MAY 2006 Pension Plan tip of the month...

TOP HEAVY TESTING

In addition to the annual testing of deferrals and other benefit limits, Qualified Plans are subject to Top Heavy testing as required by section 416 of the Internal Revenue Code. This test can

have an affect on your plan’s provisions, participation, and your company’s “bottom line.”

A retirement plan is top heavy if more than 60% of the plan’s account balances are attributable to Key Employees. In determining this ratio for any plan year, the calculation is made as of

the last day of the immediately preceding plan year (or for new plans, the last day of the first plan year).

A Key Employee is defined as an employee who owns more than 5% of the company sponsoring the plan or as an employee who owns more than 1% of the company and has annual

compensation greater than $150,000.  Family attribution rules do apply to ownership for Key Employee determination. Also, an employee who is an officer and has annual compensation

greater than $140,000 (indexed for 2006) will be a Key Employee. It’s important to note that a Highly Compensated Employee may not necessarily be considered a Key Employee. We will

help you determine who in your firm may be considered “key” for testing purposes.

The following example illustrates a Top Heavy plan scenario:

Owner A owns 50% of Company X

Owner B owns 2% of Company X and earns $200,000

Officer C has no ownership, but has decision making authority within the firm and earns $180,000.

All three of the above are deemed to be “key employees.”

Since plan X is a “calendar year plan”, if these Key employees own more than 60% of the plan assets in plan X on 12/31/2006, Plan X will be considered Top Heavy for the coming

plan year (2007).

If key employees defer or receive any (match, reallocated forfeitures, profit sharing) contribution into the plan during 2007, the sponsor of Plan X will normally be required to make a

contribution to the plan of at least 3% of eligible 2007 compensation  (as defined by statute). This minimum contribution must be given to any eligible participant still employed at year

end regardless of hours worked during the year. The vesting schedule for the profit sharing portion of the plan may be affected as well.

While certain other employer contributions may be used to help satisfy this required Top Heavy contribution, the amount required to be funded could still amount to a sizable sum.

Your Paragon Account Executive reviews clients’ plans at least annually using all information available to us and works hard to give them the earliest possible warning of top heavy

or potential top heavy status.  If a plan does become Top Heavy, we work with plan sponsors and review what allocation choices or requirements are open to them.  

The above information is intended as an overview of Top Heavy testing, individual plans and situations can and will vary.