| Question 86: Our defined contribution plan is top-heavy for the year 2009. The percentage was 61.38%. Would any of these options help? (1) Have one of our highly compensated employees ("HCEs") roll over her money into an IRA? (2) Have a non-highly compensated employee ("NHCE") roll over her money out of our plan? (3) Have an NHCE roll over her money into our plan? If the NHCE rolled her money into the plan, the top-heavy ratio would be less than 60%.
Answer: As discussed below, none of your options will help. Assuming that this is a qualified plan under Internal Revenue Code Section 401(a), the top-heavy rules specified in Code Section 416 generally apply. I will assume that your plan is subject to Code Section 416 top-heavy rules. I also assume that this is the only plan maintained by the employer or any members of a controlled group or affiliated service group under Code Section 414(b), (c), or (m).
Top-heavy status is based on "key employees," not "HCEs" so I will modify your questions accordingly. Also, note that top-heavy calculations are performed on the "determination date" of the plan, which, for plans in their first year is the last day of the plan year; for any other plan, it is the last day of the preceding plan year. (See Code Sections 416(g)(1) and 416(g)(4)(C).) Finally, be aware that, as discussed below, there are special rules for adding back distributions when determining top-heavy status. I will assume that this is not the first plan year and that the plan year is a calendar year. A. Definition of a Key Employee Generally, a plan is top-heavy if more than 60% of the total of the account balances of all employees is held by key employees. (See Code Section 416(g).) Although some employees might be classified as both HCEs and key employees, the Code defines these two groups of employees differently. Generally, an employee is a key employee for testing whether the plan is top-heavy in 2009 if, at any time during 2008 ("look back" year), the employee was described by any of these categories: - A company officer and had an annual compensation in 2008 greater than $150,000 (the $150,000 threshold is subject to change from year to year due to cost of living). Code Section 416(i)(1)(A) contains additional limitations on the number of officers included in the key employee group. - A more than 5% owner. Code Section 416(i)(1)(A)(ii). - A more than 1% owner whose annual compensation from the employer exceeded $150,000. Code Section 416(i)(1)(A)(iii).
In determining key employees, it is important to look at the applicable section of the Code for the precise definition. For example, a "more than 5% owner" is defined as someone who owns more than 5% of the employer, including ownership attribution (i.e., an employee is deemed to own the stock owned by his/her spouse, etc.) See Code Section 416(i)(1). B. Proposed Solutions: Proposal 1: Roll Key Employee Funds into an IRA Rolling key employee funds into an IRA will not help the plan avoid 2009 top-heavy status. Assuming that the accounts of this key employee must be included, the assessment of top-heavy status for 2009 will be made as of December 31, 2008. See Code Section 416(g)(1)(A) and Code Section 416(g)(4)(C). Let's say that you have $100,000 in total account balances as of December 31, 2008 with $61,380 in key employee accounts as of December 31, 2008. You would need $60,000 (or less) in key employee accounts as of December 31, 2008 to avoid top-heavy status for 2009. Since the determination is made as of December 31, 2008, transactions in and out of the key employee's account after the December 31, 2008 determination date are not taken into account for determining 2009 top-heavy status and will not help avoid top-heavy status for 2009. So rolling $1,380 out of a key employee's account in 2009 will not affect the December 31, 2008 calculation. If you roll $1,380 in key employee funds out of the account before December 31, 2008, the top-heavy rules generally require that all distributions made during the previous year (ending on the determination date) must be included in the plan’s top-heavy calculation. Code Section 416(g)(3). (The period is extended to five years for in-service distributions. Code Section 416(g)(3)(B).) Because of the add-back provision, a $1,380 rollover to an IRA made in 2008, but prior to December 31, 2008 still will be counted in making the top-heavy status determination. So the plan remains top-heavy. Proposal 2: Roll Non-Key Employee Funds Out of the Plan Rolling non-key employee funds out of the plan will not affect the 2009 top-heavy status for the same reasons discussed above. In addition, even if you could disregard the amount rolled out, rolling a non-key employee’s funds out of the plan would increase the key employee percentage rather than reduce it. (Rolling any amount out of the non-key accounts would reduce the $100,000 and lower the key employee account threshold below $60,000. This would make the percentage higher than 61.38%.) Proposal 3: Roll Non-Key Employee Funds into the Plan New funds rolled into the plan by a non-key employee generally will not be counted in the top-heaviness determination. (See Code Section 416(g)(4)(A); Treas. Reg. Section 1.416, Q&A T-32.) When an employee initiates the rollover into a plan and the transferred funds are from a different employer’s plan, the employee’s funds generally are not included in the transferee plan’s top-heavy determination because the funds are treated as an “unrelated rollover.” (See Code Section 416(g)(4)(A); Treas. Reg. Section 1.416, Q&A T-32.) However, if this rollover would be from a different plan maintained by the same or a “related” employer, it may be treated as a “related rollover” and the distribution could be included in the present value of the accrued benefits. (See Treas. Reg. Section 1.416, Q&A T-32.) A related rollover or transfer is one that is not initiated by the employee or that is made to another plan maintained by the same or a related employer. (See Treas. Reg. Section 1.416, Q&A T-32.) This Q&A is not legal advice. Individuals should seek advice based on their particular circumstances from their own counsel. Nothing in this Q&A is intended to be used, and no information can be used, for the purpose of avoiding penalties under the Internal Revenue Code, or promoting, marketing, or recommending to another party any transaction or matter addressed in this Q&A. | 
