As a 401(k) plan sponsor or administrator, you need to understand how profit-sharing contributions interact with top-heavy testing. This article explains when profit sharing may help prevent top-heavy status and when it may trigger additional contribution requirements for your Gusto 401(k) plan.
The goal of top-heavy testing is to make sure a 401(k) plan does not unfairly favor owners and key employees (certain owners or officers of the employer sponsoring the plan).
Your plan is top-heavy if key employees' account balances make up more than 60% of the total account balances in the plan. For every year except the first plan year, this is based on balances as of Dec. 31 of the prior plan year.
If your plan is top-heavy, you may owe a top-heavy minimum contribution (THMC) to non-key employees. The THMC equals the lesser of:
3% of total annual compensation for non-key participants employed on the last day of the plan year
The highest contribution percentage of any key employee (this includes elective deferrals that are not catch-up contributions, plus any employer contributions they get)
This means if your plan makes a 3% profit-sharing contribution calculated using full-year compensation, that contribution would generally satisfy the THMC. Your plan may not need an additional top-heavy minimum contribution for that plan year.
Note: Top-heavy minimum contributions go to all eligible non-key employees as of the last day of the plan year, regardless of whether those employees elected to make contributions to the plan.
Safe harbor 401(k) plans have a special advantage. If the only employer contributions you make are safe harbor contributions, your plan automatically satisfies top-heavy minimum contribution requirements. You do not need to take corrective action, even if key employees hold more than 60% of the plan balance.
However, this exemption only applies when safe harbor contributions are the sole employer contributions. If you add discretionary employer contributions like profit sharing, we reevaluate the top-heavy test, and your plan may owe a THMC.
Here is how this works:
Safe harbor contributions only — no THMC required, even if the plan is top-heavy
Safe harbor contributions plus profit sharing — your plan is subject to top-heavy testing. If the plan is top-heavy and the profit-sharing contribution does not already meet the 3% minimum for non-key employees, a corrective THMC may apply
Important: The top-heavy test is forward-looking. We determine your plan's top-heavy status based on account balances on Dec. 31 of the prior plan year. That determination then governs the current plan year's obligations.
The first plan year follows different rules from later years, which creates both a challenge and an opportunity.
Contributions count retroactively. The first plan year includes contributions made in the following year, as long as those contributions are for the first year. For example, a plan that starts in 2026 and contributes profit sharing for the 2026 plan year on Mar. 15, 2027, will have those contributions included in the Dec. 31, 2026, top-heavy determination.
Top-heavy status carries forward. If your plan is top-heavy in the first year, we deem it top-heavy for both the first and second plan years.
If a 401(k) plan exceeds the top-heavy ratio in the first plan year, we deem the plan top-heavy for the year of the failure and the following year.
If the plan maintains safe harbor status and makes no profit-sharing allocation or other discretionary employer contribution beyond safe harbor contributions, you do not need to take corrective action
If the plan makes a profit-sharing contribution for the first plan year, top-heavy minimum contributions apply
If all non-key employees who are eligible and employed on the last day of the first plan year got at least 3% of gross compensation from the employer (like a profit-sharing contribution or safe harbor nonelective contribution), there are no top-heavy minimum corrections
If non-key employees got less than 3% of gross compensation, you owe a top-heavy minimum contribution that brings the employer contribution up to 3% by the end of the second plan year
If the plan also makes a profit-sharing contribution for the second plan year, top-heavy minimum contributions apply for that year as well
Because first-year contributions count retroactively toward the top-heavy determination, some plans may be able to use profit sharing to shift the balance ratio below the 60% threshold. This can prevent top-heavy status for both the first and second plan years.
Plan sponsors with first-year plans that are projected to be top-heavy may choose to:
Use a profit-sharing allocation to avoid top-heavy contributions for both years (if reasonable and possible)
Remain top-heavy and make a top-heavy minimum contribution (if applicable)
This decision involves several tradeoffs:
Fixing top-heavy status with profit sharing is typically more expensive than providing a THMC for the first year, because profit sharing generally goes to all participants, while top-heavy minimums go to non-key participants only
You will not know the full THMC needed for both years until the end of the second year, since top-heavy minimums depend on non-key employee compensation and employer contributions received as of the end of each plan year
Top-heavy minimum contributions only go to non-key employees. You may want to consider the benefits of paying more for a contribution you can share in — one that also assures you will not owe a THMC for the following year
Gusto Retirement can help with this decision by providing guidance on minimum contributions necessary to avoid top-heavy status for first-year plans and whether profit sharing can prevent a top-heavy determination. The options for any plan depend on the plan's makeup, the profit-sharing formula, and the employer's goals.
Note: You cannot use profit sharing to retroactively fix a top-heavy plan after the first year.
As a plan sponsor, you have a few options for managing top-heavy status going forward.
If you expect to hire additional non-key employees in the second year of the plan, it may be worth making a profit-sharing contribution so you know a THMC will not be required for the next year.
The options for any plan depend on:
The number of key versus non-key employees
Their respective compensation amounts
The profit-sharing formula type (pro rata, flat-dollar, or other)
Your goals as an employer
401(k) plans with safe harbor provisions are exempt from certain compliance tests, like the Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests. If you do not make additional employer contributions beyond the safe harbor contributions, you do not need minimum corrections even if the plan is top-heavy.
Safe harbor matching provisions generally need to be added 30 days before the start of the year. To allow enough time to amend plan documents and give participants required notices (at least 30 days before the new year), start the process before Nov. 1 of the year before you want to add a safe harbor match.
Safe harbor nonelective contributions can be added up until the last day of the plan year following the plan year in which they take effect, as long as you make the contribution retroactively to the first day of the effective plan year.
You can add a safe harbor provision to your plan for the coming year by contacting Gusto Retirement support.
This information is general and for informational purposes only. It does not replace specific tax, legal, or financial advice that considers all relevant facts and circumstances. Consult a qualified financial adviser or tax professional before relying on this information.