NEWSLETTERS
Volume 3,
Issue 2 ........................................................................................................................................................
June 2002
New Top Heavy Testing Procedures
The Economic Growth and Tax Relief Reconciliation Act (EGTRRA)
of 2001 has modified the top heavy testing for plan years that begin after
December 31, 2001.
In an effort to reduce the number of top heavy plans and
decrease the number of plan sponsors that are required to contribute top
heavy minimum contributions, the Treasury has changed the definitions of a
top heavy plan and key employees. Additionally, employer matching
contributions can now be taken into account in determining whether the
minimum benefits have been provided.
Old Method of Top Heavy Testing
To determine if a plan was top heavy under the old
method, participant account balances for key and non-key employees at the
end of the year were compared. If the key employees’ account balances
represented sixty percent or more of total plan assets, the plan was
considered top heavy for the following year. Distributions made to all
employees during the current year and four preceding years were included in
the account balances.
A key employee was defined as any employee who met any
one of the following conditions in the current plan year or in any of the
four preceding plan years:
- An officer of the employer with annual compensation greater than fifty
percent of the defined benefit plan contributions dollar limit (fifty
percent of $140,000 in 2001); or
- One of the ten employees with the largest ownership interest in the
employer with annual compensation in excess of the defined contribution
plan dollar limit ($35,000 for 2001); or
- A greater than five percent owner; or
- A greater than one percent owner of the employer with annual
compensation exceeding $150,000.
New Method of Top Heavy Testing
To determine if a plan is top heavy under the new method,
participant account balances for key and non-key employees at the end of the
year are compared. Employees who did not perform services for the employer
during the current year have their account balances disregarded for testing
purposes.
Distributions made during the current year to employees
who were employed in the current year are included in the account balances.
However, hardship and in-service distributions are added back to account
balances for five years. If the key employees’ adjusted account balances
represent sixty percent or more of total plan assets, the plan is considered
top heavy for the following year.
A key employee is defined as an employee who during the
current year was:
- An officer earning in excess of $130,000; or
- A greater than five percent owner; or
- A greater than one percent owner with compensation in excess of
$150,000.
The maximum number of officers is the greater of three
officers or ten percent of the employees.
Under the new rules, safe harbor 401(k) plans are deemed
to be providing top heavy minimum contributions and are not required to
contribute additional contributions.
Requirements if a Plan is Top Heavy
All plan sponsors of qualified plans, SEP and SARSEPS are
required to annually test their plan and if it is determined to be top
heavy, contribute a top heavy minimum contribution.
The top heavy minimum contribution is subject to the
vesting schedule in the plan. For defined contribution plans (profit
sharing, 401(k) and money purchase), the minimum contribution is the lesser
of:
- The lowest contribution percentage a key employee receives through
either an employee or employer contribution, or
- Three percent of the employee’s compensation.
For example, if a key employee contributes five percent
to a 401(k) plan, the employer is required to contribute three percent to
all eligible employees (three percent rule). If all key employees contribute
two percent or less to a 401(k) plan or receive a two percent employer
contribution, the employer is required to contribute two percent to all
eligible employees (key employee contribution percentage).
401(k) plans that are top heavy can avoid the requirement
to deposit top heavy minimum contributions by not allowing their key
employees to deposit 401(k) contributions.
Plan sponsors that sponsor more than one plan are only
required to contribute the top heavy minimum contribution to one plan. For
defined benefit plans, the top heavy minimum contribution is two percent.
Contact Administrative Retirement Services, Inc. if you have any
questions
©2002 Administrative Retirement Services, Inc. |
