Top Heavy and Safe Harbor

Hi,

This plan was not a safe harbor for 2020. For 2021, plan added a safe harbor match.

The ADP test failed and one HCE has to take back $2000 of the $2500 she put in. The plan also is top heavy for 2021. Total plan assets are $7000. $5000 for the key and $2000 for the non-key. If she hadn't put that $2000 in then the plan would've been fine!

Eligibility is 3 months of service making about 30 employees eligible. Their TH contribution for 2021 is going to be big ( for them). Any suggestions to lower the cost?

Short of a time machine where she doesn't contribute in 2020, sounds like you're stuck with the TH Minimum.

For 2021, if the safe harbor match is the only employer contribution you are deemed not top-heavy. I'm assuming all amendments and notices for SHM were timely.

How/why was this not discussed with the client beforehand?

I'm guessing the Key is under 50, since her contributions were refunded instead of being reclassified as catch-up? There are some tricks you can pull with catch-up and the top heavy minimum, but if the owner/key employee isn't eligible for catch-up then it isn't going to help.

Does anyone know off the top of their head whether they can determine the alternative top heavy minimum using the net contribution after the refund? Meaning, key employee contribution rate=500/comp instead of 2500/comp.

I agree with BG - this seems like a major plan design oversight.

Did I miss something? If it's safe harbor match for 2021, then the top heavy status is irrelevant.

Was this the first year?  Could there have been the prior year/3% provision?

The person who got the refund, is she the only Key EE?  Was there a match? If so, how much does she make?  $2500 is 3% of $83,333.

Could it be the key allocation this year was less than 3%, so the TH is less?

3 minutes ago, Bill Presson said:

Did I miss something? If it's safe harbor match for 2021, then the top heavy status is irrelevant.

What if 2020 is the first year.  That will be TH, too.  Does the 2021 SHM do double duty for the '20 and '21 minimums?

1 minute ago, BG5150 said:

What if 2020 is the first year.  That will be TH, too.  Does the 2021 SHM do double duty for the '20 and '21 minimums?

SHM doesn't do double duty, but I didn't see anything asked about 2020. The whole thing said it would be top heavy in 2021 and the top heavy contribution in 2021 would be large. I don't think that's accurate. Maybe there are questions about 2020, but they weren't asked by the OP.

Is the 3 months of service eligibility for deferrals only or for deferrals and safe harbor match? If it's 1 year of service for the match, and you have any employees who can defer but are not eligible for the safe harbor match then you lose the top heavy exemption.

Hi,

2020 was not the first year for the plan. The first year was 2019 and no one contributed anything to the plan. In 2020, the 2 owners started contributing along with 1 or 2 other employees. There was no match for 2020. The owners only put in about 1.5% of pay.

Last Fall, they decided to become a safe harbor plan for 2021.

As to why it was set up like this? I work for a payroll company. The salespeople don't ask what's in the best interest of the client as to the plan set up. They are just trying to meet their quotas.

It comes across my desk at year-end to do the compliance testing and this is the result. Their payroll for 2020 was over $2M. With that 3 month eligibility, most are eligible for the plan so that TH contribution will be significant.

I was just desperately looking for some way around it because I am the one that has to deliver tis news.

So if you are not TH for 2020 and you are a safe harbor for 2021, I'm not sure I see an issue as you should be deemed not TH for 2021 if the safe harbor match is the only employer contribution.

39 minutes ago, Lou S. said:

So if you are not TH for 2020 and you are a safe harbor for 2021, I'm not sure I see an issue as you should be deemed not TH for 2021 if the safe harbor match is the only employer contribution.

Given the fact there were no contributions in 2019, was 2020 in fact the first year of the plan?  Then given the 12/31/20 balances, the plan was TH for '20?

And if the Key EEs only had a 1.5% rate, then the TH contribution is only 1.5%.  Better than 3%!

36 minutes ago, BG5150 said:

Given the fact there were no contributions in 2019, was 2020 in fact the first year of the plan?  Then given the 12/31/20 balances, the plan was TH for '20?

And if the Key EEs only had a 1.5% rate, then the TH contribution is only 1.5%.  Better than 3%!

It's an interesting question and one I don't think was contemplated when the statute or regs were written.

22 minutes ago, Lou S. said:

It's an interesting question and one I don't think was contemplated when the statute or regs were written.

I disagree. 416 is clear that in order to be top-heavy the percent requirement is that the keys have a benefit which is more than 60%. Words have meaning. Having sat with government representatives discussing the implications of adopting a plan which is then not funded for the first year (is there a 5500 requirement? successor plan rules? amongst other things) and heard them universally say that yes, Virginia, there is a 5500 requirement, etc. I think the adoption of the plan effective in 2019 means that the 2020 year is definitely not top heavy.

Was a 5500 filed for 2019?

16 minutes ago, Mike Preston said:

I disagree. 416 is clear that in order to be top-heavy the percent requirement is that the keys have a benefit which is more than 60%. Words have meaning. Having sat with government representatives discussing the implications of adopting a plan which is then not funded for the first year (is there a 5500 requirement? successor plan rules? amongst other things) and heard them universally say that yes, Virginia, there is a 5500 requirement, etc. I think the adoption of the plan effective in 2019 means that the 2020 year is definitely not top heavy.

