Top Heavy 401(k) Plan

[bzorc]

I haven't had this happen to me since the late 90's, and I can't remember if this is allowable, and the 401(k) answer book didn't address the issue:

Informed client that their 401(k) Plan become top-heavy for 2011 and that no deferrals should be made in order to avoid the 3% required non-key employer contribution. Received the payroll files yesterday and all of the owners deferred $16,500 during 2011 (plan passes ADP testing, so this is not an issue). Owner does not have the cash to make the 3% top-heavy contribution. In addition, the plan was amended 1/1/2011 to allow collectively bargained employees to participate in the plan.

Two questions: (1) May the owners remove the deferrals from the plan (as a mistake of fact) to avoid the top-heavy minimum? And (2) must the collectively bargained employees share in the top-heavy allocation, if the owners decide to fund the minimum?

Thanks for any replies!

[jpod]

(1) IRS would say "no." I would too, probably.

(2) Yes, I think.

Hope your advice was in writing.

[bzorc]

jpod, I agree with your answer after talking this around a little bit. However, if it were still 2011 and the deferrals had been discovered, I think then they could have been returned and run through payroll, subjecting them to Federal and State taxation. Sound right? Thanks! (and yes, it was in writing.)

[Lou S.]

Any chance to aggregate the CBA plan and the 401(k) and maybe they aren't top-heavy? Been a long time since I looked at those rules with respect to CBA/non-CBA aggregation so I'm not sure it is something you can do but might be worth the research if 3% contrib is significant. Otherwise I agree that they 3% is required, that's not really in doubt.

[bzorc]

Unfortuately, aggregating them together does not solve the top-heavy issue. Thanks!

[QDROphile]

"jpod, I agree with your answer after talking this around a little bit. However, if it were still 2011 and the deferrals had been discovered, I think then they could have been returned and run through payroll, subjecting them to Federal and State taxation. Sound right? Thanks! (and yes, it was in writing.)"

No.

[austin3515]

I don't think the union people get the THM. You should double check that before you finalize your figures for the client. I'm too busy to look it up for you!!

Actually, if memory serves, I think it's actually "union people are not required to receive the THM" so it would be a document issue. I remember the Corbel GUST document did not explicitlyu excluded the union people from the THM, but they always said that you could "assume they should be excluded." I think they fixed it in EGTRRA.

[actuarysmith]

I am still unclear if there is any definitive answer to the question posed-

If it is still 2011, and you make the discovery that it is top-heavy before the year closes out, could the employer leave the funds contributed by the key ee's in the plan - but recharacterize them as employer non-elective or match to be used for all participants - and adjsut the payroll records for the keys to refelct that they did not defer to the plan?

In other words, it is almost the same question asked above - but with the difference being that the funds remain in the plan. They are not returned to the key employees.

The payroll records would have to reflect that no deferrals by Key ee's have been made, and they Key ee's would have to somehow be made whole for the dollars that actually went into the plan (which would now be used to fund other employer contributions)

[austin3515]

"If it is still 2011, and you make the discovery that it is top-heavy before the year closes out, could the employer leave the funds contributed by the key ee's in the plan - but recharacterize them as employer non-elective or match to be used for all participants - and adjsut the payroll records for the keys to refelct that they did not defer to the plan?"

I have a hard time understanding how this would be legal. What is the basis for this distribution? How could it be considered a mistake of fact?

I get that the feds have bigger fish to fry but this is the number one issue facing small retirement plans. Why they have chosen to stick it to small business on this one for so many years without resolution is beyond me. I get that it's directly correlated to the size of their campaing contributions. Imagine if such a rule applied to the fortune 500 companies, how quickly it would be removed!! Oh wait, it does apply, in the form of minimum funding on their pensions. How many laws have been passed for funding relief??

[actuarysmith]

"If it is still 2011, and you make the discovery that it is top-heavy before the year closes out, could the employer leave the funds contributed by the key ee's in the plan - but recharacterize them as employer non-elective or match to be used for all participants - and adjsut the payroll records for the keys to refelct that they did not defer to the plan?"

I have a hard time understanding how this would be legal. What is the basis for this distribution? How could it be considered a mistake of fact?

I get that the feds have bigger fish to fry but this is the number one issue facing small retirement plans. Why they have chosen to stick it to small business on this one for so many years without resolution is beyond me. I get that it's directly correlated to the size of their campaing contributions. Imagine if such a rule applied to the fortune 500 companies, how quickly it would be removed!! Oh wait, it does apply, in the form of minimum funding on their pensions. How many laws have been passed for funding relief??

Part of my point was that there is NO distribution from the plan. The funds that were initially contributed as deferrals by Key's would be removed from their accounts and placed in a retainer type account to be used as employer matching or non-elective contributions.

The W2's for the affected Keys' would reflect that they had not made any deferrals to the plan for the 2011 year. There are no distributions being made from the plan.

The question (and underlying idea) is would this approach be acceptable, and would it eliminate the top-heavy minimum requirement of 3% of compensation?

[austin3515]

OK, so now we're talking about forfeiting 401k money, which is not much easier to defend What provision of the plan, or EPCRS for that matter, supports this course of action?

Also, one would presume that somehow the owners are goign to get back their money, so I'm not sure moving money from your left pocket to your right pocket before paying the money necessarily helps you out here. You're leaving out I'm sure that the owners will get a bonus to make them whole.

The point is, I think you are playing with fire. I would not recommend putting this idea in writing on your letterhead and giving it to your client. If it doesn't meet that test, then that means it is not advice that should be given.

I'll tell ya what, I wouldn't even submit the question to the IRS at a Q&A for fear of being added to a watch-list!

[chc93]

The way that we approached this situation is that for a daily valued plan, the "deferrals" have already been deposited to the key's account. At that point, there is no reason to "pull" that money out of the key's account and placed in a holding account, unless there's a testing failure. So without a testing failure, the TH min is required. In the older days when all plan money was in a pooled account, I think this could be done, since until the valuation is completed, the deferrals are not really in the key's account... just simply "contribution deposits".

[austin3515]

Personally, I think my comment applies to pooled accounts equally.

[chc93]

Personally, I think my comment applies to pooled accounts equally.

I agree with you... I was trying to think if we've ever encountered a situation like that in the past... and what we might have done... since I think it's less clear in a pooled account / quarterly, semi-annual, or annual valuation situation.