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Top Heavy and Excess Deferral


Catch22PGM

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If anyone has an opinion and/or something they have found from the powers-that-be, please share. This has stumped several colleagues but I'm sure it can't be a totally unique situation.

ABC Company has a deferral-only 401(k) plan (no match or non-elective provisions) with one key employee Fred, who is the CFO and earns $250k per year.  The ABC Company 401(k) Plan is top heavy.  Fred is also employed by XYZ Company - completely unrelated to ABC Company - and participates in the XYZ Company 401(k) plan.  In 2019 Fred had a $10,000 excess deferral - he contributed the IRS maximum in the XYZ Company 401(k) plan and $10,000 into the ABC Company 401(k) Plan.

If the entire $10,000 that Fred contributed to the ABC Company 401(k) Plan is refunded as an excess deferral, is the ABC Company still required to make a top-heavy minimum contribution to non-key employees?

My initial reaction is no, because an excess deferral is not an annual addition, but I can't find anything that would support this.  I have colleagues that feel ABC Company is required to make a 3% top-heavy minimum contribution since Fred contributed 4% of his compensation to the plan even though the entire 4% is being refunded as an excess deferral.  Again - they haven't provided anything to support their position either.

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I'm inclined to agree with your colleagues. 1.416-1, M-20 states that elective contributions on behalf of key employees are taken into account in determining the minimum contribution under 416(c)(2). The fact that these 402(g) excess distributions are not considered annual additions is a 415 issue, and I don't think that trumps the treatment otherwise applied to deferrals. What if the ADP for Keys ended up being 1%, but due to catch-up deferrals (which don't count against 415) the Key defers 4%. Would you still maintain that TH should only be 1%?

I don't have time to do any in-depth research on this, but I suspect the IRS might take the approach that the top heavy is required. I know that for, say, an ADP failure where deferrals are distributed, those deferrals still apply for calculating Top Heavy.

I also happen to think that requiring Top Heavy in the situation you posit is clearly a ridiculous result, but that's where I believe the guidance leads. Of course, I may be all wet, and I'll be interested to see what other opinions may be.

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The answer is in the reg:

1.402(g)-1(e)(1)(ii) Treatment of excess deferrals as employer contributions. For other purposes of the Code, including sections 401(a)(4), 401(k)(3), 404, 409, 411, 412, and 416, excess deferrals must be treated as employer contributions even if they are distributed in accordance with paragraph (e)(2) or (3) of this section. However, excess deferrals of a nonhighly compensated employee are not taken into account under section 401(k)(3) (the actual deferral percentage test) to the extent the excess deferrals are prohibited under section 401(a)(30). Excess deferrals are also treated as employer contributions for purposes of section 415 unless distributed under paragraph (e)(2) or (3) of this section.

TH minimum is triggered by the excess deferrals, even if refunded.

Free advice is worth what you paid for it. Do not rely on the information provided in this post for any purpose, including (but not limited to): tax planning, compliance with ERISA or the IRC, investing or other forms of fortune-telling, bird identification, relationship advice, or spiritual guidance.

Corey B. Zeller, MSEA, CPC, QPA, QKA
Preferred Pension Planning Corp.
corey@pppc.co

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