In a tight labor market, employees may feel more confident about finding another job if they’re unhappy with the one they have. For plan sponsors, 401(k) plan participation eligibility requirements take on greater significance in this market. In general, employers can require a new hire to wait a year before being eligible to participate in a qualified retirement plan, in addition to requiring that the employee be 21 years old.

What are the costs of loose 401(k) plan eligibility requirements

Employers may debate whether it’s worth the trouble and expense of giving new employees the opportunity to enroll in the plan right off the bat. If there’s a fair chance the new hire will hop to another job sooner than the plan is legally required to let them join, why bother to jump through administrative hoops and incur financial costs?

Plus, of course, it’s not unusual to have to terminate an employee who, during an informal probationary period, doesn’t turn out to be a right fit for your organization. You could wind up having to pay for the administration of a very small account until this terminated employee tells you what to do with it.

How do larger 401(k) plan requirements differ from smaller plans?

Evidently, however, larger plans and smaller plans don’t see eye to eye on the matter.

Data from the Plan Sponsor Council of America’s (PSCA’s) 61st Annual Survey of Profit Sharing and 401(k) Plans indicates that 52% of plans with less than 50 participants impose a service requirement (typically one year) for new hires. In contrast, only 23% of plans with at least 5,000 participants impose such restrictions.

Along similar lines, setting a minimum age for plan participation is also more common among smaller plans. For example, 77% of the below-50 participant plans in the PSCA survey have age restrictions, vs. 49% of the large plans.

Age 21 is the most common minimum age requirement for plans that do set a minimum age. An employee who turns 21 late in the calendar year might wind up not joining the plan until age 22, if the next plan entry date isn’t until the next year.

Creating 401(k) service requirements

In addition to setting basic age and service requirements, sponsors can choose two ways to count employee service for participation eligibility purposes:

  1. Elapsed time. This is simpler and more common; the countdown begins on the employee’s date of employment.
  2. Counting hours. This method involves counting hours worked during an “eligibility computation period” that can’t exceed 12 months and cannot require more than 1,000 hours of service. It tends to weed out part-time employees from eligibility.

The arguments in favor of not restricting participation eligibility are similar to those for immediately vesting employer matching contributions. If you promote your 401(k) plan in recruitment efforts, stating that new hires can join the plan immediately could add another few points in your favor in the mind of employees you seek to recruit. Also, to the extent that you’re thinking about employees’ retirement readiness, the sooner they’re in a 401(k) plan and saving, the better shape they’ll be in down the road.

On the other hand, if your turnover rate is high (and not due to lacking an attractive 401(k) plan), imposing service restrictions could be the best option.

Making the decision

So which will it be? Consult with your benefits advisor. Only a careful analysis of your demographics and available plan choices will give you the level of assurance you’ll need to change your current plan’s eligibility requirements.

© 2019

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