4.72.5  Top-Heavy Plans

Manual Transmittal

April 07, 2014

Purpose

(1) This transmits revised IRM 4.72.5, Employee Plans Technical Guidelines, Top-Heavy Plans.

Material Changes

(1) 4.72.5.1.2, General Requirements, has been revised to reflect changes made by the Pension Protection Act of 2006 (PPA 06).

(2) Examples throughout have been updated

Effect on Other Documents

IRM 4.72.5 dated March 01, 2006 is superseded.

Audience

TE/GE (Employee Plans)

Effective Date

(04-07-2014)


Robert S. Choi
Director, Employee Plans
Tax Exempt and Government Entities

4.72.5.1  (04-07-2014)
Overview

  1. These guidelines are provided for Employee Plans (EP) examiners with regard to whether:

    1. A qualified retirement plan is top-heavy and, if so,

    2. The plan meets the requirements for a top-heavy plan under IRC 416.

  2. This guideline reflects changes made by the Pension Protection Act of 2006 (PPA 06).

4.72.5.1.1  (03-01-2006)
Technical Overview

  1. The top-heavy rules were added to the Internal Revenue Code by the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), P.L. 97–248, effective for plan years beginning after December 31, 1983. To be qualified under IRC 401(a), a plan must contain provisions which meet the requirements of IRC 416 and which will become effective if the plan becomes top-heavy. See IRC 401(a)(10)(B).

4.72.5.1.2  (04-07-2014)
General Requirements

  1. A defined benefit plan is top-heavy if, as of the determination date, the present value of the accrued benefits (PVAB) under the plan for the key employees exceeds 60% of the PVAB under the plan for all employees.

  2. A defined contribution plan is top-heavy if, as of the determination date, the total of the accounts of the key employees under the plan exceeds 60% of the total of the accounts of all employees under the plan.

  3. A top-heavy plan must provide non-key employees with a minimum benefit if it is a defined benefit plan or a minimum contribution if it is a defined contribution plan. See IRC 416(c).

  4. A top-heavy plan must also provide a special vesting schedule:

    1. 3-year 100% vesting schedule, or

    2. 6-year graded vesting schedule. See IRC 416(b).

  5. Plans covering few employees are more likely to be top-heavy than plans covering a large number of employees. For example,

    1. If key employees make up a substantial percentage of the workforce, it is more likely the plan will become top-heavy.

    2. Plans of larger employers can also be top-heavy where the employer maintains separate plans for its divisions. If the smaller divisions employ a large number of highly-paid employees who are key employees, their plans may be top-heavy.

  6. Even if a plan passes the nondiscrimination test of IRC 401(a)(4), it must be examined for top-heaviness. Accrual or allocation rates under a plan can be nondiscriminatory, but the total amount of the allocations in the key employees’ accounts (or their benefit accruals) could cause them to have too great a share of the plan assets and result in a top-heavy plan.

  7. A top-heavy plan does not include a simple retirement account under IRC 408(p).

  8. A top-heavy plan does not include a plan for any year that it consists solely of a cash or deferred arrangement which meets the "safe-harbor" requirements under IRC 401(k)(12) for minimum contributions for participants and makes matching contributions that meet IRC 401(m)(11). See IRC 416(g)(4)(H).

  9. A top-heavy plan does not include a plan for any year that it consists solely of a cash or deferred arrangement which meets the “safe-harbor” requirements under IRC 401(k)(13) for automatic contribution arrangements and makes matching contributions that meet the requirements of IRC 401(m)(12). See IRC 416(g)(4)(H).

  10. A top-heavy plan does not include a plan, for any year that it meets the Savings Incentive Match Plan for Employees (SIMPLE) plan requirements of IRC 401(k)(11) and permits no contributions other than those required by IRC 401(k)(11). See IRC 401(k)(11)(D)(ii).

4.72.5.1.3  (03-01-2006)
Examination Steps

  1. How these guidelines are used depends upon whether the plan under examination has received a determination letter.

  2. If the plan received a determination letter, determine whether the plan is top-heavy. If the plan is top-heavy, determine whether the plan satisfies the top-heavy requirements.

  3. If the plan did not receive a determination letter, determine whether the plan contains the top-heavy provisions which meet the requirements of IRC 416 by completing Form 8385, Worksheet 7 - Employee Benefit Plan Top Heavy Requirements. Then follow the instructions at (2) above.

4.72.5.2  (03-01-2006)
Determining Top-Heavy Status

  1. Special top-heavy rules apply for Government, Collectively-Bargained and Multiple Employer Plans.

    1. Governmental plans, under IRC 414(d), are exempt from the top-heavy rules. See IRC 401(a)(10)(B)(iii) and Treas. Reg. 1.416–1, Q. & A. T–38. (Hereinafter, all citations to "Q & A" in the regulations promulgated under IRC 416 are omitted.)

