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Managing Your Plan to Minimize Top-Heavy Issues   


In the 1980s Congress enacted legislation focused on plans where more than 60% of the accounts are held by Key Employees. Key Employees are generally defined as:

Employees owning more than 5% of the Employer,

Employees owning more than 1% of the Employer and earning above $ 150,000, and

Officers of the Employer earning more than $ 170,000.

The ownership in the first two categories above is attributed to other family employees. If that ownership is greater than 5%, family member employees automatically become Key Employees. If the ownership attributed is more than 1% and the employee to whom attribution is made earns more than $150,000, that employee is a Key Employee. All employees who do not meet the Key Employee definition above are non-key employees. (Additional details, which are beyond the scope and intent of this summary, also guide the identification of Key Employees. Contact JULY further information or with any questions.)

When more than 60% of a plan’s investments or assets are held by Key Employees, the plan is top-heavy. Determining whether a plan is top-heavy is a year-by-year requirement. A plan may therefore move in and out of top-heavy status from one year to the next. Determination of top-heavy status is generally done as of the last day of the year.

Employers sponsoring a plan which is top-heavy as of year-end are required to fund employer contributions the following year for non-key employees equal to the largest contribution, up to 3% of salary that has been credited for a Key Employee for that year. For JULY clients, our annual compliance testing letter will tell you whether your plan is top-heavy and whether a contribution will be required for the following year.

Because the required contribution is defined as the lowest percentage of contribution credited to any Key Employee’s account, the way to avoid this contribution requirement is for the employer to ensure that no Key Employees are credited with any contributions, either from the employer or the employee, for that new year.

Funding a required employer top-heavy is a requirement for retaining a plan’s favorable tax-qualified status. From a different perspective, refusing to fund a required employer top-heavy contribution causes the plan to lose its qualified plan status which leads to tax and other costs that most businesses would consider unacceptable.

A strategy for avoiding unplanned, unexpected and unbudgeted employer contributions is to monitor the percentage of a plan’s assets which are held for the benefit of key employees. Calculating the precise percentage is done after year-end as part of compliance testing, which means Key Employee deferrals / contributions may have already been made in the new year. It is therefore a good strategy to monitor the percentage of a plan’s assets or investments held as of each year-end by Key Employees. When the percentage begins to approach the 60% range, and the Employer does not wish to fund a required contribution of up to 3% of payroll, a strategy for minimizing this risk is to instruct Key Employees to make no deferrals / contributions until the top-heavy test has been finalized following year-end. The Employer will then know whether contributions from Key Employees will trigger the requirement for mandatory employer contributions for the non-key employees.

If the Key Employees fund no contributions / deferrals, their contribution percentage is zero, and the required contribution drops to 0%. Unfortunately, the way this law is written there are no exceptions or other ways out of this requirement.

401(k) plans offer large numbers of Americans a realistic way to build retirement security. The approaches summarized here can help employers take actions that will improve testing results while simultaneously benefiting employees as they prepare for their own futures.

For additional information, please contact your JULY Sales Consultant at 888.333.5859.

Written by Jim Hudson, CEO, July Business Services