1 How do you define 401(k) plan eligibility and vesting?

Your plan’s eligibility provisions determine when and under what circumstances a new employee can become a plan participant.

The vesting provisions affect people already in the plan. Assuming you contribute to your employees’ accounts, the vesting schedule determines when this money will belong to participants and be available for them to take a withdrawal or loan.

2 Why are eligibility and vesting so important to plan professionals?

Eligibility and vesting have an impact on how effectively your 401(k) plan works as a recruiting and retention tool and what effect it has on your benefits budget. Immediate eligibility and vesting can be powerful incentives for potential employees to join your organization. And by setting your vesting requirements strategically, you can help successful performers feel appreciated and secure.

You also need to understand eligibility and vesting because, as a retirement plan fiduciary, you’re required to stick to the rules.

3 What are the ERISA compliance guidelines for setting 401(k) eligibility?

Under ERISA, a plan sponsor can exclude employees from eligibility until they reach age 21, complete a year of service, or both.

You can choose from several eligibility schedules, and your plan can include different eligibility periods for full- and part-time employees. Examples of eligibility schedules include:

• Immediate eligibility (no service requirement)
• 1 month or 30 days of service
• 60 days of service
• 3 months of service
• 6 months of service
• 1 year of service

ERISA requires semiannual entry dates to help ensure that plans with full-year service requirements enroll employees in a timely manner. The objective is to avoid having any otherwise eligible employee wait longer than 18 months to enroll.

4 Which eligibility service requirements are employers using?

The good news for prospective employees is that the majority of plan sponsors offer immediate or near-term eligibility. In fact, 40.5% of plan sponsors make their 401(k) plan available on day one and 25% make employees eligible within three months.¹

Plan eligibility among plans of all sizes¹

5 Once the service requirement has been met, when can employees enter the plan?

There are two ways you can determine the enrollment date:

• With a static date approach, employees can only enter the plan at some preset interval, such as monthly, quarterly, or semiannually.
• With a rolling date approach, employees can enroll immediately after reaching their required service date or anytime afterward.

6 Can a plan sponsor set varying eligibility requirements for different types of contributions?

Yes. While employees can usually begin contributing money from their paycheck as soon as they enroll in the plan, you can set separate service requirements for employee, employer matching, and profit-sharing contributions.

The required service period for profit-sharing contributions can be as long as two years—but any benefits awarded after that date must be 100% vested when received by the participant.

7 Can some classes of employees be excluded from a 401(k) plan?

Yes. Employee classes that can be excluded under ERISA include:

• Independent contractors
• Leased employees
• Union employees (unless the bargaining agreement permits inclusion)
• Interns
• Seasonal employees
• Temporary employees
• Nonresident aliens

You should tread carefully when considering excluding employees based on hours scheduled to work: Employees who log at least 1,000 hours over a 12-month period—which is a little over 19 hours a week—must be considered eligible.

After all exclusions are factored in, every 401(k) plan is still required to pass coverage tests under Section 410(b) of the Internal Revenue Code.

8 How does eligibility work for employees who move into an eligible class—or who leave the organization, then return?

Each of these situations has its own corresponding rule:

• When employees move from an ineligible class to an eligible one, all their previous work time goes toward meeting the plan’s service requirement.
• Plan participants who leave your organization and later return must be made immediately eligible.
• If employees leave before becoming eligible and subsequently return, their prior service time must generally be applied toward future eligibility.

Given the complexity of these rules, keeping track of employment histories and eligibility statuses is essential. Your third-party administrator or recordkeeper can be an invaluable resource in this process.

9 Do vesting rules apply to a participant’s entire 401(k) account?

No, just part of it. Your vesting provisions determine only how and when participants gain ownership in the contributions that you make to their retirement accounts. The money participants contribute, and any growth on those contributions, belongs 100% to them, from day one.

10 Which types of vesting schedules are available—and are there limits on how long they can last?

There are two types of vesting schedules, and each sets a limit on how long it takes for participants to become fully vested in their employer contributions.

• With cliff vesting, participants flip from 0% vested to 100% vested when the service requirement period is reached. Three years is the maximum cliff vesting period.
• With graded vesting, the percentage of vested assets increases incrementally over time. A graded schedule must provide for at least 20% vesting within two years and full vesting within six.

11 How are plan sponsors handling vesting today?

Nearly 47% of plans use a graded vesting schedule for matching contributions, while roughly 29% use cliff vesting.¹

Types of vesting schedules used for employer matching contributions¹

As with eligibility provisions, immediate vesting is the most common vesting period for employer matching contributions. More than 15% of plans, however, have a vesting schedule that lasts more than five years.¹

Vesting periods for employer matching contributions¹

12 What happens to nonvested employer contributions when participants leave an organization? 

The money must be moved into the plan’s forfeiture or suspense account, where it can be used to:

• Cover other employer contributions already payable by the plan
• Restore the accounts of rehired employees, subject to certain criteria
• Pay ERISA-approved plan expenses
• Make additional employer contributions for existing plan participants

No matter which option you use, any forfeited contributions have to be used for an appropriate purpose by the end of the plan year.

13 How is service time calculated?

Both 401(k) plan eligibility and the vesting of employer contributions depend on reaching service milestones. ERISA provides two ways to calculate a required year of service.

• The first is elapsed time, or the actual number of days the employee has been on the job starting from the official date of hire.
• The second is the 1,000-hours-of-service-per-year standard. This measure, which is ERISA’s minimum service threshold for 401(k) plan eligibility, calls for counting actual hours worked. It’s worth noting that an employee’s first calculation comes after the first 12 months of service—and generally reverts to a plan year count for the rest of that worker’s tenure.

14 Does your plan design work for your employees and your organization?

It can be a challenge to determine the right mix of eligibility and vesting requirements for your retirement plan. Consulting with your plan professionals and recordkeeper can make the process easier. They can help you model and benchmark different scenarios to design eligibility and vesting in a way that meets your staffing and budget needs—and keeps your 401(k) plan reliably compliant.