Top-Heavy Scenario

[Gadgetfreak]

Plan is NOT an SH Plan at all and has a 401k feature with a pro-rata disc PS design (not used) and a discretionary match which is not being made. A Top-Heavy test is performed in Q1 2011 which shows that the Plan IS Top-Heavy for 2011 (based on 12/31/10 assets). By this time, keys have already deferred triggering the need for a 3% TH contribution which will be around $30k. Company says straight out they cannot afford it. What are their options at that time (Q1 2011)? Can key deferrals be returned at that time?

What if they thought they WOULD be able to afford it in Q1 2011 but, by Q1 2012 (when final tests are done), they can't anymore?

I know that all regs say "tough luck" but it just seems so wrong. I am puzzled that there is really no other alternative. What if the company is faced with a HUGE TH requirement and the only alternative is to shut down the company? I simply can't believe the DOL/IRS (which is usually there to protect employees/participants) would rather this contribution be made and everyone lose their job than find a way to "correct" the situation.

Anyone have additional thoughts?

[Jim Chad]

Was the 2011 top heavy contribution made and now we are talking about the 12-31-11 calculation saying that it is top heavy this year?

[Gadgetfreak]

No. Plan was NOT top-heavy for 2010. Old TPA didn't warn client that they were getting close and to hold key deferrals for 2011. Client allowed keys to defer in 2011. We took over early 2012 and said we would do 2011 year-end work. We reviewed (well, redid) the top-heavy test (based on 1/1/11 assets) and determined Plan WAS TH for 2011. Technically, Plan must make a TH contribution for 2011 as the keys deferred. I just find it unbelievable that if a Company truly can't afford the TH contribution (and will need to go out of business and lay off all employees) they really have no choice. I do not see any correction options available (SCP, VCP, etc) for this scenario and I can't believe this is the spirit of the law. It seems logical that the keys should take their money back (with interest and maybe penalties) so that the NHCEs don't suffer. But there is nothing that I found in the guidance to suggest that.

[austin3515]

You could have terminated the plan effective 3/31/11. That would have been the only way to stop the bleeding.

The only equivalent thing for big coroproations is minimum funding on DB plans. How many tax laws have been passed for relief on minimum funding over the years?? Dozens? Hmm... I wonder if the only reason that these crippling and stupid TH rules haven't been adjusted in 30+ years is because small business owners who can't afford a 3% of pay contribution also can't afford to make huge donations to campaigns (the way Fortune 500 companies can). Yes, I think that's it.

[maverick]

I ran into this same situation several years ago, except that the TH issue was discovered during an IRS audit of the plan. After hearing that the company would go out of business if it had to contribute the top heavy minimum, the IRS examiner allowed the plan to return the key deferrals. And no, I don't remember the auditor's name.

[Lou S.]

Perhaps not the option the keys (likely the owner of the company) wants to hear but if the T-H minimum is "only" $30K (and I use this understanding it is not MY $30K) then what about the owner taking a plan loan to make the T-H minimum? Though if business is so bad a $30K contrib will put them under, owner may already have a participant loan. Just a thought to throw out there in case it is an option.

[Gadgetfreak]

Thanks for all the options. In this case, they are going to make the contribution. But it just brought up a generic situation that I am not comfortable with - the whole concept of doing a TH test in Q1 of a year based on beginning of year assets and then triggering a TH contribution with no way around it just seems very foolish.

[rcline46]

In a daily val environment, you can run TH on the first business day of the new year, no need to wait.

Top Heavy is a successful plan design! It should always be planned for. I know you had a takeover, but regardless it should have been planned for. Shame on prior TPA.

[austin3515]

Nothing frustrates me more than reading these posts with no blame being placed on the rule itself.

Sure the TPA made a mistake, but the reality is the TPA probably does a better job at this than ________. Half the time _______doesn't even tell them the THM is due after the end of the year. And let's face it, we all make mistakes. When this one happens, the consequences can be devestating. Absolutely devestating. Why should there be a rule on the books that literally cripples the unwary small business just trying to stay afloat?

I swear I'm going to write a letter to my senator, and try to get thousands of people to sign it.

[Gadgetfreak]

In a daily val environment, you can run TH on the first business day of the new year, no need to wait.

Top Heavy is a successful plan design! It should always be planned for. I know you had a takeover, but regardless it should have been planned for. Shame on prior TPA.

Well we have a daily val platform and I do not perform the TH test on the first day of the year. It is simply not practical for every client. While I agree that proper consulting should alleviate this situation in the majority of cases (with proper consultants who advise potential TH Plans on how to prepare), it is just not possible in all situations - esp one like this where there is a takeover. And again, I will not badmouth the prior TPA since I don't have both sides of the story.

