Top-Heavy Question

[Guest Cinadr]

We have a case where an employer needs to make a top-heavy contribution for the 2009 plan year. Company states that it does not have the money to pay the contribution and intends not to make a deposit. We are unsure of how to reflect this on year-end valuation and on Form 5500 - whether we should show top-heavy contribution amount as a receivable or handle otherwise.

Company would also like to terminate the plan (but will also owe top-heavy contribution for 2010 plan year). We are not cerrtain how the non-compliant act of failing to pay this contribution affects termination of the plan.

Please help!!

[My 2 cents]

Is the sponsor unable to take out a loan to cover the required contribution?

It may be that important, that they will need to borrow to raise the necessary funds.

[Guest Sieve]

Why did key employees continue to defer knowing the plan was TH? Or, were they not properly advised in early 2009 that a TH contribution would be required for 2009, & its consequences? If they knew & ignored the consequences, then they shouldn't be complaining.

Since the TH contribution is mandatory, why wouldn't it be shown as a receivable?

[Guest Cinadr]

Why did key employees continue to defer knowing the plan was TH? Or, were they not properly advised in early 2009 that a TH contribution would be required for 2009, & its consequences? If they knew & ignored the consequences, then they shouldn't be complaining.

Since the TH contribution is mandatory, why wouldn't it be shown as a receivable?

Apparently, employer was not notified in 2009 relative to top-heavy. Therefore, he did defer and was unaware of the consequences. We weren't sure about reflecting as a receivable, because he is not intending to pay it. Weren't certain about leading participants to believe they would receive money that they will not.

[Guest Sieve]

And what is the client's authority for not paying TH, or for terminating the plan without paying? If the contribution is required pursuant to the terms of the plan, on what basis would you not be required to indicate it as a receivable?

I would be more concerned about misleading the client into thinking he does not have to pay the TH contribution, than in telling participants that there is a receivable for amounts which, pursuant to the SPD, must be paid . . . How can you prepare a Form 5500 based on what the employher says he wants to do (or not do)?

[david rigby]

I would be more concerned about misleading the client into thinking he does not have to pay the TH contribution, than in telling participants that there is a receivable for amounts which, pursuant to the SPD, must be paid...

Success in this conversation might depend on who's doing the talking. If the TPA is having "difficulty" getting the plan sponsor to understand the issue, then perhaps the sponsor will more readily listen to his/her legal counsel.

[Guest Sieve]

In this case, "perhaps" is the operative word. Does the TPA have an obligation to point out administrative errors in plan operation to the client? Can/should/must the TPA contact its own legal counsel as to how to proceed, or the client's legal counsel to explain the issue? On a practical level, what's the authority for contacting client's own counsel about this?

Do you think the TPA can/should refuse to prepare the Form 5500 without indicating the receivable? At a minimum, I assume the TPA should tell the client that the 5500 is incorrectly prepared (i.e., without the receivable), as per the client's direction, and the client is signing under penalty of perjury. A written CYA letter?

[K2retire]

The 5500 can legitimately be filed on a cash basis, without the need to report a receivable. Of course, that won't match the valuation, but it takes care of the penalty of perjury issue.

[Kevin C]

If the TH minimums are not deposited, they have a qualification issue since the top heavy rules are not satisfied and another qualification issue from the operational failure by not following the plan's TH provisions.

If the business owner wants to roll over his/her distribution or have the distribution taxable when distributed, I think he/she has a vested interest in making sure the plan remains qualified.

[My 2 cents]

"...or have the distribution taxable when distributed.." from the earlier response means "as opposed to being taxed right now on the account balance when the plan is disqualified".

If the sponsor is not about to go under, this is not a matter of choice. And even if it is about to go under, life will be much simpler if they do find a way to get the top heavy minimum contributions in for the non-keys. How much could the required contributions be?

This is about a 401(k) plan, right? What valuation are people talking about (not a 401(k) service provider myself)?

Can the participants sue the sponsor (with a reasonable likelihood of success) for failing to make required contributions on their behalf?

[Guest Eric A]

If plan money is going to retain its tax-deferred status, the plan’s terms and IRC 416 need to be complied with. It’s that simple.

Have you looked at the plan document and deferral forms to make sure that the key did everything the plan requires in order to make the 2009 deferrals? Often, owner/key employees get lazy with this. Once we had a plan in a similar situation. It had only one key, he made deferrals, but we discovered that he did so without completing the plan’s “deferral form.” The plan document said that in order for an employee to make deferrals, he/she needed to complete an election form prescribed by the plan administrator. Since no form was completed, the deferrals were invalid. The error was discovered during the correction period for significant errors under EPCRS SCP, so we corrected by backing the deferrals out, which eliminated the requirement to make the top-heavy contribution.

I understand that this was not the “best” way to correct a top-heavy failure, but given our circumstances it was certainly better than nothing.

[austin3515]

Does it help the sponsor to know that there is no particular due date for the top-heavy? They could fund it piecemeal.

I like the cash basis idea, just make sure everything is cash basis at least at y/e. Would be sort of interesting if the beginning balances are on an accrual basis, not sure how/if that could be rectified since there is no means of converting on the 5500 accrual to cash.

My 2 Cents:

How much could the required contributions be?

I've seen some DEVESTATING outcomes.

If I was the owner of the TPA shop, personally, I would resign but also send an email or letter return receipt telling them they're insane for not making the contribution and the plan will surely be dqed if audited.