I'm not disagreeing with your conclusion, but is undefined more or less than 60%?

44 minutes ago, Lou S. said:

I'm not disagreeing with your conclusion, but is undefined more or less than 60%?

Zero is not undefined.  Zero is not MORE than 60% of zero.

2 minutes ago, Mike Preston said:

Zero is not undefined.  Zero is not MORE than 60% of zero.

0 / (0 + 0) is undefined. The key employee balances divided by the sum of the key employee balances plus non-key employee balances.

10 minutes ago, Lou S. said:

0 / (0 + 0) is undefined. The key employee balances divided by the sum of the key employee balances plus non-key employee balances.

But that isn't the definition. 

Once again you are right as usual Mike and a credit to this board. Thanks. After going back and looking at the code I agree that  $0 is not more than 60% of $0 which is how the statute is actual worded. I feel today has been a success learning something new that previously took for granted.

I suspect that the IRS would object to the following scenario: adopt a plan on 7/1/2021 effective 1/1/2020 which is specifically allowed per the new law.  Don't fund anything for 2020 and, magically, what would otherwise be a new plan for 2021 that is top-heavy in that first year (2021) is not top-heavy for 2021 at the cost of a 5500 with a whole bunch of zeroes.  Sounds abusive to me, but it sure does seem to "work".

28 minutes ago, Mike Preston said:

I suspect that the IRS would object to the following scenario: adopt a plan on 7/1/2021 effective 1/1/2020 which is specifically allowed per the new law.  Don't fund anything for 2020 and, magically, what would otherwise be a new plan for 2021 that is top-heavy in that first year (2021) is not top-heavy for 2021 at the cost of a 5500 with a whole bunch of zeroes.  Sounds abusive to me, but it sure does seem to "work".

Love it!  😀

If everyone contributed to the plan for 2021 then I wouldn't have to worry but there's no way that it will happen. Once she's refunded the money from the correction of the ADP test, the plan would fall below the 60%. Is that distribution counted?

1 minute ago, coleboy said:

If everyone contributed to the plan for 2021 then I wouldn't have to worry but there's no way that it will happen. Once she's refunded the money from the correction of the ADP test, the plan would fall below the 60%. Is that distribution counted?

If the plan is safe harbor match in 2021, it doesn't matter if only the owner contributes to the plan, there's no required top heavy contribution.

3 minutes ago, Bill Presson said:

If the plan is safe harbor match in 2021, it doesn't matter if only the owner contributes to the plan, there's no required top heavy contribution.

Being picky here:  If the SH Match is the ONLY employer contribution in 2021, then the plan is not considered top heavy for 2021 regardless of the balances of key employees.

6 minutes ago, BG5150 said:

Being picky here:  If the SH Match is the ONLY employer contribution in 2021, then the plan is not considered top heavy for 2021 regardless of the balances of key employees.

True. Picky is important.

So BG5150, are you saying that because even though they are Top Heavy for 2021, no TH contribution is owed for 2021? What about the people that won't contribute in 2021. They won't be due anything?

This is what I'm trying to verify. The fact that they are TH for 2021 but became a SH plan for 2021 so the TH minimums won't apply.

Quote

(H) Cash or deferred arrangements using alternative methods of meeting nondiscrimination requirements

The term “top-heavy plan” shall not include a plan which consists solely of—

(i)

a cash or deferred arrangement which meets the requirements of section 401(k)(12) or 401(k)(13), and [ADP Safe Harbor contribs and QACA contribs]

(ii)

matching contributions with respect to which the requirements of section 401(m)(11) or 401(m)(12) are met. [ACP Safe Harbor and QACA]

The above is from Sec 416. (the bold items are my emphasis and commentary)

Basically is says that if Safe Harbor is the SOLE funding method (other than deferrals), then the plan is NOT TOP HEAVY.  If the plan is not Top Heavy, then, of course, no minimum is required.

So, in your case, if the SHM is the ONLY employer money (or, more specifically, the SHM and a discretionary match that together satisfy ACP Safe Harbor), then your plan is NOT TOP HEAVY, regardless of the key assets held.

Picky point:  Safe Harbor doesn't satisfy TH minimums (if the SH is the only ER contrib); the plan is simply not TH in that case.

That's music to my ears! Thank you all for your help and insights. I always thought that this was the case but the system that I was working on kept asking for the TH minimum on a plan that was similar to this. In 2019 that plan was not a SH and tested as TH for 2020. Plan amended to a SH match for 2020 but the system kept asking for a TH contribution. That's when I began to doubt myself.

3 hours ago, coleboy said:

If everyone contributed to the plan for 2021 then I wouldn't have to worry but there's no way that it will happen. Once she's refunded the money from the correction of the ADP test, the plan would fall below the 60%. Is that distribution counted?

As others have mentioned if the SM match is the only employer contribution the plan is "deemed not top-heavy" regardless of the top-heavy ratio.

That said for the determination date of 12/31/2020 you include the full 401(k) amount (pre-refund).

The refund made in 2021 is an in-service distribution and will remain in your top-heavy test under the rules for in-service withdrawals and look backs from the determination date as detailed in 416. As long as you meet the "safe-harbor only" rules under §401(k)(12) & (13) you are deemed "not top heavy". Once you have $1 dollar of allocations outside those rules, you are back in the 416 top heavy world and need to comply with those rules.