So are plans still top heavy? Of course, we all know that some plans are still top heavy—often when the owners and highly compensated employees are maximizing contributions to their defined contribution or defined benefit plans.
By Theresa Conti
In today’s world of safe harbor plans, far fewer plans are top heavy but what happens when a client doesn’t realize they are top heavy and now several years have passed? How do we fix that?
SETTING THE TABLE
We recently had a client that came to us because they were top heavy for three years. Their plan was being handled by a provider, and even though it was in the annual compliance letter, they never read the letter—nor did the provider ever follow up when the top heavy minimum contributions weren’t made.
When I was brought in to the client, I started at the beginning because they honestly didn’t even understand what “top heavy” was or how they got there. I explained that whether something is “top heavy” is based on account balances and key employees. 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 the plan is top heavy, the employer must contribute up to 3% of compensation for all non-key employees who are still employed on the last day of the plan year.
Since they were a law firm, there were a LOT of key employees—mostly due to the more than 1% ownership and compensation over $150,000. That also meant that they did not need to give a top heavy minimum contribution to this group; however, there were some high earners who were not key employees that did need to get this contribution.
- “BELIEVE IT OR NOT, IT TOOK JUST A LITTLE LESS THAN A YEAR TO HEAR BACK AND HAVE THE IRS AGREE TO OUR CORRECTION METHOD.”
WHAT WE DID
So how did we fix it? Since they were top heavy in 2019, 2020, and 2021, we had to fix those years; then, we needed to figure out what would happen for 2022 and the ongoing years. The first thing we did—since it was late 2021 when they brought me in—was to decide that none of the key employees would be allowed to make contributions during the 2022 plan year. We did that so we could figure out how to fix the other years and because, as you know, the top heavy minimum is the maximum that a key employee contributes up to 3%. So if the key employees contributed 0%, then the contribution would be $0.
We also talked about how they could fix the problem on an ongoing basis by changing to a safe harbor plan for 2023. (Yes, we could have changed them to safe harbor for 2022 since it was late 2021, but they were not sure they could “afford” the fixes and a contribution for 2022). Therefore, we decided to wait until later in 2022 to decide if they would allow key employees to contribute to the plan and if they wanted to make some form of employer contribution for 2022.
We then reviewed the top heavy tests for 2019, 2020, and 2021 that were performed by the prior provider. We definitely agreed that based on the numbers, all three plan years were top heavy. However, when we looked at it further and added in the top heavy minimum for 2019, the plan would still have been top heavy in 2020. But when we added the top heavy minimum for 2020 to the balances (rolling it forward) as of the end of the plan year (Dec. 31, 2020), it would then NOT have been top heavy for 2021.
We decided to make that argument in our IRS Voluntary Compliance Program (VCP) submission using Form 14568 (Model VCP Compliance Statement). We presented the failure and our proposed correction, which was that they would make the top heavy minimums for the 2019 and 2020 plan years but proved that when adding in those contributions, the plan would not have been top heavy for 2021. We also stated that our revision to administrative procedures was to make sure we followed the top heavy minimum rules and potentially change the plan to a safe harbor plan for ongoing plan years.
Believe it or not, it took just a little less than a year to hear back and have the IRS agree to our correction method. They even agreed with the 2021 plan year not being top heavy, based on making the top heavy minimums for the prior two years. It was the exact result the client wanted—and we were thankful we were able to discuss this option before they just went ahead and made three years’ worth of top heavy minimum contributions.
So a few notes to finalize the story…. first, for 2022, the client still had some time to allow the key employees to make contributions to the plan if they wanted. Of course, we verified that the plan was not top heavy for 2022 based on the Dec. 31, 2021 plan year end balances (including the top heavy minimums for 2019 and 2020). Some of the key employees made deferrals, but we calculated the maximum to also allow the ADP test to pass for 2022 since they did not want to make any employer contributions.
The client also decided to do the safe harbor nonelective contribution of 3% to all employees for 2023 (and hopefully future plan years). They wanted to provide it as a benefit to all eligible employees and it was a “constant” number that they could calculate as part of their profit and loss statements that each partner attorney kept for themselves (this is super common for partners in law firms to run financials this way). By doing the 3%, they knew the exact number and were able to calculate that each pay period for the financial reporting.
So as plan consultants, we have a few takeaways with this story.
- First, by making the submission under VCP and making the appropriate corrections, we maintained the plan’s tax-favored status. We would not have wanted the client to have their plan become unqualified.
- We also helped the client by thinking outside the box. Not only did it save the plan sponsor money; it also did not harm any participants (which is sometimes the most important part in these corrections and what the IRS wants to see).
- And finally, it always amazes me regarding the value we add to these situations and how providers don’t generally have the technical knowledge to help with these types of corrections. I hope that because of the help we provided that they will become a longtime client! PC