TOP HEAVY PLAN INFORMATION SHEET
If your plan is “top heavy” then certain rules apply. This memo outlines those rules, and your responsibilities. Accelerated vesting and minimum contributions are required during years your plan is top heavy. Article IX of our Plan Document provides further details.
What does the term “top heavy” mean? Your defined contribution plan is “top heavy” when 60% of the assets or more are in the accounts of Key Employees.
Who is a Key Employee? Key employees own more than 5% of the company, or are directly related to the owner (spouse, children or parents). Officers of the corporation who earn more than $160,000 (as indexed each year, $160,000-2008 & 2009), or 1% shareholders who earn over $150,000 are also Key Employees.
How do I know if my plan is top heavy? We determine the top heavy status of your plan each year. Check the Notes section on the cover letter sent with your Annual Administrator’s Report.
When is the top heavy status determined? We check the account balances on the last day of the plan year. If more than 60% of those assets are in Key Employee accounts, then the plan is considered top heavy for the following plan year. If this is the first plan year, then the last day of the first plan year is the determination date for both the first and second plan years.
Do all assets count in making the top heavy determination? No. Rollovers from unrelated plans, and employer contributions that have not yet been deposited as of the last day of the plan year can be disregarded from the testing formula.
If a participant ceases to be a Key Employee, how does that affect the top heavy test? If a participant resigns as an officer of the corporation, or fails to meet the compensation requirement for a 1% owner or officer, the participant is considered non-key employee. If at any time during the plan year a participant owned more than 5% of the company stock, they are considered a key employee for that plan year.
What if a Key Employee takes a withdrawal from the plan? The withdrawal of a key employee’s assets will impact the test two years after the withdrawal. We must add back to the testing formula the amount withdrawn for both the year of the withdrawal and the year after the withdrawal. For example, if a Key Employee withdraws his account balance in 2006, the impact will not be seen until 2008.
Vesting: For years that a plan is top heavy, the plan must conform to the top heavy vesting schedule as outlined in the plan document. This schedule must be no longer than a 6-year graded schedule (20% after 2 years of service, and 20% each additional year), or a 3-year cliff vesting schedule (100% after 3 years of service).
Employer contribution required: For years that the plan is top heavy the employer must make a “top heavy minimum contribution” to the non-key employees. This minimum contribution is equal to the lesser of:
- 3% of compensation; or
- a percentage equal to the highest allocation made to any Key Employee;
- Key Employees may also receive a top heavy minimum contribution.
- The top heavy minimum contribution may be Integrated with Social Security if allowed by the plan document.
- Participants who terminated service during the year do not have to receive a top heavy minimum contribution.
- Safe Harbor contributions, matching contributions or Qualified Non-Elective Contributions (QNEC) may be applied to satisfy top heavy minimum contributions.
SAFE HARBOR
Can a safe harbor 401(k) plan be exempt from the top-heavy rules?
Yes. If the plan, for a plan year, has only elective deferrals (which are under the ADP safe harbor), and nonelective contributions and/or matching contributions that satisfy the ADP and ACP safe harbors, the plan is not top-heavy. If, in addition to the deferrals and safe harbor contributions, the plan allocates a profit sharing contribution (other than a safe harbor nonelective contribution) or allocates forfeitures as a profit sharing contribution, the plan is not exempt, and the top-heavy rules will apply. The top-heavy exemption applies on a plan year-to-plan year basis. For example, the plan may be exempt from the top-heavy rules in one plan year when the plan only has elective deferrals and a safe harbor match, and then be subject to the top-heavy rules in the next plan year, when the employer makes a profit sharing contribution.
If an employer amends mid-year a safe harbor 401(k) plan that qualifies for the top-heavy exemption to eliminate or reduce (“exit”) the safe harbor match, will the plan lose its top-heavy exemption?
Yes. The top-heavy exemption only applies if the plan qualifies as a safe harbor 401(k) plan for the entire plan year. If the plan loses its top-heavy exemption during the plan year, the employer must satisfy the top-heavy rules for the entire plan year.
If an employer terminates mid-year a safe harbor 401(k) plan that qualifies for the top-heavy exemption, will the plan lose its top-heavy exemption?
Generally yes. Usually, a safe harbor 401(k) plan that terminates mid-year loses its safe harbor 401(k) plan status and thus its top-heavy exemption. However, if the plan termination is because: (1) the employer incurs a substantial business hardship that satisfies the pension plan funding waiver requirements; or (2) the employer is involved with an acquisition or disposition that satisfies the requirements of Code §410(b)(6)(C), the plan will retain its safe harbor 401(k) plan status and its top-heavy exemption for the plan year of termination.
