Beyond 401k for Highly Compensated Employees

For highly compensated employees, the traditional 401k plan may not be the most effective way to save for retirement. The current tax law limits the amount that can be contributed to a 401k plan, which can be a significant obstacle for those with higher incomes.

In 2020, the IRS set the limit for 401k contributions at $19,500. This may not be enough for highly compensated employees who need to save more for retirement. Additionally, the 20% tax deduction on 401k contributions may not be as beneficial as it seems, as it only reduces the amount of taxable income, not the overall tax liability.

Some highly compensated employees may find that alternative retirement plans, such as deferred compensation plans or executive compensation plans, offer more flexibility and benefits. These plans can provide a more tailored approach to retirement savings, taking into account the individual's unique financial situation and goals.

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Employers have several options to help highly compensated employees save for retirement without creating new problems. For defined contribution plans in 2025, anyone earning over $160,000 is considered a Highly Compensated Employee (HCE).

Cash balance plans are a great alternative, combining high contribution limits with flexibility and portability. Each eligible participant has an account that grows from both an employer contribution and a guaranteed interest credit. Business owners can save significantly on corporate and personal taxes, and many owners can double or even triple their pre-tax retirement savings.

Employers can also consider Nonqualified Deferred Compensation (NQDC) plans, which are typically used by companies to actively retain and reward key employees. These plans are exempt from nondiscrimination and top-heavy testing rules, allowing for more flexibility in participation eligibility.

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Cash balance plans can be a great option for business owners who want to attract and retain top talent. These plans combine the benefits of a traditional defined benefit plan with the flexibility of a 401(k) plan.

Business owners who are likely to benefit from cash balance plans include those who have a principal seeking a tax deduction of over $66,000 in 2023, or those making over $265,000 per year. Highly profitable businesses, family-owned or closely held companies, and professional services firms such as CPAs, law firms, or medical groups may also be a good fit.

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One of the advantages of cash balance plans is that they can help business owners save significantly on corporate and personal taxes. Many owners can even double or triple their pre-tax retirement savings. This can make a firm's retirement package much more appealing to future partners and employees.

Business owners can customize the contribution amounts for different participants or groups of employees, which can be a competitive advantage in attracting top talent. Participants can also roll over their cash balance accounts into an IRA or another qualified plan when they leave the company.

Here are some business types that might be a good fit for cash balance plans:

In 2025, anyone earning over $160,000 is considered a Highly Compensated Employee (HCE) in defined contribution plans. Employers can help higher-paid employees save more for retirement by exploring various options.

To ensure compliance, employers need to work with their 401(k) provider's compliance team to evaluate these options. The maximum contribution from all sources is $70,000, and any compensation over $350,000 is not considered in any plan calculations.

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Employers have several arrows in their quiver to help higher-paid employees, including creating a performance-driven environment or a transition plan for successors. This can be done by offering a bonus structure for key personnel that defers their taxes until retirement and potentially a lower tax bracket.

Employers may also want to consider offering additional incentives and benefits not available with qualified plans. For example, they can create a Nonqualified Deferred Compensation (NQDC) plan to actively retain and reward key employees.

Here are four types of nonqualified plans:

These plans offer benefits such as longer-term employment commitments to the company, deferred assets that remain a part of the company's assets, and more flexibility in participation eligibility.

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Highly Compensated Employees are subject to special rules when it comes to retirement benefits. They must be identified by employers to comply with IRS nondiscrimination testing.

The IRS defines an HCE based on income and ownership criteria. Officers making over $160,000 in 2025 qualify as HCEs.

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Compensation doesn't just include your regular paycheck, but also overtime, bonuses, commissions, and deferred salary contributions. Your employer can designate you an HCE if you rank among the top 20% of employees in terms of compensation.

Ownership also includes shares held directly or indirectly through family attribution rules. This means you can be classified as an HCE due to stakes held by a spouse, children, or parents.

The 5% rule requires that 401(k) plan participants who are more than 5% owners of the employer must start required minimum distributions (RMDs) by April 1 of the first year after the calendar year in which the participant reaches age 73.

