encourages savings among all employees.

Categories

NHCEs are typically defined by what they are not: Highly Compensated Employees. Here’s a brief overview of the HCE criteria as of 2023:

• Compensation Threshold: Employees who earned more than $135,000 in the preceding year.
• Ownership: Employees who own more than 5% of the business at any time during the current or preceding year.

Key Events

• 1986 Tax Reform Act: Introduced key reforms impacting retirement plans and initiated anti-discrimination testing.
• ERISA Amendments: Over the years, ERISA has been amended to strengthen anti-discrimination rules to protect NHCEs.
• IRS Annual Updates: The IRS periodically updates the HCE compensation threshold, impacting the classification of NHCEs.

Detailed Explanation

The inclusion of NHCEs in retirement plans is crucial for passing Non-Discrimination Tests (NDTs) such as:

• Actual Deferral Percentage (ADP) Test: Ensures that the 401(k) plan contributions of NHCEs are proportionate to those of HCEs.
• Actual Contribution Percentage (ACP) Test: Similar to ADP but includes matching and after-tax contributions.
• Top-Heavy Test: Ensures that the plan assets of key employees (HCEs and owners) do not exceed 60% of the total assets.

Importance and Applicability

Importance:

• Equity: Ensures all employees benefit from retirement plans, not just high earners.
• Compliance: Vital for companies to comply with IRS regulations to avoid penalties.
• Employee Morale: Equitable retirement plans contribute to overall employee satisfaction and retention.

Applicability:

• 401(k) Plans
• Pension Plans
• Profit-Sharing Plans

Examples

Consider a company with 100 employees, where 20 employees are HCEs and the remaining 80 are NHCEs. To pass the ADP test:

• If the average deferral percentage for NHCEs is 4%, the average for HCEs must generally not exceed 6%.

Considerations

• Regular Testing: Companies must conduct annual NDTs.
• Plan Design: Modifying the plan design to include safe harbor provisions can automatically satisfy some tests.
• Employee Education: Educating employees on plan benefits encourages participation, which can help in passing NDTs.

Related Terms

• Highly Compensated Employee (HCE): Employees who meet the IRS criteria based on compensation and ownership.
• Safe Harbor 401(k): A type of 401(k) plan that automatically meets NDT requirements if certain conditions are met.

Comparisons

• HCE vs. NHCE:
  • Compensation: HCEs earn more than the set threshold, while NHCEs earn less.
  • Plan Testing: NHCE participation rates directly impact the ability to pass NDTs.

Interesting Facts

• The distinction between NHCEs and HCEs originated to promote fairness and prevent disproportionate tax advantages for higher earners.

Inspirational Stories

Companies with equitable retirement plans often see higher employee loyalty and improved performance as employees feel valued and secure.

Famous Quotes

• Albert Einstein: “The hardest thing in the world to understand is the income tax.”
• Benjamin Franklin: “An investment in knowledge pays the best interest.”

Proverbs and Clichés

• “Save for a rainy day.”
• “Don’t put all your eggs in one basket.”

Expressions

• “Retirement readiness starts today.”

Jargon and Slang

• ADP Test: Actual Deferral Percentage Test
• ACP Test: Actual Contribution Percentage Test
• Top-Heavy: Describing a plan where key employees hold a majority of the plan’s assets.

FAQs

Why are NHCEs important in retirement plans?

NHCEs are crucial for compliance with IRS non-discrimination tests, ensuring equitable benefits across employee levels.

How does a company determine if an employee is an NHCE?

An employee is an NHCE if they do not meet the IRS’s compensation and ownership criteria for HCEs.

What happens if a plan fails the ADP or ACP test?

The plan sponsor must take corrective actions, such as making qualified non-elective contributions (QNECs) to NHCEs.

References

1. IRS Guidelines on HCE: IRS HCE Definition
2. ERISA Overview: Department of Labor

Final Summary

Non-Highly Compensated Employees (NHCEs) play a vital role in ensuring the fairness and compliance of employer-sponsored retirement plans. Understanding the distinction between NHCEs and HCEs is essential for plan administrators and company leadership to promote equity, boost employee morale, and maintain regulatory compliance.

    graph TD;
	    HCE-->ADPTest[Actual Deferral Percentage Test];
	    HCE-->ACPTest[Actual Contribution Percentage Test];
	    NHCE-->ADPTest;
	    NHCE-->ACPTest;
	    ADPTest-->PassFail[Pass/Fail Determination];
	    ACPTest-->PassFail;
	    PassFail-->CorrectiveActions[Corrective Actions if Failed];