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A 401(k) plan is considered top heavy when the account balances of “key employees” exceed 60% of total plan assets. This ratio is tested every year based on account balances as the last day of the prior plan year (the "determination date"). For example, the determination date for 2024 calendar-based plan year is December 31, 2023.
Here's what you need to know about the top heavy test.
Who is Considered a Key Employee?
A Key Employee is defined as any employee (including former or deceased employees), who at any time during the year was:
- An officer making over $215,000.
- A 5% owner of the business (a 5% owner is someone who owns more than 5% of the business)
- An employee owning more than 1% of the business and making over $150,000 for the plan year
Most Safe Harbor 401(k) Plans Automatically Pass
Safe harbor 401(k) plans automatically pass the top heavy test UNLESS one or more of the following conditions apply:
- The safe harbor contribution is subject to longer eligibility requirements than employee deferrals.
- A profit-sharing contribution (including forfeiture reallocations) is made during the year.
- A match that’s not exempt from the ACP test is made during the year.
- Voluntary (non-Roth) after-tax contributions are made during the year.
How to Correct a Failed Test
When a 401(k) plan is top heavy, non-Key Employees must generally receive an employer contribution equal to 3% of their annual compensation.
Any employer contribution can be used to offset this top heavy minimum contribution requirement.
Don’t Be Surprised By a Top Heavy Failure!
Safe harbor 401(k) plans are the most popular form of small business 401(k) plan in large part due to the top heavy test. Many - if not most - small plans cannot pass the test, while a safe harbor contribution will cost about the same as a top heavy minimum contribution.
Not sure your 401(k) plan's top heavy status? Ask your 401(k) provider. Finding out your plan is top heavy down the line is never a welcome surprise.