Creative Top Heavy Solutions

Today my skills as a magician are being questioned, as I have failed to pull a rabbit out of hat....

A referral partner has brought us a situation with a client of his who is not our client.  The party in question has a 401(k) plan that eliminated its Safe Harbor match in 2012 and has been subject to all testing ever since.  This employer is angry because he has been told that for the first time, his plan became Top Heavy for 2018 based on the 12/31/2017 results of the test.  He has been told that if he doesn't want to be obligated to make a Top Heavy contribution of any kind, then the Key employees cannot defer in 2018.  Deferrals count, and even if a Key only deferred 1% of pay, then the company would owe the non-Key participants 1% of pay as a TH minimum contribution.  Of course if any Key deferred 3% or more, then the company would have to make the standard 3% TH minimum contribution.

The referral partner is looking to us for some kind of magic trick to allow the Keys to defer whatever they want to defer and somehow not owe a TH minimum contribution.  My crystal ball must be cloudy or something because there's nothing I can find to do about 2018.

For 2019, they should adopt Safe Harbor provisions again, whether it's the 3% SHNE or the basic SH match.  If they aren't willing to do that, then they just have to accept the fact that the Keys can't defer.

Am I missing something?  The referral partner has been told that a "creative solution" should be found.  I can think of all kinds of creativity for failed ADP/ACP tests, cross-tested formulas that don't work out, etc., but I don't know of a "creative" solution to Top Heavy!

Any ideas will be appreciated.  Thanks!

My only thoughts are absurd.  Have the employer buy another company that is not TH?  Have the Key's contribute to IRA's for 2018 and rollover the funds to the Plan.  Realistically, they probably already deferred and are out of luck.  I don't think you are missing anything. 

@JackS.....I like that idea of having the Keys contribute to IRAs and roll the money into the plan at a later date.....I wouldn't have thought of that.  Ok, it's not a rabbit out of a hat but it's at least a chipmunk.....Thanks!! 

non qualified plan?

@ PensionPro - a non-qualified deferred compensation plan separate and apart from the 401(k) plan?  It is worth suggesting to the referral partner.  We don't design or try to do anything of service for that kind of plan but they could pursue it elsewhere.

Short of reviewing the TH test to confirm it's accurate, you have not missed anything wrt to the qualified plan.

Put in a DB plan for 2018 pays big bucks to the owners. They will have a 5%+ contribution to the PS but they will be happy.

I agree with Pension Pro; a Non-Qual plan can work really well, subject to the usual disclaimers.

you indicated the plan for the first time was top heavy. curiosity killed the cat, just how close to the magic 60% is the plan?

and then of course depending on how large it would be, if top heavy is indeed provided in 2018 will the plan cease to be top heavy (guestimation)?

I'm also curious about how close they are to 60% at 12/31/2017.

There was a question at the 2002 ASPPA Annual IRS Q&A Session about receivable contributions and top heavy testing.  The IRS response indicated that a profit sharing contribution deposited after the end of the year, but allocated and deducted for that year was included in the account balances for the top heavy testing at year end.  If they are close to 60%, it might be worth looking at additional contributions for 2017.

16 hours ago, ldr said:

@JackS.....I like that idea of having the Keys contribute to IRAs and roll the money into the plan at a later date.....I wouldn't have thought of that.  Ok, it's not a rabbit out of a hat but it's at least a chipmunk.....Thanks!! 

 

Curious as to how they would see the IRA rollover option as a benefit. Why not just keep the money in the IRA?

Have they not already deferred for 2018, and therefore subject to TH anyway? Or have they not yet deferred anything?

Kevin C - those were my thoughts exactly

this was Q49 from the ASPPA Conference

p 49. Receivable Contribution and Top Heavy Determination? Is a discretionary profit sharing contribution for the prior plan year that is deposited after the end of the prior plan year included in the top heavy determination for the current plan year? Let’s say we have a

calendar year plan, effective several years ago. We are determining the plan's top heavy percentage for the 2002 plan year. The determination date is therefore 12/31/01. The employer makes a contribution in February, 2002, which is allocated and deducted as of

12/31/01. There is a question as to whether this contribution is included in the top heavy determination for the 2002 plan year. The question relates to Q&A T-24 of the 416 regulations, which says that if a plan is not subject to 412, then the account balances are not

“adjusted” to reflect a contribution made after the determination date.