    2. The top-heavy minimum benefits rules of IRC 416(c) and the vesting rules of IRC 416(b) do not apply to any employee included in a unit of employees covered by a collective-bargaining agreement in which retirement benefits were the subject of good faith bargaining. A collective-bargaining agreement is an agreement between employee representatives and one or more employers. See IRC 416(i)(4) and Treas. Regs. 1.416–1, T–3 and T–38.

      Note:

      "Employee representatives" do not include any organization more than one-half of the members of which are employees who are owners, officers, or executives of the employer. See IRC 7701(a)(46).

    3. A multiple employer plan is subject to the top-heavy rules on an employer-by-employer basis. If a portion of a multiple employer plan is top-heavy with respect to one employer, the top-heavy rules apply only to the employees of that employer. If the top-heavy rules are not in effect for the employees of that one employer, the entire multiple employer plan can be disqualified. See Treas. Reg. 1.416–1, G–2.

4.72.5.2.1  (03-01-2006)
Examination Steps

  1. Determine whether the plan is a government plan under IRC 414(d). If yes, the plan is exempt from the top-heavy requirements.

  2. Determine whether the plan is a collectively-bargained plan in which retirement benefits were the subject of good faith bargaining. If yes, the plan may still have to be included in testing if it is part of a required aggregation group.

  3. Determine whether the plan is a multiple employer plan. If yes, determine whether the plan is top-heavy on an employer-by-employer basis.

4.72.5.2.2  (03-01-2006)
Employer

  1. In determining which plans of the employer are top-heavy, the employers who will be treated as a single employer must be identified.

    1. The aggregation rules under IRC 414(b), (c) and (m) apply for IRC 416 purposes. See Treas. Reg. 1.416–1, T–1(b). Also, see Form 8388, Worksheet 10 - Determination of Qualification: Employee Benefit Plan Affiliated Service Groups.

    2. The recipient of the services of a leased employee within the meaning of IRC 414(n) is treated as an employer for top-heavy purposes.

4.72.5.2.2.1  (03-01-2006)
Examination Steps

  1. Determine whether the employer maintaining the plan under examination is a member of a controlled group of corporations; a partnership, sole proprietorship, trade or business under common control; or a member of an affiliated service group. Identify all of these aggregated employers.

  2. Identify the recipient of services from a leased employee under IRC 414(n).

4.72.5.2.3  (04-07-2014)
Determination Date

  1. Assessing whether a plan is top-heavy for a plan year is made as of the determination date for the plan year. The determination date for a plan year is—

    1. The last day of the preceding plan year, or

    2. In the case of a plan’s first plan year, the last day of that plan year. See IRC 416(g)(4)(C).

      Example:

      An employer maintains Plan A, a defined contribution plan, in which key employees participate. For Plan A’s 2012 plan year, (a calendar year), the determination date is December 31, 2011. As of the determination date, the aggregate of the accounts of the key employees under the plan exceeds 60% of the aggregate of the accounts of all employees under the plan. Plan A is top-heavy for the 2012 plan year.

4.72.5.2.3.1  (03-01-2006)
Examination Steps

  1. Find the plan’s determination date. Use this date to determine the value of the benefits of all employees.

    Note:

    The value of the benefits on the determination date can be based on a calculation done on the plan’s valuation date. See IRM 4.72.5.2.6, Calculating the Top-Heavy Ratio.

  2. Check whether the plan complied with the top-heavy vesting and allocation rules in the following plan year (same plan year, if the first year of the plan).

4.72.5.2.4  (04-07-2014)
Key Employee

  1. There are a number of terms which comprise the definition of "key employee" , e.g., officer, 5% and 1% owner. See IRC 416(i).

  2. Pre-EGTRRA: For plan years beginning before 2002, the general definition of a key employee is:

    Any employee who at any time during the plan year containing the determination date (the determination date year) or the four preceding years is an officer who meets a compensation threshold, one of the 10 largest owners of the employer who meet a compensation threshold, a 5% owner of the employer, or a 1% owner of the employer who meets a compensation threshold.

  3. Post-EGTRRA: Effective for years beginning after December 31, 2001, the general rules which apply to a key employee are as follows:

    1. Any employee who at any time during the plan year containing the determination date (the determination date year) is an officer who meets a compensation threshold, a 5% owner of the employer, or a 1% owner of the employer who meets a compensation threshold. See IRC 416(i).

    2. Compensation includes elective deferrals under a qualified cash or deferred arrangement (CODA) and other elective deferrals under IRC 402(g)(3), as well as any amount which is contributed or deferred by the employer at the election of the employee and which is not includible in the gross income of the employee by reason of IRC 125, 132(f)(4) or 457. See IRC 416(i)(1)(D). See also Treas. Reg. 1.415(c)-2.

    3. The compensation received from each employer is aggregated under IRC 414(b), (c) and (m) to determine who is a key employee. See Treas. Reg. 1.416–1, T–20.

4.72.5.2.4.1  (03-01-2006)
Officer

  1. An officer of the employer having annual compensation greater than $130,000 (as adjusted under IRC 416(i)(1) for plan years beginning after December 31, 2002) for the determination date year is a key employee. See IRC 416(i)(1)(A) and Treas. Reg. 1.416–1, T–12.

