A retirement plan is considered to be top heavy when a significant portion of the money in the plan is attributable to key employees. An employee is a key employee if they are:
- A 5% owner of the employer;
- A 1% owner of the employer with annual compensation in excess of $150,000; or
- An officer of the employer with annual compensation in excess of $170,000.
Top Heavy Status – Defined Contribution Plans
To determine a defined contribution plan’s top heavy status, begin by calculating the top heavy ratio:
Total Account Balance for Key Employees ÷ Total Account Balance for All Employees
If this ratio is less than or equal to 60 percent, the plan is not top heavy and no action is required. If the ratio exceeds 60 percent, the plan is top heavy and the plan is required to make a top heavy minimum contribution for all non-key employees, which is the lesser of:
- 3% of compensation for the entire plan year; or
- A contribution percentage equal to that of the key employee who receives the largest contribution as a percent of compensation.
Top Heavy Status – Defined Benefit Plans
To determine a defined benefit plan’s top heavy status, begin by calculating the top heavy ratio:
Total Present Value of Accrued Benefit for Key Employees ÷ Total Present Value of Accrued Benefit for All Employees
If this ratio is less than or equal to 60 percent, the plan is not top heavy and no action is required. If the ratio exceeds 60 percent, the plan is top heavy and the plan is required to provide a top heavy minimum accrual for all non-key employees. This benefit may not be less than the participant’s average compensation multiplied by the lesser of:
- 2% times the number of years of service or participation for benefit accrual during top heavy years; or
Top Heavy Vesting
If a plan is top heavy, accelerated vesting may be required.
Plan sponsors should not perceive top heavy as necessarily a bad thing. Often, the safe harbor contributions or discretionary profit sharing contributions that the firm is already making are equal to or exceed the top heavy minimum contribution, thus satisfying the requirement. In such cases, there is no downside to being top heavy. As key employees take advantage of sophisticated plan design and accumulate significant amounts for their retirement, the plan will become top heavy.
Contact Pinnacle Plan DesignPinnacle Plan Design is a third-party administrator (TPA) for employer-sponsored qualified retirement plans. We specialize in retirement plan design, administration and actuarial consulting for 401(k)/profit-sharing plans, defined benefit plans, cash balance plans, and 403(b) plans. Pinnacle Plan Design proudly serves businesses nationwide.