Top Heavy Vesting

[New2EB]

I'm having a tough time reconciling the top heavy vesting schedule requirements to a 401(k) profit sharing plan (contributions include elective deferral, Roth, safe harbor, and employer discretionary non-elective) in a situation where all plan contributions are 100% vested. The plan document calls for a 3-year cliff vesting if it becomes top heavy.

Reg. 1.416-1 Q&A V-3 provides that "all accrued benefits within the meaning of section 411(a)(7) [the entire balance of an employee's account] must be subject to the minimum vesting schedule.

In that scenario, it seems to indicate that my otherwise 100% vested plan account balances would become subject to the 3-year cliff vesting schedule after becoming top heavy (until the plan ceases to be top heavy).

Clearly the top heavy vesting regulations from 1984 are far outdated, particularly now that vesting schedules have been basically aligned and many plans offer better vesting than the top heavy requirement (see language calling top heavy a "minimum" vesting).

So, what is the best answer or what are others doing about this? Is there some other IRS guidance that helps clarify best practices? Any chance of the IRS issueing updated TH regs?

My most reasonable solution is to make the 3-year cliff vesting only apply to the top heavy minimum contribution (not the entire participant's account)....but it appears that I risk violating an old Reg if I do that.

Thanks in advance for any tips!!

[Bill Presson]

If all the sources are 100% vested, then you are meeting the "minimum" vesting requirements.

[New2EB]

Thanks for the response, Bill. If I'm reading that correctly, you might suggest that all top heavy minimum contributions could be subject to the 100% vesting that applies to other types of contributions.

I'll definitely propose that idea to my client, which would also mean a plan amendment to eliminate the Plan Document language for top heavy vesting. But, it begs a couple follow-up nuances, such as....

- I read IRC 416(b) to be the only allowable vesting options for TH, which doesn't include a 100% vesting option, but I haven't looked for IRS cases or rulings about100% vesting for TH yet either

- Even though the Regs say "minimum" vesting, the IRC doesn't specifically indicate that 416(b) TH vesting is a minimally-required vesting schedule

I also get a sense from my client that they like the 3-year cliff vesting option and may want to retain it, if possible

[New2EB]

I did find some good language in the preamble to support the 100% vesting perspective, too - "In general, if a plan is top heavy, such plan must...provide faster vesting than that required by section 411..."

[david rigby]

T-H rules provide minimums (benefit, vesting). If the plan is more generous than the minimum, then it automatically satisfies T-H. Don't worry, be happy.

BTW, I think that all plans must include T-H language even if all other plan provisions provide something better. (am I remembering that correctly?)

[jpod]

I agree with all the comments to the effect that the TH minimum vesting schedules are only minimums; vesting in a TH plan can certainly be more generous.

As to one of the OP's questions, if the plan sponsor is generous and has immediate vesting for the contributions it makes intentionally, but wants to impose a 3-year cliff vesting schedule on additional contributions which Uncle Sam forces him to make due to the TH rules, that can be done (with care in drafting not to mention proper record-keeping).

[Mike Preston]

jpod, no amount of drafting can effect the result you posit. Minimums are minimums.

[jpod]

Not sure I am following you, Mike Preston. If a plan provides for immediate vesting on employer contributions generally, why can't it provide that any additional contributions necessary to satisfy TH will be subject to a 3-year cliff? That was what I was suggesting, but if it came out garbled that's my bad.

[Mike Preston]

Because it lays waste to the concept of what a minimum benefit is. What you are looking for is two sources, with alternative vesting schedules. Just not possible if there really is one source.

[jpod]

Really? Part of the source is subject to immediate vesting. The make-up part is subject to 3-year cliff. That wouldn't work?

[ETA Consulting LLC]

I'm not sure, but I think Mike's point is that everything that is legal is not administratively feasible (or perhaps not possible). It's a redundancy to provide a vesting schedule (e.g. 100% immediate for non-elective), and then say if your non-elective happens to be made pursuant to a Top Heavy minimum, then the vesting for that TH minimum is 3 year cliff (or one of several other vesting schedules). So, now you'd have to actually choose whether it is 3 year cliff, 6 year graded, 5 year graded, etc... How would you draft that into a plan?

To your point, jpod, many documents are already written to say "If the plan provides for only deferrals and match, but doesn't provide for non-elective, AND IF a top heavy minimum is made, then the vesting schedule on the TH minimum is 6-year graded. What this does is to assign a vesting schedule to a source of funds that does not already exist in the plan, but comes into existence by the need for a TH minimum. So, IF the source does not already exist, then I agree with you. But, if you already have a non-elective source, then you'll have a drafting nightmare to apply one vesting schedule to some non-electives and another vesting schedule for other non-electives.

I 'think' I may have summed your arguments up.

Good Luck!

[jpod]

Let's put the wisdom of plan design aside for the sake of discussion. Here are a couple of examples. Assume in each case that the plan provides for a discretionary profit sharing contribution in an amount to be determined each year allocated in accordance with a safe harbor integrated formula, and that contribution is immediately vested.

1. Plan has a 1,000-hour requirement. For year x employer contributions at least 3% of compensation for all participants, including keys, except for participants with less than 1,000 hours. If plan is top-heavy for year x, employer must make a 3% contribution for the non-keys with less than 1,000 hours. If the plan document so provides, why can't the contribution for those participants be subject to a 3-year cliff vesting schedule?

2. No 1,000-hour requirement. For year y employer contributes enough to give everyone 2% up to SSTWB and 2% above SSTWB. If plan is top-heavy for year y, employer must make an additional contribution for each non-key to bring him/her up to at least 3%. Why can't that additional contribution be subject to a 3-year cliff?

[jpod]

Here's another example (again, plan design merits aside). Plan has immediate eligibility for 401k elective contributions. Employer profit sharing contributions are subject to a 2-year service requirement but with immediate vesting; those contributions are typically well above 3% for everybody. Plan is top-heavy. Employer must make 3% contribution for non-keys not yet eligible for the profit sharing contributions. Why can't those contributions be subject to a 3-year cliff vesting requirement?

[New2EB]

Thank you, everyone, for all of the wonderful feedback.

I find jpod's point quite persuasive because the operative plan document came from a very intentional individually-designed plan and my goal is not to argue with the client's plan design wisdom. In fact, the TH vesting schedule is intentionally meant to address the client's separate concern related to a high turnover rate. This client wants to retain the 3-yr cliff TH vesting, if at all possible. The term "minimum" as it pertains to TH vesting is only defined as either the 3-yr cliff or 6-yr graded, so our concept of "minimum" under the Code and Regs is somewhat distorted given the current vesting environment.

I also partially agree with ETA because I am still waiting to hear from the TPA about adminstrative feasability. Even though Reg. 1.416-1 Q&A V-3 appears to require that the participant's entire account must be subject to the TH vesting (3 yr cliff) schedule, the results are too unreasonable to justify....and it has me worried about 411(d)(6) implications.

The Code, Regs, and Preamble for top heavy appear to be in desparate need of updating!

[Belgarath]

Does the document, since individually designed, have an IRS favorable determination letter?