Top Heavy
Top Heav Rules
401(k) retirement plans are a win-win vehicle for both small business owners and their employees. Offering a flexible 401(k) plan gives your business the opportunity to offer a tangible and appreciated retirement benefit to your staff. However, small business owners should be aware of potential issues that may arise as a result of complex retirement plan rules in combination with demographics of their workforce.
Quick Fact
While corporate 401(k) plans are subject to top heavy rules, the testing does not apply to not-for-profit 403(b) plans.
What is a top heavy 401(k) plan?
This test compares the account balances of key employees (described below) to those of non-key employees. If more than 60 percent of the assets of the 401(k) plan are owned by key employees, the plan is determined to be top heavy. The plan is then subject to additional requirements:
- Minimum contributions to all non-key employees.
- An accelerated vesting schedule for account balances attributable to top-heavy minimum contributions.
Who is a key employee?
Generally, key employees are the owners and officers of the plan sponsor. More specifically, a key employee is an individual, who at any time during the plan year, fits into at least one of the following classes:
- An individual who owns more than 5% of the plan sponsor or a related employer.
- An individual who owns more than 1% of the plan sponsor or a related employer AND has annual compensation exceeding $150,000.
- An officer of the plan sponsor or a related employer with annual compensation exceeding $2150,000 (indexed for future years).
How do I know if my 401(k) plan is top heavy?
- Top heavy testing is performed on an annual basis.
- For existing plans, top heavy status is determined as of the last day of the previous plan year.
- For new startup plans, top-heavy status is determined on the last day of the initial plan year.
What must I do if my plan is top heavy?
Elective deferrals contributed by a key employee are considered an employer allocation, and those contributions trigger a top heavy allocation requirement for non-key employees. When a key employee receives an employer contribution or makes a 401(k) contribution, the employer must make a minimum contribution to all non-key plan participants.
How much is the required contribution?
The mandatory minimum contribution is 3 percent of compensation to all eligible employees who are not “key” employees. Note that if the highest actual contribution to any key employee is less than 3 percent of compensation, then that is the rate to be used for the top heavy allocation.
Who must receive the top heavy minimum contribution?
IRS rules require the contribution to be made on behalf of all non-key employees who are eligible to participate in the plan and are actively employed on the last day of the plan year. The plan cannot impose a condition that a participant works a minimum number of hours to share in the top heavy minimum contribution. Note that an employee who is qualified to make 401(k) contributions must share in the top heavy minimum contribution, even if he or she chooses not to make deferrals or is otherwise not yet qualified to share in company matching.
What is the required minimum contribution requirement if the plan is a safe harbor 401(k) plan?
As a safe harbor 401(k) plan, the employer is already making a required contribution, therefore an additional contribution may not be necessary. The safe harbor contribution can do “double duty” and correct a top heavy plan.
- A safe harbor non-elective contribution of 3 percent or more will typically satisfy the top-heavy contribution requirement.
- A top-heavy safe harbor 401(k) plan designed with a matching contribution.
When is a top heavy plan exempt from minimum contributions?
- If only safe harbor contributions are made (no profit sharing contributions and no matching contributions), no top heavy contribution is required for that plan year.
- If the contributions consist of only the elective deferrals and the employer contributions necessary to satisfy the ADP (elective deferral test) and ACP (employer matching contribution test), no top-heavy contribution is required.
- If an employer makes a discretionary matching contribution that is within the ACP safe harbor requirements (less than 4% of compensation and not matching deferrals in excess of 6% of compensation), no top-heavy contribution is required for that plan year.
- If a profit sharing contribution is made, the employer must make top-heavy contributions for that year. However, all profit sharing and matching contributions can be used to satisfy the required top-heavy minimum contributions.
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NESA Plan Consultants (NESA) is a retirement plan provider working with advisors, recordkeepers and CPAs to offer customized 401(k), 403(b) and 457(b) plans. NESA offers modern solutions and provides resources to employers and employees to secure a brighter financial future.