Top-Heavy Chart
Rev. 09/03/04, E-mail Alert 2004-18 Updated 11/14/08

Top-Heavy Definition

Defined Contribution Plan
As of the determination date when the aggregate value of the plan accounts of key employees exceeds 60% of the aggregate value of the plan accounts of all employees.

Defined Benefit Plan
As of the determination date when the present value of the accrued benefits of key employees exceeds 60% of the present value of accrued benefits of all employees.

Key Employee Definition
A key employee is an employee, who at any time during the plan year containing the determination date is:

• a more than 5% owner of the employer (family attribution rules apply).
  
• a more than 1% owner of the employer with annual compensation greater than $150,000 (family attribution rules apply).
  
• an officer with annual compensation greater than $130,000 (indexed). The dollar limit is anticipated to increase to $160,000 in 2009.

The number of officers is generally determined as 10% of the employees. This 10% is capped at 50 officers and has a minimum of 3. To exemplify:
So if there are less than 30 employees, the maximum officers would be 3.
If there are between 31 and 499 employees, the maximum officers would be 10% of those employees.
If there are over 500 employees, the maximum officers for the test would be capped at 50.

The authority of a job is used to determine “officer” status, rather than officer title.

Determination Date
The determination date is the last day of the preceding plan year. For example, for a calendar year plan for the 2009 top-heavy test, the determination date would be December 31, 2008.

For the first plan year, the last day of the first plan year would be the determination date for both the first plan year and the second plan year. For example for a calendar year plan which started in 2008, the 2008 plan year determination date would be December 31, 2008, and the determination date for the 2009 plan year would also be December 31, 2008.

Vesting Requirements for a Plan That Is Top Heavy

Cliff Vesting: 3 Year Maximum Term
Graded Vesting: Maximum Term is 6 years also known as the 2/20 schedule. Specifically:
Year 1 = 0% Vested
Year 2 = 20% Vested
Year 3 = 40% Vested
Year 4 = 60% Vested
Year 5 = 80% Vested
Year 6 = 100% Vested

Allocation Requirement for a Plan That Is Top Heavy

Defined Contribution Plan
3% of compensation
or
if the highest actual allocation to any key employee is less than 3% of compensation, then that is the rate to be used for the top-heavy allocation.

(Note: elective deferrals contributed by a key employee are an employer allocation which will trigger a top-heavy allocation requirement for non-key employees.)

The top-heavy allocation is provided to all non-key plan participants who are active employees on the last day of the plan year regardless of actual hours of service performed. Thus, there may be no 1,000-hour requirement for a top-heavy allocation and anyone employed on the last day of the year who is eligible to participate in the plan is to receive a top-heavy allocation. A plan document may also call for the top-heavy contribution to be provided to the key employees also.

Defined Benefit Plan
The lesser of 2% for each year of service while a participant or 20% — which effectively limits the top heavy benefit to 10 years (use normal benefit formula thereafter).

Top-heavy benefit is provided to all non-key participants with at least 1000 hours of service; no last day rule.

Defined Contribution and Defined Benefit Plan of the Same Employer

The top heavy can be satisfied by making applicable top heavy allocation to the DC and the DB, OR by:

• Providing the minimum TH benefit to the DB
• Providing just to the DC, then TH contribution must be 5% not 3%
• Providing DB top heavy minimum with a floor offset where the minimum DB is offset by the DC benefit
• Providing some TH to DC and DB, provided the combined benefits are at least equal to the DB top heavy minimum

Plan Design Alternatives
There are certain plan design alternatives that will avoid top heavy testing. For example:

• A Safe Harbor 401(k) Plan in which the only allocations made to the plan are elective deferrals and the safe harbor contribution. Rev. Rul. 2004-13 provides details. And for even further clarification.
  
• SIMPLE IRA or SIMPLE 401(k) Plans are exempt from top-heavy testing.
  
• Where multiple plans of the same employer are involved, frequently the Defined Benefit Plan or Money Purchase Pension Plan plan will provide the top-heavy benefit due to cost effectiveness for the employer; however, eligibility provisions must be identical to allow this to work properly.
  
  For example, a required 5% money purchase plan contribution may also be used to satisfy the top-heavy 401(k) plan contribution while still satisfying the employer's money purchase contribution requirement; again this is only possible if the eligibility provisions for the money purchase plan are the same as the 401(k) plan.
  

CAVEAT: Plans with fewer than 100 employees are the plans most likely to become top heavy and thus be affected by the top-heavy rules. Managing client expectations should always include informing small business employers who are considering a new retirement plan that employers with less than 100 employees need to consider not only the possibility of becoming a top heavy plan but also of the resultant rules and consequent costs that will apply if top heavy.

Bill Grossman, QPA