Basics of IRS Nondiscrimination Testing: Top Heavy Test

August 4, 2016
2 min read
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Every single day, I work with people in compliance and 401(k) plan administration. I talk to recordkeepers, compliance officers, and 401(k) fiduciaries. And every single day, I find new ways to appreciate the responsibilities, challenges, and art behind creating a place where employees are happy and appreciated. For all the HR, finance, and leadership teams out there struggling with IRS and Department of Labor regulations: this is for you.

If you’re a small business owner thinking of starting a 401(k) plan or a small business owner that already has a 401(k) plan, you’ve probably heard the terms top heavy, nondiscrimination testing, and ACP vs. ADP thrown around. Don’t panic.

At the end of the year, 401(k) plans are subject to a series of nondiscrimination tests. The purpose of these tests is to make sure your 401(k) plan isn’t inherently designed to favor certain employees.

Today, I’m going to address one of these nondiscrimination tests — the top heavy test.

While there are three 401(k) nondiscrimination tests in total, the top heavy test is the most painful one to correct if your company ends up failing it.

Here’s how the IRS Top Heavy Test works:

Most small companies have employees who qualify as “key employees.” If over 60% of the assets in a plan are owned by these key employees, a plan is considered top heavy. You probably have some questions based on what you just read. “What’s a key employee?” and “why do I care?” are probably up there.

A key employee is someone who:

  1. Owns greater than 5% of the company
  2. Or is an officer making $170,000 in 2016
  3. Or is an employee who owns more than 1% and makes over $150,000 in 2016

**Why is this important? **Good question.

If your plan is top heavy, you might have to make a 3% nonelective contribution to all non-key employees and this could add up pretty quickly. This means putting in 3% of gross pay into the 401(k) on behalf of each employee eligible to participate in the plan — effectively increasing your payroll by 3% for the year.

To avoid this, ForUsAll collects data from plan sponsors to run mid-year testing on plans. Additionally, we run weekly reporting to see if your plan is trending toward being top heavy. If your plan is trending toward this, we’ll let you know ASAP. Our services don’t end there though.

We’ll even advise you on how to reduce the risk of being top heavy and continue monitoring your plan until that risk has sufficiently subsided. As a 3(16) fiduciary, we take on these responsibilities so you can go about doing your actual job.

If you want to check “plan design” and “nondiscrimination testing” off your to-do list — schedule time to talk. We’ve got you covered.

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This material has been prepared for informational and educational purposes only and should not be construed as a recommendation by ForUsAll, Inc., its affiliates or employees (collectively, “ForUsAll”)  to activate a cryptocurrency window or invest in crypto.  Investing in crypto can be risky and investors must be able to afford to lose their entire investment.  You should consult with your own advisers before activating a cryptocurrency window or investing in crypto.  ForUsAll does not provide legal, tax, or accounting advice. Please refer to your Plan's fee disclosure for more details.© 2023 ForUsAll, Inc. All rights reserved.
1 Schwab 2022 401(k) Participant Study - Gen Z/Millenial Focus, October 2022.
2 As of 12/31/2022. Employees include both current employees and terminated participants with a balance.
3 "Morgan Stanley At Work: The Value of a Financial Advisor" Morgan Stanley, March 2022.
4 Sarah Britton was a client when she provided this testimonial through an independent third party review website. She received no compensation for her remarks. There are no known conflicts of interest in the provision of her comments related to the services provided.