Click to view Top Heavy Plan Questions - Part 1

If you are looking for a more basic understanding of Safe Harbor 401k Plans (as this article is a more in-depth piece on certain rules for plans that are top heavy, meaning a plan is already in place and benefiting mainly the key employees.) then you may want to head over to our post called Safe Harbor 401k Plans - 9 Questions Answered.

Can a safe harbor 401k 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.

Safe Harbor 401k Plans - Compliance Issues 

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.

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Mid-Year Changes to Safe Harbor 401k Plans

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.

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.

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Top Heavy Plan Questions - Part 1 Guide to Safe Harbor 401(k) Plans

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