Everything above that is returned to them as compensation-and it is taxed. Under the ADP and ACP testing rules, the highly-compensated employee can contribute only 4%, which is based on the average of the non-HCE group rate, plus an additional 2%. The 5 employees are considered non-participating because they are eligible to participate and don’t their non-participation brings down the average. Thus, the average of those 10 eligible employees is 2% of the entire group. Of those 5 employees, each contributes 4%. Of the remaining 10, only 5 contribute to a traditional 401(k) plan. Of those 11 people, only one is considered highly compensated. Imagine your company has 11 people who are eligible to contribute to a 401(k) plan. Looking for a clear, thorough guide to the entire payroll process for small businesses? Download The Small Business Guide To Payroll In many cases, they get a refund for excess contributions, because as a general rule, highly compensated employees can’t contribute more than 2% of the average of all other employees who are eligible to participate. Oftentimes, owners try to stash away the maximum amount allowable per year, unaware they may be over-contributing to the plan. Key employees are defined as employees who own more than 5% of the business, their spouses, and lineal relatives, as well as certain shareholders and company officers. Top-heavy testing: This rule prevents plan assets of key employees to be comprised of 60% or more of the total assets in the plan.ADP and ACP testing: These special non-discrimination rules ensure that deferrals made by HCEs are not disproportionate to deferrals made by non-HCEs.The Problem With Traditional 401(k) PlansĪ traditional 401(k) plan limits business owners, company officers, and high wage earners, often referred to as highly compensated employees (HCEs) in how much money they can contribute to the plan. Here’s why this happens, and what you may elect to do instead. Sometimes, the traditional 401(k) plan doesn’t end up providing you the full benefit you’d hoped for. If you’re a small business owner interested in starting a 401(k) plan for your employees, you already understand how they will benefit, but you should also understand how the plan will affect you.

Safe harbor 401k rules