What Is the Top-Heavy Test and What Should Plans Do if Top Heavy?

by Rachel Fetters, QKA, QPA

What is the top-heavy test?

The top-heavy test ensures that qualified retirement plan (QRP) participants identified as “key employees” do not receive a disproportionate amount of benefits when compared to “nonkey employees.” Under Internal Revenue Code Section (IRC Sec.) 416, a QRP is considered to be top-heavy if more than 60 percent of plan benefits are in the accounts of key employees. A QRP is required to test annually to determine if the plan is top-heavy.

Who is a key employee?

An employee will be identified as a “key employee,” if at any time during the plan year that employee is

an officer with annual compensation exceeding $175,000 for 2018 (subject to cost-of-living adjustments each year),
more than a five percent owner, or
more than a one percent owner with annual compensation exceeding $150,000 (not subject to cost-of-living adjustments).

When identifying a key employee, family attribution rules under IRC Sec. 318 will apply. This means that an employee who is a spouse, child, parent, or grandparent of an owner is considered to share a family member’s ownership for plan purposes such as testing. A “nonkey employee” is any employee who is not a key employee.

What if the plan is deemed top-heavy?

If a plan is deemed top-heavy, the employer must make a mandatory contribution, called a top-heavy minimum contribution, to all nonkey employees who are employed on the last day of the plan year. (As will be described below, employer contributions made for other purposes may count toward satisfying the top-heavy minimum contribution.) The top-heavy minimum contribution generally must be at least three percent of a nonkey employee’s compensation. If the amount of each key employee’s contribution is less than three percent, including employer contributions and employee deferrals, then the top-heavy minimum contribution is only required to be the same percent as the highest contributing key employee’s percentage.

(Certain 401(k) plans known as “safe harbor” plans may be exempt from making this top-heavy minimum contribution if certain contribution rules are followed.)

The definition of compensation used for calculating the top-heavy minimum contribution is IRC Sec. 415 full-year gross compensation. The plan should not use an alternate definition of compensation for this test, as it would produce incorrect results.

The top-heavy minimum contribution is due to the nonkey employees by the employer’s tax filing due date plus extensions for deductibility purposes.