Qualified retirement plans are required to run compliance tests each year. This includes, but is not limited to, Top Heavy testing. Hopefully, this compliance test is being performed by a qualified TPA, like TriStar, to ensure that the retirement plan doesn’t run afoul of the rules and lose its very beneficial tax-qualified status. If it is determined that a plan is, in fact, Top Heavy, then it is likely the employer will be required to make a minimum contribution to all eligible participants under the plan. Some 401(k) plans that meet certain requirements and limitations can avoid the Top Heavy minimum contribution even if they are in fact Top Heavy. For the purposes of this article, we will only discuss plans that require Top Heavy testing.
During Top Heavy Testing, the third party administrator will review the client’s census data to determine who the Key Employees are. Key Employees (defined below) are an integral part of the Top Heavy test. This is one of the reasons that collecting accurate census data, ownership information and family member information is so important each year.
Key employees are any one of the following:
- An officer of the company with compensation in excess of $170,000 (for 2016, or $175,000 for 2017) with certain limitations on how many are in this group;
- A more than 1% owner of the company with compensation in excess of $150,000 (for 2016 and 2017) or;
- A more than 5% owner of the company, regardless of their compensation or;
Certain family members (spouse, children, parent, grandchild) of the key employees with ownership interests are generally treated as key employees due to family attributions rules.
Often, the definition of a Key Employee gets confused with that of a Highly Compensated Employee. However, even though in smaller companies the two definitions may often include the same group of people, there are distinct differences. Highly Compensated Employees are identified for nondiscrimination and coverage testing in qualified plans; whereas a Key Employee is defined for the purposes of determining whether or not the plan is Top Heavy.
It is required that Top Heavy testing be performed annually utilizing the plan’s determination date. The determination date for existing plans is the last day of the previous plan year. Currently, TPA’s are testing the 2016 plan year, so the determination date for existing calendar year plans would be December 31, 2015. Therefore, plans should have known when their 2015 Plan Valuation and Form 5500 were completed and whether or not they would have to make a Top Heavy minimum contribution for the 2016 Plan Year. For new plans beginning in 2017, the determination date is the last day of the first plan year. Therefore the determination date for new calendar year plans would be December 31, 2017.
In Top Heavy Testing, the TPA compares the Key Employees’ ending account balances to the plan’s total ending value (excluding certain items such as prior year distributions and certain rollovers). If the Key Employees’ account balances exceed 60% of the plan’s total account balances on the determination date, then it is deemed that the plan is Top Heavy.
What happens if a plan is top-heavy?
When a plan is Top Heavy, the employer must meet minimum contribution requirements. To meet minimum contribution requirements the employer must make an employer non-elective contribution to all Non-Key employees eligible to participate in the plan. The contribution is equal to the lesser of:
- 3% of the Participants’ total gross annual compensation or;
- The highest percentage contribution made for any Key Employee (including salary deferrals).
In general, only Non-Key employees who are eligible to participate in the 401(k) plan and who are employed on the last day of the plan year will receive this contribution. This means that all eligible Non-Key employees will receive this contribution, even if they don’t participate in the 401(k) plan. The minimum contribution required can be offset by any matching contributions previously allocated to the Participant in the Plan Year for which the minimum contribution is owed.
Plans that repeatedly fail Top Heavy Testing and require minimum contributions from the employer may be able to be designed in a better way to avoid future failed tests or at least to avoid the required minimum contribution. This can save the employer money and a lot of headaches. Please remember that each plan is designed differently and these rules may not apply to every plan. Please reference your plan document or call us if you have any questions about Key Employees and Top Heavy Testing in 401(k) plans.