The rules for qualified retirement plans are based on the Internal Revenue Code (IRC) and mirror provisions in the Employee Retirement Income Security Act (ERISA).
Many times employers, when providing employee census information to their service provider, omit employees they believe are not covered by the plan. The intentions are well meaning – why bother providing useless data to the service provider. All too often, however, this scrubbing of the census creates compliance problems. This is because the IRC imposes strict standards on who must be covered by a plan, and these standards are not based on the same terminology or concepts used by employers. The IRC does not use the term “part-time,” “seasonal,” “on call,” or other similar terminology. In fact, if you were to ask various employers how they define each of these terms, you would likely get different responses.The law sets forth a maximum service requirement that can be used for covering employees. This maximum is one “year of service” for eligibility for deferrals to a 401(k) plan, and can be up to two “years of service” for other contributions and/or plans, provided there is full vesting. While a plan can exclude various classes of employees, if there is an exclusion that is based on service, it cannot exceed these maximums. For example, a plan could exclude all left-handed employees as long as nondiscrimination tests are passed, but a plan cannot exclude all employees with less than three years of service even if the nondiscrimination tests can be passed. The same applies to a plan that excludes part-time employees if these part-time employees have completed the maximum service condition. An employer that excludes what it considers to be “part-time” employees can disqualify the entire plan if the employer’s definition of “part-time” is not the same as the year-of-service standard set forth in the law.
So what is a “year of service” under the IRC and ERISA? In simple terms, it's a twelve-month period of time during which an employee completes at least 1,000 hours of service. It's important to understand that this isn't based on whether an employer considers an individual to be a part-time, seasonal or temporary employee. It also does not depend on employment for the full twelve months. The twelve-month computation period starts on the employee's date of hire. After that, it usually switches to a plan year (for most plans, January 1 to December 31) computation period.
For example, suppose an employee is hired on a part-time basis March 15, 2012, and does not complete 1,000 hours of service by March 14, 2013. The employee quits March 30, 2013, but is rehired May 15, 2013 on a full-time basis. If the employee is credited with 1,000 hours during the period January 1, 2013 to December 31, 2013 then the employee will generally be credited with a year of service and would be eligible under the employer's 401(k) plan (unless the person is in an excluded class of employees). From an employer perspective, it may seem unusual to allow the employee to participate in the plan because the employee has not worked twelve months on a full-time basis. Unfortunately, omitting this person could result in the disqualification of the plan.
This is just a general overview of the rules, which are very complex and difficult for even seasoned practitioners to apply. Therefore, it is important for plan sponsors to provide a full employee census to their service providers to enable them to determine who is eligible for the plan.
# # #By Robert Richter, J.D., LL.M. and vice president of SunGard’s Relius, wealth & retirement administration solutions. Richter manages the consulting department for SunGard’s Relius retirement services recordkeeping solution, responsible for drafting and supporting qualified retirement plans, cafeteria plans and self-funded health plans. He is a frequent lecturer and author on topics related to cafeteria plans and qualified retirement plans, and served as the president of American Society of Pension Professionals & Actuaries (ASPPA) from 2011 to 2012.