Chapter 5: Key Employees and Top-Heavy Plans

List the steps to determine if a plan is top-heavy.

1) Identify who is the employer for the plan(s) 2) Determine the date as of which top-heavy status must be determined for the employer's plans for the plan year at issue (determination date) 3) Determine which employees are key employees, former key employees & non-key employees 4) Identify the plans that must be considered in the analysis 5) Determine the account balances and/or PVABs for all included employees 6) Determine the percentage of the total value of the account balances and/or PVABs that belong to the key employees (top-heavy ratio) 7) Identify whether the top-heavy ratio exceeds 60%

What sources are not included in the top-heavy ratio?

1) deemed IRA account balances 2) unrelated rollover account balances 3) former employees' account balances 4) former key employees' account balances

What sources are included in the top-heavy ratio?

1) employer pension contributions 2) employer nonpension contributions (IF contributed by the determination date) 3) catch-up contributions (disregard those made for the PY ending on the determination date; include others) 4) employer contribution account balances 5) elective deferral account balances 6) after-tax employee contribution account balances 7) distributions due to severance of employment, death, or disability (IF participant worked at least one hour during determination year) 8) in-service withdrawals made by active participants (IF distribution occurred within the 5-year period ending on determination date) 9) related rollover account balances (include in recipient plan's ratio)

What is the top-heavy minimum allocation?

3% of IRC 415 compensation for the entire plan year.

Top-Heavy Ratio

= key employee includible account balances, present value of accrued benefits & distributions / includible account balances, & PVABs distributions for key and non-key employees

What are the steps to calculating a participant's minimum top-heavy contribution?

A non-key employee's allocation under a top-heavy defined contribution plan must be at least 3% of compensation for the entire plan year. If the participant's allocation of 1) employer pension; 2) employer nonelective; 3) employer matching; 4) forfeitures; 5) QNECs; 6) QMACs; 7) SHNEC; and/or 8) SHMAC is/are equal to or greater than 3%, then no further contribution is required.

Top-heavy plan

A plan in which the value of the account balances (for DC plans) or the present values of accrued benefits (PVABs) (for DB plans) for key employees is GREATER THAN 60% of the plan total.

Describe the plan aggregation rules as they pertain to top-heavy testing.

A required aggregation group consists of 1) each plan in which at least one key employee participates; and 2) any other plan that enables the plan with the key employee to satisfy nondiscrimination testing under IRC 401(a)(4) or coverage testing under IRC 410(b).

Related rollover

A rollover or transfer that is 1) made to another plan maintained by the same or a related employer; OR 2) made without the participant's election (i.e. made pursuant to a merger). Recipient plan includes the rollover account in its top-heavy ratio.

Unrelated rollover

A rollover or transfer that is both 1) elected by the participant; AND 2) made to a plan maintained by another, unrelated employer. The distributing plan includes the amount as part of the accrued benefit.

What are the vesting and allocation requirements of a top-heavy plan?

A top-heavy plan must satisfy one of two minimum vesting schedules: the "three-year cliff" or "six-year graded" vesting schedule. A plan must state the vesting rules that will apply if the plan is top-heavy, even if the plan isn't currently top-heavy. A non-key employee's allocation under a top-heavy defined contribution plan must be at least 3% of compensation for the entire plan year.

Three-year cliff vesting

An employee becomes 100% vested once he/she is credited with 3 years of service. Prior the completion of the third year of service the employee's vesting percentage is zero.

Six-year graded vesting

An employee becomes 100% vested once he/she is credited with at least 6 years of service.

Officer test

An employee who is an officer AND satisfies the compensation requirement (more than $130,000 subject to cost-of-living adjustments COLA).

5 percent owner test

An employee who owns MORE THAN 5% of the employer (or more than 5% of a related employer). No minimum compensation is required.

Key employee

An employee who satisfies at least one of three tests: 1) The 5 Percent Owner Test 2) The 1 percent Owner Test 3) The Officer Test

Former key employee

An individual who was a key employee at some time in the past, but no longer meets the requirements to be a key employee. Once someone has been a key employee, he/she may never be treated as a non-key employee.

Which distributions are and are not included in top-heavy testing?

Any distributions made during the 12-month period ending on the determination date are added back and included in top-heavy testing. This includes 1) terminated participants who received distributions of all or part of their accounts & worked at least one hour of service during the PY; and 2) current participants who took in-service distributions.

Non-key employee

Any employee who is neither a key nor former key employee.

1 percent owner test

Any employee who owns MORE THAN 1% of the employer or related employer AND has annual compensation IN EXCESS of $150,000 (not indexed for cost-of-living increases).

Required aggregation group

Consists of 1) each plan in which at least one key employee participates; and 2) any other plan that enables the plan with the key employee to satisfy nondiscrimination testing under IRC 401(a)(4) or coverage testing under IRC 410(b).

T/F - A SEP plan is not subject to the top-heavy aggregation rules.

F - A SEP plan is subject to the top-heavy aggregation rules.

T/F - A SIMPLE 401(k) plan is subject to the top-heavy aggregation rules.