Sieve, you're breadth of knowledge is very impressive, to say the least. However, I don;t think you've dealt a lot with owners of small businesses who work 80 hours a week for $50,000 a year instead of closing their business and putting 20 or 30 people out of work altogether, which could be a VERY real possibility when facing a 3% THM. Is that a fair statement? I'm not suggesting I don't agree with you in principal, but I'm not hearing any compassion for the poor guy that got "punched in the face" by the most ridiculous rule ever conceived.

[Guest Sieve]

austin --

Actually--surprisingly?--I don't lack compassion, which is why my first post wondered out loud how the employer got into a position of owing a TH contribution without knowing about it in advance (with a potential opportunity to stop deferrring). Unfortunately, once TH status is reached, what good is compassion when the reality is that the contribution is owed?--&, in fact, someone probably screwed up & the small business owner has to pay for it, and that is inexcusable (although, we all know that it does happen). What is needed here is good planning for the future. And, after all, the OP related to 5500 reporting, which is the context in which my responses were posted.

Frankly, the adviser should (a) make plans to prevent TH status in another year, or at least plan to prevent the need to make TH contributions in another year, and (b) consider putting in the $$ over time, with earnings, and immediately (or shortly) file for VCP correction. But, (a) is a critical mechanism that must be addressed, and should have been addressed from the get-go--bad rule or not, there may have been ways to prevent TH from adversely impacting this plan. And, if the employer truly is one where a 3% TH employer contribution will be a huge burden, and who clearly does not want to contribute even a single penny to employee accounts out of the employer's coffers, then someone dropped the ball in not preventing the TH contribution from being required.

Very few plans move into a TH position from a non-TH position within the 401(k) environment, unless they are very small (much smaller than even the 20 to 30 non-keys you mention)--usually the direction is the other way (unless there are lots of <5% owners). I wonder how TH was reached in this instance--did a long-term never-been-a-key terminate with a huge account balance? Or was it a TH PSP which recently added deferrals, & no one informed the owner that his/her deferrals would trigger TH required contributions, even if no one received a PS contribution? There should have been warning signs that a TPA, or some adviser to the employer, should not have ignored. Everyone is not innocent, here--except, as you suggest, perhaps the business owner. But the horse has escaped from the barn--& correcting this apparent lack of appropriate advise and preventing the situation from occurring again are big issues, but they are separate from how to report the TH contribution failure on the 5500 and whether the employer is required to make the contribuion.

[austin3515]

Very few plans move into a TH position from a non-TH position within the 401(k) environment, unless they are very small (much smaller than even the 20 to 30 non-keys you mention)--

-Owners who have participated for 20 or 30 years can have close to a million dollars in their account or more

-Family businesses (oh biy, this is a great one - Dad, Wife and 2 kids!)

-Plans with 5 or more owners.

I've just described MANY small businesses.

Sure, plans with 3 employees are almost always going to be top-heavy, but I would not go so far as to call it uncommon in plans with 30 employees.

[K2retire]

At my first TPA job I was told that if a plan was NOT top heavy, then we were doing something wrong. In the small plan world top heavy is almost inevitable if there is any turnover among the non-keys.

[Guest Sieve]

austin -- I did not say that small plans are not TH, or cannot become TH. As I said in the quote you cited, I believe that employers of this size (30 employees) generally are moving AWAY from becoming TH in a 401(k) environment, not moving towards it. So, non-TH plans of that size usually do not become top heavy for the first time all of a sudden (absent some unusual circumstance). Just another way of saying that someone probably should have realized that this plan might become TH, and then should have properly relayed the message to the right people . . .

[PensionPro]

The plan's advisors need to timely and proactively communicate on this issue.

http://www.reish.com/publications/article_...m?ARTICLEID=429

[Lou S.]

austin -- I did not say that small plans are not TH, or cannot become TH. As I said in the quote you cited, I believe that employers of this size (30 employees) generally are moving AWAY from becoming TH in a 401(k) environment, not moving towards it. So, non-TH plans of that size usually do not become top heavy for the first time all of a sudden (absent some unusual circumstance). Just another way of saying that someone probably should have realized that this plan might become TH, and then should have properly relayed the message to the right people . . .

3 years ago I would have agreed with you a 100%.

With the economy the way it is and with staff turnover combined with cuts in employee contribution rates, often coupled with reduced or eliminated matches, we've seen a lot more plans in the 20 - 35 life range moving towards or becoming top-heavy.

And possibly more will as some of the hardship distributions in recent years fall off the books after the 5 year look back period.

[Guest Sieve]

Lou -- You make a good case for economic conditions causing TH to pop up. And, with that comes a challenge to my position that a TPA ought to pre-warn a client if TH could become a problem. These issues may be unpredictable, and therefore may require a pre-test before year-end in order to protect the possibility of taking timely corrective action--all of which may be an unrealistic administrative expectation to place on already overburdened TPAs.

Still, a very proactive TPA could perform a preliminary projected TH test at the start of the year by taking into account, at a minimum, the drop-off accounts for that year's year-end test (e.g., termination of employment in the prior year & hardship distributions 5 years prior). Is there anyone out there who performs that kind of monitoring for plans close to TH (e.g., at 40% or 50% the prior year)?

[Kevin C]

We do preliminary TH testing for a couple of clients just before their year end. These are ones that don't want to contribute anything at all for their employees. Fortunately, most of our clients contribute enough employer $ that the TH minimum isn't an issue. Most of our small plans are already TH.

Economic conditions are not the only thing that can affect TH status. We've had a few become TH after a long term non-key employee retires. At least with that one you have some advanced warning. The fun one is when you find out after year end that they changed their ownership percentages and there are a couple of new >1% owners making over $150K.