Top-Heavy Testing
By Kathy Hamlin, QKA, QPA, CIP
What does the top-heavy test measure?
The top-heavy test in Internal Revenue Code Section (IRC Sec.) 416 compares the benefits that have accrued under the plan for key employees to those of nonkey employees. A plan is deemed to be top-heavy if more than 60 percent of plan assets are held in the accounts of key employees. In any year a plan is determined to be top‑heavy, the nonkey employees must receive a minimum employer contribution if a contribution is made on behalf of any key employee.
Who is a key employee?
A key employee is an employee who, at any time during
the plan year is
an officer of the company earning over $215,000 for 2023 and $220,000 for 2024 (subject to cost-of-living adjustments (COLAs)),
a greater than five percent owner of the company, or
a greater than one percent owner of the company with annual compensation exceeding $150,000 (not subject to COLAs).
The family ownership attribution rules in IRC Sec. 318 apply when determining key employees. The attribution rules identify relatives of one percent and five percent owners who are attributed ownership. They include a spouse, child, parent, or grandparent. Family attribution does not apply when determining who is an officer of the company. In addition, only ownership can be attributed, not compensation. Therefore, for someone to be a key employee based upon the one percent ownership rule, the individual must also have met the compensation threshold of $150,000 on her own.
What is the timing for top-heavy determination?
The top-heavy determination must be made for each plan year as of the “determination date.” Except for the first plan year, the determination date is the last day of the prior plan year. For the first plan year, the determination date is the last day of the current plan year. The plan year leading up to the determination date is known as the determination year. All of the top-heavy
determinations, including whether an employee is a key employee and what account balances are reviewed to see if the plan is top-heavy, are based on data for the determination year.
What action must be taken for a year in which a plan is deemed to be top-heavy?
When a plan is top-heavy, the employer generally must ensure that a top-heavy minimum contribution of up to three percent of compensation is made on behalf of each nonkey employee who is a participant in the plan at the end of the plan year. If no key employee receives a contribution (including employee deferrals and employer contributions) of three percent or more, the minimum contribution need only equal the same percent as that of the key employee with the highest contribution percentage.
Do other employer contributions offset the top-heavy minimum contribution?
Yes, employer contributions that are taken into account to determine if a nonkey employee has received the required minimum contribution are as follows.
Matching contributions
Profit sharing contributions
Safe harbor contributions
Money purchase pension contributions
Qualified nonelective contributions (QNECs)
Qualified matching contributions (QMACs)
Forfeiture allocations
