The IRS has issued a ruling clarifying the application of the safe harbor 401(k) plan top-heavy exemption introduced by EGTRRA. Under the EGTRRA provision, a 401(k) plan that “consists solely of” contributions that satisfy the ADP test and ACP test safe harbors is exempt from the top-heavy rules. In a safe harbor 401(k) plan, the employer automatically may satisfy the ADP test by providing a 3% nonelective contribution to all eligible nonhighly compensated employees. Alternatively, the employer may provide a fixed matching contribution and, in addition, a discretionary matching contribution, which automatically will satisfy both the ADP test and the ACP test, provided the matching contributions satisfy prescribed limits. The ruling states the top-heavy exemption applies on a year-by-year basis, so that a plan may satisfy the exemption in one plan year and not in the next.

The ruling analyzes the application of the exemption in four situations in which a safe harbor 401(k) plan permits discretionary profit sharing contributions subject to a vesting schedule. The four rules the IRS enunciates are as follows:

1. In a plan year in which the employer does not make a discretionary profit sharing contribution and the plan does not allocate any forfeitures, the top-heavy exemption applies.
2. If the employer actually makes a profit sharing contribution for a particular plan year, in addition to the safe harbor contributions, the top-heavy exemption does not apply.
3. In a plan year in which the plan allocates forfeitures in the same manner as it allocates profit sharing contributions, the top-heavy exemption does not apply.
4. If the plan permits immediate eligibility with respect to deferrals, but limits ADP and ACP safe harbor matching contributions to employees who have completed one year of service, the top-heavy exemption does not apply, even though the plan may satisfy the safe harbor rules with respect to the employees who have satisfied the one year requirement, and separately may satisfy the ADP test with respect to the “otherwise excludible employees.” In other words, the top-heavy exemption may not apply to only one portion of the plan.

The ruling does not address the use of forfeitures as safe harbor contributions. However, if the plan uses forfeitures either to offset the employer’s safe harbor nonelective contribution obligation or to offset the employer’s safe harbor matching contribution obligation (or as a discretionary matching contribution that satisfies the ACP test safe harbor limitations), the plan still should qualify for the top-heavy exemption with respect to forfeitures.

Revenue Ruling 2004-13 is located in the Official Resources section of our Web site.

401(k) Plan Workshop
SunGard Corbel will examine this and other new IRS guidance in the upcoming one-day 401(k) Plan Workshop, which focuses on practical solutions to 401(k) administrative problems.