I am not debating the theory behind TH. I just think the application of the rule with no way to correct seems problematic. Look at the ADP test (if using current year testing). You have options to correct after year-end that don't cost the owners a cent out of pocket. IMHO, the TH should have the same 2.5 months to return key deferrals if they don't want to do a TH contribution.

Thanks for letting me vent .

[austin3515]

"I am not debating the theory behind TH."

Boy would I love to see the candidates go to head-to-head on this... Name one argument in favor of this rule.

[Bird]

Name one argument in favor of this rule.

Full employment for the pension industry. Be careful what you wish for.

Seriously, I think there was a legitimate point to it way back when, but since then more testing and compliance rules have narrowed the "opportunities" for discrimination and made it at least somewhat redundant, but not completely as we see in this example. It's not an original thought, but why not make it a universal rule? If you want to have a plan, be prepared to make a 3% employer contribution. I mean, why should someone who works for company A that has a plan, with no employer contributions, be allowed to put away $17,000 while someone else who works for a company with no plan, be limited to $5,000 in an IRA (if not otherwise limited)? That really makes no sense at all (along with a lot of other things).

[K2retire]

I think there is still a place for a top heavy minimum requirement -- but it should not be triggered by deferrals. If there is an employer contribution it is entirely appropriate.

[austin3515]

but it should not be triggered by deferrals

Amen.

[Bird]

QUOTE

but it should not be triggered by deferrals

Amen.

But the whole point of TH rules is that for a small business, there's potentially not much difference between deferrals and an employer contribution. Someone...just posted a scenario where a business owner deposited $16,500 thinking that's how to make a deferral contribution. Keep in mind that there's a tax break involved in all of this, and to the extent that a business owner gets a break, we all have to pay a little more (at least in theory, I know that's not the case in today's bizarro world...we're just borrowing that much more). The idea behind that break is to encourage broader coverage, not to let Mr. Owner put away money for himself and no one else.

[austin3515]

Bird -

The ADP Test covers your concerns. AT least in my opinion. IF participation is so good that the owner can put away $16,500, doesn't that address your concerns? Put another way, which concern in particular is not addressed by the ADP test?

What is so terrible about a small business owner having a 401k plan with no employer contributions? I mean is the guy a piranha of society just because he can't afford to have a 3% of pay contribution for his staff? If he's bleeding cash, and just trying to say afloat, but still wants to put away 3% of his own pay for retirement (or maybe it's his kids, or the CFO who want to), is this behavior that needs to be punished? Oh and by the way, often times plans are top-heavy simply because a) the owners has been in the plan for 20 years, b) the owner chooses to employ his or her family. Why should these kinds of companies be on such an uneven footing with a brand new start up with 10 employees? Neither has any employer contribution, yet it is the 20 year veteran employer who is being "punished" for having such a discriminatory plan. Yet it's the same lousy plan that a lot of American companies sponsor.

Yes, I know, he can do an IRA, and yada yada yada. The point is, he should be able to sponsor a 401k plan and save inside the plan.

[pmacduff]

I'm with Austin. I have a LOT of small employers that are barely eeking by in this economy but are still trying to maintain the 401(k) plan so that everyone (including the owner(s)) is at least saving something for retirement. Many are of my generation (just behind the baby boomers) and it's been drilled into us that there will be no Social Security when we retire.

The top heavy testing and required contributions on a deferral only plan are ludicrous in my mind and put an unecessary burden on these small employers.

I'll get off my soap box now, thanks for the chance to vent

[Bird]

I understand your points and to an extent am just playing devil's advocate. I think there was a time when there was no ADP test and the 401(k) limit was the DC limit, so owners could stash away big bucks just for themselves. The ability to do that has been largely diminished.

If we're talking policy, and not feelings, I could make a pretty good case that we should just have those individual accounts that were proposed some years ago where anyone can contribute $15,000 or some other number in between the IRA and max DC limit. Get rid of all these contradictory rules and let people do what they want within clear, defined limits. And put 90% of us out of work.

[austin3515]

Oh there's still plenty of work to do. Half our plans are safe harbors and exempt from all this stuff, and we still find plenty to keep us busy.

[Lou S.]

The top heavy testing and required contributions on a deferral only plan are ludicrous in my mind and put an unecessary burden on these small employers.

I'll get off my soap box now, thanks for the chance to vent

I'm probably in the minority but I've always felt that deferral only plans are the ones that are ludicrous.