  2. An officer is determined based on the source of the officer’s authority, the term for which elected or appointed, and the nature and extent of the duties. If an employee has the title of an officer but not the authority, that employee is not an officer for purposes of determining who is a key employee. An employee who does not have the title of an officer but who has the authority of an officer is an officer for key employee purposes. See Treas. Reg. 1.416–1, T–13.

  3. Officers (see Treas. Reg. 1.416–1, T–15) are in:

    1. Corporations

    2. Sole proprietorships

    3. Partnerships

    4. Trusts

    5. Labor organizations

    6. Associations

  4. For purposes of determining the number of officers taken into account, employees described in IRC 414(q)(5) are excluded. See the flush language of IRC 416(i)(1)(A) and IRC 414(q)(5).

  5. There is no minimum number of officers that may be taken into account. The maximum number of employees who can be treated as officers for purposes of counting as key employees is 50, or, if lesser, the greater of 3, or 10% of the employees. If there are more than 50 officers who meet these requirements, select the 50 officers who had the largest annual compensation during the year of the determination date. See IRC 416(i)(1) and Treas. Reg. 1.416–1, T–14.

4.72.5.2.4.2  (03-01-2006)
Five Percent Owner

  1. An employee who is a 5% owner of the employer at any time during the determination date year is a key employee. A 5% owner of a corporation is any person who owns more than 5% of the outstanding stock of a corporation or stock possessing more than 5% of the total combined voting power of all stock of the corporation. Use the constructive ownership rules of IRC 318 to help determine whether an employee is a 5% owner. In determining who is a 5% owner, ownership is determined without aggregating any employers under IRC 414(b), (c) or (m). See IRC 416(i)(1)(B)(i) .

4.72.5.2.4.3  (03-01-2006)
One Percent Owner

  1. An employee who is a 1% owner of the employer at any time during the determination year and whose compensation exceeds $150,000 for the determination date year is a key employee. (See IRC 416(i)(1)(A)(iii)). Use the constructive ownership rules of IRC 318 to help determine whether an employee is a 1% owner. In determining who is a 1% owner, ownership is determined without aggregating any employers under IRC 414(b), (c) or (m).

4.72.5.2.4.4  (03-01-2006)
Examination Steps

  1. Identifying all the key employees of the employer is necessary in determining whether the plan being examined is top-heavy and whether the plan must be aggregated with other plans of the employer in testing for top-heaviness. See IRM 4.72.5.2.2.

  2. Identify all key employees of the employer, including those in the plan under examination and any other plans of the employer (as aggregated).

    1. Determine the 5% and 1% owners of the employer.

    2. Determine, as necessary, whether any employees who do not have the title of an officer have the authority of an officer.

    3. Determine whether any employees make elective deferrals under a CODA of the employer and any other elective deferrals under IRC 402(g)(3), as well as any amount which is contributed or deferred by the employer at the election of the employee and which is not includible in the gross income of the employee by reason of IRC 125, 132(f)(4), or 457. Make sure the employer included these deferrals in compensation for purposes of identifying the key employees.

    4. Request information to determine who the key employees of the employer were.

4.72.5.2.5  (03-01-2006)
Aggregation of Plans

  1. To determine whether a plan is top-heavy, it must be aggregated with certain other plans of the employer. This type of aggregation is known as the "required aggregation group." Under certain circumstances, an employer may use "permissive aggregation" to aggregate plans not part of a required aggregation group. See IRC 416(g)(2).

4.72.5.2.5.1  (03-01-2006)
Required Aggregation Group

  1. The "required aggregation group" is defined in IRC 416(g)(2)(A)(i). It consists of each plan of the employer in which a key employee participates during the determination date year (or participated in during any of the four preceding years), and any other plan of the employer which, during this period, is aggregated with a plan in which a key employee participates to meet the nondiscrimination requirements of IRC 401(a)(4) or IRC 410.

  2. If the required aggregation group is top-heavy, each plan in the required aggregation group is top-heavy, even if it would not be top-heavy if tested independently, or if it covered no key employees. Similarly, if the required aggregation group is not top-heavy, no plan in the required aggregation group is top-heavy.

  3. All plans in a required aggregation group that are top-heavy must satisfy the vesting requirements of IRC 416(b) and the minimum benefits requirements of IRC 416(c). See Treas. Reg. 1.416–1, T–10.

    1. Only one defined contribution plan need satisfy the minimum contribution requirements for any non-key employee who participates in more than one defined contribution plan in the required aggregation group. See Treas. Reg. 1.416–1, M–8 and T–10.

    2. Only one defined benefit plan must satisfy the minimum accrual requirements for any non-key employee who participates in more than one defined benefit plan in a required aggregation group. See Treas. Reg. 1.416–1, T–10.

