Top Heavy in First Year

[Guest KMP]

In the first year of a plan, a top-heavy calculation performed at the end of the year results in a top-heavy percentage of 70%. Top-heavy minimum contributions are only required for non-key employees, and since this is the first year of the plan, contributions made after the determination date are included in the top-heavy ratio.

When recalculating the top-heavy percent after the top-heavy contribution, the ratio drops below 60%.

Does this mean that for the first plan year, the plan is top-heavy, but for the second year, the plan is not top-heavy? It seems odd since you use the same determination date for the first and second years.

[Mike Preston]

You haven't said what type of allocation formula is built into the plan. What usually happens is that the plan sponsor deposits enough money so that the plan's top-heavy ratio is just beneath 60%. The plan is therefore usually not top-heavy for the first or the second year.

This can be a difficult thing to accomplish if the plan's allocation formula is specialized in some manner. Worst case scenario, though, is that the plan gets a contribution which is essentially the same as if the plan was top-heavy.

Care to share the details?

[Guest KMP]

The employer was not going to make a profit sharing contribution for the year. If they did, it would be allocated to all employees including the keys. This is an integrated plan (100% of wage base).

The only contribution will be the top heavy contribution.

[Mike Preston]

It still kind of depends on the allocation language. Is it 2-tier, 3-tier or 4-tier integrated allocation language? Does it use reverse language or bottom up (which is normal)?

In any event, I think you will find that there is a level of contribution below 3% of pay to everybody which will result in the plan not being top-heavy.

[Guest KMP]

Thank you for your response.

If we just deposit the 3% top-heavy minimum, though, will they be top heavy next year if the top-heavy minimum makes the ratio decrease below 60%?

[Mike Preston]

No, it will not be top-heavy because the ratio is less than 60%. However, neither will the first year be top-heavy. Hence, you can't just deposit the 3% top-heavy minimum. You must deposit an amount, which when allocated in accordance with the regular allocation rules of the plan (not the top-heavy rules), creates a top-heavy ratio of less than 60%. Now, these two may be the same, but it depends on the terms of the allocation formula under the plan.

There really is no substitute for doing the work. Pick a number, allocate it in accordance with the plan's provisions, and see what you get.

[Guest KMP]

Thank you again. I just want to make sure that I'm completely clear.

They must make a contribution in accordance with the allocation formula in the plan in order to avoid being top heavy this year and next year. Contributing the top-heavy minimum alone will not satisfy the requirement.

[Guest KMP]

I just want to reiterate that key employees do not get the top-heavy minimum contribution, but under the plan's allocation formula, they would. It seems that allocating according to the plan's formula would make the plan more top-heavy, not reduce the top-heavy ratio.

[Mike Preston]

I don't know what you mean by: contributing the top-heavy minimum alone will not satisfy the requirement. It might. I don't know. It is possible that the plan allocates the first 3% to non-key employees, on a pro-rata basis. If so, then contributing the top-heavy requriement will most assuredly do the same thing as following the plan's allocation formaula, because they are functionally identical.

[Mike Preston]

I didn't see your second follow-up before I posted my prior. If the plan's allocation formula is pro-rata to everybody, and you previously stated that a full 3% contribution results in the plan being not top-heavy, then your most recent statement that allocating 3% across the board would make the plan more top-heavy is at the least inconsistent.

I think you'll need to play with the numbers a bit in order to figure out what I'm saying. Feel free to post some statistics if you think it will clarify things.

[Guest KMP]

Well, here goes. The top-heavy ratio before the top-heavy minimum contribution is 35,926.54/50,890.79 = 70.60%. The top-heavy minimum is $9,958.35 which only gets allocated to non-key employees. Thus, the new ratio is 35,926.54/60,849.14 = 59%.

If I use the plan's integrated formula, everyone (including key employees) would receive a benefit. For example, if I allocate a $25,000 contribution, the keys would receive about $20,000 of the total. That would make the top-heavy ratio 55,926.54/75,890.79 = 74%.

Do you see an error with anything in the above calculations? Please let me know. Thanks!

[Mike Preston]

This is perhaps the best example to draw a distinction between the 2-tier, 3-tier and 4-tier integrated allocation formulas.

Which one do you have?

If you have a 4-tier allocation formula, then you can contribute just enough to make the plan not top-heavy, which according to my calculations would be a contribution of $8,986.83. You need to determine whether you are comfortable with that close of a result. If not, you can increase the contribution a bit, but certainly not all the way up to $9958.35.

However, if you have just a 2-tier formula, you are stuck with a regular integrated allocation. In that case, you will find that you will need the entire 3%, plus the 3% to those over the wage base, plus the 3% in excess of the wage base. If you drop $1 beneath that threshold, the allocation under the plan will leave at least one person with a contribution that doesn't satisfy top-heavy.

I don't have a 3-tier formula handy, but I think that it might be the same as a 4-tier formula for this purpose.

Does that make it clear?

[Guest KMP]

Yes, thank you. The formula is a four-step integrated allocation, and I agree with the amount that you calculated. So, if they contribute $8,986.83, they will not be considered top-heavy for either the first or second plan year?

I just want to be sure.

[Mike Preston]

You will need to make your own judgement on that one. If the result of the calculations is that the top-heavy ratio is not greater than 60%, then the plan is not top-heavy as of the determination date. The same determination date is used to determine top-heavy status in both the first year and second year of a plan (assuming no other plans, including terminated ones, in the last five years for 2001, but only the last year for 2002).

So, if there are no other plans and there haven't been for the past 5 years, my calculations are that you are at slightly less than 60%, but certainly not more than 60% based on the numbers you have provided.

[Guest EDSAADE]

KMP,

you stated "the employer was not making a p/s contribution", therefore, i'm assuming you have a (k)and (m) feature. If all your key employees are HCE's (typically true in small plans) and your plan allows, you can contribute $8,987 qnec to the nhce's which should bring it out of top heavy for both plan years. Be sure sure to check plan provisions to see if you can use this "work-around" allocation.

[Mike Preston]

Why would an employer want to make a contribution that is 100% vested if they could otherwise make a contribution that is subject to the regular vesting schedule?

[Guest EDSAADE]

Mike,

"point taken"...

I have come across scenarios where the $'s are significant lower and the employer did not mind giving up the vesting or if plan allowed making a discretionary (vested) match to nhce's only in order to avoid two years of TH minimum contribs.

[Mike Preston]

I am so confused. We have already determined that the employer can make a regular profit shring contribution which would be allocated to the non-keys such that the plan would not be top-heavy for the first or the second year. Your suggestion only makes sense if the regular profit sharing contribution was "two-tiered" integration, resulting in the inability to make a regular profit sharing contribution that would be allocated solely to the non-keys. Unless you are driving at something that I'm just missing the boat on.

[Mike Preston]

KMP, since this came up in another thread, I thought I'd throw it out here just in case it matters. Remember, the top-heavy determination date in the first year of a plan is the typically the last day of the first plan year. You test the account balances on that date, not just the contributions for the year. Hence, if some of these monies were contributed before the end of the year, then the account balances might be different from the total contributions for the year. That might require you to adjust the number somewhat.