Written By Jenny Kiffmeyer, J.D – The Retirement Learning Center
If a safe harbor 401(k) plan permits after-tax contributions, can it still be exempt from the top-heavy requirements?
Highlights of the discussion
Unfortunately, the exemption for safe harbor 401(k) plans related to top-heavy testing is nullified when after-tax contributions are present. In such cases, the safe harbor plan must satisfy top-heavy requirements. However, the plan can take safe harbor nonelective and matching contributions into account in determining whether an employer has satisfied its top-heavy minimum-contribution obligation [IRC §416(c)(2)(A)].
The top-heavy rules require a plan sponsor to make certain minimum contributions to participants and satisfy special vesting rules if a plan is deemed to be top-heavy (i.e., where key employees hold more than 60 percent of the plan’s assets) [IRC §416(a)]. One advantage of safe harbor plans is that they can qualify for an exemption from the top-heavy (as well as other nondiscrimination) requirements.
IRC §416(g)(4)(H) provides an exemption from the top-heavy requirements for certain safe harbor plans. To qualify, the plan “must consist solely of” 1) a cash or deferred arrangement, and 2) basic safe harbor employer contributions (matching or nonelective).
Treas. Regs. 1.401(k)-1(a)(2)(ii) states that a cash or deferred arrangement does not include after-tax employee contributions. A safe harbor plan that permits after-tax contributions would not consist solely of a cash or deferred arrangement and minimum safe harbor employer contributions, and, therefore, would not qualify for the top-heavy exemption. The IRS has provided guidance on other circumstances where a safe harbor plan will not qualify for the top-heavy exemption in Revenue Ruling 2004-13, which is discussed here.
Voluntary, non-Roth, after-tax contributions have gained popularity as a 401(k) plan feature, in part, because they can facilitate tax-efficient Roth conversions a la the ” back-door Roth” strategy. However, permitting after-tax contributions in a safe harbor 401(k) plan subjects them to the actual contribution percentage (ACP) test as well as top-heavy requirements.
Conclusion
While after-tax contributions have grown in popularity as a 401(k) plan feature, plan sponsors should be aware of the potential consequences of permitting after-tax contributions in their plans, especially safe harbor plans.
