There’s a magic number that can complicate your open enrollment process: $120,000.
If you earned that much or more in 2018 from a business, the IRS considers you a “highly compensated employee,” or HCE, of that company. (In 2019, the threshold will rise to $125,000.) That HCE designation also automatically applies if you owned more than 5 percent of the business at any time in that preceding year.
Further, employers can elect to consider you a highly compensated employee if your pay puts you among the top 20 percent of employees.
Becoming an HCE, however, can require extra planning at open enrollment.
Highly compensated workers are often subject to reduced contribution limits or access to certain pre-tax benefits — notably, 401(k) plans and dependent care flexible spending accounts. They may also have an opportunity during open enrollment to sign up for something called a deferred compensation arrangement, whereby the company holds a portion of their salary to be paid out at a later date.
“Don’t just assume your open enrollment choices are the same as last year,” said certified financial planner Carolyn McClanahan, director of financial planning for Life Planning Partners in Jacksonville, Florida.
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Restrictions on highly compensated workers stem from so-called non-discrimination tests, which the IRS requires retirement plans and certain benefit offerings to pass every year to maintain their tax advantages. Broadly speaking, the tests compare how HCEs and non-HCEs are making use of those programs, to ensure the highly paid workers aren’t disproportionately benefiting, said Nicole Wruck, national health leader at benefits administrator Alight.
“The burden is on the plan sponsor to make sure they pass those IRS tests,” she said.
Roughly 15 percent to 20 percent of companies curb highly compensated employees’ 401(k) contributions in some way to keep their plans from failing those nondiscrimination tests, said Rob Austin, head of research for Alight.
“What is kind of an interesting angle is, these people who are newly highly compensated,” he said. “Crossing over the threshold, it can be jarring to see the percentage of pay you can contribute drop.”
How companies handle that cutoff varies. Some plans cap highly paid workers’ contributions either upfront or at some point during the year, Austin said. About 12 percent return excess pre-tax contributions to workers as taxable pay after the plan year ends, according to the Plan Sponsor Council of America’s annual survey of profit sharing and 401(k) plans.
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