The Economic Growth and Tax Relief Reconciliation Act (EGTRRA) of 2001 has modified the top heavy testing for plan years that begin after December 31, 2001.

In an effort to reduce the number of top heavy plans and decrease the number of plan sponsors that are required to contribute top heavy minimum contributions, the Treasury has changed the definitions of a top heavy plan and key employees. Additionally, employer matching contributions can now be taken into account in determining whether the minimum benefits have been provided.

To determine if a plan was top heavy under the old method, participant account balances for key and non-key employees at the end of the year were compared. If the key employees’ account balances represented sixty percent or more of total plan assets, the plan was considered top heavy for the following year. Distributions made to all employees during the current year and four preceding years were included in the account balances.

A key employee was defined as any employee who met any one of the following conditions in the current plan year or in any of the four preceding plan years:

• An officer of the employer with annual compensation greater than fifty percent of the defined benefit plan contributions dollar limit (fifty percent of $140,000 in 2001); or

• One of the ten employees with the largest ownership interest in the employer with annual compensation in excess of the defined contribution plan dollar limit ($35,000 for 2001); or

Distributions made during the current year to employees who were employed in the current year are included in the account balances. However, hardship and in-service distributions are added back to account balances for five years. If the key employees’ adjusted account balances represent sixty percent or more of total plan assets, the plan is considered top heavy for the following year.

A key employee is defined as an employee who during the current year was:

• An officer earning in excess of $130,000; or

• A greater than five percent owner; or

Under the new rules, safe harbor 401(k) plans are deemed to be providing top heavy minimum contributions and are not required to contribute additional contributions.

All plan sponsors of qualified plans, SEP and SARSEPS are required to annually test their plan and if it is determined to be top heavy, contribute a top heavy minimum contribution.

The top heavy minimum contribution is subject to the vesting schedule in the plan. For defined contribution plans (profit sharing, 401(k) and money purchase), the minimum contribution is the lesser of:

• The lowest contribution percentage a key employee receives through either an employee or employer contribution, or

• Three percent of the employee’s compensation.

For example, if a key employee contributes five percent to a 401(k) plan, the employer is required to contribute three percent to all eligible employees (three percent rule). If all key employees contribute two percent or less to a 401(k) plan or receive a two percent employer contribution, the employer is required to contribute two percent to all eligible employees (key employee contribution percentage).

401(k) plans that are top heavy can avoid the requirement to deposit top heavy minimum contributions by not allowing their key employees to deposit 401(k) contributions.

Plan sponsors that sponsor more than one plan are only required to contribute the top heavy minimum contribution to one plan. For defined benefit plans, the top heavy minimum contribution is two percent.

Contact Administrative Retirement Services, Inc. if you have any questions

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