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Unravel Key contributions back through payroll in top heavy year


legort69
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401k communication about DC plan's top heavy status came during the year in which a plan was top heavy and key employees had been making contributions during the top heavy year.

Is it allowable to unravel their current year contributions (EE/Matches etc) and run it through payroll so that their effective contribution rate is 0% in order to avoid owing a top heavy contribution?

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Thank you Mr. Bagwell,

But when you say its not allowable, is there a regulation that addresses this circumstance?

My position would be that you can unravel the contributions because its basically an administrative error in that the client was not notified timely or was not aware of the unexpected financial cost of being top heavy. I mean shouldn't the punishment fit the crime?

In reality, and from time to time the last payroll (bonus etc) of the year can kick up an officer or 1% owner into key status for the upcoming plan year. Or that the client remits their payroll records to the TPA in Mid February (for example), or the TPA did not timely test the plan just after the final contribution of the prior year, or a key child is making small contributions unaware that their contributions are creating a financial penalty.

This may not have been foreseen and the client does not want to be on the hook for a top heavy funding and there can be a lot of finger pointing about the protocols. That is why I believe that we can treat this as an administrative error.

There should be some recourse in the regs that allow for the key EE current year contributions to be returned to the employees through payroll. To not allow this would be very un-American.

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My position would be that you can unravel the contributions because its basically an administrative error in that the client was not notified timely or was not aware of the unexpected financial cost of being top heavy. I mean shouldn't the punishment fit the crime?

No... Not knowing the rules is not an "administrative error". An administrative error would be something like depositing 10,000 instead of 1,000 because you added an extra 0 by mistake. Finding out that you messed up is not an administrative error.

 

 

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More important than fairness, is understanding why it happened and how to prevent it. This type of surprise is completely preventable. This type of situation should have been considered when the plan was created, and it should have been designed to either avoid it altogether or at a minimum make it very clear to the sponsor what they can and can't do in order to avoid a "surprise". Obviously, service providers can only do so much, and sometimes the client completely disregards what they have been told. In any event, it will never be a surprise if there is proper planning from day one.

At this point, you contribute what you need to contribute due to top-heavy minimums and you sit down and re-design the plan to prevent this from happening in the future.

 

 

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curiosity-
just what was the top-heavy ratio at the end of last year?
let's say the ratio was 61%, and if the company had made a profit sharing contribution of 1% to all employees last year the ratio would have been only 59%, so not top heavy.
at the 2002 ASPPA Conference Q and A 49
Receivable Contribution and Top Heavy Determination? Is a discretionary profit sharing contribution for the prior plan year that is deposited after the end of the prior plan year included in the top heavy determination for the current plan year? Let’s say we have a calendar year plan, effective several years ago. We are determining the plan's top heavy percentage for the 2002 plan year. The determination date is therefore 12/31/01. The employer makes a contribution in February, 2002, which is allocated and deducted as of 12/31/01. There is a question as to whether this contribution is included in the top heavy determination for the 2002 plan year. The question relates to Q&A T-24 of the 416 regulations, which says that if a plan is not subject to 412, then the account balances are not “adjusted” to reflect a contribution made after the determination date. A. The key phrase here is “account balance”. The participants’ account balances, as of (say) 12/31/01, include the profit sharing contribution that is allocated and deducted for the 12/31/01 plan year end. So the guidance regarding “adjustments” does not apply to the receivable profit sharing contribution; it is already part of the participants’ account balances.
The following is my analysis:
The question as to what contributions are considered due on the determination date is determined under §1.416-1, Q&A T-24, which says that it “is generally the amount of any contributions actually made after the valuation date but on or before the determination date”. It then goes on to say that any amounts due under §412 are considered due, even if not made by the determination date. One could take the position that this is a exclusive statement; in other words, if a contribution is NOT due under 412 and is made after the determination date, it is not considered 'due'. However, the answer to the question (T-24), “How is the present value of an accrued benefit determined in a defined contribution plan” is answered, “the sum of (a) the account balance as of the most recent valuation date occurring within a 12-month period ending on the determination date, and (b) an adjustment for contributions...” The term, "the account balance" includes contributions credited to the account of a participant, it does NOT mean only the contributions actually made that have been credited.
For example, if a 100% vested participant terminated after the determination date but before the contribution was actually made, the distribution would include that contribution, even though it had not yet been made to the plan. This is because the account balance, as of the last day of the plan year, includes the contribution. So, when the regulation addresses adjusting the account balance for contributions made after the determination date, we must start with the account balance, and then apply the adjustments. Since the account balance includes the receivable profit sharing contribution, the adjustment does not refer to the receivable. The reference to §412 in §1.416-1 is with regard to a waived funding deficiency that is not considered part a the participants' “account balance”, as the term is defined. Q&A T-24 refers to a DC plan with a waived funding deficiency that is being amortized. Such a plan must maintain an “adjusted account balance” (reflecting the amount of the contribution that has not been deposited) which must be maintained until the actual account balance increases to the point where it equals the “adjusted account balance”. It is to this (unadjusted) account balance that the (waived) contribution must be added, since the amortized contribution only becomes a part of the actual account balance as it is paid to the plan. The requirement therefore has the effect of determining top heavy status as though the contribution required under 412 had actually been made. In other words, the “account balance” would not include the waived minimum funding contribution, so an adjustment is required.
IRS response: We accept this analysis.