F - A SIMPLE 401(k) is not subject to top-heavy aggregation rules.

T/F - Whether someone is or is not an officer is determined solely by title.

F - A person's status as an officer is a facts and circumstances determination, taking into account the source of the employee's authority, the term for which the employee is elected or appointed and the nature and extent of the employee's duties.

T/F - Catch-up contributions are included when determining a key employee's allocation rate.

F - Catch up contributions are disregarded when determining a key employee's allocation rate.

T/F - Key employee determination for top-heavy testing is the same as the HCE determination needed for nondiscrimination testing.

F - Do not confuse the two; the determination of key employees needed for top-heavy testing does not apply to the various nondiscrimination tests.

T/F - Distributions due to death made in the five-year period ending on the determination date are included in the top-heavy ratio.

F - Only certain in-service withdrawals made in the five-year period are included in the top-heavy ratio. A distribution due to death would only be included if made in the one-year period ending on the determination date and the deceased participant had at least one hour of service in that same period.

T/F - An employee with annual compensation in excess of $80,000 (as indexed) is a key employee in 2018.

F - The employee's compensation level alone will not make the employee a key employee. Do not confuse HCE determination with key employee determination.

T/F - A top-heavy minimum contribution is required for all plan participants.

F - if a top-heavy minimum contribution is required, it need only be allocated to non-key employees who are employed on the last day of the plan year, not all participants.

What compensation is used for purposes of determining whether the threshold for the officer test is reached?

IRC 415 compensation. The plan may use one of three prescribed definitions: 1) current includible compensation; 2) W-2 compensation; or 3) compensation for Federal Insurance Contributions Act (FICA) withholding purposes.

Is employment on the last day of the plan year required to receive the allocation?

It may be a condition to receive the allocation. Although, a plan document may select to offer the top-heavy minimum without the last day allocation requirement.

Is a minimum number of service hours required to receive the allocation?

No

Who must receive the top-heavy minimum?

Non-key employees

Employer

Plan sponsor, plus any other company that is a member of a controlled group of affiliated service organization that includes the plan sponsor (related employers).

Identify types of plans that may be exempt from top-heavy testing.

SIMPLE IRA and SIMPLE 401(k) plans are exempt from top-heavy testing.

T/F - A plan is top-heavy if more than 60 percent of the benefits are attributable to key employees.

T

T/F - A plan termination distribution from a plan in a required aggregation group is included in the top-heavy determination.

T

T/F - A required aggregation group includes each plan of an employer in which a key employee participates.

T

T/F - A required aggregation group includes each plan of an employer that enables a plan within which a key employee participates to satisfy coverage or nondiscrimination requirements.

T

T/F - After-tax employee contributions are included in calculating the top-heavy ratio.

T

T/F - An officer earning more than $180,000 in 2018 may be considered a key employee.

T

T/F - Catch-up contributions made in the year in which the determination date falls are included in calculating the top-heavy ratio.

T

T/F - Employer matching contributions may be used to satisfy top-heavy minimum requirements.

T

T/F - Forfeitures are considered employer contributions for determining top-heavy minimum allocation requirements.

T

T/F - If a permissive aggregation group is not top-heavy, then all plans in the group are not top-heavy.

T

T/F - If a terminated plan is not fully paid out (or if account balances must be added back), that plan must be aggregated with active plans if it is part of the required aggregation group.

T

T/F - If the required aggregation group is top-heavy, each plan in the group is top-heavy unless the safe harbor exception applies.

T

T/F - In a new plan, the determination date is the last day of the first plan year.

T

T/F - In order for two plans to be part of a permissive aggregation group, they must be able to satisfy coverage and nondiscrimination requirements when considered together.

T

T/F - In-service withdrawals made during the five-year period ending on the determination date are included in calculating the top-heavy ratio.

T

T/F - Only a non-key employee who is a participant in the plan for the plan year is entitled to the top-heavy minimum allocation.

T

T/F - Plans are permissively aggregated only when to do so will cause the group not to be top-heavy.

T

T/F - Qualified nonelective contributions (QNECs) and qualified matching contributions (QMACs) used to help the employer pass the nondiscrimination testing for elective deferrals and matching contributions also count for satisfying the top-heavy minimum.

T

T/F - Related rollover between plans maintained by the same employer are included only in the recipient plan for top-heavy determination.

T

T/F - Rollovers between plans of unrelated employers are included only in the distributing plan's top-heavy testing.

T

T/F - Some safe harbor 401(k) plans are deemed not top-heavy.

T

T/F - Top-heavy defined contribution plans have minimum allocation requirements.

T

T/F - Top-heavy plans have minimum vesting requirements.

T

T/F - Two plans that are not part of a required aggregation group may be permissively aggregated for top-heavy purposes.

T

T/F - the accrued benefit of a former key employee and distributions to a former key employee are excluded from both the numerator and the denominator of the top-heavy ratio - like that person never existed.

T

T/F - Catch up contributions are disregarded for top-heavy purposes only for the plan year in which they are made.

T - Catch up contributions made for prior plan years are taken into account for the top-heavy ratio.

