The Top-heavy determination compares the account balances of Key Employees to those of Non-Key Employees. If the sum of all Key Employee balances exceeds 60% of the total balances in the entire plan as of the determination date, the plan is Top-heavy, potentially requiring the plan sponsor to make a minimum contribution for each Non-Key employee.
Who is considered a Key Employee?
Key employees are the owners and officers of the plan sponsor. More specifically, a key employee is anyone, who at any time during the plan year, fits into at least one of the following categories:
- An individual who owns more than 5% of the plan sponsor or a related employer
- An individual who owns more than 1% of the plan sponsor or a related employer AND has annual compensation exceeding $150,000
- An officer of the plan sponsor or a related employer with annual compensation exceeding $215,000 during 2023 (indexed for future years)
There are a couple of additional points to note. For purposes of ownership, family attribution rules apply. That means that an individual is generally deemed to own company stock owned by his or her spouse and lineal ascendants/descendants.
For purposes of officer status, no more than 10% of the total employees can be considered officers.
When is my plan determined to be Top-heavy?
At the end of each plan year, the Top-heavy determination is made to establish whether or not the plan is Top-heavy for the coming plan year. For example, consider a plan that operates on the calendar year. As of December 31, 2022, it is determined whether that plan is Top-heavy for 2023.
The last day of the first plan year will be used for a new plan, both for the first year and the second year in existence.
What information is used to determine if the plan is Top-heavy?
The calculation includes dividing the participants into Key employees and Non-Key Employees. Take the sum of their respective account balances as of the determination date and from there, the following adjustments are made:
- Subtract all unrelated rollovers (those that came from another plan or are not related to your plan)
- Add back termination distributions that were paid during the twelve-month period ending on the determination date
- Add back all in-service distributions paid during the five-year period ending on the determination date
- Subtract all amounts related to participants who have not performed at least one hour of service for the company during the one-year period ending on the determination date
- Subtract all amounts related to participants who used to be but are no longer key employees
The sum of the key employee balances (after the above adjustments) is divided by the total plan balance (again, after the above adjustments). If the ratio is greater than 60%, the plan is top heavy for the coming year.
The top heavy determination is typically made on a cash basis; however, for the first year a plan is in existence, the accrual method is used.
What happens if my plan is Top-heavy?
IRS guidelines require a Top-heavy Minimum Contribution to be made on behalf of all Non-Key employees who are eligible to participate in the plan and remain employed on the last day of the plan year. The plan cannot impose a requirement that a participant works a minimum number of hours to share in the Top-heavy minimum contribution. Note that an employee who is eligible to make 401(k) contributions must share in the Top-heavy minimum contribution even if he or she chooses not to make deferrals or is otherwise not yet eligible to share in company contributions.
How much is the Top-heavy Minimum Contribution?
The top heavy minimum contribution is based on the amounts contributed by Key Employees. The top heavy minimum contribution is the lower of:
- 3% of annual compensation, or
- The highest percentage contributed to or for any Key Employee.
That means that if any Key Employee defers or receives company contributions of more than 3% of pay, the Top-heavy Minimum Contribution is equal to 3% of annual compensation. If, however, all Key Employees are below 3%, the required contribution is equal to the highest percentage received by any of the Key Employees. If no Key Employees receive any contributions, the Top-heavy Minimum Contribution is 0%.
A participant's full-year compensation is used to calculate the Top-heavy Minimum Contribution even if they were a participant for only part of the year. The Top-heavy Minimum Contribution is offset dollar-for-dollar by any other company contributions that have already been made, including Employer Matching and Profit-sharing contributions.
When will we deposit the Top-heavy Minimum Contribution to Non-key Employees’ accounts?
In order to satisfy Top-heavy rules, the contribution must be deposited no later than the last day of the year following the year for which it is required; however, in order to deduct the contribution, it must be deposited by the due date of the tax return for the year for which it will be deducted.
Is there any way we can avoid the Top-heavy Minimum Contribution?
Generally, Safe Harbor 401(k) plans are deemed to satisfy the Top-heavy requirements. A plan that provides for a Safe Harbor Non-elective or Safe Harbor Match will qualify for a “free pass” provided there are no additional employer contributions or employee after-tax contributions. , contributions must be limited to only salary deferrals and safe harbor contributions. If there are additional employer contributions, the plan is subject to the regular requirements described above. In addition, if your plan includes a longer eligibility period for the Safe Harbor contributions than the employee contributions, the “free pass” for the Top-heavy test may be waived.