Here's a breakdown of the HCE income and ownership criteria:

For highly compensated employees (HCEs), traditional 401(k) plans may not be the most effective way to maximize retirement savings. HCEs can still contribute to a 401(k) as much as their employer will allow without penalty, but other options may be more beneficial.

Cash balance plans are a good alternative, offering high contribution limits and flexibility. This type of plan combines the benefits of a traditional defined benefit plan with the portability of a 401(k) plan, making it a great option for principals seeking a tax deduction of more than $66,000 in 2023 or making more than $265,000 per year.

To take advantage of cash balance plans, business owners can specify different contribution amounts for different participants or groups of employees, making it a competitive advantage in attracting talented employees. Participants can also roll over their cash balance accounts into an IRA or another qualified plan.

Business owners can save significantly on corporate and personal taxes with cash balance plans, and many owners can double or even triple their pre-tax retirement savings. This makes a firm's retirement package much more appealing to future partners and employees.

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Highly compensated employees (HCEs) have access to various retirement account options beyond the traditional 401(k). They can contribute up to the allowed amount to a 401(k) without penalty.

A 401(k) might not be enough to maximize retirement savings, so consider other options. Nonqualified Deferred Compensation (NQDC) plans are used by companies to retain and reward key employees, often high-level leadership. These plans come in four types: Executive bonus plans, Group carve-out plans, Deferred-compensation plans, and Split-dollar life insurance plans.

NQDC plans offer benefits such as creating a performance-driven environment, deferring taxes until retirement, and providing additional incentives and benefits not available with qualified plans. They also create longer-term employment commitments to the company, as benefits are realized in the future or forfeited if certain conditions aren’t met.

Cash balance plans, or hybrid plans, combine the high contribution limits of traditional defined benefit plans with the flexibility and portability of a 401(k) plan. Business owners can save significantly on corporate and personal taxes, and many owners can double or even triple their pre-tax retirement savings.

Businesses that might be a good fit for cash balance plans include principals seeking a tax deduction of more than $66,000 in 2023, highly profitable companies, family-owned or closely held businesses, and professional services firms. The benefits of cash balance plans include making a firm’s retirement package more appealing to future partners and employees, and allowing participants to roll over their cash balance accounts into an IRA or another qualified plan.

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As an HCE, you're probably aware that your 401(k) contributions are subject to certain rules to ensure they don't unfairly benefit you at the expense of lower-paid employees.

Employers conduct annual nondiscrimination tests, such as the Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests, to compare your contributions to those of non-highly compensated employees (NHCEs).

If your contributions exceed the permitted ratios, you may need to take corrective action, such as having excess contributions refunded or adjusting employer match allocations.

These tests are designed to prevent HCEs from dominating the plan, and if you're found to be in non-compliance, you may face penalties or fines.

Employers are responsible for conducting these tests and taking corrective action if necessary, so it's essential to work with your HR department to ensure your plan is in compliance.

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Contributing to a 401(k) can be a good idea for HCEs, especially if they haven't reached the contribution limit. The IRS considers a plan "top-heavy" if the owners and key employees own more than 60% of the plan assets, which can lead to the employer having to pay a minimum 3% benefit into non-key employees' accounts.

However, HCEs can avoid top-heavy testing by creating a safe harbor 401(k) plan. To qualify, the plan must receive minimum safe harbor contributions or elective deferrals.

Safe harbor 401(k) plans are exempt from nondiscrimination tests, which is a big advantage. In exchange, the business owner must offer a minimum employer match, which can be one of three types: non-elective, basic, or enhanced.

Here are the details of each type of match:

Employer matches under a safe harbor 401(k) must vest immediately, meaning employees receive the money right away and aren't required to work for the company for a certain period.

As a highly compensated employee, you may face complications and considerations when exploring alternatives to a 401(k). You can still contribute to a 401(k) as much as your employer will allow without penalty.

One complication is that you may need to consider the tax implications of your retirement savings. You may want to look at ways to maximize your retirement savings beyond a 401(k), such as other retirement accounts.

Another consideration is that you may not be able to contribute as much to a 401(k) as you would like, due to the contribution limits for highly compensated employees. Nonetheless, you can still contribute as much as your employer will allow.

You may also need to consider the fees associated with alternative retirement accounts, which can eat into your retirement savings. Let’s explore some options below.