McKay Hochman - Commentary

Commentary

Top-heavy Rules for Safe Harbor Plans October 21, 2004 Small business owners commonly select a safe harbor 401(k) retirement plan design. These same employers often see their plans become top heavy. A plan is considered top heavy when more than 60% of the aggregate value of the plan accounts belongs to key employees – the owners and officers of the business. Coordinating Contributions If a plan becomes top heavy and any key employee has had an allocation of 3% or more, then the employer must provide an allocation of 3% to all eligible employees. However, if it is a safe harbor 401(k) plan, the employer is already providing a contribution, so there are special top-heavy rules that apply to safe harbor plans. If a safe harbor 401(k) plan is top heavy, the employer can get twice the mileage out of its safe harbor contribution. There are three ways this can happen:

1.	If a nonelective contribution of 3% or more is made to a top-heavy plan, that contribution will generally satisfy the top-heavy contribution requirement.

2.	If a plan that is top heavy calls for making a safe harbor matching contribution (and is not exempt as described below), then the safe harbor contribution will count towards satisfying the top-heavy minimum contribution for those employees who receive it. For example, if a participant defers 2% and receives a 2% safe harbor match, when the employer makes the top-heavy contribution, that employee would need to receive only 1% to satisfy the 3% top-heavy contribution.

3.	In 2004, the IRS clarified the circumstances under which a safe harbor 401(k) plan would be exempt from the top-heavy rules. Basically, to be exempt, there cannot be any employer contributions to the plan other than elective deferrals and contributions that satisfy the ADP and ACP safe harbor. Thus, there can be no profit sharing contributions. Forfeitures generally may not be allocated as additional contributions. There is an exception that permits discretionary matching contributions provided they stay within the ACP safe harbor requirements of being less than 4% of compensation and not matching deferrals that exceed 6% of compensation.
An Annual Determination Top-heavy status is determined on a yearly basis. If a profit sharing contribution was made in 2004, for example, the plan cannot be exempt from the top-heavy rules in 2004. However, if no profit sharing contributions are made in 2005 and no employer contributions are made (other than the employer safe harbor contribution), then the plan will be exempt from the top-heavy rules for 2005. *A safe harbor 401(k) matching contribution plan is not* exempt from top-heavy rules if:**
1.	The employer makes a discretionary nonelective contribution;
2.	Forfeitures are allocated to participant accounts in the same manner as nonelective contributions; or
3.	Employees are eligible to make elective deferrals when they are hired but are not eligible for the employer match until one year of service is completed. For example, if a plan permitted employees to make elective deferrals after three months of service but required one year of service to be eligible for the safe harbor matching contribution, that plan would not be eligible for the top-heavy exemption.

We need to correct an error in the chart of safe harbor 401(k) plan formulas that was included in Alert 2004-18 (September 3, 2004). The example identified as Plan 6 stated that a safe harbor 401(k) plan with:
		elective deferrals
		a safe harbor enhanced matching contribution formula of dollar-for-dollar on the first 5%, and
		a discretionary match of 50 cents on a dollar up to 5% of compensation,
would meet the safe harbor but would still require top heavy testing. However, that is not the case. Such a design would be exempt from the top-heavy test. See the article below for details.


Bill Grossman, QPA
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Top-heavy Rules for Safe Harbor Plans October 21, 2004

Top-heavy Rules for Safe Harbor Plans
October 21, 2004