| The principal advantage of the safe harbor 401(k) plan is the ability to obtain the "free" pass on the ADP and ACP tests. However, a safe harbor 401(k) plan may also qualify for an exemption to the top-heavy requirements. The top-heavy exemption is not automatic. The exemption depends on the design and the operation of the plan. This is the first of a two-part Technical Update dealing with the top-heavy exemption. Part I defines the top-heavy exemption and explains how the top-heavy rules apply to a safe harbor 401(k) plan. Part II will discuss the financial effect, benefits, and limitations of the top-heavy exemption.
How does a safe harbor 401(k) plan that otherwise would be top-heavy avoid top-heavy status?
Under the Code, a plan that "consists solely of" elective deferrals and contributions that will satisfy the ADP safe harbor, and if applicable, matching contributions satisfying the ACP safe harbor, is not a top-heavy plan.
What does it mean to "consist solely of" elective deferrals and safe harbor contributions?
The IRS has interpreted the top-heavy exemption to apply on a plan year by plan year basis. In general, a safe harbor plan is not top-heavy in any plan year in which the contributions are limited to:
- Elective deferrals which are not subject to the ADP test because of the safe harbor (using either nonelective or matching contributions to satisfy the safe harbor).
- Employer contributions satisfying the ADP safe harbor, including:
- 3% (or more) nonelective contributions
- Basic safe harbor matching contributions.
- Enhanced matching contributions which satisfy the ADP and ACP safe harbors.
- Other matching contributions which satisfy the ACP safe harbor.
In a plan year in which a plan that otherwise is top-heavy allocates an employer contribution or forfeiture as a profit sharing contribution (other than a safe harbor nonelective contribution), the plan is subject to the top-heavy rules. Similarly, if the plan has matching contributions which do not qualify for the ACP safe harbor, or accepts after-tax voluntary employee contributions, the plan does not qualify for the top-heavy exemption. See the question below for further discussion of forfeitures.
Example #1. Top-heavy exemption. Plan X is a top-heavy calendar year 401(k) plan that satisfies the ADP safe harbor using a 3% nonelective contribution (based on gross compensation while a participant), and provides a fixed match of 50% of the first 6% of compensation deferred (which satisfies the ACP safe harbor). While the plan allows for additional profit sharing contributions in the employer’s discretion, for 2012, the plan does not allocate any employer contribution or forfeiture, other than the safe harbor nonelective contribution and the fixed match. The plan is exempt from the top-heavy rules for 2012.
Example #2. Allocation of profit sharing. Continuing Example #1, assume for 2013 Employer X, in addition to the safe harbor nonelective and matching contributions, makes a profit sharing contribution that results in an allocation of 5% of compensation to each participant. The plan is subject to the top-heavy rules for 2013. However, all the employer contributions (safe harbor nonelective, match, and 5% nonelective) will offset the top-heavy minimum. In fact, if the plan defines compensation for safe harbor purposes as 415 compensation (total compensation for the plan year), the 3% safe harbor nonelective contribution will completely satisfy the top-heavy minimum, assuming it goes to all plan participants.
Example #3. Allocation of forfeiture. Assume for 2013 Employer X does not make a profit sharing contribution other than the safe harbor nonelective and matching contributions. However, a $2,000 forfeiture results from a cash-out distribution during the plan year, and the plan provides that forfeitures will be allocated during the plan year as an additional profit sharing contribution. The plan is subject to the top-heavy rules for 2013. The highest key employee contribution rate will determine the top-heavy minimum, subject to a maximum of 3% of compensation. Key employee deferrals, match, forfeitures, and safe harbor nonelective count in determining the key employee contribution rate, and it is likely the top-heavy minimum will be 3%. The forfeitures, 3% safe harbor, and match can be used to satisfy the top-heavy minimum for non-key employees. If an employee entered midyear, it is possible the forfeitures, 3% safe harbor contribution and match will be less than the required top-heavy minimum, and the employer must “top-up" the allocations to the employee.
If an employer wishes to take advantage of the top-heavy exemption, what plan provisions should it consider to facilitate maintaining the exemption?
The employer should assure that the plan’s forfeiture allocation provision allocates forfeitures in a manner that will not create “non-safe harbor" allocations. The plan therefore should provide for allocating forfeitures to pay plan expenses, to reduce the employer’s safe harbor (nonelective or match) contribution requirement, or as a discretionary match not exceeding the safe harbor discretionary match limit. Note: The IRS is now taking the position that a plan may not use forfeitures to offset an ADP safe harbor contribution. However, many pre-approved plans permit such offsets and the employer should be able to rely on the IRS approval if they use the offset provision.
Can the top-heavy exemption apply to a Qualified Automatic Contribution Arrangement (QACA)?
Yes. The top-heavy exemption can apply to a QACA, the automatic contribution version of the safe harbor plan.
We will discuss safe harbor 401(k) plan in more details in the live seminar Cross-Tested/Safe Harbor 401(k) Plan Design and Troubleshooting Workshop scheduled in August through October. See details below.
ERISA Forms Online.
Are you looking for sample disclosure forms? SunGard’s ERISA Forms Online provides sample plan-related, expense (annual and quarterly), investment, covered service provider and disclosure change forms. In addition, the service offers more than 400 other forms and, of course, we update the forms and add new forms for new guidance. For more information, visit our Web site at: www.relius.net/Products/PPDLibrary.aspx
Upcoming Web Seminars:
Death and the 401(k) Plan, July 19, 12:00 p.m. ET (early start time)
457(b) Plans for 401(k) Practitioners 2012, July 24, 2:00 p.m. ET
Brokerage Accounts and 404a-5: Making Sense of the Rules, August 9, 2:00 p.m. ET
403(b) Plans for 401(k) Practitioners – 3 parts, August 14-15-16, 2:00 p.m. ET each day
Troubleshooting Participant Loans, August 28, 2:00 p.m. ET
And watch for this Web seminar topic coming in August:
Filing streamlined applications under VCP – step-by-step explanation
Visit our Web site at www.relius.net/Events/events.aspx?Web for more details and to register online.
Fundamentals of 401(k) and Other Qualified Plans – 1 City Left
Visit our Web site at www.relius.net/Events/events.aspx?Seminar now for detailed information, dates/locations, and to register online.
Cross-Tested/Safe Harbor 401(k) Plan Design Workshop – August-October, Registration Open
See complete agenda and register online here: www.relius.net/Events/events.aspx?Seminar
Chicago Advanced Pension Conference – September 5-7, Earn up to 19 hrs of CE credits
Registration is now open here: www.relius.net/Events/events.aspx?Conference
Just for ERPAs Workshop, Chicago IL – September 4, Earn up to 8 hrs of ERPA credits, including 2 ethics hrs
Register online here: www.relius.net/Events/events.aspx?Seminar |
