401(k) Plan Fix-It Guide - The plan was top-heavy and required minimum contributions were not made to the plan



Find the Mistake

Fix the Mistake

Avoid the Mistake

11. The plan was top-heavy and required minimum contributions weren't made to the plan. Review the rules and definitions for top-heavy in your plan document. Determine whether your plan is top-heavy for the plan year. Properly contribute and allocate the required top-heavy minimum, adjusted for earnings, to the affected non-key employees. Perform a top-heavy test each year.

The top-heavy rules generally ensure that the lower paid employees receive a minimum benefit if the plan is top-heavy. A plan is top-heavy when, as of the last day of the prior plan year, the total value of the plan accounts of key employees is more than 60% of the total value of the plan assets.

If a 401(k) plan is top-heavy, the employer must contribute up to 3% of compensation for all non-key employees still employed on the last day of the plan year. This contribution is subject to a vesting schedule requiring participants to be 100% vested after three years; or 20% after 2 years, 40% after 3, 60% after 4, 80% after 5 and 100% after 6 years.

Key employee: To determine if your plan is top-heavy, you must first identify key employees - any employee (including former or deceased employees), who at any time during the plan year was:

  • An officer making over $215,000 for 2023 ($200,000 for 2022; $185,000 for 2021 and for 2020; $180,000 for 2019);
  • A 5% owner of the business (a 5% owner is someone who owns more than 5% of the business), or
  • An employee owning more than 1% of the business and making over $150,000 for the plan year.

A non-key employee is everyone else.

Remember, when you’re determining ownership interests, family aggregation rules apply. These rules may affect the treatment of stock owned directly or indirectly by family members. The rules treat any individual who is a spouse, child, grandparent or parent of someone who is a 5% owner, or who, together with that individual, would own more than 5% of a company’s stock as a 5% owner. As a 5% owner, the law considers each of these individuals a key employee for the plan year. It’s important to identify the family ownership interests of all company stock and to forward that information to your TPA, advisor or person performing the nondiscrimination tests.

SIMPLE 401(k) plans and certain safe harbor 401(k) plans aren't subject to the top-heavy rules.

How to find the mistake:

Review the top-heavy rules and definitions in your plan document. Determine if your plan is top-heavy each plan year. Be careful to properly identify owners and their family members.

It's common for a 401(k) plan to be top-heavy, especially for smaller plans and plans with high turnover. If you’ve been operating a 401(k) plan covering only you and your spouse, and you hire other employees who become eligible under the plan, you'll probably have to make required minimum contributions if the new employees are non-key employees.

It’s important to note the distinction between key employees, who count for top-heavy purposes, and highly compensated employees, who count for the ADP and ACP tests, but not the top-heavy tests.

How to fix the mistake:

Corrective action:

The employer must make a corrective contribution that includes lost earnings to the non-key employees. The contribution is generally 3% of compensation and then adjusted for plan earnings through the date of correction.

Example: Employer J, a husband and wife business, have sponsored a 401(k) plan since 2012. As business expanded, they hired two employees on July 31, 2018. According to the plan document, both new employees became eligible for the 401(k) plan on January 1, 2020. Both new employees made elective deferrals to the plan and it passed the actual deferral percentage (ADP) test for both 2020 and 2021. During a review of the plan, Employer J determined the plan was top-heavy for the 2020 and 2021 plan years; however, J didn’t make minimum top-heavy contributions.

Correction programs available:

Self-Correction Program:

The example shows an operational problem because the employer didn't follow the plan’s top-heavy provisions. If the other eligibility requirements of SCP are satisfied, Employer J may use SCP to correct the failure.

  • No IRS imposed fees for self-correction.
  • Practices and procedures must be in place.
  • If the mistakes are significant in the aggregate, Employer J needs to make corrective contributions for the 2020 plan year by the end of 2023. J needs to make the corrective contribution for the mistake that occurred in 2021 by December 31, 2024.
  • If the mistakes are insignificant in the aggregate, Employer J can correct beyond the three-year correction period for significant errors. Whether a mistake is insignificant depends on all facts and circumstances.

Voluntary Correction Program:

Correction is the same as under "Corrective action." If the plan is not under audit, Employer J makes a VCP submission per Revenue Procedure 2021-30 via the Pay.gov website following the procedures set forth in Section 11. Consider, using Form 14568, Model VCP Compliance Statement PDF. User fees for VCP submissions are generally based upon the current value of all assets that are associated with the Plan. For example, if the value is between $0 and $500,000, the user fee is $1,500 if the submission is made in 2022. User fees may change in subsequent years. If the value of plan assets exceeds $500,000, the user fee will be higher.

Audit Closing Agreement Program:

Under Audit CAP, Employer J and the IRS enter into a closing agreement outlining the corrective action and negotiate a sanction. The sanction under Audit CAP is based on facts and circumstances, as discussed in Section 14 of Revenue Procedure 2021-30.

How to avoid the mistake:

  • Perform a top-heavy test annually.
  • Take care to identify ownership interests under the family aggregation rules so the test is accurate. Be especially careful if you have a smaller plan or one that only covered owners for a period of time and now has other participants.

401(k) Plan Fix-It Guide

401(k) Plan Overview

EPCRS Overview

401(k) Plan Checklist PDF

Additional resources