Take a Fresh Look at Plan Eligibility and Vesting

Jan 31, 2017

Today most pension plans are gone, and employers must offer a defined contribution plan that is competitive in retaining and recruiting employees. If you’re a plan advisor, you can help your plan sponsor clients revisit their plan’s eligibility and vesting requirements to ensure their plan is competitive and driving their desired participant savings outcomes.

Eligibility Options

An employer can require that employees attain a certain age (up to 21) before they are eligible to participate in the plan. Employers are not allowed to set a maximum age requirement, such as requiring employees to be under age 55 to participate in the plan. Employers may also require a certain period of employment or “service” before employees are allowed to participate in the plan or receive employer contributions. An employer can also choose to exclude certain “classes” of employees from participating. For example, employees covered by a collective bargaining agreement and nonresident aliens with no U.S. source income may be excluded, as can leased employees and even highly compensated employees.

Vesting Options

Vesting in a retirement plan account in its simplest terms means “ownership.” An employee who is 100 percent vested owns all of his or her account and will receive the entire balance when taking distributions from the account. An employer can require that employees satisfy a minimum period of service before they become vested in certain types of contributions. Employee deferral contributions must always be 100 percent vested and are non-forfeitable. Employer matching or profit sharing contributions can be subject to a vesting schedule. The longest vesting schedules that an employer can adopt are the three-year cliff and the six-year graded vesting schedules. An employer also has the option to adopt a shorter, more generous vesting schedule.

Here are some tips for when you’re discussing eligibility and vesting with a plan sponsor:
  • An employer is not required to impose age or service requirements or a vesting schedule
  • If the employer’s objective is to recruit new employees or to help employees begin saving for retirement as soon as possible, immediate eligibility, at least for employee deferral contributions, and 100% vesting of employer contributions may be desirable
  • An employer can set different eligibility requirements for different types of contributions, sometimes referred to as dual eligibility (e.g., immediate eligibility for elective deferrals, one year for matching contributions)
  • By excluding employees who haven’t met the plan’s eligibility requirements, employers can reduce administrative costs and, perhaps more importantly to some employers, the amount of employer contributions
  • Excluding employees who generally work fewer hours and are no likely to participate in the plan can help some 401(k) plans pass required nondiscrimination testing and increase the amount that highly compensated employees can save
  • In other plans, however, including more employees produces more favorable test results
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