SECURE 2.0: Minimum Contribution Rules Changed for Top-Heavy Plans, A Win for Small Businesses and Their Employees

Updated August 24, 2023

In addition to compliance testing, which compares benefits received by the highly compensated and non-highly compensated employees, qualified retirement plans are subject to a top-heavy test that checks whether account balances of  ‘Key Employees’ make up more than 60% of the total plan balances. Employers with top-heavy retirement plans are required to provide a minimum contribution (typically up to 3% of pay) and accelerated vesting to employees enrolled in the plan. Click here to read more about ‘Key Employees’ and top-heavy requirements.

Because small business retirement plans are typically top-heavy or likely to become heavy, the minimum contribution requirement often prevents them from offering retirement savings programs to new hires sooner and may result in part-time employees being unable to access a retirement plan altogether. Retirement plans of larger businesses have generally not been impacted by the top-heavy rules because their non-key employee numbers and account balances typically account for the largest share of plan participants and balances.

Favorable Testing Approach for New Hires and Part-time Employees

Pre-SECURE 2.0, compliance testing rules already allowed placing plan participants into two separate groups: those who satisfied the maximum-allowed (statutory) age and service eligibility requirements (age 21 and completion of one year of service, defined as 12 months with at least 1,000 hours worked) and those in the plan because of its more favorable eligibility and entry rules, called otherwise excludable employees. However, the same option wasn’t available for top-heavy testing. Consequently, an employer with a top-heavy retirement plan faced a choice to either make mandatory plan contributions for the recently hired and/or part-time employees or keep them out of the savings program until they satisfied the statutory eligibility conditions.

Beginning in 2024, SECURE 2.0 amends the top-heavy testing rules to allow a similar bifurcated testing approach. As a result, top-heavy plans may disregard employees who do not meet the maximum age and service eligibility requirements in determining whether the top-heavy minimum contribution requirements are satisfied.  Note: Safe harbor 401(k) plans must provide the employer safe harbor contribution to all participants who are eligible to defer in order to avoid top heavy minimum contributions to employees who do meet the statutory service requirements.  The effects of allowing otherwise excludable employees to defer without also providing them the employer safe harbor contribution should be carefully examined.

Long-term Part-time Employees and Top-Heavy Contribution Requirements

Another important point relates to the enrollment of long-term part-time employees (LTPT), which begins on January 1, 2024 (read more about the LTPT rules). Are these employees required to receive a top-heavy minimum contribution? SECURE Act of 2019, which first introduced the LTPT rules, provided employers with an option to exclude LTPT employees from compliance testing and top-heavy testing. As a result, these employees are not required to receive a minimum required contribution prescribed by the top-heavy rules.

Employers May Contribute to Otherwise Excludable and LTPT Employee Accounts

The law doesn’t preclude employers from making contributions for employees who do not meet the age 21 and one year of service requirements. Since contributions to this employee group may be tested separately from the rest of the plan population, small employers now have significant flexibility in designing effective benefit packages that consider their entire workforce thus allowing them to compete better with larger organizations whose plans are not limited by the top-heavy requirements.

Importantly, SECURE 2.0 removes a barrier to part-time and seasonal employee participation in retirement savings programs, setting more communities on a path to a financially secure retirement.

Let Pinnacle Plan Design Help

Consultants at Pinnacle Plan Design are actively monitoring new guidance concerning SECURE 2.0. This represents our understanding of the laws at this time. Additional guidance will provide further clarity. If you have any questions about the updated top-heavy rules, the impact of long-term part-time employee rules, or options for crafting effective eligibility conditions, don’t hesitate to contact us at (520) 618-1305.

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