26 U.S.C. § 416 — Special rules for top-heavy plans

(a) General rule A retirement trust doesn't qualify for tax benefits under section 401(a) if its plan is "top-heavy" for that year — unless the plan meets two extra requirements: the vesting rules in (b) and the minimum benefit rules in (c). (b) Vesting requirements A plan can satisfy vesting in one of two ways. (1)(A) 3-year vesting: after 3 years of service, an employee has a full, unforfeitable right to 100% of the benefit built up from employer contributions. (1)(B) 6-year graded vesting: instead, the plan can give a rising percentage — 20% after 2 years, 40% after 3, 60% after 4, 80% after 5, and 100% after 6 or more years. (2) The general vesting rules in section 411 also apply here, except where they conflict with this subsection. (c) Minimum benefits (1) Defined benefit plans: For each "non-key" employee (someone who isn't a key employee), the plan must provide an accrued benefit worth at least a set percentage of the employee's average pay. (A)-(B) That percentage is 2% times the employee's years of service, capped at 20%. (C) Years of service generally follow section 411(a), with two exceptions: years don't count if the plan wasn't top-heavy that year or the year ended before 1984, and years don't count if during that year the plan covered no key employee at all. (D) The employee's average pay is based on their highest 5 consecutive years of pay, adjusted to exclude years that don't count as service; years ending before 1984 or after the plan's last top-heavy year don't count unless the plan says otherwise. (E) "Annual retirement benefit" means the benefit paid yearly as a single life annuity with no extra benefits, starting at normal retirement age. (2) Defined contribution plans: The employer must contribute at least 3% of each non-key employee's pay each year (matching contributions count toward this). (B) If the employer contributes less than 3% for its highest-contributing key employee, that lower percentage becomes the required minimum instead — and special rules apply when combining ("aggregating") multiple plans. (C) Employees who don't meet the age and service requirements of section 410(a)(1) can be left out of this minimum-benefit calculation. (d) [Repealed.] This subsection was repealed by a 1986 law (Pub. L. 99–514). (e) Ignore Social Security offsets A plan can't count Social Security taxes or benefits — or similar state or federal programs — toward meeting the vesting or minimum-benefit rules. (f) Multiple plans If an employer has two or more plans, the Treasury Secretary will issue regulations to make sure minimum benefits aren't skipped or unfairly duplicated across those plans. (g) What makes a plan "top-heavy" (1)(A) A defined benefit plan is top-heavy if, as of the determination date, more than 60% of all accrued benefits belong to key employees. A defined contribution plan is top-heavy if more than 60% of all account balances belong to key employees. (B) If a plan is grouped with others in a required "aggregation group," it's treated as top-heavy whenever that whole group is top-heavy. (2) Aggregation: The group must include every plan a key employee participates in, plus any other plan needed so those plans pass separate nondiscrimination tests. Employers may voluntarily add other plans to the group too, as long as the group still passes those tests. The whole group counts as top-heavy if key employees hold more than 60% of the combined benefits and account balances. (3) Recent distributions count too: money paid out to an employee in the year before the determination date (5 years, for in-service withdrawals not caused by leaving the job, death, or disability) gets added back in when calculating these percentages — even payouts from a terminated plan that would otherwise have been part of the group. (4) Other special rules: rollover money an employee brings in after 1983 usually doesn't count toward the new plan's top-heavy test. If someone was a key employee in an earlier year but isn't anymore, their old accrued benefit doesn't count either. "Determination date" means the last day of the prior plan year (or, for a brand-new plan, the last day of its first year). Someone who hasn't worked for the employer at all in the year before the determination date has their benefit ignored too. A non-key employee's benefit is treated as building up steadily over time — using whatever accrual method the employer's plans use, or otherwise the slowest rate the law allows. SIMPLE retirement accounts under section 408(p) are never considered top-heavy plans. Nor is a plan that consists only of certain safe-harbor 401(k) arrangements, starter 401(k) plans, or safe-harbor 403(b) plans described in the law — even if it doesn't give certain employees extra employer contributions. If a plan would only be top-heavy because it belongs to a top-heavy group, its contributions can still count toward another plan in the group's minimum-benefit test. (h) [Repealed.] This subsection was repealed by a 1996 law (Pub. L. 104–188). (i) Definitions (1) Key employee: an employee who, at any point in the plan year, is an officer earning more than $130,000 a year, owns more than 5% of the company, or owns more than 1% and earns more than $150,000. No more than 50 employees (or a smaller group tied to company size) count as "officers." The $130,000 figure adjusts for inflation over time, rounded down to the nearest $5,000. Employees of certain government-plan entities don't count, and certain highly compensated employees are excluded when counting officers. (2) Percentage owners: a "5-percent owner" owns more than 5% of a corporation's stock or voting power (or, for a non-corporate employer, more than 5% of its capital or profits). A "1-percent owner" is the same test using 1% instead of 5%. Special ownership-attribution rules apply, based on section 318 but using a 5% threshold instead of 50%. (3) The usual rules combining related employers under section 414(b), (c), and (m) don't apply when figuring out who owns the company for this purpose. (4) "Compensation" here has the same meaning as in section 414(q)(4). (2) [Non-key employee] Anyone who isn't a key employee. (3) Self-employed people are treated as employees, and their earned income counts as compensation. (4) Collective bargaining: the vesting, minimum-benefit, and (repealed) subsection (d) rules don't apply to employees covered by a genuine collective bargaining agreement where retirement benefits were actually negotiated in good faith. (5) "Employee" and "key employee" both include their beneficiaries. (6) Simplified employee pensions (SEPs) count as defined contribution plans. Employers can choose to measure top-heaviness using total employer contributions instead of account balances.