Top-Heavy 401k when Adding Employee to Owner-Only Plan

[Anagoge]

Consider a safe harbor 401k plan with a few owner/key employees in the plan (nobody else). If the company adds a new non-key employee to the plan, won't the plan immediately become top-heavy, since the owners all have several years of assets in the plan and the non-keys have basically nothing at that point?

Are there any workarounds for that problem, other than these I've found:

• Make sure the 401k only has safe harbor employer contributions (no more profit sharing, etc.), to qualify for the safe harbor top heavy testing exemption. The downside here is no profit sharing anymore, which hurts everyone.
• Provide an extra contribution for the new employee only, to fix the top heavy failure. The downside is that the employee kind of gets "more benefits" per year than the owners, which the owners may not like.

[Lou S.]

Yes you would be top heavy.

You could be a safe harbor match with no PS and get the TH exemption. Or you could do a PS contribution but this would blow the TH exemption so you would likely have a 3% minimum PS contribution to comply with TH.

You could be a safe harbor 3% with the 3% as a floor that satisfies TH and make a PS that could be on top of that and possibly cross tested. There could be some issues with satisfying TH in some cases like bases contribution on date of entry where TH is on full year.

Or you could not do a safe harbor and you might blow the ADP test, refund all deferrals to HCEs and still have a TH minimum that year.

[Bird]

Well, the plan is top heavy before that employee becomes a participant (100%). It's just that the consequences are different when a non-key becomes a participant.

What, exactly, is the problem here? You don't say what kind of safe harbor it is, but (I guess) the only way that non-keys would get "more benefits" than keys is if keys are excluded from SH contributions, but then if there weren't any keys, why was it a SH? Just in case there were non-key, in which case it is working perfectly?

I tell my small clients - which is most of our clients - that if they can't make a 3% contribution for staff, they shouldn't bother having a plan. It's a bare minimum and we're going to build other contributions from there.

[Anagoge]

This is a QACA safe harbor plan (auto-enroll at 6%, 2 year vesting, immediate eligibility for everything, most of the owners max out the deferral/match). It was designed to be safe harbor since the plan knew it would be top heavy with the first non-key employee, due to the original employees all being owners. It was exempt from top heavy testing in some past years, due to no profit sharing that year (just the basic QACA SH match).

I did some more reading and it looks like the TH failure required 3% employer contribution requirement for non-keys includes any 3.0%+ SH QACA match the employer is likely to put in for any new non-key employees, so this might not be a big issue. Am I right on that? The owners are OK putting in 3% for non-keys, since that is below the max QACA SH match of 3.5% anyway. But they didn't want to put in 3.5%+3% (plus optional profit sharing) for employees when owners can only get 3.5% (plus optional profit sharing), but it looks like that isn't the case. Hopefully I'm right and this isn't nearly as big a deal as I first thought...

[BG5150]

If the non-key is deferring, and there will be no PS, then the QACA match will suffice.

If the non-key is not deferring and there is no PS, the QACA match will suffice.

If the non-key is deferring and there will be PS, then QACA match may suffice. The non-key must get 3% of full year comp between the QACA & PS. So if the calculated match is at 3.5%, they are ok. (I believe the doc must say the match offsets the the TH. If it doesn't you have to do a 3% on top of the match). If the match is lower than 3%, the ER must add enough to get the non-key to 3%.

If the non-key is not deferring and there is PS, they are owed 3% of full year comp.

[Anagoge]

Thanks, everyone. I'll double check the plan document allows the QACA SH match to offset the 3% TH failure contribution, but otherwise, the plan is probably OK as-is.