4.72.5.2.5.2  (03-01-2006)
Permissive Aggregation Group

  1. An employer may also aggregate plans that are not part of a required aggregation group with the plans in a required aggregation group to create a permissive aggregation group, as long as the permissive aggregation group satisfies IRC 401(a)(4) and 410. See IRC 416(g)(2)(A)(ii).

    If a permissive aggregation group is not top-heavy, none of the plans are top-heavy. If a permissive aggregation group is top-heavy, then the top-heavy requirements apply only to those plans in the required aggregation group. See IRC 416(g)(2) and Treas. Regs. 1.416–1, T-1(b) and (c), T-6, T-7, and T-9–11.

    Example:

    An employer maintains Plan A which covers key employees as well as other employees and independently satisfies the requirements of IRC 401(a)(4) and 410. Assume that Plan A is top-heavy when tested on its own. The employer also maintains Plan B. Plan B has no key employees. Plan B is not top-heavy. The employer may permissively aggregate these plans in testing for top-heaviness provided the permissive aggregation group satisfies IRC 401(a)(4) and 410.

4.72.5.2.5.3  (03-01-2006)
Examination Steps

  1. List all plans of the employer that contain key employees in the determination date year.

  2. List all plans that permit any of these plans to satisfy IRC 401(a)(4) or 410 (the required aggregation group). Determine whether this required aggregation group is top-heavy.

  3. List all plans that are not part of the required aggregation group that are permissively aggregated. Make sure that this permissive aggregation group satisfies IRC 401(a)(4) and 410. Determine whether this permissive aggregation group is top-heavy.

4.72.5.2.6  (03-01-2006)
Calculating Top-Heavy Ratio

  1. A defined contribution plan is top-heavy for a plan year if, as of the determination date, the aggregate of the accounts of the key employees under the plan exceeds 60% of the aggregate of the accounts of all the employees under the plan. See IRC 416(g)(1).

  2. A defined benefit plan is top-heavy for a plan year if, as of the determination date, the present value of the cumulative accrued benefits (PVAB) under the plan for the key employees exceeds 60% of the PVAB under the plan for all employees.

    1. If all defined benefit plans of the employer accrue benefits under the same method, determine the accrued benefits of employees using that accrual method.

    2. If the plans of the employer use different methods for accruing benefits, determine the accrued benefits of non-key employees by using the slowest permitted rate under the fractional accrual rule of IRC 411(b)(1)(C). See IRC 416(g)(4)(F).

4.72.5.2.6.1  (03-01-2006)
Calculating Present Value (PVAB)

  1. In a defined contribution plan, calculate the account balances as of the determination date. Add up the account balances as of the most recent valuation date within the 12-month period ending on the determination date and add in contributions due as of the determination date. In the first plan year, also add in contributions made after the determination date that are allocated during such year. See Treas. Reg. 1.416–1, T–24.

  2. In a defined benefit plan, calculate the PVAB as of the determination date by using the most recent valuation date within the 12-month period ending on the determination date.

    1. The valuation date must be the same valuation date used for computing plan costs for minimum funding purposes.

    2. The actuarial assumptions used for determining the PVAB must be reasonable. Any assumptions which reflect a reasonable mortality experience and an interest rate not less than 5% or greater than 6% will be considered as reasonable. Plans are not required to use an interest rate in this range.

    3. Withdrawal assumptions may not be used.

    4. Present values should be based on a benefit payable at normal retirement age, and should not take into account pre-retirement death and disability benefits and post-retirement medical benefits.

    5. The assumptions do not have to be the same as the assumptions used for minimum funding or for actuarial equivalence of optional benefits.

  3. Subsidized early retirement benefits and subsidized benefit options are taken into account only if they are nonproportional subsidies, i.e., available to a group of employees that does not satisfy the coverage requirements of IRC 410(b). A benefit that is a nonproportional subsidy is valued as if it commenced at the age at which it is the most valuable. See Treas. Regs. 1.416–1, T–25, 26 and 27.

  4. Accrued benefits include benefits attributable to employee contributions, other than deductible employee contributions. See Treas. Reg. 1.416-1, T-28.

4.72.5.2.6.2  (03-01-2006)
Required or Permissive Aggregation Group

  1. If there are two or more plans in an aggregation group, calculate the value of the benefits separately for each plan as of each plan’s determination date and add them when the plan years are the same. When the plan years are not the same, aggregate the values for each plan year as of the determination dates for such plans that fall within the same calendar year. See Treas. Reg. 1.416–1, T–23.

    Note:

    Employer X maintains Plan A, a defined contribution plan, and Plan B, a defined benefit plan. Key employees participate in both plans. The two plans are a required aggregation group and are calendar year plans.

    Plan A (DC) Plan B (DB)
    Key Eees Accounts Key Eees PVAB
    A 170,000 A 940,000
    B 120,000 B 660,000
    Non-Key Eee
    C 40,000 C 50,000
    D 70,000 D 30,000
    E 65,000 E 95,000
    F 70,000 F 0
    G 20,000 G 0
    290000 ÷ 555000 = 52% 1.6 million ÷ 1.775 million = 90%

    Note:

    Plan A + Plan B: 1.89 million ÷ 2.33 million = 81% Both Plans are top-heavy.