[Gadgetfreak]

I am glad to have sparked such a lively dialogue and appreciate that I was able to get this TH issue off my chest. I agree with what was said here. It is some of these ludicrous laws that keep us all in business. But there is ludicrous and there is preposterous . I often have sponsors arguing with me about why they need to have HCE refunds just because no one is deferring. They are offering it, it is not their fault that no one is utilizing. I see that as a valid argument from the point of view of the layman. Anyway, its nice to know I am not alone in my views and I am happy to have a community like this to discuss them.

[austin3515]

I'm probably in the minority but I've always felt that deferral only plans are the ones that are ludicrous.

Perhaps you don't have a clients who run small businesses?

[Lou S.]

I'm probably in the minority but I've always felt that deferral only plans are the ones that are ludicrous.

Perhaps you don't have a clients who run small businesses?

No, that's pretty much all we do. And we do have a lot of deferral only plans.

I think they are BS personally and the IRS should just say if you have a deferral only plan the deferral limit is the same as the IRA limit and there is no testing.

But I'll get off my soap box now.

[austin3515]

Yes, I'm sure your deferral only clients would appreciate that political movement...

[Lou S.]

Yes, I'm sure your deferral only clients would appreciate that political movement...

...and most of asppa too!

Hey just because I don't like the tax code and the basic structure of US retirement policy planning, doesn't mean I don't understand it and try give my clients the best advice I can within that framework, and that includes the deferral only clients too.

[Bird]

I'm with you Lou. Just because something is good for us and our clients doesn't mean it is "good."

[Guest ghal]

After searching the board this is the post (Feb 27, 2012) that most resembles my question. I don't want to rehash everyone's opinion on top heavy rules and small businesses that has already been done I also don't want to get into whose fault it is that no one knew the plan was top heavy and the keys should have been told not to defer. My question was not exactly addressed in the prior posts.

Question: Plan is deferral only, Top Heavy for the first time for 2011. The allocation is calculated as of December 31, 2011. The company cannot afford to fund it (period). They want to, but can't. How much time do they have to fund it? Can they drag it out or does it need to be funded by December 31, 2012?

Thanks for your help.

[Lou S.]

It needs to be funded by 12/31/2012.

After that you are in EPCRS land.

[austin3515]

I'm not so sure there is a "due date" for top-heavy contributions. I've asked the question before, and there is certainly nothing like there is for Safe Harbor, which is clearly due by 12/31. Not to say I migh not add interest on after 12/31/12.

[four01kman]

Not to add to the confusion or the different views, but a real life scenario for one of my clients:

Employee deferrals with company match, and up to 2012 no HCEs participated. In 2012, one HCE rolled over an IRA balance in order to take a loan from a previous employer's plan. The rollover is sufficent enough that there may be a top-heavy plan by the end of the year. Where do the rules stand on this? I don't think there is any help but to make a TH contribution. Certainly this is not what anybody would have characterized as an egregious situation requiring a TH contribution.

[Tom Poje]

1. Rollovers are generally not included unless they are related $. Just where did the IRA come from? you said it was a previous employer, so that shouldn't have any effect on the test. its unrelated $

2. You indicated an HCE did the rollover. There is a difference between 'key' and 'hce'. lets make sure we use terms correctly.

[K2retire]

Not to add to the confusion or the different views, but a real life scenario for one of my clients:

Employee deferrals with company match, and up to 2012 no HCEs participated. In 2012, one HCE rolled over an IRA balance in order to take a loan from a previous employer's plan. The rollover is sufficent enough that there may be a top-heavy plan by the end of the year. Where do the rules stand on this? I don't think there is any help but to make a TH contribution. Certainly this is not what anybody would have characterized as an egregious situation requiring a TH contribution.

If the rollover is not from a related employer, it is not used in the top heavy test.

[Guest A_Dude]

In my opinion TH is needed. I also agree that there needs to be a method of correction, and there is always room for regulations to improved & in most case simplified. The purpose of TH, is to make sure employers do not simply open a 401(k) so they can contribute more. And, even if they do pass the ADP (great!), but disparity can exists if when over time if they have practices where employees do not stay with employers. Its basically an assets test, and the ADP is contributory test. Both realms are covered, and should be. Look at it as a fine when you have plan where the owner expeirences signifcant investment gains do to excellent financial advising, and the adivor basically does not talk to other participants (they get stuck in low performing default investments).

Employers should be aware of TH contributions, and when they are triggered. As professionals of course we serve our clients (the plan sponsor/owner), but we also have a duty to serve the plan particpants. Mistakes happen, and there should be an open means to correction. But, why does the employer have a plan designed to go Top Heavy if they cannot afford it? Possibly, this is not the right plan design. In most cases yes, in the small employer world plans are designed to maximize the disparity. This isn't for everyone though.