Is Your Client's 401(k) "Top Heavy" or Will It Become "Top Heavy"

401(k) Plan Sponsors need to understand the implications of their Plan being Top Heavy.  Slipping into the Top Heavy category can bring a nasty surprise to a client that does not want to be committed to making employer contributions.

For a Plan to be Top Heavy for a given Plan Year the Key Employees have more than 60% of the total account balances as of the last day of the prior Plan Year. I won't go into it here, but the Key Employee definition is not quite the same as the definition of Highly Compensated Employees.

Being a Top Heavy Plan is not problem as long as times are good and the company contributes 3% of pay or more each year as a Profit Sharing contribution.  Top Heavy is also not a problem for a client who maintains a Safe Harbor 401(k) Plan. But many companies maintain the 401(k) Plan simply to allow employees to make salary deferrals with no intention of adding company contributions or at some point they decided to stop making company contributions due to a business downturn. Unfortunately if over time the Key Employees take advantage of doing salary deferrals more than the rest of the staff and the percentage of plan assets for Key Employees creeps over the 60% level as of the last day of the year, then the Employer can be in for a very nasty surprise for the next Plan Year.

If a 401(k) Plan is Top Heavy and if ANY of the Key Employees engage in salary deferrals, then the company is going to be faced with making Top Heavy minimum contributions, whether they can afford to or not. Ouch!

If any of the Key Employees have made salary deferrals of 3% of pay or more, then the Top Heavy minimum contribution is 3% of the pay of all of the Non-Key Employees. So, for example, if a small company had a payroll of $1,000,000 for all of the Non-Key employees, the Top Heavy minimum contribution would be $30,000. This is not something the business owner is very happy about finding out when it is too late to do anything about it.

It takes a bit of forward planning to avoid the nasty surprise. First, you have to be aware of whether or not the Key Employees might have more than 60% of the total assets as of the last day of a Plan Year. If it appears likely that the plan will be Top Heavy, to avoid the Top Heavy Minimum, the Plan Sponsor will need to tell all of the Key Employees to cease their salary deferrals as of the first day of the Top Heavy year. They can do salary deferrals later in the year if it is determined that the company will be able to afford a Profit Sharing contribution of 3% of pay or more for everybody.

If the plan is close to being Top Heavy, the Plan Sponsor may want to routinely cease the salary deferrals of all Key Employees at the beginning of each plan year until it is determined by the TPA or record keeping vendor if that year is Top Heavy or not. The business owner will tend to blame everybody for not proactively warning them that this might be an issue.

It would be a good idea if you are the CPA for some clients who sponsor 401(k) Plans to have the client ask the TPA how close they are to being Top Heavy and for those that are close, take the protective action described above.  If a client finds out they are Top Heavy already, then they need to gain a full understanding of the implications.

If you know certain clients do have a 401(k) Plan, you might consider sending them an email link to this blog post - just a little service "above and beyond" for them from their proactive CPA.

Retirement Plan Limits for 2014

Here is a brief recap of the retirement plan limits for 2014:

Salary Deferral Limit for 401(k) and 403(b) Plans is $17,500. Additional Salary Deferral for someone Age 50 by 12/31/2014 is $5,500.  Therefore a 50 year old can defer up to $23,000. The maximum amount of compensation counted for plan purposes is $260,000. Maximum Annual Additions Limit from all contributions is $52,000 and you can add $5,500 if age 50 or more if salary deferrals available. The maximum Defined Benefit Plan retirement amount is $210,000 per year. The amount of compensation in 2014 that would make someone an HCE in 2015 is $115,000. The Social Security Taxable Wage Base for 2014 is $117,000.


For a more complete chart go here:

 http://401kacademy.com/storage/Copy%20of%20limitations2014_Orange.pdf

Did Your Client Fail Their ADP Testing and Have to Take Refunds of Salary Deferrals?

Most 401(k) plans are run on a Calendar Year basis. Unless the plan is a Safe Harbor plan, the infamous ADP (average Actual Deferred Percentage) test is performed in the first couple of months following plan year end. So, most plan sponsors have recently been informed as to whether or not the test was passed for the prior year and some of your client's key people may have been forced to take refunds of some of their salary deferrals.  They are never happy about that!

If you are not familiar with the annual ADP test, see our 401k) Primer:  Click Here to Download the 401(k) Primer.

If the ADP test is not passed, then the Plan Sponsor will have to either return salary deferrals to some of their most important employees or make additional contributions for the Non-Highly Compensated Employees. Either way, the Plan Sponsor is not happy.  Plan Sponsors are looking for solutions.

The possible solutions (and it may take several) may involve adding automatic enrollment, considering a small incentive match, re-energizing the employees by having some really effective enrollment meetings, explaining why now is the ideal time to get a lot of money into to the market at the earliest age possible so time is on their side.   It might be even time to change the entire program to a new, more exciting vendor - reboot the plan by making some major changes.

Of course, the most obvious solution is to convert the plan into a Safe Harbor plan - see the Primer mentioned above to educate yourself on the Safe Harbor options. The Plan Sponsor will not be able to implement a Safe Harbor in the middle of a year, so that might only work for the next Plan Year.

As a CPA, if you client is complaining about the 401(k) Plan not working as they had hoped, encourage them to see a fresh new opinion about how their program is structured.