“How do in-service distributions affect the determination of whether a plan is top-heavy?”
Highlights of Discussion
• Some may be surprised to learn that in-service distributions from a qualified retirement plan can affect the top-heavy determination for up to five years.
• Recall that a plan is considered top-heavy if the “key employees” own over 60% of plan’s assets or benefits on the “determination date.”
• If a plan is top-heavy, the plan must satisfy certain minimum employer contribution and vesting requirements.
• Generally, key employees include those who are:
– more than 5% owners of the business;
– more than 1% owners of the business with annual compensation greater than $150,000; or
– officers with annual compensation greater than $170,000 for 2014.
• For most plans, the determination date is the last day of the prior plan year. For new plans, the determination date is the last day of the current plan year.
• For defined contribution plans, the top-heavy ratio is the sum of the fair market value of key employees’ accounts divided by the sum of fair market value of all employees’ accounts.
• Certain distributions must be added back in when calculating the top-heavy ratio. For example, in-service distributions for active employees (i.e., distributions made for reasons other than termination, death or disability) are added back if the distribution occurred within the five-year period ending on the determination date (Treasury Regulation 1.416-1 T-30).
Example: Robin took a $15,000 in-service distribution from her 401(k) plan on Aug. 12, 2009. As of Dec. 31, 2013 (the date for determining whether the plan is top heavy for 2014) the value of Robin’s account is $300,000. The plan must add back in the $15,000 in-service distribution for top heavy determination purposes because it was taken within the last five years. Consequently, Robin’s account value for top-heavy determination purposes is $315,000.
Conclusion
In-service distributions from a qualified retirement plan can affect the top-heavy determination for up to five years. It is important for plan sponsors and their plan providers to be aware of this nuance to avoid any surprises.
The Columbia Management Retirement Learning Center Resource Desk is staffed by the Retirement Learning Center, LLC, a third-party industry consultant that is not affiliated with Columbia Management. For informational purposes only. Please consult a tax advisor or attorney for specific tax or legal needs. © 2014 Columbia Management Investment Advisers, LLC. Used with permission.
