(b)lines Ask the Experts – Differing ‘Year of Service’ Definitions for Different Plan Provisions

Our recordkeeper for our Employee Retirement Income Security Act (ERISA) 403(b) plan recently informed me that our plan document year of service definition is different for satisfying our one-year waiting period to receive employer contributions than it is for vesting purposes.
By PS

“Why are the definitions different? Would it not make more sense for the definitions to be the same, thus making the provisions easier to administer?” 

Stacey Bradford, David Levine and David Powell, with Groom Law Group, and Michael A. Webb, vice president, Retirement Plan Services, Cammack Retirement Group, answer: 

Good question, and good to see that you and your recordkeeper are staying on top of such an important provision as to what constitutes a year of service for initial eligibility and vesting. Though the rules regarding service crediting for eligibility and vesting are similar, it is indeed quite possible for a plan to credit service in one fashion for initial eligibility to participate and in a different fashion for vesting purposes. There could be any number of reasons for a plan using different requirements—the employer’s choice of eligibility and vesting service crediting rules ultimately depends on what the employer is trying to accomplish and what its administrative reporting abilities are. 

As you might recall, for an ERISA 403(b) plan with a vesting schedule, ERISA section 202(a) limits the maximum eligibility requirement to one year of service, which is a 12-month period during which the employee completes at least 1,000 hours of service. The initial 12-month period begins with the first hour of service, and thereafter may switch to the plan year. Alternatively, the eligibility requirement may be measured by a continuous period of employment (i.e., elapsed time), such as 12 months beginning with date of hire, or six months, etc. For vesting service, 403(b) plans must satisfy the provisions of Code Section 411. Similar to the ERISA 202(a) definition, a year of service for vesting purposes is defined in Code Section 411 as a 12-month period during which an employee must complete at least 1,000 hours of service. However, the measurement period can be ANY 12-month period, as long as it applies to all participants. For example, the measurement period may be the plan year, which is typical, but could instead be the 12-month period beginning with the participant’s date of hire (or first hour of service). Alternatively, an employer might choose to measure vesting service by years of employment under the elapsed time method.  

NEXT: Employer choices

An employer may choose to use the hours of service method for both eligibility and vesting, or elapsed time for both, or one method for eligibility and the other method for vesting. For example, an employer that does not track actual hours worked probably will not choose to credit a year of service based on 1,000 hours of service in a year. Instead, the plan could provide that a year of eligibility service and a year of vesting service are credited for each twelve month period of employment with the employer (i.e., each twelve-month anniversary of employment). An employer that does track hours might decide to have a more stringent rule for earning a year of vesting service by requiring at least 1,000 hours of service in a plan year to earn a year of vesting credit but use the same eligibility service requirement in the prior sentence. Or, the employer could make it harder to get into the plan with a 1,000 hours of service requirement, but reward employees who do by crediting vesting service based on years of employment. Then again, an employer could require at least 1,000 hours for both eligibility and vesting service if, for example, there is a high rate of employee turnover.   

Also, making the service crediting methods the same for eligibility and vesting purposes might not necessarily simplify administration. Both methods of crediting service (measuring periods (i.e., the elapsed time method) and the hours of service requirement) have complicated rules for crediting service during absences and when a terminated employee is rehired. While it may seem easier to count periods of employment for both eligibility and vesting purposes, the recordkeeper has to track multiple vesting dates in its system. Under the hours of service method, the only vesting date (besides special vesting dates like normal retirement age) is the last day of the plan year (e.g., December 31 for a calendar year plan). Simply put, both methods of crediting service have advantages and disadvantages. An employer should analyze its workforce and goals for its employees with respect to the plan, as well as the administrative reporting requirements for each method, and choose accordingly.

 

NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.  

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