Creative Top Heavy Solutions

[ldr]

Today my skills as a magician are being questioned, as I have failed to pull a rabbit out of hat....

A referral partner has brought us a situation with a client of his who is not our client.  The party in question has a 401(k) plan that eliminated its Safe Harbor match in 2012 and has been subject to all testing ever since.  This employer is angry because he has been told that for the first time, his plan became Top Heavy for 2018 based on the 12/31/2017 results of the test.  He has been told that if he doesn't want to be obligated to make a Top Heavy contribution of any kind, then the Key employees cannot defer in 2018.  Deferrals count, and even if a Key only deferred 1% of pay, then the company would owe the non-Key participants 1% of pay as a TH minimum contribution.  Of course if any Key deferred 3% or more, then the company would have to make the standard 3% TH minimum contribution.

The referral partner is looking to us for some kind of magic trick to allow the Keys to defer whatever they want to defer and somehow not owe a TH minimum contribution.  My crystal ball must be cloudy or something because there's nothing I can find to do about 2018.

For 2019, they should adopt Safe Harbor provisions again, whether it's the 3% SHNE or the basic SH match.  If they aren't willing to do that, then they just have to accept the fact that the Keys can't defer.

Am I missing something?  The referral partner has been told that a "creative solution" should be found.  I can think of all kinds of creativity for failed ADP/ACP tests, cross-tested formulas that don't work out, etc., but I don't know of a "creative" solution to Top Heavy!

Any ideas will be appreciated.  Thanks!

[JackS]

My only thoughts are absurd.  Have the employer buy another company that is not TH?  Have the Key's contribute to IRA's for 2018 and rollover the funds to the Plan.  Realistically, they probably already deferred and are out of luck.  I don't think you are missing anything. 

 

[ldr]

@JackS.....I like that idea of having the Keys contribute to IRAs and roll the money into the plan at a later date.....I wouldn't have thought of that.  Ok, it's not a rabbit out of a hat but it's at least a chipmunk.....Thanks!! 

 

[PensionPro]

non qualified plan?

[ldr]

@ PensionPro - a non-qualified deferred compensation plan separate and apart from the 401(k) plan?  It is worth suggesting to the referral partner.  We don't design or try to do anything of service for that kind of plan but they could pursue it elsewhere.

 

[Lou S.]

Short of reviewing the TH test to confirm it's accurate, you have not missed anything wrt to the qualified plan.

[Mike Preston]

Put in a DB plan for 2018 pays big bucks to the owners. They will have a 5%+ contribution to the PS but they will be happy.

[XTitan]

I agree with Pension Pro; a Non-Qual plan can work really well, subject to the usual disclaimers.

[Tom Poje]

you indicated the plan for the first time was top heavy. curiosity killed the cat, just how close to the magic 60% is the plan?

and then of course depending on how large it would be, if top heavy is indeed provided in 2018 will the plan cease to be top heavy (guestimation)?

[Kevin C]

I'm also curious about how close they are to 60% at 12/31/2017.

There was a question at the 2002 ASPPA Annual IRS Q&A Session about receivable contributions and top heavy testing.  The IRS response indicated that a profit sharing contribution deposited after the end of the year, but allocated and deducted for that year was included in the account balances for the top heavy testing at year end.  If they are close to 60%, it might be worth looking at additional contributions for 2017.

[401king]

16 hours ago, ldr said:

@JackS.....I like that idea of having the Keys contribute to IRAs and roll the money into the plan at a later date.....I wouldn't have thought of that.  Ok, it's not a rabbit out of a hat but it's at least a chipmunk.....Thanks!! 

 

Curious as to how they would see the IRA rollover option as a benefit. Why not just keep the money in the IRA?

[Belgarath]

Have they not already deferred for 2018, and therefore subject to TH anyway? Or have they not yet deferred anything?

[Tom Poje]

Kevin C - those were my thoughts exactly

 

this was Q49 from the ASPPA Conference

p 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.

Of course such a response doesn't necessarily reflect an actual Treasury position, but still...

 

[ldr]

Hi to all and thank you very much for your responses.  To answer all your thoughts if I can:

We have been led to believe that they were warned on time and that the Keys have not yet deferred anything for 2018 (which I find very hard to believe but ok, maybe).

These are not high rollers who could afford a DB plan.  They are balking at the idea of giving anything to the rank and file and are all ticked off over 3% so they certainly wouldn't do 5%.  The salaries of the Keys are not even quite up to the HCE determination level.  Stock ownership is what makes them Keys and HCEs, not salaries.

