(b)lines Ask the Expert – Eligibility Exemption Clarification

May 5, 2009 (PLANSPONSOR (b)lines) - In the last (b)lines Ask the Expert, it was stated that "if the 403(b) is an ERISA plan, the sponsor cannot simply rely on the IRS's exemption that an employee is exempt from eligibility if the sponsor expects that the employee will work less than 1000 hours in the year because ERISA requires the actual counting of hours. The employee must be included in the plan each year he or she actually works 1000 hours or more, and could fall in and out of eligibility."

This statement is, however, not entirely correct.  

In brief, the ERISA minimum participation rules generally provide that once an employee has performed a year of service (which generally requires 1000 hours of service) – two years if the plan provides for 100% vesting – and has attained age 21, the employee is entitled to participate, and will not drop out of eligibility until he or she has a break in service as defined in ERISA.  This does not necessarily mean that the employee must, in addition to being eligible to make salary reduction contributions if the plan provides for those, receive an employer nonelective contribution, since nonelective contributions are subject to other rules which can in certain circumstances impose an annual requirement that an employee completed 1000 hours each year or limit eligibility to certain classes of employees, for example. 

For 403(b) plans not subject to ERISA, the language in the Treasury regulation is less clear.  It essentially states that after the initial 12-month period, satisfaction of the “normally works fewer than 20 hours per week” rule is only satisfied if for “each” plan year or 12 month period under the plan the employee worked fewer than 1000 hours of service.  This could be read to either to mean that once eligible, the employee is always eligible, or that the employee is eligible just if the employee worked 1000 of hours or more in the preceding 12-month period or year.  IRS representatives have informally indicated that if an employee participating in the 403(b) plan changes jobs at an employer to one which performs less service, it may be possible to “re-start” the testing of the 20 hour rule.  Also, because the 403(b) regulations define hours of service by reference to the related provisions Code section 410, it is possible that the hour equivalency rules under that Code section apply by reference if actual hours are not counted.

In sum, however, the service rules under ERISA and how they coordinate with the service rules under the Code is an extremely complicated area, and not all aspects of it are clear.  The complexity and issues can be drafted around by providing broader eligibility for elective deferrals, for example, by allowing any employee to participate for salary reduction purposes without regard to hours, and many employers do so.  Employers seeking to use exclusions such as the 20 hour rule are strongly urged to consult with their tax advisor as to how they should be applied, especially if the plan is subject to ERISA.

David Powell, Groom Law Group, Chartered

NOTE: This feature is to provide general information only, does not constitute legal advice as part of an attorney-client relationship, and cannot be used or substituted for legal or tax advice.