    The accounts of the key employees in the defined contribution plan are 52% of the value of all the employees’ accounts under the plan. The accrued benefits of the key employees in the defined benefit plan are 90% of the value of the accrued benefits of all employees under the plan. The plans are aggregated by adding together the results for each plan. The sum of the accrued benefits and account balances of the key employees under both plans is 81% of the accrued benefits and account balances for all employees under both plans. Thus, both plans are top-heavy.

4.72.5.2.6.3  (04-07-2014)
Amounts Added or Excluded

  1. Distributions made within the 1-year period (5-year period in the case of any distribution made for a reason other than severance from employment, death or disability, and in determining whether the plan is top-heavy for years beginning before January 1, 2002) ending on the plan’s determination date are added back in determining the accrued benefits or account balances of plan participants. See IRC 416(g)(3). If an annuity contract is distributed, the amount distributed is the current actuarial value of the contract determined on the distribution date plus any prior distribution within the applicable period.

  2. If a key employee becomes a non-key employee, exclude the accrued benefit or account balance of that employee in determining whether the plan is top-heavy. This individual is referred to as a former key employee. See IRC 416(g)(4)(B) and Treas. Reg. 1.416–1, T–1(d).

  3. If an individual (key or non-key) has not performed services for the employer maintaining the plan at any time during the 1- year period (5-year period in determining whether the plan is top-heavy for plan years beginning before January 1, 2002) ending on the determination date, exclude the accrued benefit or account balance of that employee in determining whether the plan is top-heavy. See IRC 416(g)(4)(E) and Treas. Reg. 1.416–1, T–1(d).

  4. Treat amounts rolled over or transferred between plans as part of the accrued benefit or account balance in the plan making the rollover or transfer, or in the plan accepting the rollover or transfer, in accordance with whether the rollover or transfer is unrelated or related.

    Example:

    You are examining a plan for the 2011 calendar year to determine whether it is top-heavy. The determination date for the 2011 plan year is December 31, 2010. Individual A, an officer of the employer whose compensation exceeded the threshold limit, separated from service in 2010. Even though Individual A is no longer an employee of the employer, Individual A is treated as a key employee for purposes of determining whether this plan is top-heavy for the 2011 plan year. However, for purposes of determining whether the plan is top-heavy for the 2012 plan year, Individual A’s benefits under the plan are not counted because Individual A did not perform services for the employer during 2011.

4.72.5.2.6.3.1  (03-01-2006)
Related and Unrelated Rollovers

  1. A "related rollover" is a rollover or transfer of plan assets into a plan maintained by the same employer group, or a rollover/transfer not initiated by the employee.

    1. This amount is treated as part of the accrued benefit or account balance in the plan accepting the rollover.

    2. The amount is not treated as a distribution under the plan making the rollover and therefore is not counted as part of the accrued benefit or account balance in that plan for purposes of determining whether it is top-heavy.

    3. A rollover or transfer made pursuant to the division of one plan into two, or the merger of two or more plans into one, is generally not treated as initiated by the employee. See IRC 416(g)(4)(A) and Treas. Reg. 1.416–1, T–32.

  2. The rollover or transfer of an employee’s account balance when the employee moves to an unrelated employer is an "unrelated rollover."

    1. An unrelated rollover or transfer counts as a distribution under the plan making the rollover in testing for top-heaviness.

    2. The unrelated rollover/transfer is not treated as part of an accrued benefit or account in the plan accepting the rollover in testing whether it is top-heavy.

4.72.5.2.6.4  (03-01-2006)
Terminated and Frozen Plans

  1. The determination of whether a terminated or frozen plan is top-heavy is the same as for any other plan. See Treas. Reg. 1.416–1, T–4 and T–5.

  2. For IRC 416 purposes, a terminated plan is a plan that has been formally terminated, no longer credits service for benefit accruals and vesting, and distributed or is distributing all plan assets as soon as administratively feasible (generally within one year). See Rev. Rul. 89–87, 1989–2 C.B. 81.

    1. The plan must be aggregated with other plans of the employer if it was maintained within the last 5 years ending on the determination date of the plan under examination, and would, but for the fact that it terminated, be part of a required aggregation group.

    2. Distributions from the terminated plan which have taken place during the 1-year period (5-year period in the case of any distribution made for a reason other than severance from employment, death or disability, and in determining whether the plan is top-heavy for years beginning before January 1, 2002) ending on the determination date are added back in determining whether the required aggregation group is top-heavy. If the required aggregation group is top-heavy, no additional contributions, benefit accruals or vesting is required for participants in the terminated plan, but the ongoing plans must satisfy the top-heavy rules. See IRC 416(g)(3) and Treas. Reg. 1.416–1, T–4.