If an employer freezes a safe harbor 401(k) plan mid-year, will the plan be able to cut off the compensation on which the plan calculates the top-heavy minimum contribution as of the freeze date?
No. Freezing the plan does not cut off the compensation for determining the top-heavy minimum contribution as of the freeze date. The plan is ongoing even though contributions have stopped. The top-heavy minimum will be the lesser of: (1) 3% of compensation for the plan year; or (2) the highest key employee contribution rate for the plan year. The key employee contribution rate for a plan year is the key employee’s employer contribution plus forfeiture allocations (including elective deferrals) for the plan year divided by the key employee’s compensation for the plan year. Compensation for purposes of the key employee contribution rate and top-heavy minimum is 415 compensation (“gross” compensation) for the entire plan year.
What is the difference between freezing a safe harbor 401(k) plan and terminating the plan?
When an employer freezes a safe harbor 401(k) plan, it amends the plan to eliminate the employer and employee contributions to the plan. Nevertheless, the plan continues and it is considered a “frozen plan.” As a frozen plan, the employer must continue updating the plan for law changes and must continue filing annual reports with the government. If there is a substantial discontinuance of contributions, then all participant accounts are fully vested. An employer could partially freeze a plan by eliminating some contributions but retaining other contributions (e.g., freezing the employer contributions but retaining the elective deferrals). On the other hand, when the employer terminates a plan, the employer not only amends the plan to eliminate the plan contributions but also provides for complete distribution of all plan assets. The IRS has ruled that it will honor a designated plan termination date as long as the plan completes distribution within a reasonable period of time following the termination date. Generally, the IRS considers a year following the termination date as reasonable. If the plan files for a determination letter (Form 5310) shortly after the termination date, the reasonable period of time would be extended while the application is pending. If a plan does not complete distributions within a reasonable period of time following termination, the IRS considers the plan a frozen plan rather than a terminated plan. In such a case, the employer would need to amend the plan for law changes which occurred after the termination date. Of course, all accounts are fully vested upon termination.
If an employer terminates a safe harbor 401(k) plan mid-year, will the termination cut off the compensation on which the plan calculates the top-heavy minimum contribution as of the termination date?
Yes. If an employer terminates a safe harbor 401(k) plan mid-year, the plan will determine the top-heavy minimum on compensation up to the termination date.
The following example illustrates the costs the employer should consider in deciding whether to freeze, terminate or continue a safe harbor 401(k) plan which is top-heavy.
Example: KM, Inc. maintains a safe harbor 401(k) plan (top-heavy exempt) with a safe harbor match of 100% of elective deferrals not exceeding 4% of compensation. The troubled economy is causing KM to reevaluate its expenses, including its safe harbor 401(k) plan contribution. KM is considering three options: (1) freeze the plan; (2) terminate the plan; or (3) continue the plan but have the two doctors terminate their deferral elections to reduce the cost of their match. The example assumes that if KM continues the plan, deferrals for the doctors would stop as of 3/31, but for the other employees would continue at the same rate through the end of the plan year. The “Additional Match” column shows the additional matching contributions the deferring employees would receive after 3/31 if the plan continues through the end of the plan year. The amounts in the top-heavy columns represent the additional contribution KM would need to make to satisfy the top-heavy minimum contribution requirement. The example illustrates that because of the top-heavy minimum contribution, KM would save $1,000 by continuing the plan as a safe harbor 401(k) plan rather than freezing the plan and having to satisfy the top-heavy rules for the plan year. Of course, terminating the plan would be the most cost effective.
|
|
Comp
|
Comp (to 3/31)
|
Deferrals (to 3/31)
|
Match (to 3/31)
|
Additional Match (plan not frozen)
|
TH min (plan continues)
|
TH min (frozen 3/31)
|
TH min (plan terminates 3/31)
|
|
Dr#1
|
200,000
|
50,000
|
5,000
|
2,000
|
0
|
0
|
0
|
0
|
|
Dr#2
|
200,000
|
50,000
|
3,000
|
2,000
|
0
|
0
|
0
|
0
|
|
Ann
|
50,000
|
12,500
|
625
|
500
|
1,500
|
0
|
1,000
|
0
|
|
Ben
|
40,000
|
10,000
|
300
|
300
|
900
|
0
|
900
|
0
|
|
Ted
|
30,000
|
7,500
|
0
|
0
|
0
|
0
|
900
|
225
|
|
Deb
|
20,000
|
5,000
|
0
|
0
|
0
|
0
|
600
|
150
|
|
|
|
|
8,925
|
4,800
|
2,400
|
0
|
3,400
|
375
|
If an employer terminates a 401(k) plan (including a safe harbor plan), when is the earliest date the employer can establish another defined contribution plan (e.g., 401(k) plan)?
12 months from the date of the final distribution from the plan.