Vesting Service in Governmental Plan

[EBECatty]

May a governmental defined contribution plan exclude from vesting service time in which the employee was ineligible to participate in the plan?

More specifically, an employee is in a category of employees excluded from the plan, works for a year or two, then is transferred to an eligible class. May the plan count only the employee's service for vesting purposes from the date he or she became eligible to participate?

Thanks in advance. 

[Peter Gulia]

If a governmental plan seeks to tax-qualify under Internal Revenue Code § 401(a), one considers nondiscrimination and vesting standards as in effect before September 2, 1974.

To get into the details, use Carol V. Calhoun, Cynthia L. Moore & Keith Brainard, Governmental Plans Answer Book (Wolters Kluwer 5th ed., updated December 19, 2023), https://law-store.wolterskluwer.com/s/product/governmental-plans-answer-book-pension3-mo-subvitallaw-3r/01t0f00000J4aDTAAZ.

Whether service may, must, or must not be counted turns on State law and, if permitted regarding a local government employer’s plan, further local law.

Consider that a governmental plan often is not expressed in one fully integrated writing that looks like what pension practitioners call a plan document. Rather, a plan might be stated by some combination of a legislature’s statutes, executive agencies’ (including a retirement system’s) rules and subrule guidance documents, and courts’ interpretations of those law sources.

[EBECatty]

Thanks Peter. A little more context may help.

The plan is a matching and non-elective DC plan qualified under 401(a). The plan is for a state agency, so has adopted a single plan document containing (with amendments) all the plan's terms. There is no relevant state or local law, and there is no guidance internal to the agency. 

The issue revolves around a small number of seasonal employees who often return from year to year and are occasionally hired into full-time roles. This category of employees is excluded from eligibility under the terms of the plan, regardless of amount of service. The plan uses elapsed time to measure vesting credit and largely incorporates the 410(a) elapsed time rules, including its service-spanning rules.

Because 410(a) does not apply to the plan (and assuming the pre-ERISA rules you note above are satisfied in any event), the question has arisen whether it's permissible to exclude, for vesting purposes, time spent in the ineligible seasonal category and only grant vesting service credit for time spent in an eligible category. 

[Peter Gulia]

Is your task:

Interpreting what the plan now provides?

or

Evaluating whether it's feasible, and would be effective, to amend the plan?

[EBECatty]

The latter.

[Peter Gulia]

Beyond considering whatever is the before-1974 Federal tax law about vesting:

You’ll want to consider whether: (1) the Contracts Clause of the US Constitution [U.S. Const. art. I, § 10], (2) a similar clause of the State’s constitution, or (3) the State constitution’s provision about retirement-plan rights (if any) precludes the change.

States’ courts differ widely in how they interpret constitutional provisions of these kinds.

That includes differences about when a right against change attaches. Under some provisions and interpretations, a right against change attaches as soon as the employee first became eligible for the retirement plan.

The analysis turns on the exact texts of the constitutional provisions and the interpretations the State’s courts have found or would find.

[EBECatty]

Peter, thanks, and I did consider those sources as well. Appreciate your input. 

[Luke Bailey]

EBECatty, I agree completely with Peter's comments. I would also point out that the Mark O'Donnell IRS memorandum giving guidance to DL request reviewers for governmental plans (which is, of course, only soft guidance), set forth (somewhat arbitrarily) certain safe harbor vesting schedules for governmental plans, and therefore had to, at least obliquely, address what years of service needed to be counted. Although not the subject of the memo, the formulation chosen implies that pre-eligibility service would not need to be counted for purposes of compliance with the Internal Revenue Code's requirement that a governmental qualified retirement plan satisfy the pre-ERISA vesting rules. For example: "(service can be based on years of employment, years of participation, or other creditable years of service)." The full memo can be found here: https://www.irs.gov/pub/irs-tege/directive_vesting_043012.pdf. Of course, the plan document or state law could differ, as Peter points out, and it might or might not be possible under state law to impose a change on employees hired before the date of the change.

 

[EBECatty]

Luke, excellent point. Thanks for flagging.