Understanding highly compensated employees within 401ks
HCE is defined as being above 120k$ or in the top 20 % of the company. The exact cutoff point might be different for each company. Typically, only the base salary is considered for that, but it's the company's (and 401(k)-plan's) decision. The IRS does not require HCE treatment; the IRS requires that 401(k) plans have a 'fair' distribution of usage between all employees. Very often, employees with lower income save (over-proportionally) less in their 401(k), and there is a line where the 401(k) plan is no longer acceptable to the IRS. HCE is a way for companies to ensure this forced balance; by limiting the amount of 401(k) savings for HCE, the companies ensure that the share of all contributions by below-HCE is appropriate. They will calculate/define the HCE cutoff point so that the required distribution is surely achieved. One of the consequences is that when you move over the HCE cutoff point, you can suddenly save a lot less in your 401(k). Nothing can be done about that. See this IRS page: https://www.irs.gov/retirement-plans/plan-participant-employee/definitions Highly Compensated Employee - An individual who: Owned more than 5% of   the interest in the business at any time during the year or the   preceding year, regardless of how much compensation that person earned   or received, or For the preceding year, received compensation from the   business of more than $115,000 (if the preceding year is 2014;   $120,000 if the preceding year is 2015 or 2016), and, if the employer   so chooses, was in the top 20% of employees when ranked by   compensation. There are some nuances with HCE definition. To answer your questions. It's compensation as defined by the plan. Usually it's gross comp, but it can exclude things like fringe benefits, overtime pay, commissions, bonuses, etc. The compensation test is also a look-back test, meaning that an EE is determined to be an HCE in the current year if their compensation in the previous year was over the limit. I'm not sure how stock options affect this, but I expect they would be counted. Probably have an ESOP plan at that point too which is a whole other can-o-woms. The 5% owner test applies to the current year and also has a one-year look-back period. If at ANY point, even for a day, an employee was more than 5% owner, they are HCE for that year and next. Yes there is a limit. A company may limit the amount of HCE's to the top 20% of employees by pay like Aganju said. They can also disregard employees that may otherwise have been excluded under the plan using statutory exclusions. Example, they can disregard employees under 21 years and with less than 1 year of service. Hahaha, the IRS does not like to concisely define things. You can look here, that's probably as concise as you'll get. Hope this helps!
This is an old question that has an accepted answer, but it has gotten bumped due to an edit and the answers given are incorrect. I am assuming this means that every other Friday, the company is going into the open public market, buying those shares and then giving it out to the employees. No. Companies will internally hold shares that it intends to offer employees as additional compensation. There are no open market transactions, so the market price of the stock does not change (at least not due to buying pressure).  The only net effect is an equivalent expense for the compensation, but that should already be accounted for in the share price as normal operating expenses. These share may come through an initial buyback from the market, but more common is that when companies issue new shares they keep some internally for exactly this situation.  If they issued new shares every pay period, it would dilute the existing shares several times a quarter which would be difficult to account for. IRAs were invented to help individuals save for retirement. 401(k)s were invented to help corporations provide more compensation to highly valued employees. Let me add another consideration to the company's side of the equation.  Not only is a 401K a tool for the company to make them competitive when recruiting employees among other companies that offer that benefit, it is also a good retention tool. Most company's 401K plans include a vesting period of at least 3 years, sometimes more. An employee that leaves the company before they are vested in the plan will have to give up some % of the employer matched funds in the account. This gives employees incentive to stick around longer and the company reduces the risk of turnover which can be costly in terms of training and recruiting. This also factors into the reason why employers would rather give matching on the 401K than a simple pay raise. Some of those employees are going to leave during the vesting period anyway, and when that happens the employer got the benefit of motivating (extrinsically) the employee, but in the end got to keep some of the money. I use the self-directed option for the 457b plan at my job, which basically allows me to invest in any mutual fund or ETF. We get Schwab as a broker, so the commissions are reasonable. Personally, I think it's great, because some of the funds offered by the core plan are limited. Generally, the trustees of your plan are going to limit your investment options, as participants generally make poor investment choices (even within the limited options available in a 401k) and may sue the employer after losing their savings. If I was a decision-maker in this area, there is no way I would ever sign off to allowing employees to mess around with options. Stated plainly... it's a benefit. Companies are not required to offer you any compensation above paying you minimum wage. But benefits attract higher quality employees.  I think a big part of it is that it is the norm. Employees want it because of the tax benefits. Employees expect it because almost all reputable companies of any significant size offer it. You could run a great company, but if you don't offer a 401k plan, you can scare away good potential employees. It would give a bad impression the same way that not offering health insurance would. My understanding is that to make the $18,000 elective deferral in this case, you need to pay yourself at least $18,000.  There will be some tax on that for social security and Medicare, so you'll actually need to pay yourself a bit more to cover that too. The employer contribution is limited to 25% of your total compensation.  The $18,000 above counts, but if you want to max out on the employer side, you'll need to pay yourself $140,000 salary since 25% of $140,000 is the $35,000 that you want to put into the 401k from the employer side. There are some examples from the IRS here that may help: https://www.irs.gov/retirement-plans/one-participant-401-k-plans I know that you're not a one-participant plan, but some of the examples may help anyway since they are not all specific to one-participant plans. Employer matches (even for Roth 401Ks) are put into traditional 401K accounts and are treated as pre-tax income.  Traditional 401K plans are tax deferred accounts, meaning you won't owe any taxes on it this year, but will have to pay taxes on it when you take the money out (likely after retirement). 401K contributions (including the match) are reported to the IRS and are entered in box 12 on the W2 form. It's not a 60% raise. He made 60% more than the previous year. There's lots of things that could account for that. One of them is an annual bonus that was larger than his previous annual bonus - the calculation of that bonus was likely negotiated as part of his contract.  A large chunk of the gains seems to be between that and stock/option awards. Often stock/option vest differently in the first year than remaining years, and the value changes over time as the stock market moves. If you have options granted with a strike price set based on the closing price of stock the day you start, and you cash them out as you get them, after a year if it's gone up 5% you make a bit. After the second year if it's gone up 10%, you doubled your income from that source even though you didn't receive any more options that year.  His salary raise doesn't seem out of line. I've gotten larger raises in my career.  Now... suppose all of his compensation was spread out evenly across all of the employees. CAT has a bit over 100K employees. His total compensation was $16M 16M / 100K = $160. You could give every employee $160/yr more for the cost of the CEO's entire compensation package. That comes out at 7-8 cents/hour. If you only do it with his raise and not the one time bonuses and returns from stock/option grants well... $3/employee/yr.  The best way to invest in people is to offer training to help them move to higher value jobs. Things like tuition reimbursement programs based on maintaining good performance in classes are solid benefits to offer. Or even job training to those who show aptitude for different classes of work. Maybe some merit based bonus structure - people who come up with good ideas for cutting costs, improving efficiency, etc and work to see them implemented qualify for some sort of bonus based on a percentage of the value of that change.  The bigger problem with those types of programs is that collective bargaining agreements tend to forbid any sort of merit based pay. They also make jumping line in seniority impossible - i.e. the union agreement would say that the person most qualified for the extra training is the one who's been in the job the longest. Some of these rules make sense if your goal is that everybody is equal and your idea of fairness is based on avoiding inequality. To justify it, they'll throw up things like the boss's cousin's brother-in-law's ex-wife's son could get preferential treatment if the contract doesn't prevent it.