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% owner1 of the employer (someone who directly or indirectly owns more than 5%);
- A 1% owner of the employer with an annual compensation more than $150,000; or
- an officer of the employer with annual compensation in excess of $215,00 (2023, adjusted for inflation), with certain limits on the maximum number of officers considered.
Top-Heavy Status – Defined Contribution Plans
To determine a defined contribution plan’s top-heavy status, we begin by calculating the top-heavy ratio:
Total Account Balance for Key Employees ÷ Total Account Balance for All Employees2
If this ratio is less than or equal to 60 percent, the plan is not top heavy, and no action is required. When the ratio exceeds 60 percent, the plan is top-heavy, and the employer is required to make a top-heavy minimum contribution for most non-key employees.3 This contribution 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 (including salary deferrals) as a percent of compensation.
Note: Safe harbor 401(k) plan designs may allow top-heavy minimum contributions to be avoided if certain rules are followed. Read here for more regarding safe harbor 401(k) plans.
Top Heavy Status – Defined Benefit Plans
To determine a defined benefit plan’s top-heavy status, we 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 (typically the highest five consecutive years) 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 Status – Combination
Plans When an employer has multiple plans, balances / benefits in all plans must typically be combined4 to calculate the top-heavy ratio. Good news – if the top-heavy ratio for the combined plans exceeds 60%, the top-heavy minimum contribution need only be provided to non-key employees under one plan. There are several options for determining the top-heavy minimum amount, but the two typically used in practice provide that the benefit may not be less than one of the following:
- Minimum benefit in the defined benefit plan (described above)
- 5% of compensation for the entire plan year in the defined contribution plan
Top Heavy Vesting
If a plan is top heavy, accelerated vesting may be required.
Plan sponsors should not perceive top heavy status of a plan as necessarily a detriment. Often, the safe harbor contributions or discretionary profit-sharing contributions that the employer 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 and additional funding requirements are generally addressed in the plan design process.
The content of this page is for general information only. While it is believed to be accurate and reliable as of the posting date, it may be subject to change. It is not intended to provide investment, tax, or legal advice. For advice regarding your specific circumstances, please seek services of an appropriate independent legal, tax, or investment professional.
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.
- Attribution of ownership rules under IRC Sec 318 apply. More information about family attribution ↩︎
- This represents the general formula. Account balances are adjusted for various items, like excluding unrelated rollovers, certain former employees and former Key Employees, and catch ups, and including certain distributions paid in the previous five years. ↩︎
- There is no requirement to provide minimum contributions to union employees, and those not employed on the last day of the plan year (unless they also participate in the defined benefit plan of the employer, in which case they may be required to share if they worked 1000 hours during the plan year). ↩︎
- Each plan of the employer in which a Key Employee participates, and each plan that enables a plan in which a Key Employee is a participant to meet coverage and non-discrimination requirements, must be aggregated. ↩︎