The Top-Heavy Rules for a Defined Contribution Plan

Retirement plans can be structured and managed in a number of significant ways by top-heavy plans. Here’s what business owners should know about key employees, top-heavy plans and the adjustments that need to be made for compliance.

What is Top-Heavy?

A top-heavy plan is one where more than 60% of its total accrued benefits or account balances are allocated to key employees. To ensure fairness among all participants, these plans must meet additional qualification standards.

A plan is considered top-heavy for a given year if it has to provide faster vesting than otherwise required. The plan can either have 100% vesting after three years of service or six-year graded vesting as follows:

Who Is A Key Employee?

A key employee is defined for top-heavy rules as someone who satisfies any of the following conditions at any time during the year:

• An officer of the employer with annual compensation exceeding $185,000 (indexed in 2021).
• More than 5% ownership interest in the employer.
• 1% ownership interest in the employer with annual compensation from such employer exceeding $150,000.

It should be noted that no more than 50 employees (or if less than 3-10%) will be treated as officers for these purposes.

How Does A Top-Heavy Plan Affect The Structure Of A Retirement Plan?

When a given plan becomes top-heavy during a particular year, it has to comply with stricter vesting and benefit requirements:

• Vesting: The plan must either provide full vesting after three years of service or graded vesting over six years.
• Minimum Benefits: In defined contribution plans, employer contributions during any year when it was determined to be “top heavy” must equal at least 3% of non-key employee compensation.

These requirements guarantee that non-key staff members receive equitable benefits which allow their retirement savings to accrue fairly over time.

Remedies For Top Heavy Plans

Business owners have various options they can consider to address the issue caused by this nature within their plans:

1. Increase Contributions For Non-Key Employees: Ensure minimum required contributions are provided for non-key staffers.
2. Revise Vesting Schedules: Implement faster vesting schedules so as per top heavy guidelines.
3. Review and Monitor Plan Status: Consistently check your plan status regularly which helps you anticipate potential issues around being ‘top heavy’ before they arise. 

By understanding these requirements concerning being “Top Heavy”, making necessary changes that will enable business owners to maintain a balanced compliant retirement plan(s) benefiting all workers involved.