No, there probably isn't any advantage to having the Keys use IRAs and then roll the money into the plan.  For just a moment I was thinking about that old belief that retirement money is safer in a qualified plan than in an IRA but that was explored thoroughly in another thread a few weeks back and the general idea put forth was that this used to be true but isn't any longer.

I will ask about the non-qualified deferred compensation idea.

Nobody has given us the exact figure for the TH percentages but it's reasonable to assume they are just barely TH since this is the first year they have been TH.  I will ask for the %s.

Now just to be sure I understand:  it's being suggested that they might yet put in just enough profit sharing contribution for 2017 for the NHCEs to tip the account balances back to being not Top Heavy.  That's very clever.  The obstacles I see are these:

1. They may have already finished up and filed their corporate return and their 5500-SF for 2017.  Of course those could always be amended, I suppose.

2. Their document calls for a straight up salary ratio profit sharing allocation for all eligible participants.  Can the Keys choose to exclude themselves from a potential allocation?  If they can't the purpose would be defeated.  I think most places I have worked have turned a blind eye to anything that discriminates against Keys and HCEs, but isn't that technically failure to follow the terms of the plan document?  

 

[Bird]

23 minutes ago, ldr said:

I think most places I have worked have turned a blind eye to anything that discriminates against Keys and HCEs, but isn't that technically failure to follow the terms of the plan document?  

It is a failure to follow the plan document, no "technically" about it.

[PensionPro]

30 minutes ago, ldr said:

Can the Keys choose to exclude themselves from a potential allocation? 

Check plan document provisions relating to top heavy minimum allocation.  It is an elective provision in the documents we use.

[ldr]

@ PensionPro.....for 2017 this wouldn't be a top heavy minimum allocation.  This is just an additional profit sharing contribution whose purpose is to boost the non-Key account balances to the point that the plan would not be Top Heavy for 2018 based upon 2017 test results.

[Tom Poje]

in other words, lets say the top heavy ratio was only 60.5%

since it was indicated the keys have small comp it might be possible that a small comp to comp contribution would tip the scale. e.g. if the keys had 40% of total comp of all employees

 

[ldr]

@ Tom - I see!  Thanks for suggesting that.  It could be worth exploring even if the Keys do have to receive the same % as the non-Keys.

 

[ldr]

@ Tom - indeed, the Key compensation is only 27.93% of the compensation that would be eligible for a profit sharing contribution.  This really could work.  I passed the information along.....let's see if there is any interest.

[Tom Poje]

well, you never know.

maybe not the most creative...

the best one I came up with years ago...

was asked to run a rare pre lim ADP test - must have been Oct or something.

one NHCE who was deferring the max had projected comp of 120,000.07. of course that was 7 cents more than HCE comp limit at the time. I told them I don't care what happens, if the guy finds 10 pennies sitting on his desk one morning before the end of the year and by chance a pay check which was 10 cents less than normal, well, those things happen. you don't want to mess up next years test!

[ldr]

Lol - at least you had a chance to say that before the plan year was over and it was too late!  

We think your idea on the TH situation is very creative - we simply never thought of this before and we actually had a client of our own we could have used this idea on earlier this year!  Thanks again :)

[Mike Preston]

Yet another argument for a plan provision that allows for allocations pursuant to an "everybody in their own group" formula.  You can always allocate comp-to-comp, if you want.  And in this case you would not have to dilute the effectiveness of an employer contribution.

[ldr]

@Mike PrestonIsn't that the truth!  We were just discussing that, and being surprised that this plan still has a comp-to-comp formula.  That would certainly be a must-do recommendation, should we eventually land this prospect as a client.

[C. B. Zeller]

One more possible trick, if the keys are over age 50, is to amend the plan to impose a limit on elective deferrals for key employees equal to $0. Then they can defer up to $6,000 and it would be reclassified as catch-up due to exceeding a plan-imposed limit, and catch-up contributions are not included when determining the minimum allocation rate for the keys.

If you want to play it safe, instead of a $0 limit you can do a $1 limit. Since you have to be eligible to defer in order to be eligible for catch-up, and you could make the argument that someone with a $0 limit is not eligible to defer, this avoids that possible interpretation. However there will be a (small) top heavy minimum required for the non-keys.

I also do not know off the top of my head if there are any complications with amending a plan mid-year to add a limit. If the keys have not deferred anything to date then my feeling is it wouldn't be a problem. But I might be forgetting something.