If your 401(k) plan is projected to be top-heavy, there are steps you can take to try to avoid having to make the associated top-heavy minimum contributions. Some of the solutions may be similar to those used to address ADP and ACP testing, as well.
Tips to help your plan pass the Top-Heavy test
The goal of the Top-Heavy test is to ensure that the plan is not benefiting “key employees” too much more than non-key employees. A plan is considered top-heavy when key employees hold more than 60% of the total account balances by value in a 401(k) plan. To help avoid tipping the scale, here are several tips:
Encourage non-key employees to increase their contributions. You can do this by educating employees on the importance of saving for retirement. Guideline provides a wealth of resources on participant education, such as our employee Help Center as well as our helpful Video Library.
Request that key employees reduce or stop their contributions. However, you cannot offer any incentive or disincentive to key employees that may affect their decision to contribute to the plan.
If it is your first year having a 401(k) plan, making a profit sharing contribution may help you avoid top-heavy status for both the first and second years.
Additionally, there are some plan design changes that can help prevent top-heavy status, such as:
Removing the service requirement for your plan. This may help by allowing previously ineligible employees to participate.
Adding a small match to incentivize participation. For example, a 25% match of up to 8% of contributions can encourage participants to increase their contributions to 8% or more in order to take full advantage of the company match. Compared to the Top-Heavy minimum correction of 3% (which must go to all eligible employees and not just those contributing).
Adding a safe harbor nonelective contribution mid-year. If your plan is currently expecting to exceed top-heavy limits by the end of the year, you may consider adding a safe harbor non-elective contribution (note that the contribution will need to be made to all employees for all eligible compensation). As long as no other employer contributions are made, this will avoid top-heavy minimums for the applicable plan year.
Things that won’t help your plan pass testing
Taking a disbursement. If your plan is currently exceeding limits, taking a disbursement mid-year will not change the results. For active participants, any distributions taken in the past 5 years must be added back to their account balance when calculating the plan’s top-heavy status.
Removing key employees from your roster. Even if a key employee is terminated or moves their funds elsewhere, test results are based on the determination date and all contributions made up to their date of dismissal will be taken into account for testing.
Canceling/terminating the plan. Upon plan termination, all Guideline plans undergo an account review, where we will address compliance testing per its current standing. You would need to make contributions prior to completing termination to comply with IRS rules.
Taking a reversal. Making a correction for funds that have already been contributed is not an IRS-permissible method to withdraw funds.
How a safe harbor plan design can help avoid top-heavy failure
401(k) plans with safe harbor provisions are exempt from making the top-heavy minimum contributions so long as no additional employer contributions are made beyond the safe harbor harbor contributions. Safe harbor plans are also exempt from ADP and ACP compliance testing.
Safe harbor matching provisions generally must be added 30 days before the start of the year, but safe harbor nonelective contributions can be added mid-year and even into the next plan year (as long as the contributions are made retroactively to the first day of the plan year). The required nonelective contribution minimum will vary depending on when the provision is added.
If you’re interested in adding a safe harbor provision to your plan, you should begin the process as soon as possible to ensure the amendment and all contributions can be completed timely.
Learn more about the benefits of a safe harbor plan or contact us to add this provision to your plan today.