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