Highly Compensated Employees (HCEs) are individuals in a business who are at the top of the income ladder. They usually earn more than $130,000 in compensation as well as owning at least 5% of a business. It is important to understand that an eligible HCE has to make annual contributions to their 401(k) plan to take advantage of the full tax benefits available.

The IRS limits on the amount of contributions that HCEs are allowed to make is designed to ensure that everyone who participates in a 401(k) plan receives the same benefit in regards to pre-tax advantages. To this effect, all 401(k) plans must annually pass a nondiscrimination test that helps to verify if all employees are being treated equally.

The maximum contribution amount that an HCE can make is based on the nondiscrimination test results as well as the level of non-HCE participation in the plan. If a plan fails the nondiscrimination test, the IRS could require the employer to redistribute some of the pre-tax contributions allocated to HCEs to other employees. The employer or plan sponsor may also be liable for additional taxes associated with nondiscrimination failures.

HCEs should keep an eye on their plans' nondiscrimination tests results, which should be reported to them annually. Being informed of the test results will help them to know their contribution limits and adhere to them.

The ability to contribute more pre-tax money to their 401(k) plan is a major benefit for HCEs. Therefore, it is essential that HCEs understand the rules and regulations associated with their plan to avoid any unwanted tax liabilities in the future.