Top Heavy Retirement Plan: What is the Minimum Contribution?

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The Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) established a new category of plans known as “top heavy plans” to prevent small business owners from designing pension plans to primarily benefit themselves while providing little or no benefits to lower-paid employees.

A plan is generally considered to be top heavy if more than 60% of the total benefits (account balances for defined contribution plans or accrued benefits for defined benefit plans) under the plan belong to “key employees.” If the plan is determined to be top heavy, employers must make minimum contributions or provide minimum benefits for non-key employees and comply with special vesting requirements.

The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) substantially simplified and liberalized the application of the top heavy rules by narrowing the definition of “key employee,” reducing the testing period, and allowing matching contributions to be counted toward satisfying the minimum contribution requirements.

In addition, safe harbor 401(k) plans with only deferrals and a safe harbor matching formula are no longer subject to the top heavy requirements. The simplified rules are effective for plan years beginning in 2002.

Table of contents

    Key Employees

    The first step in top heavy testing is determining which employees are “key employees.” EGTRRA shortened the five-year testing period for determining key employees to a one-year testing period. The determination of key employee status is now based upon only the preceding plan year. For example, if the plan year ends December 31, 2001, the employee data for 2001 will be used to identify key employees for purposes of the 2002 top heavy test.

    A key employee is an employee who at any time during the preceding plan year was in one of the following three categories:

    • A more than 5% owner.
    • A more than 1% owner whose annual compensation exceeded $150,000.
    • An employee who was an officer of the employer and earned more than the indexed limit ($130,000 for 2001).

    Prior to EGTRRA, employees who were one of the ten largest owners of the employer earning over the defined contribution annual additions limit ($35,000 in 2001) were also considered to be key employees. EGTRRA also dramatically increased the compensation limit for determining whether an officer is a key employee from $67,500 in 2000 to $130,000 in 2001. These changes make it less likely that a plan will be top heavy.

    Stock Attribution Rules

    For purposes of determining whether an employee is a more than 1% or 5% owner, stock attribution rules are applicable. An employee is deemed to own the stock owned by his spouse, parents, children or grandchildren. For example, if a husband and wife own 4% and 2% respectively, they are both considered more than 5% owners since by attribution they are deemed to own each other’s stock.


    The number of officers to be included as key employees is limited to the greater of (a) 10% of all employees to a maximum of 50 officers, or (b) 3. If the company has more than the maximum number of officers earning over the indexed limit, the officers with the lowest compensation are disregarded.

    Compensation for purposes of determining whether officers are key employees includes 401(k) deferrals and contributions made at the employee’s election to a cafeteria plan.

    Determination Date

    The determination of whether the plan is top heavy is generally made as of the last day of the preceding plan year, referred to as the “determination date” (new plans use the last day of the plan’s first year). For calendar year plans, the new EGTRRA rules are applicable to the December 31, 2001 determination date since the top heavy determination will apply to the plan year beginning on January 1, 2002.

    Top Heavy Test

    The test includes total benefits (not just vested benefits) and is performed by dividing the total benefits of key employees by the total benefits of all employees based upon the value on the determination date adjusted as described below. Generally, if the employer sponsors multiple plans, the total benefits from all plans are added together to perform the test which includes the following:

    • Employer account balances, i.e., matching, profit sharing, money purchase pension.
    • Employee account balances, i.e., 401(k) deferrals, 401(k) catch-up contributions, voluntary after-tax contributions.
    • Present value of accrued benefits for defined benefit plans.
    • Outstanding loan balances.
    • Cash surrender value of any whole life insurance contracts.
    • Rollovers from another plan previously maintained by the employer.
    • Distributions due to the participant’s termination made during the plan year ending on the determination date.
    • In-service distributions, i.e., hardship withdrawals, made during the five plan years ending on the determination date.

    Prior to EGTRRA, all distributions made during the five plan years preceding the determination date were included in the calculation.

