In general, a plan is considered to be top-heavy when more than 60% of plan assets are attributable to “key employees” as of the “determination date”. Top-heavy plans are subject to certain minimum contribution and vesting requirements.
Who is a key employee?
A key employee is an employee who at any time during the plan year: (1) owned more than 5% of the company, (2) owned more than 1% of the company and had compensation in excess of $150,000, or (3) was an officer of the company with compensation in excess of a specified dollar amount ($180,000 for 2019). Note that stock attribution rules apply when determining ownership for this purpose.
What is the determination date?
For the first plan year, the determination date is the last day of the plan year. For subsequent years, the determination date is the last day of the prior plan year. Note that top-heavy status is measured annually and may change from year to year.
How is top-heavy status calculated?
The top-heavy ratio is calculated by comparing the account balances of key employees to non-key employees, after making certain adjustments. First, certain participant balances are excluded (i.e. rollover account balances from unrelated employers; account balances of terminated participants who did not work for the company during the year; and account balances of former key employees). Next, certain amounts are added back (i.e. distributions made on account of termination, death or retirement if the participant worked for the company during the year; and in-service distributions made within the 5-year period ending on the last day of the plan year).
What are the minimum contribution requirements for top-heavy plans?
Generally, the employer must make a contribution on behalf of all non-key participants who were employed on the last day of the plan year equal to the lesser of 3% or the highest contribution rate of any key employee. Certain contributions count towards satisfying the top-heavy minimum requirement (e.g. employer matching contributions, profit sharing contributions, and forfeiture allocations). If a participant has already received an amount sufficient to satisfy the top-heavy minimum, no additional contributions must be made on their behalf.
Caution: Plans that allow for immediate entry for 401(k)/Roth purposes but have a longer eligibility period for employer contributions are still required to make top-heavy minimums for non-key participants who were only eligible for the 401(k)/Roth portion of the plan.
How is the highest contribution rate for key employees determined?
All contributions (other than rollover contributions) are considered when calculating the contribution rates for key employees. This means that 401(k) deferrals and Roth contributions are included.
What are the minimum vesting requirements?
Top-heavy plans must use either a 3-year cliff or 6-year graded vesting schedule. This requirement has little impact since most plans use vesting schedules that meet or exceed these standards.
Are safe harbor 401(k) plans exempt?
Safe harbor plans are generally not required to make top-heavy minimums if all non-highly compensated employees are eligible for the safe harbor contribution, and the employer makes no contributions to the plan other than (1) safe harbor matching contributions, (2) additional matching contributions that satisfy the safe harbor rules, or (3) safe harbor nonelective contributions.
Caution: Forfeiture allocations can trigger top-heavy minimums in safe harbor plans.
What happens if the employer doesn’t fund top-heavy minimums?
Failure to make top-heavy minimums is an operational failure that can jeopardize the qualified status of the plan. As a result, any “missed” top-heavy minimums must be funded along with related earnings.
If you have any questions regarding the top-heavy rules or would like to learn more, please contact us.