  3. A frozen plan is one in which benefit accruals have stopped but the plan has not distributed all the assets. If a frozen plan is top-heavy, it must provide top-heavy minimum contributions, benefit accruals and vesting. However, in a defined contribution plan, no top-heavy minimum contribution is required if no key employee receives a contribution. See Treas. Reg. 1.416–1, T–5 and IRC 416(c)(2)(B).

4.72.5.2.6.5  (03-01-2006)
Simplified Top-Heavy Ratio Method

  1. Treas. Reg. 1.416–1, T–39 provides four simplified methods an employer can use to compute a plan’s top-heavy ratio. These methods permit using imprecise data to show the plan is not top-heavy. Using these methods results in computing a top-heavy ratio that is higher than if precise data had been used. Thus, if the simplified method results in a top-heavy ratio that is less than 60%, an employer can demonstrate that the plan is not top-heavy.

    1. The employer overestimates the value of benefits for key employees and underestimates the value of benefits for non-key employees. (Estimated fraction will be higher than exact fraction)

    2. The employer considers only some non-key employees. (Adding more non-key employees would only further decrease the ratio)

    3. The employer uses imprecise data to determine the accounts of key employees, resulting in an overstatement of their benefits. (Worst case scenario)

    4. The employer uses imprecise withdrawal assumptions in computing the top-heavy ratio resulting in an overstatement of key employees’ benefits. (Worst case scenario)

4.72.5.2.7  (03-01-2006)
Examination Steps

  1. To do a preliminary test of the top-heavy ratio, calculate the aggregate account balances and/or accrued benefits of the key and non-key employees:

  2. Key Employee Aggregate Balance = Top-Heavy Ratio
    Total Employee Aggregate Balance

  3. If the top-heavy ratio is considerably greater than 60%, the plan is most likely top-heavy. If the top-heavy ratio is near 60%:

    1. Add in all distributions made to employees during the 1-year period (5-year period in the case of a distribution made for a reason other than severance from employment, death or disability, and in determining whether the plan is top-heavy for plan years beginning before January 1, 2002) ending on the determination date.

    2. Exclude the account balances, accrued benefits and distributions of former key employees.

    3. Exclude the account balances, accrued benefits and distributions of employees who have not performed services for the employer at any time during the 1-year period (5-year period in determining whether the plan is top-heavy for plan years beginning before January 1, 2002) ending on the determination date.

4.72.5.3  (03-01-2006)
Top-Heavy Allocations

  1. A minimum contribution (in a defined contribution plan) or minimum benefit (in a defined benefit plan) must be given to a non-key employee who is a participant in a top-heavy plan, in accordance with the top-heavy rules.

  2. If non-key employees have been excluded from the plan because compensation is less than a stated dollar amount, they must accrue a minimum benefit.

4.72.5.3.1  (03-01-2006)
Top-Heavy Minimum Contributions

  1. If a defined contribution plan is top-heavy, the employer must make a contribution to each non-key employees’ account who is a plan participant equal to at least 3% of the participant’s compensation.

    1. Forfeitures allocated to a participant’s account are included in determining whether a 3% minimum contribution has been made, but elective contributions are not. Matching contributions under IRC 401(m)(4)(A) are taken into account for years after December 31, 2001.

    2. The 3% minimum contribution requirement is reduced if the largest percentage contribution made on behalf of a key employee for the plan year is less than 3%.

    3. The minimum contribution cannot be reduced due to social security contributions.

  2. If the required aggregation group includes a defined contribution plan and a defined benefit plan aggregated to meet the requirements of IRC 401(a)(4) or 410, then a 3 % minimum contribution is generally required in the defined contribution plan even if the highest contribution rate for a key employee is less than 3%. See IRC 416(c)(2) and Treas. Reg. 1.416–1, M–7.

    Example 1: Plan A is a top-heavy plan. The largest percentage contribution made on behalf of a key employee during the 2011 plan year is to Employee M. Employee M’s compensation is $269,000. The employer makes a contribution of $8,000 to Employee M. Because Employee M’s compensation is limited to $200,000 for contribution purposes by IRC 401(a)(17), the percentage contribution made on behalf of Employee M is 4% (8,000 ÷ 200,000 = 4%). Each non-key employee must receive a contribution equal to 3 % of compensation.

    Example 2: The facts are the same as in the Example above, except that the employer makes a contribution of $4,000 to Employee M in 2003. The percentage contribution made on behalf of Employee M is 2% (4,000 ÷ 200,0000 = 2%). Each non-key employee must receive a contribution equal to 2% of compensation.

  3. If the employer maintains only one defined contribution plan, each non-key employee covered by the plan must receive the defined contribution minimum. If the employer maintains more than one defined contribution plan and a non-key employee participates in more than one, then only one defined contribution plan has to provide a minimum contribution for the employee. See Treas. Regs. 1.416–1, T–10, M–8 and M–12.

4.72.5.3.1.1  (03-01-2006)
Benefits for Non-Key Employees

  1. A top-heavy defined contribution plan must provide a minimum contribution to each non-key employee who has not separated from service at the end of the plan year. See Treas. Reg. 1.416–1, M–10. This includes non-key employees who—

    1. Are participants but fail to complete 1000 hours of service for an accrual computation period.

    2. Have satisfied the plan’s eligibility requirements even if the employees have not received any contributions for several years.