a reminder that such response do not necessarily reflect an accrual Treasury position.

but if valid, then it is possible a contribution for the prior year might be less than a 3% top heavy this year. since we are still before 9/15 it might be possible....

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On slide 99 of ASPPA's Advance Top Heavy Testing and Plan Design Techniques presented by Bill Grossman, it says that there is no known correction of rescinding or returning the key employees deferrals so that a Top Heavy allocation will not be required.

The presentation can be found here. Slide 99 in on page 50.

http://benefitslink.com/boards/index.php?app=core&module=attach&section=attach&attach_id=1148

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Thanks everyone. It just seems that providing no recourse in the top heavy year is very draconian and maybe the regulations should be revisited. I would be in favor of the rules incorporating plan asset size thresholds or even higher TH % for smaller plans. I mean the punishment should fit the crime.

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Amen.

Practically speaking:

1) watch out for terminated employees with large balances. They are in your 12/31/15 test but not 12/31/16 - i.e., you can see with clarity sometimes that the 2017 year is going to be top-heavy (I wont even charge for that tip!).

2) If plans are "almost top-heavy" ( a relative term that depends on a lot of thing) tell keys not to defer until you've done the top-heavy test. Make a big deal about it, get them on the phone, etc. This is a life sentence in terms of punishments at times and it does not fit the crime. Be vigilant!!

But to your point about the officer (or perhaps 1% owner) who crept over the earnings threshold, I agree not much that can be done there. Thankfully it's never happened to me but I can see where that is nasty trapped hidden in a most clandestine manner...

Austin Powers, CPA, QPA, ERPA

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Thanks everyone. It just seems that providing no recourse in the top heavy year is very draconian and maybe the regulations should be revisited. I would be in favor of the rules incorporating plan asset size thresholds or even higher TH % for smaller plans. I mean the punishment should fit the crime.

Taking the top-heavy contributions to which they are entitled away from the rank and file is what would be "very draconian", not making the owners cough up something for the non-owners.

Always check with your actuary first!

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  • 2 weeks later...

My position would be that you can unravel the contributions because its basically an administrative error in that the client was not notified timely or was not aware of the unexpected financial cost of being top heavy. I mean shouldn't the punishment fit the crime?

Top heavy is not a punishment. It is part of the price to be paid for the tax benefits of having a plan that successfully creates a significant retirement balance for for the company's key people.

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A plan becoming top heavy because of contributions made by key employees for their own benefit is not the result of an "error". The entire premise is just wrong. If they don't like having to put minor amounts away for the non-key employees, then the key employees should just save what they can on an after tax basis and pay taxes on the investment income. If they want to receive tax-favored treatment, they have to jump through the relevant hoops. From the standpoint of the general taxpaying population and the government, for owners and officers to receive a tax-favored way to save, they need to kick in enough for their other employees to help reduce the risk of those other employees becoming wards of the state after they are unable to continue working due to age or infirmity. No sympathy for people who act as though they are allergic to having to pay taxes or to share in a meaningful way with the people making their success possible.

Always check with your actuary first!

