Top-Heavy and Nondiscrimination Rules

Background

To maintain their tax-advantaged status, retirement plans must demonstrate that they are equitable and inclusive. Plans are subject to so-called top-heavy and nondiscrimination rules.

Plans are top-heavy when the value of benefits for the owners and officers exceeds 60 percent of the value of benefits for all other employees. Plans that are top-heavy must adopt specific policies. These include faster vesting and certain minimum benefits for employees who are not owners or officers. Such policies ensure that rank-and-file workers receive some benefit from the tax preferencesProvisions in the tax code—such as exclusions, deductions, credits, or special tax rates—that reduce the amount a person owes in taxes. that the employer enjoys because of the plan.

Plans must also demonstrate that they do not discriminate in favor of highly compensated employees. To satisfy this requirement, plans can either perform certain tests or follow one of several safe-harbor rules. That is, by using certain structures and procedures, the plan is deemed to be nondiscriminatory. For example, 401(k) plans that adopt automatic enrollmentA feature whereby employees are enrolled automatically in their employer's retirement savings plan and must take action if they do not want to be enrolled. provisions can satisfy the nondiscrimination rules if they provide a specified minimum benefit or a matching contribution.

TOP-HEAVY AND NONDISCRIMINATION RULES: Policy

TOP-HEAVY AND NONDISCRIMINATION RULES: Policy

Ensuring equity

Policymakers should maintain and strengthen top-heavy rulesA nondiscrimination test meant to ensure that owners and officers of a business do not own a disproportionate share of company's retirement plan assets.  so that benefits are distributed equitably among plan participants.

The use of 401(k) safe harborsA provision of a statute or a regulation that reduces or eliminates a party's liability on the condition that the party is in compliance with defined standards. should be assessed to ensure broad plan participation by lower-paid employees.