401k Limits for Highly Compensated Employees

As a highly compensated employee, your 401k limits on employer-paid contributions will be capped based on the national average. This average is called the "Average Deferral Percentage," and it tracks the average contribution from employers of tax-deferred dollars into a 401k plan. You cannot be compensated by your employer at more than 125 percent of this national average as of 2010.

Definition of Highly Compensated

A highly compensated person is defined as any individual earning more than $110,000 in 2009/2010. This limit is subject to change, but the IRS typically holds these levels steady for several years. You will be subject first to an individual contribution not exceeding a certain percentage of your income like all individuals. The second limit strictly speaks to the employer's ability to compensate you with a 401k match option.

Penalties for Over-Compensation

If your employer over compensates you, the contributions will have to be paid back to you as taxable dollars. Essentially, this penalty exists to stop employers from giving you additional compensation above-and-beyond that provided to lower income individuals in the form of non-taxable dollars. If you receive additional income from your employer, the IRS wants to assure you pay taxes on that income.