T/F - Pension plans use accrual method.

T - Defined contribution pension plans (money purchase pension or target benefit pension), employer contributions due as of the determination date under the minimum funding requirements are included in the account balance, even if the contributions were not deposited by that date.

T/F - Nonpension plans use cash method.

T - Defined contribution pension plans (profit sharing, 401(k) or stock bonus plan), only employer contributions actually made by the determination date are included. Common method for daily valued plans.

T/F - If a distribution is made for a reason other than severance from employment, death or disability, the lookback is extended and the distribution is added back if it occurred within the five-year period ending on the determination date.

T - Distributions due to termination are included only if made during the 12-month period ending on the determination date to participants with at least one hour of service.

T/F - If a rollover is related, the plan making the distribution does not count the distribution in its top-heavy ratio.

T - However, the recipient plan would count the rollover in its top-heavy ratio.

T/F - A defined contribution plan may provide that, unless a non-key employee is still employed on the last day of the plan year, he/she is not eligible to receive a top-heavy minimum allocation for that plan year.

T - If a non-key employee is employed at year end, the plan may NOT require that he/she complete a certain number of hours to be eligible to receive the top-heavy minimum allocation for that plan year.

T/F - Treasury Regulations indicate that an officer is someone who is an administrative executive in regular and continued service with the employer, and not someone who is employed for a special and single transaction.

T - If someone has a nominal title of officer but very little authority, that person is not an officer for top-heavy determination purposes.

T/F - There is an exception to the 3% allocation minimum if all key employees have an allocation rate for the plan year (not the determination year) of less than 3%.

T - In this case, the minimum benefit for that year for top-heavy allocation purposes is the highest allocation rate for any key employee.

T/F - Even though not included in taxable income, elective deferrals and catch-up contributions to 401(k) plans, cafeteria plans, 403(b) programs, SIMPLE IRAs, SARSEPs, section 457 plans and qualified transportation fringe benefit programs are includible in IRC 415 compensation.

T - Regardless of which IRC 415 compensation definition is used by the plan.

T/F - SIMPLE IRA or SIMPLE 401(k) plans are not subject to aggregation for top-heavy purposes.

T - SIMPLE IRA and SIMPLE 401(k) plans are both exempt from top-heavy rules.

T/F - If a required aggregation group's top-heavy ratio exceeds 60%, every plan in the group is considered to be top-heavy, even if the plan would not be top-heavy if it was examined separately.

T - Similarly, if the required aggregation group's top-heavy ratio is 60% or less, every plan in the group is considered not to be top-heavy, even if such plan would clearly be top-heavy if it was examined separately.

T/F - In the case of an unrelated rollover, the plan receiving the rollover excludes the amount from the accrued benefits.

T - The distributing plan includes the amount as part of the accrued benefit. Exception: all unrelated rollovers received before January 1, 1984 must be included in the top-heavy ratio of the recipient plan.

T/F - Two plans that are not part of a required aggregation group may be permissively aggregated.

T - The effect of permissively aggregating plans is to reduce the top-heavy ratio.

T/F - The top-heavy ratio does not include the value of the former employee's account or accrued benefit if he or she has not been credited with at least one hour of service during the lookback period.

T - The lookback period for this purpose is the 12-month period ending on the determination date.

T/F - If an employee has met the requirements to be eligible to make an elective contribution under the 401(k) arrangement, the employee is entitled to a top-heavy minimum allocation.

T - This is regardless of whether the employee actually elects to contribute to the plan.

Determination date

The last day of the prior plan year. Unless it is the first plan year, then determination date is the last day of the first plan year.

What is the limit on how many officers may be considered key employees in a given year?

The maximum is the greater of 10% of the number of employees OR 3. No more than 50 officers are treated as key employees, even if the 10% cap is greater than 50.

Determination period

The plan year that contains the determination date.

How is the top-heavy ratio determined?

The top-heavy ratio is equal to the account balances and present values of accrued benefits accumulated for all key employees (as of the determination date), divided by such total for all participants includible in the test.

What contributions are used to determine the key employees' highest contribution rate?

To determine the highest key employee allocation rate, the plan must take into account the amount of employer contributions and forfeitures allocated to each key employee for the plan year, and divide this amount by the key employee's IRC 415 compensation.

What types of contributions satisfy the top-heavy minimum requirements?

Top-heavy minimum must be satisfied with employer contributions and/or forfeitures. Employer contributions include profit sharing and pension contributions, as well as matching contributions under a 401(k) arrangement. QNECs and QMACs also count for satisfying top-heavy minimum.

Permissive aggregation group

Used to show that the combined plans are not top-heavy. Plans may be part of a permissive aggregation group if 1) they are not required to be aggregated because of the required aggregation group rules; and 2) they satisfy coverage testing under IRC 410(b) and nondiscrimination testing under IRC 401(a)(4) if they are considered together. Effect of permissively aggregating plans is to reduce the top-heavy ratio.

Are there any exceptions to the 3% minimum?

Yes. If all key employees' allocation rates for the plan year are less than 3%, the minimum is the highest allocation rate for any key employee.