rollovers/top heavy testing

[Guest jdw]

We're debating whether you count earnings on rollovers for top heavy purposes. The regs that allow exclusion of rollovers don't mention earnings on them. And with today's market, some rollovers throw off LOTS of earnings each year.

We have people on both sides. Comments?

[Guest David Dye]

The purpose of the Top Heavy test is to determine if excessive benefits are being accrued in favor of Key employees. The accrual of benefits here deals with ongoing employee and employer contributions, forfeiture reallocations, and the earnings thereon. Amounts rolled over from another plan, and the earnings on the rollover, are not included. This is assuming that the rollover is initiated by the employee/participant, as opposed to a rollover resulting from a merger of plans or otherwise initiated by the employer.

The rollover portion of a participant's account balance should be segregated. This segregated account includes earnings on the original rollover amount. The entire segregated rollover account is disregarded for Top Heavy purposes. Of course, the original rollover amount must be included by the plan that distributed the rollover for a period of 5 years. Also, if the rollover was accepted before 1/01/84, the receiving plan must include the rollover in its Top Heavy test.

IRC Sect. 416(g)(4)(A); Reg. 1.416-1, T-32

[401 Chaos]

Sorry to dredge up such an old topic but this is on point and I did not see a more recent discussion of this issue.

I'm just trying to confirm that David Dye is correct here. While I follow the logic, the regulations do not appear to expressly provide that earnings on excluded rollovers are also excluded for top heavy testing purposes. If the above is correct, can anyone point me to any guidance from the IRS that addresses? We have TPA that has run top heavy testing that says earnings on excluded rollovers are counted.

Thanks.

[Belgarath]

I agree, I don't think the regulations address this specifically. I vote for not counting the interest. It seems absurd to me to suggest that earnings on an IRA rollover, for example, which has nothing to do with employer contributions, should affect top heavy testing. And I would assume that was the intent of excluding non-related rollovers in the first place.

FWIW, I checked with our folks who do valuations, and Relius does NOT include the earnings on unrelated rollovers.

[Tom Poje]

I'd go further and say that the whole concept of top-heavy is to 'penalize' key employees for having the majority of $ in a plan. it would seem rather absurd to count earnings from non-key employees' rollover to reduce this possibility.

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As a side note - and only because I suspect most people wouldn't even know it - the only item I know specifically addressing earnings is in regards to SEPs, in which it is optional to include or exclude earnings - IRC 416(I)(6)

why the heck that rule is in there is beyond me!

[401 Chaos]

Thanks very much for the responses. Agree on the lack of logic on counting earnings on unrelated rollovers. I'm not sure whether the TPA here counts earnings just on the key employees from a conservative perspective or counts earnings for both key and non-key employees. (I'm not sure the plan in question even has any non-key rollovers).

Unfortunately, I have not found any formal guidance expressly addressing but based on these discussions it seems it may be fair to go back and ask if they have some basis or authority for thinking they need to count earnings on unrelated rollovers and to note that we understand that is not common practice among major national providers?

(In this case, the plan is just a couple of percentage points over for the past couple of years with just about all of that attributable to inclusion of the rollover earnings.)