    3. Were excluded from plan participation because the (i) employees’ compensation was below a stated amount; (ii) employees made no elective deferrals to a IRC 401(k) plan; or (iii) employees made no mandatory employee contributions.

4.72.5.3.1.2  (03-01-2006)
CODA Rules

  1. Elective deferrals by non-key employees cannot be treated as contributions for purposes of the minimum contribution requirement in a top-heavy defined contribution plan. But elective deferrals are taken into account in determining the contribution percentage of a key employee. See Treas. Reg. 1.416-1, M-20.

  2. A qualified nonelective contribution (QNC) is treated as a contribution for purposes of the minimum contribution requirement. (A QNC is an employer contribution which can be used to satisfy the actual deferral percentage (ADP) or average contribution percentage (ACP) tests, but is not a matching contribution.) See Treas. Reg. 1.416-1, M-18.

  3. For plan years after December 31,2001, matching contributions to non-key employees are counted towards satisfying the minimum contribution requirement. IRC 416(c)(2)(A).

  4. IRC 415(c)(3)(D) defines compensation as including an elective deferral under IRC 402(g)(3) and any amount which is contributed or deferred by the employer at the election of the employee and which is not includible in the gross income of the employee by reason of IRC 125, 132(f)(4) or 457. For example, in the case of elective contributions under an IRC 401(k) plan, the required minimum contribution is based on an employee’s compensation including the elective deferral.

4.72.5.3.1.3  (03-01-2006)
Examination Steps

  1. In examining a plan determined to be top-heavy, make sure the top-heavy minimum required contributions (or benefits) and vesting rules are met in operation.

  2. Check whether the employer has made a minimum contribution to the non-key employees in a top-heavy defined contribution plan. If there is more than one defined contribution plan in the required aggregation group, look at all the plans to determine whether any key employee receives contributions equal to or greater than 3% of compensation.

  3. Make sure non-key employees who have not separated from service at the end of the plan year receive a minimum contribution, even if they have less than 1000 hours of service.

  4. Check that the minimum contribution is properly computed. Check to make sure elective deferrals by non-key employees were not counted as minimum contributions.

  5. Make sure minimum contributions for non-key employees are made even if the only contributions on behalf of key employees are elective deferrals.

4.72.5.3.2  (03-01-2006)
Top-Heavy Minimum Accrued Benefits

  1. A top-heavy defined benefit plan must give each non-key employee who is a plan participant a minimum accrued benefit that, when expressed as a single life annuity (with no ancillary benefits) beginning at normal retirement age, equals the participant’s highest aggregate compensation for a period of consecutive years up to 5 (called the testing period) multiplied by the lesser of 2% times years of service, or 20% (the applicable percentage). See IRC 416(c)(1).

    Example:

    Employee M, a non-key employee, has been a participant in Plan A for 5 years, during which time, it was top-heavy. Employee M’s average annual compensation during those five years was $30,000. Employee M’s minimum pension must be $3,000 ($30,000 x (2% x 5 years of plan participation)).

  2. The defined benefit plan minimum is not satisfied if a plan provides a normal retirement benefit equal to the greater of the plan’s projected formula or the projected minimum benefit, and if the benefits accrue under the fractional accrual rule at IRC 411(b)(1)(C). See Treas. Reg. 1.416–1, M–5.

    Example:

    Employee N, a non-key employee, becomes a participant at age 25 in Plan X, a top-heavy defined benefit plan. The plan provides that the normal retirement benefit is equal to the greater of the plan’s projected formula or the projected minimum benefit. The plan provides for the accrual or benefits under the fractional accrual rule. Employee N’s projected minimum benefit is greater than the plan’s projected formula. At age 35 under the fractional accrual rule, Employee N’s accrued benefit will equal 5% (20% x 10 ÷ 40). This benefit does not satisfy the top-heavy minimum benefit of 20%.

  3. In determining the applicable percentage, a defined benefit plan may disregard a year of service—

    1. That ends in a plan year beginning before January 1, 1984;

    2. If the plan was not top-heavy for any plan year ending in that year of service. See IRC 416(c)(1)(C)(ii).


      A plan may also disregard service with the employer, for purposes of determining an employee’s year of service with the employer, to the extent that this service occurs during a plan year in which no key employee or former employee benefits under the plan. See IRC 416(c)(1)(C)(iii).

  4. For purposes of determining the years in the testing period, a plan can disregard a year of service—

    1. That ends in a plan year beginning before January 1, 1984;

    2. In which the employee did not participate in the plan; or

    3. That begins after the close of the last year in which the plan was top-heavy. See IRC 416(c)(1)(D)(iii). But if a plan is top-heavy in year 1, not top-heavy in year 2, and top-heavy in year 3, the compensation earned in the intervening year is included in the testing period.

