We have found that many of our
clients have questions regarding a qualified plan’s “top-heavy”
status – questions they are sometimes afraid to ask! This
newsletter provides answers to the most common questions regarding
“top-heavy” in defined contribution (e.g., 401(k) or profit sharing)
Q1. What is a top-heavy plan?
A top-heavy plan is one in which the total of the accounts of all
key employees is greater than 60% of the total of the accounts of
all employees as of the determination date. In determining this
ratio, account balances of employees that have not performed any
service for the employer during the 1-year period ending on the
determination date are disregarded. Account balances of former key
employees and balances consisting of unrelated rollovers are also
disregarded. In-service distributions (e.g., corrective
distributions, hardships, other distributions from the plan made by
active employees) made during the 5-year period ending on the
determination date are added back into the calculation if the
participant has performed at least one hour of service during the
1-year period ending on the determination date.
Q2. What is the determination date?
The top-heavy ratio is determined on the last day of the preceding
plan year. For new plans, the determination date is the last day of
the first plan year. The ratio on this date for new plans will
determine top-heavy status for the current and following plan year.
Q3. What is a key employee?
A key employee is any employee who is an owner (or attributed owner)
of more than 5% of the company at any time during the plan year.
Additionally, owners of more than 1% who also earn greater than
$150,000 and/or officers who earn greater than $185,000 will also be considered key.
Q4. If my plan fails the ADP/ACP test, does
that mean it’s top-heavy?
No. The term “top-heavy” is often confused with ADP/ACP test
failure, but is not related to that issue. A plan may be
top-heavy without failing those tests or may fail those tests
without being top-heavy.
What can cause a plan to become top-heavy?
As discussed above, a qualified plan is considered top-heavy when
key employees own more than 60 percent of total plan assets. This
happens most often in smaller plans with low deferral rates among
non-key employees. Plans with a profit sharing allocation method
that heavily skews the contribution towards key employees (such as
new comparability or age-weighted) often end up top-heavy. Also,
for some plans, long-term non-key employees may have accumulated
larger account balances that have kept the plan from becoming
top-heavy. For the determination date in the year following the
year one or more of these employees terminates employment, the
top-heavy ratio will no longer consider their account balance in the
denominator, thus causing the percentage of assets held by key
employees to exceed 60%.
Q6. How will I know if my plan is top-heavy?
We provide your plan’s
top-heavy ratio in each year-end report. For newly top-heavy plans
or those close to becoming top-heavy, your consultant will contact
you to discuss your options.
Q7. My plan is top-heavy – now what?
There are two qualification requirements that apply to top-heavy
plan must provide minimum vesting at least as liberal as a 3-year
cliff or 6-year graded schedule. All benefits, including benefits
accrued before the plan becomes top-heavy, are subject to these
minimum-vesting requirements once the plan enters top-heavy status.
minimum contribution may be required. A profit sharing contribution
must be made for all non-key employees for a plan year in which key
employees benefit. The minimum contribution required is 3%, unless
the highest benefit received by a key employee is less than this
amount. If no key employee benefits during the plan year (i.e., no
deferrals, employer contributions, or reallocated forfeitures), no
top-heavy minimum contribution will be required for that year. For
years in which a top-heavy minimum contribution is required, all
participants employed on the last day of the year must share in the
contribution based on their full-year gross compensation,
regardless of hours worked or plan entry date.
If entry requirements for profit
sharing contributions are more stringent than those for 401(k), all
participants eligible for 401(k) must receive the top-heavy
minimum contribution. If the profit sharing contribution allocation
is greater than the top-heavy minimum, participants not yet eligible
for profit sharing will receive only the top-heavy minimum,
based on their full-year gross compensation. Under the cross-tested
allocation method, other minimum contribution requirements may
Q8. I don’t like this whole top-heavy thing.
Is there any good news?
Qualified Non-Elective Contributions
and Matching Contributions can count towards your minimum
contribution requirement. The safe-harbor non-elective contribution
generally will satisfy the top-heavy minimum contribution
requirement. Additionally, a 401(k) plan that satisfies the
safe-harbor rules and satisfies the ACP test safe harbor for
matching contributions will be exempt from the top-heavy rules as
long as no other employer contributions are made to the plan.
SIMPLE plans are not subject to the top-heavy rules, but other
restrictions do apply.
If this Q & A hasn’t answered all of
your questions regarding top-heavy plans, or has generated some new
ones, please give your consultant at MBC a call. This is by no
means a comprehensive account of all possible top-heavy scenarios.
Each qualified plan is unique, and each employer has different goals
for its plan. Different situations involving controlled groups or
aggregation of plans can affect an employer’s top-heavy status or
contribution requirements. If you have any questions or concerns
regarding your plan’s top-heavy status, it’s always best to contact
your consultant to discuss your specific situation.
The general information provided in this guide is based upon complex requirements of the Internal Revenue Code and Treasury Regulations. It is provided with the understanding that, for the purposes of this publication, MBC Retirement Services, Inc. is not engaged in rendering legal, accounting, or other professional services. Although care has been taken to present the material accurately, MBC Retirement Services, Inc. disclaims any implied or actual warranties as to the accuracy of any material herein and any liability with respect thereto.