A. The key phrase here is “account balance”. The participants’ account balances, as of (say) 12/31/01, include the profit sharing contribution that is allocated and deducted for the 12/31/01 plan year end. So the guidance regarding “adjustments” does not apply to the

receivable profit sharing contribution; it is already part of the participants’ account balances.

The following is my analysis: The question as to what contributions are considered due on the determination date is determined under §1.416-1, Q&A T-24, which says that it “is generally the amount of any contributions actually made after the valuation date but on or before the determination date”. It then goes on to say that any amounts due under §412 are considered due, even if not made by the determination date. One could take the position that this is a exclusive statement; in other words, if a contribution is NOT due under 412 and is made after the determination date, it is not considered 'due'. However, the answer to the question (T-24), “How is the present value of an accrued benefit determined in a defined contribution plan” is answered, “the sum of (a) the account balance as of the most recent valuation date occurring within a 12-month period ending on the determination date, and (b) an adjustment for contributions...” The term, "the account balance" includes contributions credited to the account of a participant, it does NOT mean only the contributions actually made that have been credited.

For example, if a 100% vested participant terminated after the determination date but before the contribution was actually made, the distribution would include that contribution, even though it had not yet been made to the plan. This is because the account balance, as of

the last day of the plan year, includes the contribution. So, when the regulation addresses adjusting the account balance for contributions made after the determination date, we must start with the account balance, and then apply the adjustments. Since the account balance includes the receivable profit sharing contribution, the adjustment does not refer to the receivable. The reference to §412 in §1.416-1 is with regard to a waived funding deficiency that is not considered part a the participants' “account balance”, as the term is defined. Q&A T-24 refers to a DC plan with a waived funding deficiency that is being amortized. Such a plan must maintain an “adjusted account balance” (reflecting the amount of the contribution that has not been deposited) which must be maintained until the actual account balance increases to the point where it equals the “adjusted account balance”. It is to this (unadjusted) account balance that the (waived) contribution must be added, since the amortized contribution only becomes a part of the actual account balance as it is paid to the plan. The requirement therefore has the effect of determining top heavy status as though the contribution required under 412 had actually been made. In other words, the “account balance” would not include the waived minimum funding contribution, so an adjustment is required.

 IRS response: We accept this analysis.

Of course such a response doesn't necessarily reflect an actual Treasury position, but still...

Hi to all and thank you very much for your responses.  To answer all your thoughts if I can:

We have been led to believe that they were warned on time and that the Keys have not yet deferred anything for 2018 (which I find very hard to believe but ok, maybe).

These are not high rollers who could afford a DB plan.  They are balking at the idea of giving anything to the rank and file and are all ticked off over 3% so they certainly wouldn't do 5%.  The salaries of the Keys are not even quite up to the HCE determination level.  Stock ownership is what makes them Keys and HCEs, not salaries.

No, there probably isn't any advantage to having the Keys use IRAs and then roll the money into the plan.  For just a moment I was thinking about that old belief that retirement money is safer in a qualified plan than in an IRA but that was explored thoroughly in another thread a few weeks back and the general idea put forth was that this used to be true but isn't any longer.

I will ask about the non-qualified deferred compensation idea.

Nobody has given us the exact figure for the TH percentages but it's reasonable to assume they are just barely TH since this is the first year they have been TH.  I will ask for the %s.

Now just to be sure I understand:  it's being suggested that they might yet put in just enough profit sharing contribution for 2017 for the NHCEs to tip the account balances back to being not Top Heavy.  That's very clever.  The obstacles I see are these:

1. They may have already finished up and filed their corporate return and their 5500-SF for 2017.  Of course those could always be amended, I suppose.

2. Their document calls for a straight up salary ratio profit sharing allocation for all eligible participants.  Can the Keys choose to exclude themselves from a potential allocation?  If they can't the purpose would be defeated.  I think most places I have worked have turned a blind eye to anything that discriminates against Keys and HCEs, but isn't that technically failure to follow the terms of the plan document?  

