Art by Joe CiardielloRetirement plans frequently exclude “temporary employees” from eligibility. But what is a temporary employee? The term isn’t clearly defined in the law, and plan sponsors do not all use it the same way. Some employers use it really to mean a leased employee or independent contractor. Others use it to denote an employee hired for a short period or for a specific project. How temporary employee is defined in a qualified retirement plan is significant for several reasons and determines which such workers might be eligible for the plan and when they can begin to participate. Here are some possibilities:
- Leased employee. If a plan sponsor really means leased employees when referring to temporary employees and intends to exclude them, that must be made clear in the plan document. Generally, a plan may exclude leased employees, but the plan sponsor may still need to count these temporary—i.e., leased—workers for purposes of the minimum coverage rules.
- Independent contractor. Sometimes, plan sponsors really mean independent contractors when they talk about temporary employees. Whether an employee is in fact an independent contractor is based on a facts-and-circumstances analysis and is an area often challenged by government agencies as well as individuals.
Most plans that exclude independent contractors include language providing that if the employee is misclassified and should have been considered a regular employee, he is deemed eligible for the plan only on a prospective basis.
- Employee hired for a short period or a specific project. If the plan sponsor uses a time- or project-based definition, this can raise issues under the Internal Revenue Code (IRC) rule regarding minimum age and service requirements to qualify for participation. Generally, under the minimum participation rule, a plan may not require an employee to complete more than one year of service—i.e., 1,000 hours of service or more in a plan year—before becoming eligible to participate in the plan. The Internal Revenue Service (IRS) interprets this as prohibiting exclusions that explicitly require more than a year of service, as well as those that have the effect of imposing a service requirement, for plan participation.
Consider a plan that excludes part-time employees. If a part-time employee is defined as an employee who works less than 1,000 hours of service, the plan does not violate the minimum participation rule because it excludes only employees who work up to that time. But if a part-time employee is defined as an employee scheduled to work less than 1,000 hours in a year, the exclusion violates the rule because the plan’s service requirement could exclude someone who actually completes more than 1,000 hours. To address this issue, plans that exclude part-time employees or employees scheduled to work less than a certain number of hours often provide an exception allowing for eligibility if the employee actually does complete 1,000 hours of service in a plan year.
But what does this mean? If someone is classified as a temporary employee when he is hired for less than three months, this is a service-based classification. If a plan excludes these temporary workers without providing an exception that permits eligibility for any who actually complete 1,000 hours of service, the plan has an impermissible service-based exclusion.
If an employee is classified as temporary because he is hired to work on a specific project, regardless of how long the project takes, the temporary employee exclusion is not service-based. In this case, temps may be excluded without violating the minimum participation rule. Note that coverage and nondiscrimination rules must still be considered.
So What Should Plan Sponsors Do?
Review their plan documents to see whether temporary employees are excluded and, if so, whether temporary employee is defined. Consider what you mean by this term. If the plan sponsor really means leased employees or independent contractors, make sure this is reflected in the plan document and that workers are being classified correctly. If the definition of a temporary employee is project-based, make sure the operations reflect this. If the criteria being used to determine temporary employee status is service-based—e.g., hired for a three-month period—the plan should include a safety net providing for eligibility if the employee actually completes a year of service.
Summer Conley is a partner in Drinker Biddle’s Los Angeles office where she assists clients in a variety of employee benefit areas, including qualified plan work, executive compensation, and health and welfare issues such as HIPAA, COBRA, Internal Revenue Code Section 125 and health care reform. Conley assists plan sponsors as well as advises plan service providers with respect to their Employee Retirement Income Security Act obligations.