    The test does not include the following:

    • Account balances of participants who did not perform an hour of service during the plan year ending on the determination date.
    • Distributions due to the participant’s termination or in-service distributions to participants who did not perform an hour of service during the plan year ending on the determination date.
    • Former key employee account balances and any distributions. A former key employee is a participant who was previously a key employee but is now a non-key employee. The account balances of former key employees are excluded entirely from the calculation.
    • Rollovers from an unrelated employer’s plan.

    Minimum Vesting Schedules

    If the plan is top heavy, one of the following vesting schedules must be used unless the plan’s current vesting schedule is more liberal:


    Years of Service6-Year Graded3-Year Cliff


    If a participant does not have an hour of service after the top heavy schedule goes into effect, the participant will continue under the prior schedule. For example, Don terminates December 10, 2001, the plan year ends December 31, 2001 and the plan becomes top heavy January 1, 2002. If Don does not return to work and have an hour of service after January 1, 2002, his vesting will be determined by the pre-top heavy schedule.

    Minimum Contributions

    For defined contribution plans, the required top heavy minimum contribution is the lesser of:

    • 3% of compensation, or
    • The highest percentage allocated to a key employee.

    If no key employee receives an allocation, as in the case of a profit sharing plan that does not make a discretionary contribution, then the employer is not required to make a minimum contribution since the required minimum is the lesser of 3% or 0%. If the employer makes a profit sharing contribution that is 1% of compensation, the minimum contribution is satisfied as long as no key employee receives more than 1%.

    The minimum contribution is allocated to employees who have met the plan’s eligibility requirements to become plan participants and are employed on the last day of the plan year. Plans cannot require participants to have a minimum number of hours of service during the plan year in order to receive the minimum contribution.

    If the employer sponsors multiple top heavy plans, only one plan is required to provide the minimum benefit or contribution.

    Top heavy minimum contributions must be made by the end of the following plan year, i.e., if the plan is top heavy for the plan year ending December 31, 2001, the employer has until December 31, 2002 to make the contribution. Forfeitures are considered employer contributions and count toward satisfying the minimum.

    401(k) Plans

    Elective 401(k) deferrals are considered employer contributions when determining the highest percentage allocated to a key employee. For example, if a 401(k) plan allows for elective deferrals only (no match or profit sharing contribution) and the highest deferral of a key employee is 4%, a 3% top heavy minimum contribution will be required. If no key employee makes an elective deferral, then no top heavy minimum contribution will be required. Catch-up 401(k) deferrals are not considered when determining the highest percentage allocated to a key employee.

    All employees who have met the plan’s eligibility requirements to make deferrals must receive the top heavy minimum contribution even if they have elected not to defer.

    Effective for plan years beginning in 2002, employer matching contributions will now count in determining whether the employer has satisfied the top heavy minimum requirement. Prior to 2002, matching contributions needed to satisfy the actual contribution percentage (ACP) test could not be counted toward the minimum. Employers sponsoring top heavy 401(k) plans that provide matching contributions may see substantial reductions of their top heavy minimum contributions due to this new rule.

    Qualified nonelective contributions (QNECs) may be used to satisfy the top heavy minimum and, at the same time, be used to pass ADP/ACP tests. QNEC contributions must be immediately 100% vested and subject to hardship withdrawal restrictions.

    Minimum Benefits

    For defined benefit plans, the required minimum benefit is an annual benefit payable as a life annuity at normal retirement age not less than 2% of average compensation multiplied by years of service up to a maximum of ten years.

    EGTRRA included a provision that no longer requires frozen top heavy defined benefit plans to make minimum contributions on behalf of non-key employees.


    Although the top heavy rules apply to all qualified plans, they primarily affect smaller businesses. The consequences of a plan becoming top heavy may have prevented many small employers from adopting plans.

    Tightening of the class of employees considered to be key employees will lower the likelihood that the plan will be considered top heavy. If the plan does become top heavy, matching contributions are now permitted to count toward satisfying the top heavy minimum contributions, reducing the employer’s burden. Plus certain safe harbor 401(k) plans are now exempt from the top heavy rules. These positive changes serve as an incentive for small businesses to adopt and maintain qualified retirement plans for their employees.

    Paul Sundin

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