23 minutes ago, ldr said:

I think most places I have worked have turned a blind eye to anything that discriminates against Keys and HCEs, but isn't that technically failure to follow the terms of the plan document?  

It is a failure to follow the plan document, no "technically" about it.

30 minutes ago, ldr said:

Can the Keys choose to exclude themselves from a potential allocation? 

Check plan document provisions relating to top heavy minimum allocation.  It is an elective provision in the documents we use.

@ PensionPro.....for 2017 this wouldn't be a top heavy minimum allocation.  This is just an additional profit sharing contribution whose purpose is to boost the non-Key account balances to the point that the plan would not be Top Heavy for 2018 based upon 2017 test results.

in other words, lets say the top heavy ratio was only 60.5%

since it was indicated the keys have small comp it might be possible that a small comp to comp contribution would tip the scale. e.g. if the keys had 40% of total comp of all employees

@ Tom - I see!  Thanks for suggesting that.  It could be worth exploring even if the Keys do have to receive the same % as the non-Keys.

@ Tom - indeed, the Key compensation is only 27.93% of the compensation that would be eligible for a profit sharing contribution.  This really could work.  I passed the information along.....let's see if there is any interest.

well, you never know.

maybe not the most creative...

the best one I came up with years ago...

was asked to run a rare pre lim ADP test - must have been Oct or something.

one NHCE who was deferring the max had projected comp of 120,000.07. of course that was 7 cents more than HCE comp limit at the time. I told them I don't care what happens, if the guy finds 10 pennies sitting on his desk one morning before the end of the year and by chance a pay check which was 10 cents less than normal, well, those things happen. you don't want to mess up next years test!

Lol - at least you had a chance to say that before the plan year was over and it was too late!  

We think your idea on the TH situation is very creative - we simply never thought of this before and we actually had a client of our own we could have used this idea on earlier this year!  Thanks again :)

Yet another argument for a plan provision that allows for allocations pursuant to an "everybody in their own group" formula.  You can always allocate comp-to-comp, if you want.  And in this case you would not have to dilute the effectiveness of an employer contribution.

@Mike PrestonIsn't that the truth!  We were just discussing that, and being surprised that this plan still has a comp-to-comp formula.  That would certainly be a must-do recommendation, should we eventually land this prospect as a client.

One more possible trick, if the keys are over age 50, is to amend the plan to impose a limit on elective deferrals for key employees equal to $0. Then they can defer up to $6,000 and it would be reclassified as catch-up due to exceeding a plan-imposed limit, and catch-up contributions are not included when determining the minimum allocation rate for the keys.

If you want to play it safe, instead of a $0 limit you can do a $1 limit. Since you have to be eligible to defer in order to be eligible for catch-up, and you could make the argument that someone with a $0 limit is not eligible to defer, this avoids that possible interpretation. However there will be a (small) top heavy minimum required for the non-keys.

I also do not know off the top of my head if there are any complications with amending a plan mid-year to add a limit. If the keys have not deferred anything to date then my feeling is it wouldn't be a problem. But I might be forgetting something.

You might also want to check the plan's QNEC provisions to see if an ADP or ACP testing failure is required before a QNEC can be made.  Our VS document does not require a testing failure.  You might be able to use a QNEC to get additional contributions in the TH test without increasing the balances of the Keys.

@Kevin C

Thanks!  That's a great idea too. The only drawback I see to that is that the money would be 100% vested immediately where the PS money wouldn't, but that might not matter.....

@ Tom Poje and Kevin C:

Thank you both for suggesting the extra profit sharing contribution to tip the scales in favor of the NHCEs to bring the percentages to just under Top Heavy.  For the prospect, we have made the suggestion and explained how it works.  To be seen whether they will follow the advice and whether we will eventually have them as a client.  This was an interesting case.  Once we finally got our hands on enough data to know the situation, it turned out that the Key balances as adjusted for distributions came to only 60.13% of the total.  A contribution of only .058% of pay as a profit sharing contribution would drive them back down to 59.99% for the Keys.  This is far less than the cost of a 3% SHNE or even a basic Safe Harbor match (for 2019) and could work for them for a few years. 

