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A recent call with a financial advisor in New York is representative of a common question on top-heavy requirements for 401(k) plans.
Welcome to the Retirement Learning Center’s (RLC’s) Case of the Week. Our ERISA consultants regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans, and other types of retirement savings and income plans, including nonqualified plans, stock options, Social Security, and Medicare. This is where we highlight the most relevant topics affecting your business.
“My client’s 401(k) plan is top-heavy and, as the plan sponsor, he must make top-heavy minimum contributions. How does he determine which participants should receive a top-heavy contribution? Does it matter if the plan has annual allocation conditions of 1,000 hours of service and employment on the last day of the plan year for employer nonelective contributions?”
First, help your client review the terms of the plan document, which will describe who is entitled to receive the top-heavy minimum contribution. Treas. Reg. §1.416-1, Q&A M-10 permits a defined contribution plan to limit the required top-heavy minimum contribution to participants who are not “key employees” (defined later) and have not separated from service by the end of the plan year. Importantly, those non-key employees are entitled to receive the contribution regardless of how many hours they worked during the plan year. This is the case even if the plan generally requires that a participant complete 1,000 hours of service during the plan year to receive an allocation of employer contributions, such as nonelective or matching contributions.
For example, a non-key employee in a calendar-year plan who worked more than 1,000 hours during the year but terminated employment before December 31 would not be entitled to a top-heavy minimum contribution. Conversely, a non-key employee who worked only 650 hours during the plan year, but was still employed on December 31, must receive the contribution.
If a non-key employee has met the plan’s age and service eligibility requirements for elective deferrals and was employed on the last day of the plan year, they are generally required to receive the top-heavy minimum contribution, even if they did not make elective deferrals to the plan.
As background, under IRC §416, a 401(k) plan will be considered top-heavy if more than 60 percent of the plan assets are held by “key employees.” Key employees generally include:
Employees who own more than five percent of the employer;
Employees who own more than one percent of the employer and have annual compensation exceeding $150,000; and
Certain officers of the plan sponsor whose compensation exceeds a dollar threshold ($235,000 for 2026).
If a plan is top-heavy, the plan sponsor is generally required to make a top-heavy minimum contribution of three percent of plan-year compensation for participants who are non-key employees. However, if the highest contribution percentage allocated to any key employee for the year is less than three percent, the top-heavy minimum generally is reduced to that lower percentage.
Employer nonelective contributions (including QNECs) and matching contributions (including QMACs) already allocated for the year may be counted toward the applicable top-heavy minimum. A non-key employee’s elective deferrals, however, cannot be counted. Special rules may apply to employees who participate solely under the long-term, part-time employee provisions, and certain safe-harbor 401(k) plans may be exempt from the top-heavy requirements.
There are top-heavy vesting requirements as well. The plan must provide vesting at least as rapidly as either three-year cliff vesting or six-year graded vesting, where a participant becomes 20 percent vested after two years of service and gains an additional 20 percent vesting for each subsequent year, until reaching 100 percent after six years.
Always start with the plan document language when determining who should receive the minimum required contribution in a top-heavy plan. Generally, defined contribution plans allocate the required top-heavy minimum contribution to non-key employees who have not separated from service by the end of the plan year.