401(k) plan design: deciding who's eligible

In the early days of 401(k) plans, employees generally had to wait one year before being allowed to participate, but as usage has evolved, eligibility requirements have become more inclusive. There are several factors to consider when determining eligibility provisions:

Age requirement—Although an age requirement isn’t necessary, any plan that has one can’t exclude anyone older than 21.

Service requirement—Although not necessary, an employer may impose a minimum service requirement, which, generally for a 401(k) plan, can’t exceed one year of service. In plans that have both an age requirement and a service requirement, the employee must satisfy the later of the two conditions before becoming eligible.

Entry date—Employers must decide when employees can join the plan. They can make participation immediate on the date of hire, or they can delay it. If they choose a delayed entry date, it must be by the first day of the plan year after meeting any age and service requirements or, if earlier, six months following that same meeting of age and service requirements.

Contribution types—Different types of contributions can have different eligibility requirements. For example, elective deferrals may have immediate eligibility, while the company match requires one year of service.

Exclusions—A 401(k) plan may impose other conditions not related to age and service, especially helpful in the case of retirement plans for small business. One common exclusion is by job category, such as hourly versus salaried. Part-time or seasonal employees can’t be excluded as a category, although they would be excluded if their status causes them to fail to meet a minimum hours requirement during an eligibility computation period. The plan may exclude employees based on job location, job description, job title, employees under a collectively bargained agreement (union members), and some nonresident aliens.

Testing—Exclusions, however, may make it difficult to pass the ERISA Section 410(b) coverage test, as it takes into account employees who have satisfied the plan’s minimum age and service requirements but have been excluded for some other reason. Exclusions, and all other eligibility provisions, should be decided on with advice from a plan consultant or counsel.

The sooner employees can begin saving for retirement, the better off they should be at retirement. An employer can affect this greatly with eligibility rules, but the plan has to work for both the employee and the employer. Plan sponsors should work with their advisors and consultants—considering factors such as the benchmarks within the employer’s industry, company culture, overall benefits strategy, and the job market—to determine eligibility rules that are right for their plan.