Certified Plan Sponsor Professional (CPSP) Practice Exam

How is a Highly Compensated Employee (HCE) defined in the Internal Revenue Code?

1. Employees who earn above a set threshold only

2. More than 5% owners and employees who earned above the applicable limit

3. Only owners of the stock of the plan sponsor

4. All employees of the plan sponsor

The correct answer is: More than 5% owners and employees who earned above the applicable limit

A Highly Compensated Employee (HCE) is defined in the Internal Revenue Code as individuals who meet specific criteria, particularly regarding their compensation and ownership status. This definition includes employees who are more than 5% owners of the company, as well as employees whose compensation exceeds a certain threshold, which is adjusted annually for inflation and specified by the IRS. By including both ownership status and compensation levels, this definition helps ensure that the tax advantages associated with retirement plans primarily benefit employees who have significant influence over the company's operations or who are in a high compensation bracket. This dual criteria approach is crucial for ensuring equitable treatment of employees in a retirement plan context and for compliance with nondiscrimination rules under the Internal Revenue Code. The focus on ownership and compensation helps to differentiate HCEs from the general employee population, ensuring that retirement plan benefits are not disproportionately skewed towards higher earners or those with more control over the company's financial decisions. Other definitions provided do not encompass the comprehensive criteria outlined by the IRS, thus lacking the necessary components that define an HCE accurately.