Top Heavy Safe Harbor Plans

ERISA consultants at the Retirement Learning Center (RLC) Resource Desk 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, and Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business.  

A recent call with a financial advisor from Florida is representative of a common inquiry related to safe harbor 401(k) plans.The advisor asked: “One of my clients has a safe harbor 401(k) plan and his recordkeeper told him the plan was top heavy. How could that be? I thought all safe harbor plans were exempt from the top-heavy testing rules.”

Highlights of Discussion

No—not all safe harbor plans are exempt from the top-heavy rules.A safe harbor plan that provides for salary deferrals and just the required safe harbor contribution (i.e., either the employer matching or nonelective contribution) would be exempt from top-heavy testing. However, there are three scenarios that would make a safe harbor plan subject to top-heavy testing, according to Revenue Ruling 2004-13:  

1. If, in addition to employee salary deferrals and the employer’s safe harbor contribution, the plan allocates an additional profit-sharing contribution; 

2. If the plan allocates forfeitures as a profit sharing contribution; and  

3. If employees are eligible to make elective deferrals upon hire but are not eligible for matching contributions until after they complete one year of service.  

If your client’s safe harbor plan falls under one of the three above-listed exceptions, then the plan will have to be tested for top-heaviness. In general, a plan is considered top heavy if more than 60 percent of the plan’s assets belong to key employees. A top-heavy plan must satisfy minimum contribution and vesting requirements (see Treasury Regulation 1.416, Q&A Sections V and M).

Here are a couple of extra pointers regarding the minimum contribution requirement for safe harbor plans that fail top-heavy testing: 

• Safe harbor employer contributions can be used to help satisfy the minimum contribution requirement for a top-heavy plan. 

• When determining the top-heavy minimum contribution amount, the plan must use “full year compensation,” regardless of how the plan document defines compensation for contribution purposes (see Treasury Regulations 1.416-1, Q&As M-7 and T-21).

Conclusion

Not all 401(k) safe harbor plans are exempt from top-heavy testing. The IRS has identified three scenarios in which safe harbor plans would be required to apply the test and, if found to fail, meet minimum contributions and vesting requirements.