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A plan becoming top heavy because of contributions made by key employees for their own benefit is not the result of an "error". The entire premise is just wrong. If they don't like having to put minor amounts away for the non-key employees, then the key employees should just save what they can on an after tax basis and pay taxes on the investment income. If they want to receive tax-favored treatment, they have to jump through the relevant hoops. From the standpoint of the general taxpaying population and the government, for owners and officers to receive a tax-favored way to save, they need to kick in enough for their other employees to help reduce the risk of those other employees becoming wards of the state after they are unable to continue working due to age or infirmity. No sympathy for people who act as though they are allergic to having to pay taxes or to share in a meaningful way with the people making their success possible.

You make a good point (or points rather).

However, I still feel a little bad for the small business owner who gets hit with a big required contribution when its due to poor plan design and bad communication from a "service provider".

 

 

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...due to poor plan design and bad communication from a "service provider". - Well, the "free market" corrects for that by making them a "former" service provider.

If the failures on the part of the service provider are a breach of their contract with the sponsor, it may even give rise to a litigate-able claim.

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Top-heavy rules are idiotic and draconian. There is no defending these rules. It is NOT the price of admission for a qualified plan. Nondiscrimination covers that. This is a penalty for being in business too long and employing too many relatives. And if you don't see it that way, then you're probably out of touch with small employers. I can see how those who work with large wealthy companies might not appreciate what a $10,000 top-heavy minimum can do to a small business owner making $110,000 a year, who's just trying to save for retirement by putting away a few thousand dollars a year. Oh and by the way, giving his employees the opportunity to do the same.

Austin Powers, CPA, QPA, ERPA

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Top heavy is not a punishment. It is part of the price to be paid for the tax benefits of having a plan that successfully creates a significant retirement balance for for the company's key people.

Actually, "punishment" is partially correct, but also misleading. TH rules can affect small plans that are exactly identical to large plans, except for the relative number of Key EEs. Is that a logical reason to impose stronger N-D tests? A little analysis of the history of non-discrimination rules will make it clear that TH was created long before the 401a4 rules. If we had a little common sense in Washington, they would review all the N-D rules taken together, and find ways to simplify.

However, those of use who have been around know that anything that goes in with the label of "simplification" comes out with the description of "complification".

I'm a retirement actuary. Nothing about my comments is intended or should be construed as investment, tax, legal or accounting advice. Occasionally, but not all the time, it might be reasonable to interpret my comments as actuarial or consulting advice.

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...due to poor plan design and bad communication from a "service provider". - Well, the "free market" corrects for that by making them a "former" service provider.

If the failures on the part of the service provider are a breach of their contract with the sponsor, it may even give rise to a litigate-able claim.

You are absolutely correct, both on the free market correction and possible claim for damages. I can still empathize with the employer who picked a bad service provider though :)

 

 

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I may be doing the math wrong, but wouldn't it take at least a third of a million dollar payroll, counting only the non-keys, to get to a $10,000 top-heavy minimum contribution? $10,000/3% [3% = the top-heavy minimum contribution when there is no defined benefit plan] = $333,333.33. And that $10,000 is a tax-deductible expense.

Which is not to say that the top-heavy rules are not idiotic and draconian. IF the non-discrimination rules were completely rational and effective (thinking of "new comparability", as in finding a way under the non-discrimination rules to have 85% or more of the contributions go to the keys), then there would be no real need for top-heavy rules. The changes in the integration rules back in the 1980s did away with the abuses that resulted in top-heavy rules being justifiable. I am thinking [as always, in terms of defined benefit plans] of plans with formulas like 30% of average earnings minus 60% of Social Security or 0% of average earnings up to covered compensation plus 1% of the excess (and that before compensation had to be limited!), where most of the rank and file would necessarily earn no pensions at all.

Always check with your actuary first!

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Top-heavy rules are idiotic and draconian. There is no defending these rules. It is NOT the price of admission for a qualified plan. Nondiscrimination covers that. This is a penalty for being in business too long and employing too many relatives. And if you don't see it that way, then you're probably out of touch with small employers. I can see how those who work with large wealthy companies might not appreciate what a $10,000 top-heavy minimum can do to a small business owner making $110,000 a year, who's just trying to save for retirement by putting away a few thousand dollars a year. Oh and by the way, giving his employees the opportunity to do the same.

Most of my clients are small businesses. We generally tell them that if their plan is NOT top heavy, they are doing something wrong. Of course, we also encourage them to go safe harbor so that it's a mute point.

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