Avoiding top-heavy retirement plans.

• Author: Waddles, Nicholas J.
• Position: RetirementPlans

Failing to timely file Form 5500, failing to advise clients about restrictions on types of distributions and adviser actions that cause a retirement plan to fail to operate within its terms are just a few reasons why those who provide services to retirement plans get sued.

But the leading reason of claims against plan service providers seems to be the "top-heavy" status of qualified retirement plans.

BECOMING TOP HEAVY

Generally, a tax-qualified retirement plan is top heavy when the benefits of certain company executives (called "key employees" in the Internal Revenue Code) account for more than 60 percent of the plan's assets.

Once this happens, the company sponsoring the plan must make a minimum contribution to the accounts of "non-key" employees equal to 3 percent of their pay.

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Claims are most often made against the administrative or actuarial firm that performed the top-heavy test. But these types of claims are not limited to those firms. Other advisers who have close relationships with the company also are targets. CPAs, who are often the frontline advisers to the company and act as liaisons between their clients and their retirement plan administration firms, need to be on the lookout for signs a retirement plan may be top-heavy--and know how to keep the balance.

CLAIM COMMONALITIES

While the circumstances of claims against professionals differ, there are commonalities to most claims. Generally, the claims are brought after the company has learned it has incurred a large top-heavy obligation. When the contribution is greater than anticipated (or when the company did not anticipate a contribution), the company looks for someone to share the blame and ease the cost of the 3 percent minimum payment.

The argument usually advanced by the company: Had it known the plan was going to be top heavy (or that the top-heavy obligation was going to be so great), it would have taken some action to avoid or reduce the liability.

The sponsor claims it either never would have adopted the plan, would have frozen the plan before it became top heavy or would not have permitted key employees to continue to defer income into the plan, thereby avoiding the top-heavy obligation.

Each of these arguments is subject to attack. First, it may be a stretch for the company to argue that it would not have sponsored a plan--particularly when its competitors offer retirement plans--to avoid the top-heavy contribution. Moreover, since businesses...