Crediting Prior Service Under New 401(k) Plan

[401 Chaos]

When an existing company establishes a 401(k) plan, does it have to count service for eligiblity purposes for periods prior to the effective date of the plan for those individuals not actively employed with the company on the effective date of the plan but rehired at a later time?

Facts are as follows:

Company has been in existence awhile. It sets up a 401(k) Plan effective January 1, 2010. Plan includes basic 1 Year of Service requirement for eligibility. Plan SPD provides that "in determining whether an indiviudal satisfies the minimum service requirements to participate in the Plan, all service the individual performs for the Employer will generally be counted."

On January 1, 2010 there are a number of regular employees that have been employed with company continuously for a long time. They all have a Year of Service based on their prior service and begin participating in the Plan immediately. The company also has some seasonal summer employees--some of whom come back and work multiple summers. During the summer, the seasonal employees may work 1,000 hours or more and so would earn a Year of Service for participation purposes. My question is when do these seasonal employees enter the Plan.

In particular, if the company had a seasonal employee that worked the summer of 2009 and earned 1,000 hours that summer--does that employee have to be permitted to participate in the Plan June 1, 2010 (upon return for 2010 seasonal work) or does that individual have to earn 1,000 hours in the 2010 summer season (i.e., the first period following adoption of the plan) before getting into the plan?

No dispute that the seasonal employee would be entitled to participate June 2011 if he returns in 2011 after working 1,000 hours in summer 2010. Just not sure if they get in right away based on service earned prior to the time the plan went into effect when they were not a current employee on the effective date. (Note, I have also seen plenty of guidance that indicates prior service must be counted for active employees in place on the effective date as well as plenty of guidance regarding the need to track prior service for rehires that previously worked during periods when the plan was in place but this is a different question.)

The plan document does not seem as clear as it might be on this point because it speaks in terms of employment commencement dates and tracks eligibility based on computation periods starting on the employee's employment commencement date. The Year of Service definition in the Plan notes that "the initial computation period shall begin with the date on which the Employee first performs an Hour of Service (employment commencement date)." The seasonal folks arguably have multiple employee commencement dates though (i.e., they come and go each year) so question would be which commencement date counts and does first hour of service mean first hour of service once the plan has been adopted. In particular, do we look at the first commencement date beginning after the effective date if the individual was not actively employed on the plan's effective date?

[401 Chaos]

Just FYI in case anybody has new or different thoughts, based on our research we have concluded that service prior to the effective date of the plan must be counted even for rehires that were not actively employed on the effective date.

We looked at trying to stretch the plan provisions to mean the "first hour of service" or employment commencement date starting after the effective date for those not actively employed upon start up of the plan. Obviously that flies a bit in the face of allowing those that were employed on the effective date to get in immediately based on their prior service but we were wondering if that could be distinguished since the applicable employment commencement date there necessarily was the one linking back to their service on the effective date. In Chapter 2, Section III, Part C of Sal's ERISA Outline book, he noties that "All service with the employer must be credited, even service before the plan is established, unless disregarded under the break in service rules (discussed in Section V of this chapter). See IRC 410(a)(5)(A) / ERISA 202(b)(1)."

That seems pretty clear but we then considered his example 1 under that section indicating that service may be completed as of the plan's effective date noting "When an employer first establishes a plan, a current employee may already have completed the minimum service requirement" and whether there was meant to be any magic to being a current employee or if that was just part of the facts of the example. We also considered in 410(a)(5)(A) where it says ". . . all years of service with the employer or employers maintaining the plan shall be taken into account in computing the period of service for paragraph (1)" to see if there was any way to interpret that to mean you only had to count service with the company if the company was maintaining the plan during your employment computation period. Again, that sort of flies in the face of immediate eligibility for current employees but we wondered if you could distinguish that situation since service there would necessarily include some point while the plan was in place while looking back to prior service as compared to simply looking or using some computation period ending well before the plan was established.

Ultimately, we did not find any support for any of those thoughts and it seems the better argument is to view all prior service with the plan sponsor (and any predecessors or affiliates) as counting toward service. There was apparently some thought by some of our colleagues that the rules might actually permit you to draft a plan that would require all participants to accrue a Year of Service after the effective date and not give any credit to anybody for prior service but that obviously is not what is usually desired and in any event is not the way the volume submitter plan in our case works.

Interestingly, several experienced benefit people here and at volume submitter provider when asked this question initially said they were unsure but thought you would not have to count the prior service for those re-hired after the effective date. With the help of the volume submitter's Compliance Department, however, we think we've arrived at a different but correct answer, at least for most volume submitter plans. The fact that many volume submitters and prototypes also permit elections not to have the break-in-service rules apply means this is likely even more of a compliance issue. Wonder how many employers out there never go back to consider prior service for eligiblity purposes with re-hires--particularly those that have some significant gap since their last employment?

[Jim Chad]

FWIW This my understanding from everything I have ever heard or read from the DOL. In the late 90's, this question came up in a big way with one of my plans. I have asked many people form the DOL since as well as watched for anything related to this question. If I get an answer it is always the same answer.

[Guest Sieve]

Your analysis is correct, especially when you consider that, for vesting purposes, years before the establishment of the plan can be excluded. Comparable exclusionary language is not in the eligibility provisions. And, the general rules for inclusion of years of service specifically mention the limited exceptions (in IRC Sections 410(a)(5)(A) & 411(a)(4)).

[401 Chaos]

Jim and Sieve,

Many thanks. Glad to have confirmation that we do not appear to have missed any argument for being able to exclude.

401 Chaos

[thepensionmaven]

How is this different from "dual eligibility" which is quite common under 401(k) plans as well as profit sharing plans?

The so-called "dual eligibility"seems to be used quite a bit.