Non-highly compensated employees (NHCE)

When navigating the world of qualified retirement plans, you'll encounter the term "non-highly compensated employee," or NHCE. Understanding who NHCEs are and why they matter is fundamental to grasping how qualified plans function and maintain their tax-advantaged status. This article explains the definition, importance, and impact of NHCEs on retirement plan compliance.

Who are non-highly compensated employees (NHCEs)?

In simple terms, NHCEs are the everyday employees who form the majority of a company's workforce. They do not meet the Internal Revenue Service's (IRS) criteria for being a "highly compensated employee" (HCE). Think of them as the rank-and-file employees, the foundation of most businesses.

The IRS definition: a two-pronged test

The IRS definition of an HCE (and therefore, who is not an HCE) relies on two key factors:

1. Compensation: For 2025, an employee is an HCE if they earned more than $160,000 in the preceding year (2024). This is adjusted annually for inflation. For 2024, this was $155,000. All forms of compensation are included, such as salary, bonuses, and commissions.

If elected in the plan document, HCEs determined by compensation may be limited to the top 20% of the employer’s workforce. 

1. Ownership: An employee is also an HCE if they owned more than 5% of the company's interest at any time during the current or preceding year, regardless of compensation. This includes direct ownership and, sometimes, indirect ownership through family (family attribution rules). Under these rules, an employee is considered to own shares held by their spouse, children, parents, and, in some cases, grandchildren, potentially pushing them over the 5% threshold.

Anyone who does not meet either of these criteria is an NHCE.

Why the distinction matters

The distinction between HCEs and NHCEs isn't arbitrary. It's central to ensuring fairness and preventing qualified plans from disproportionately benefiting a company's highest earners. The IRS mandates that qualified plans benefit a broad cross-section of employees. This is accomplished through specific nondiscrimination tests, primarily the Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests, which compare the contribution rates of HCEs versus NHCEs.

The critical role of NHCEs in plan compliance

Qualified plans are subject to rigorous annual testing to ensure they don't discriminate in favor of HCEs. These nondiscrimination tests are heavily influenced by the participation and contribution rates of NHCEs. Low NHCE participation can be a major red flag.

Encouraging NHCE participation

Because NHCE participation is so vital, employers have a strong incentive to encourage it. This is about helping all employees build a secure retirement. Strategies include:

• Automatic enrollment: automatically enrolling employees (with the option to opt-out), along with other plan features, can significantly increase participation. Automatic enrollment is required for all plans effective Dec 29, 2022 and after.

• Clear communication: explaining the benefits in plain language and providing user-friendly materials is crucial.

• Financial wellness programs: offering broader financial education can help employees understand the importance of saving.

• Matching contributions: employer matching is a powerful incentive.

• Easy access and online tools: making it easy to manage accounts online is essential.

• Targeted outreach: some employers may conduct targeted outreach to specific NHCE groups.

While HCEs may get more attention, NHCEs are vital for 401(k) plan success. Their participation is a legal requirement that ensures the long-term viability and tax-advantaged status of these retirement savings vehicles. By understanding the role of NHCEs, employers and employees can work together to create a robust and compliant 401(k) plan that benefits everyone.