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Employee Plans Compliance Unit (EPCU) - Completed Projects - Project with Summary Reports – Top-Heavy

Top-Heavy Project Overview

The Employee Plans Compliance Unit (EPCU) Top-Heavy project began in January 2013. We sent contact letters to a judgment sample of 401(k) plan sponsors whose plans were likely to be top-heavy.

The project goals were to determine whether the:

  1. Plan is exempt from the top-heavy requirements,
  2. Sponsor properly tested the plan to determine if the plan was top-heavy,
  3. Plan met the top-heavy requirements in Code section 416,
  4. Sponsor made the correct top-heavy minimum contributions, and
  5. Sponsor made the correct top-heavy vesting.

Results

The responses showed that the sampled plans had the following characteristics:

  • 64 were safe harbor plans not subject to the top-heavy requirements, and
  • 30 were operated as top-heavy at all times.

Background

The EPCU designed a Top-Heavy project (project) to determine whether sponsors of 401(k) plans are complying with the Internal Revenue Code (IRC) section 416 top-heavy requirements.

The top-heavy rules are designed to ensure that lower paid employees receive at least a minimum benefit in plans where most of the assets are owned by higher paid employees (referred to as key employees). When a defined contribution plan is top-heavy, certain minimum vesting and allocation requirements must be satisfied. Plans with fewer than 100 participants are the most likely to become top-heavy and thus affected by the top-heavy rules.

Technical Requirements

Under IRC section 416, a 401(k) plan is top-heavy if the aggregate amount held in the accounts of key employees under the plan exceeds 60% of the aggregate amount held in the accounts of all employees.

The term key employee generally refers to an employee who, at any time during the plan year, is:

  • An officer of the employer with annual compensation greater than $160,000 for 2010 (as adjusted for increases in the cost-of-living);
  • A 5% owner of the employer; or
  • A 1% owner of the employer having annual compensation of more than $150,000.

If a defined contribution plan is top-heavy, it must meet special minimum contribution requirements. Specifically, contributions made on behalf of non-key employees under a top-heavy plan must be at least equal to the lesser of:

  • 3% of compensation, or
  • The highest percentage contribution made for a key employee.

Elective deferrals made by a non-key employee in a 401(k) plan do not count toward the minimum benefit.

If an employer maintains more than one qualified plan, the plans may be aggregated for purposes of satisfying the top-heavy contribution requirements. If an employer sponsors more than one qualified plan, the plan documents must specify how the minimum top-heavy contribution requirement will be coordinated between or among those plans. If an employer sponsors a defined contribution plan and a defined benefit plan, the top-heavy contribution requirement can be satisfied by providing a 5% contribution in the defined contribution plan to employees who are participants in both plans.

Some types of qualified plans are not subject to the top-heavy minimum contribution requirements. For example, the top-heavy-minimum contribution rules do not apply to collectively bargained plans. Further, safe harbor 401(k) plans are not subject to the top-heavy minimum contribution requirements.

A top-heavy plan must also satisfy one of two minimum vesting schedules: three-year cliff or six-year graded vesting. A plan must state the vesting rules that will apply if the plan becomes top-heavy, even if the plan is not currently top-heavy.

Under three-year cliff vesting, employees must be 100% vested once they have three years of service. Prior to completing the third year of service, the employee’s vesting percentage may be any percentage, including zero. Under six-year graded vesting, employees must be 100% vested once they have six years of service with certain minimum requirements for the interim periods.

Unless a plan is a safe-harbor or designed to satisfy the top-heavy rules in all years, employers must test their plans every year to determine their top-heavy status. If the plan is top-heavy for a given year, employees must receive the minimum benefit and vesting for that year. By failing to follow the top-heavy rules, a plan can lose its qualified status.

Page Last Reviewed or Updated: 09-Sep-2014