Question: I’ve been told my company retirement plan is top-heavy and we must make a contribution to the employees for the year. We don’t want to do it and we don’t have the cash to fund it this year. How did this happen?

Answer: To understand what happened, it helps to know what causes a company retirement plan to be top-heavy. As an abridged explanation, a plan is considered top-heavy when plan assets at the end of the previous plan year were more than 60 percent owned by the “key employees”. Key employees for this purpose are owners of over five percent of the company, officers who earn over $175,000 (in 2018), or owners of over one percent of the company who earn over $150,000. If the plan was top-heavy at the end of the prior plan year then an employer contribution will be required if any key employee receives ANY retirement contribution benefit during the current plan year. The top-heavy contribution will be a required amount to all active eligible participants equivalent to the highest amount received by any key employee up to three percent of compensation. Problems can arise when the plan reconciliation isn’t finished until the next calendar year and it is mid-year when it is determined the company retirement plan has already become top-heavy.

Here is an example of a company retirement plan that is top-heavy:

In July 2018 it is determined the plan became top-heavy on December 31, 2017. This means the plan must meet the top-heavy requirements for the year 2016. The 2018 year is already halfway over and the key employees have been contributing their own money to the plan throughout the year so now a top-heavy minimum will be required to all participants who are employed on the last day of the plan year in 2018.

If the plan was close to being top-heavy in the previous year there should be time to recognize the plan could be turning top-heavy in the near future. However, the plan can become top-heavy as a surprise when a non-key employee with a large account balance leaves the company and in the same year withdraws their account balance so their balance is no longer in the equation. This unwelcome surprise can be costly when the key employees have been participating since this could trigger the top-heavy minimum contribution requirement.

Making either a safe harbor matching contribution or a safe harbor non-elective contribution to the plan will meet the top-heavy minimum requirements as long as no additional employer contribution is made for the year. Safe harbor contributions also allow a plan sponsor to ignore the annual ADP/ACP testing. This is why the safe harbor contribution can be helpful to companies with low staff participation rates. If the key employees are predominately the only ones contributing, it is inevitable the plan will become top-heavy. Unfortunately, the decision to make a safe harbor contribution must be made before the start of the plan year so that won’t help you with the minimum contribution requirement unless you knew the plan was top-heavy before the start of the plan year. Hopefully, your plan administrator has been keeping an eye on your top-heavy testing to see if it is likely your plan could go top-heavy so you won’t have any surprises. If you end up with this unhappy surprise, you really do need to make the top-heavy contribution to the plan for the year. Failure to do so can cost you IRS penalties if they examine a year in which the plan was top-heavy and you didn’t make the mandatory contribution. You can self-correct if you correct it within two years but only if the IRS doesn’t notice it first.

Contact us to understand what causes a company retirement plan to be top-heavy and how to deal with the challenges a top-heavy company retirement plan can bring.