exclusion for those working less than 20 hours/week

[Santo Gold]

We have a larger employer who has well over 500 employees and who sponsors a 403(b) Plan. However, about 80% of those employees have less than 1000 hours. Since 1000 hours is roughly the difference between being over/under 20 hours/week, is it safe to say that the employer could simply exclude all of these individuals from the plan, even the employee 403(b) contribution?

I assume that when these individuals are hired, a determination has to be made (and applied consistently) as to whether the individual will be over/under 20 hours/week in order to determine if they are in the plan. Is this how it is handled?

Thanks

[Guest Matthew Gouaux]

It might be permissible to exclude most of these employees, but I wouldn't say it's safe. Take a close look at Treas. Reg. 1.403(b)-5 and perform the necessary tests before making a decision.

With respect to employer contributions, the exclusion rules are the same in 403(b) and 401(k) plans. For example, the plan can exclude certain classes of employees if the exclusion is reasonable and nondiscriminatory, and can require employees to complete a year of service to be eligible for employer contributions.

Section 1.403(b)-5 states (in part):

(a) Nondiscrimination rules for contributions other than section 403(b) elective deferrals—(1) General rule. Under section 403(b)(12)(A)(i), employer contributions and after-tax employee contributions to a section 403(b) plan must satisfy all of the following requirements (the nondiscrimination requirements) in the same manner as a qualified plan under section 401(a):

(i) Section 401(a)(4) (relating to nondiscrimination in contributions and benefits), taking section 401(a)(5) into account.

(ii) Section 401(a)(17) (limiting the amount of compensation that can be taken into account).

(iii) Section 401(m) (relating to matching and after-tax employee contributions).

(iv) Section 410(b) (relating to minimum coverage).

With respect to elective deferrals, if the plan allows anyone to defer, it must allow everyone to defer (unless an exception applies). Be careful about excluding employees who work anywhere near 1000 hours per year from elective deferrals. Such an exclusion can be difficult to administer, particularly in a larger plan. Also, given that elective deferrals are funded by employees, the cost of administering the exclusion may outweigh its benefits.

Section 1.403(b)-5 states (in part):

(4) Exclusions—(i) Exclusions for special types of employees. A plan does not fail to satisfy the universal availability requirement of this paragraph (b) merely because it excludes one or more of the types of employees listed in paragraph (b)(4)(ii) of this section. However, the exclusion of any employee listed in paragraph (b)(4)(ii)(D) or (E) of this section is subject to the conditions applicable under section 410(b)(4). Thus, if any employee listed in paragraph (b)(4)(ii)(D) of this section has the right to have section 403(b) elective deferrals made on his or her behalf, then no employee listed in that paragraph (b)(4)(ii)(D) of this section may be excluded under this paragraph (b)(4) and, if any employee listed in paragraph (b)(4)(ii)(E) of this section has the right to have section 403(b) elective deferrals made on his or her behalf, then no employee listed in that paragraph (b)(4)(ii)(E) of this section may be excluded under this paragraph (b)(4).

(ii) List of special types of excludible employees. * * * * (E) Subject to the conditions applicable under section 410(b)(4), employees who normally work fewer than 20 hours per week (or such lower number of hours per week as may be set forth in the plan).

(iii) Special rules. * * * * (B) For purposes of paragraph (b)(4)(ii)(E) of this section, an employee normally works fewer than 20 hours per week if and only if—

(1) For the 12-month period beginning on the date the employee’s employment commenced, the employer reasonably expects the employee to work fewer than 1,000 hours of service (as defined in section 410(a)(3)©) in such period; and

(2) For each plan year ending after the close of the 12-month period beginning on the date the employee’s employment commenced (or, if the plan so provides, each subsequent 12-month period), the employee worked fewer than 1,000 hours of service in the preceding 12-month period. (See, however, section 202(a)(1) of the Employee Retirement Income Security Act of 1974 (ERISA) (88 Stat. 829) Public Law 93-406, and regulations under section 410(a) of the Internal Revenue Code applicable with respect to plans that are subject to Title I of ERISA.)

[Kevin C]

If this is an ERISA covered plan, I would forget about using the <20 hour per week exclusion. The ERISA minimum participation rules will eventually force you to allow a person to defer who fits in the <20 hour per week category. The usual example is someone who previously worked 1,000 hours and drops below 1,000 hours in later years. The IRS regs will have you exclude them for the year after the first year they work less than 1,000 hours, but ERISA says they must be eligble to defer. At that point, the all or nothing rule in (4)(i) of the second cite above kicks in and you can't use the <20 hour per week exclusion.

Even if it isn't an ERISA covered plan, I would advise against using it. We have an on-going IRS audit where the agent is insisting the all or nothing rule applies if a single <20 hours per week person is allowed to defer by mistake. The agent wants them to retroactively include about 200 people and correct their "improper exclusion" under EPCRS.

There are some older threads discussing the <20 hour per week exclusion.