This technique also worked beautifully for a 03/31/2018 plan I just finished.  We will go explain the concept to the client and see if she wants to go for the very small profit sharing contribution it would take to tip their plan back under the Top Heavy limit.  Their Key balances are only 60.04%!  It won't take much money at all to fix their situation.  It's embarrassingly simple once we know it, but we never thought of it on our own.

If Tom Poje had not recognized that I didn't "get it" at first and hadn't persisted, this wouldn't all have turned out this way - you are a great teacher whether it's in person at the annual ASPPA convention or online!  Much appreciated!

I'm not sure I would go so far as to say you 'didn't get it', once you indicated the 'key' compensation was small, that offered potential and a simple example to illustrate.

but appreciate the comments, maybe more than you would realize. (for some deeply personal reasons not worth going into I no longer attend ASPPA, but at least here I can still share) guess a 'few' years of experience and a hopelessly mathematical mind for tinkering with numbers paid off.

@Tom Poje  it has been a few years, I guess.  I just remembered that you taught some classes I saw there and that you were really good.  But I have been going to the annual convention off and on for about 24 years so I am not sure what year(s) those were.  I am not going presently just because I now live and work really far away from DC and it has gotten prohibitively expensive for very small shops to send people.  In past years, when it was still at the Hilton and I lived in MD, it was feasible for my employers, but not now.  So I watch a lot of John Hancock webinars!

Have a great day!  :)

All great suggestions made previously.

Many years ago, we would contribute a per diem discretionary contribution, say $50 each,to the lowest or lowest several pay grades at a given company and helped several companies work out of this problem. A typical lowest pay grade might be the custodial staff, the receptionists, and entry-level assistants.

C.B.Z,

That is a very creative solution for those age 50 or more.  Kudos

Editorially, for a company that is not rolling in the green stuff,  it might be better for Keys to skip the deferrals and pay taxes at the lower current tax rates. Then invest in capital appreciation instruments and pay capital gains taxes in the future. Also, maybe just get rid of the 401(k) plan. The government considers an employer to be a potential public enemy when it sponsors a plan. Steer employees to IRAs. Give bonuses to the ones who excel, and focus on the business.

All great suggestions made previously.

Many years ago, we would contribute a per diem discretionary contribution, say $50 each,to the lowest or lowest several pay grades at a given company and helped several companies work out of this problem. A typical lowest pay grade might be the custodial staff, the receptionists, and entry-level assistants.

Great thoughts-agreed, depends on the employer.

In the mid-90s we had a foreign parent (who almost never understands this stuff)--and for about $5k in QNECs we helped them to pass the test---the only issue is if the lowest pay grades are paying attention, they might say "Where are these pennies from heaven coming from and why ?" But no one ever complains. 

@Tom Poje  Update:  the prospect opted to go with your solution!  Thank you again for a great idea.

As a side note, someone involved with this plan objected vehemently and insisted that accruals do NOT belong in the Top Heavy test and that this methodology is flatly wrong.   If that was true, then there would be thousands upon thousands of plans whose Top Heavy tests are not being done correctly, because every TPA firm I have worked for in the last 40 years has included the accruals in the participants' balances when the Top Heavy test was run.  Our software provider has as many years of experience as I do and she also said all of her clients, to her knowledge,  include the accruals.  She told me how to exclude them if I wanted to do it - enter the accruals as a separate investment item and carve them out of the test - but why, when nobody does this, was her point. 

Thanks to everyone who wrote in.  All's well that ends well!

of course just because one IRS individual voiced an opinion you could include them doesn't necessarily reflect an actual Treasury position, though the Q and As generally were submitted beforehand and so the answers aren't simply off the cuff. it is odd how you would include accruals in just about everything (nondiscrim testing) and optional for 70 1/2. and at least one can point to the Q and A as a starting point...

I thought whoever posed the question put forth a valid argument / description as reason for including such amounts. on the other hand it is hard to unlearn something you have been taught "Never ever ever ever include accruals except year one in a profit sharing plan

I could see not including missed deferrals and make up contributions, etc made under EPCRS (e.g they don't make you go back and rerun the ADP test)