  5. If a non-key employee in a plan has accrued benefits due to employer contributions in non-top-heavy years, these accruals count in determining whether the minimum accruals were received in a top-heavy year. See Treas. Reg. 1.416–1, M–2(e).

4.72.5.3.2.1  (04-07-2014)
Benefits for Non-Key Employees

  1. Each non-key employee who is a participant in a top-heavy defined benefit plan with at least 1000 hours of service in a plan year must receive a minimum benefit. See Treas. Reg. 1.416–1, M–4.

  2. A non-key employee must receive a minimum benefit even if the employee—

    1. was not employed on a specific date; or

    2. is excluded from participation because the employee did not make mandatory employee contributions or because the employee’s compensation is less than a stated amount.

      Example:

      Employer M maintains Plan X, a defined benefit plan. Plan X requires employees to contribute at least 3% of compensation in order to participate. Employee A does not make any contributions to Plan X in the 2012 plan year, and consequently is not a participant. Employee A has more than 1000 hours of service with Employer M in 2012. Plan X is top-heavy in 2012. Employee A must receive a top-heavy minimum benefit in 2005. Employee A must receive a top-heavy minimum accrued benefit for 2012 because Employee A has more than 1000 hours of service for Employer M in 2012.

4.72.5.3.2.2  (03-01-2006)
Examination Steps

  1. Check to make sure that non-key employees in a top-heavy defined benefit plan who had 1000 hours of service or more received the minimum benefit.

  2. Check to determine whether non-key employees in a top-heavy defined benefit plan who did not participate because they did not make mandatory employee contributions received the minimum benefit.

4.72.5.4  (03-01-2006)
Additional Allocation

  1. Special top-heavy rules apply when an employer maintains, and employees participate in, both a defined contribution plan and a defined benefit plan, which are top-heavy. Safe harbor rules for calculating top-heavy minimums are available.

4.72.5.4.1  (03-01-2006)
Safe Harbor Top-Heavy Minimums

  1. A non-key employee who participates in both a top-heavy defined contribution plan and a top-heavy defined benefit plan maintained by the same employer need not receive both a defined contribution and defined benefit minimum, but should receive more than just a 3% contribution to the defined contribution plan. See IRC 416(f) and Treas. Regs. 1.416-1, M-12.

  2. A plan may use one of four alternative safe harbor methods to provide top-heavy minimums. The plan must specify the method selected. See Treas. Regs. 1.416–1, M–12 and M–15.

    1. Only the defined benefit plan must provide the minimum benefit.

    2. A floor offset arrangement under which the defined benefit plan minimums can be offset by the defined contribution plan benefits.

    3. Both the defined contribution plan and the defined benefit plan together, using comparability analysis, provide benefits at least equal to the defined benefit plan minimum.

    4. A safe harbor defined contribution minimum of contributions and forfeitures equal to 5% of the compensation of each non-key employee.

4.72.5.5  (04-07-2014)
Top-Heavy Vesting

  1. IRC 416(b) requires that a top-heavy plan provide one of two alternative vesting schedules: 100% vesting after three years of service, or a six-year graded vesting schedule. See IRC 416(b)(1)(A) and (B).

  2. Top-heavy vesting applies to all amounts contributed or accrued in a plan, even though accrued prior to the plan becoming top-heavy.

    1. The rules apply to an employee who has at least one hour of service after the plan becomes top-heavy.

    2. It does not apply to an employee who has no service after the plan becomes top-heavy.

      Example:

      Plan X has a plan year beginning on July 1 and maintains a 5–year vesting schedule. The plan provides for a 3–year vesting schedule in a year in which it is top-heavy. Plan X became top-heavy in the plan year beginning July 1, 2011. Employee A became a plan participant on August 1, 2008, and terminated service on August 15, 2011 with 240 hours of service during the top-heavy plan year. Employee A becomes 100% vested in her/his accrued benefit under the top-heavy vesting schedule because Employee A had hours of service in the plan year in which the plan became top-heavy.

  3. When a top-heavy plan ceases to be top-heavy, the vesting schedule can be changed to one that would otherwise be permitted, but see Treas. Reg. 1.416–1, V–7 and IRC 411(a)(10).

    1. The employee’s vested percentage under the top-heavy vesting schedule as applied to benefits accrued before and after the plan ceases to be top-heavy cannot be reduced.

    2. Any employee with three or more years of service must be given the option to remain under the top-heavy vesting schedule.

4.72.5.5.1  (03-01-2006)
Examination Steps

  1. Make sure employees who have hours of service in the year a plan is top-heavy vest under one of the top-heavy vesting schedules.

  2. Check whether benefits accrued or contributions made before the plan became top-heavy are subject to the top-heavy vesting once the plan is top-heavy.

  3. If a plan that was top-heavy ceases to be top-heavy and changes back to a normal vesting schedule, check that amounts vested under the top-heavy vesting schedule are not reduced, and that employees with three or more years of service are given the option to remain under the top-heavy vesting schedule.


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