Highly Compensated Employee Contribution Curtailment
(Employee Communication)

Summary

Use this template to communicate with employees that they are designated "highly compensated employees" for the relevant plan year and that their contributions to the 401(k) plan in which they participate may be limited as a result. This template includes practical guidance, drafting notes and an optional paragraph. Determining who among eligible employees in a retirement plan is considered a "highly compensated employee" (HCE), as that term is defined in I.R.C. § 414(q), is one of the most important factors in maintaining retirement plan compliance. HCE status matters in nondiscrimination testing under I.R.C. § 401(a)(4). It is especially important in a 401(k) plan that has any non-safe harbor plan feature as the impact of failing nondiscrimination testing under sections 401(k)(3) and 401(m)(2) (aka, ADP and ACP testing) can not only limit plan contributions (and matching contributions) for the affected HCEs. See Treas. Reg. §§ 1.401(k)-2, 1.401(m)-2 for discussions regarding the ADP (actual deferral percentage) and ACP (Actual contribution percentage, tests) and see Employee Benefits Guide § 26.12, "Nondiscrimination Testing". It can sour those employees if a return of contributions comes unexpectedly if the plan fails the ADP/ACP tests and chooses to return contributions to HCEs in accordance with Treas. Reg. §§ 1.401(k)-2(b)(1)(i)(B), (b)(2). Other avenues for the employer are to make additional contributions for non-HCEs or to recharacterize them. Treas. Reg. §§ 1.401(k)-2(b)(1). In general, an employee will be an HCE based on compensation if the employee's annual compensation in the lookback year was $150,000 or more (if the preceding year is 2023). See I.R.C § 414(q)(1)(B) and see Cost of Living Adjustments Chart for Employee Benefit Plans for the indexed limit for any year. Instead of risking failure of the ADP/ACP tests for any non-safe harbor feature in a 401(k) plan, the plan may permit the employer to place a limit on the percentage of compensation that any HCE can contribute to the plan, for any plan year, to optimize satisfaction of ADP/ACP testing for that year. This assumes it is a non-safe harbor plan feature and is usually based on prior plan year ADP/ACP testing experience. The plan administrator should be proactive in communicating to employees both (1) that they will be treated as HCEs for the plan year, and (2) that their contributions to the plan may (or will) be limited in some way. Use this template to provide such notification. The plan's summary description should warn eligible employees that the plan is permitted to place this limit on contributions by HCEs for any plan year. For a discussion of nondiscrimination testing in a 401(k) plan, see Employee Benefits Guide § 26.12, "Nondiscrimination Testing" and 401(k)ology: Highly Compensated Employees. For a discussion of 401(k) plans, see 401(k) Plans: Understanding the Rules. For a discussion regarding disclosure rules for nonparticipating employees, see Employee Benefits Guide § 26.15, "Special Disclosure Rules for Nonparticipating Eligible Employees." For a plan clause that defines the term "highly compensated employee" see Definition of Highly Compensated Employee (Qualified Retirement Plan).