One of the most fundamental requirements in managing a qualified retirement plan is counting an employee’s length of service. It is the basis for determining such items as plan eligibility, entitlement to company contributions, vesting and even retirement itself. Although this seems like a straightforward task, the rules are quite complex and create traps for the unwary.
Methods of Counting Service
Before reviewing the reasons for counting service, it is important to understand the methods available for doing so. There are several and each has certain advantages and disadvantages depending on how a plan sponsor runs its business.
Elapsed Time Method
The elapsed time method credits an employee for a period of service if he is still employed at the end of that period. For example, if Herbert is hired on April 1, 2012, he receives credit for a year of service if still employed on March 31, 2013. Credit is given regardless of the number of hours Herbert works even if he terminates employment and is rehired prior to March 31, 2013.
One of the advantages of the elapsed time method is that it is not necessary to keep track of actual hours worked. One of the potential disadvantages is that employees who work only limited hours may still be credited with service they would not earn under one of the other methods, entitling them to the same level of benefits as a full-time employee. However, for plan sponsors who seek to benefit all employees equally, this could also be considered an advantage.
Actual Hours Method
The actual hours method considers the hours that each employee works and/or is entitled to payment, e.g. vacation, sick leave, jury duty, etc. An employee is required to complete a specified number of hours in a period to receive credit for that period. A common example is to require completion of 1,000 hours of service within a 12-month period in order to be credited with one year of service.
Unlike elapsed time, this method requires employers to keep and review records of the actual time each employee works. For hourly-paid employees, records are already available, so there would be minimal additional recordkeeping. For salaried employees, the actual hours method will likely impose added recordkeeping. One of the advantages of this method is that it requires all employees to work the same minimum hours of service to be entitled to the same level of benefit under the plan.
Equivalency Method
This method is a hybrid of the first two. It credits employees with a certain number of hours for each period they work as follows:
- 10 hours per day
- 45 hours per week
- 95 hours per semi-monthly pay period
- 190 hours per month
For a plan that uses the monthly equivalency, an employee who performs any service in a month is treated as working 190 hours during that month. If the plan credits a year of service as described above, i.e. 1,000 hours in a 12-month period, an employee would need to perform at least one hour of service in at least six out of the 12 months (6 months x 190 hours per month = 1,140 hours) to earn a year of service.
The equivalency method has the advantage of requiring continuous service while minimizing additional recordkeeping requirements; however, similar to the elapsed time method, it can still have the effect of crediting very limited time employees with the same benefits as full-time workers.
Reasons for Counting Service
Now that we have reviewed the methods, it is time to cover some of the reasons why properly counting service matters.Initial Plan Eligibility
Many plans require employees to satisfy certain age and/or service requirements to become eligible. If there is a service requirement, the plan must specify how to determine when an employee has satisfied it. In plans that use the elapsed time method for eligibility, measuring the service requirement can be straightforward. For example, if a plan requires employees to complete six months of service to be eligible, any employee who remains employed six months after his hire date has satisfied the service requirement as of that date. Similarly, if the plan requires completion of one year of service, employees satisfy the requirement if they are still employed a year after they are hired. There are some additional complexities for plans that require completion of a minimum number of hours as part of the service requirement. Keep in mind that the hours component may be reviewed based on either actual hours worked or an equivalency. Consider a plan with a requirement of one year of service, defined as completion of 1,000 hours in a 12-month period. With a few very limited exceptions, this is the maximum service requirement a plan can impose. One of the first items to identify is the 12-month period used to measure the hours worked. This is called the eligibility computation period. In this scenario, an employee’s first eligibility computation period always runs from initial date of hire to the first anniversary date. However, the plan must specify whether the second and all subsequent eligibility computation periods shift to the plan year or continue to follow employment anniversary dates. Let us return to our friend Herbert.| Shift to Plan Year | Anniversary Year | |
|---|---|---|
| Date of Hire: | 4/1/12 | 4/1/12 |
| 1st ECP*: | 4/1/12 – 3/31/13 | 4/1/12 – 3/31/13 |
| 2nd ECP*: | 1/1/13 – 12/31/13 | 4/1/13 – 3/31/14 |
| 3rd ECP*: | 1/1/14 – 12/31/14 | 4/1/14 – 3/31/15 |
| *Eligibility Computation Period | ||
Vesting
While not quite as complex as eligibility, counting service for vesting has a few noteworthy nuances. Similar to eligibility, the plan must specify which counting method (elapsed time, actual or equivalency) is to be used and define the measurement period (vesting computation period) as either the plan year or anniversary year. Unlike eligibility, however, the vesting computation period does not shift after the initial year. It is either always the plan year or always the anniversary year.
For plans defining the vesting computation period as the plan year and using the actual hours or equivalency methods, new employees effectively have fewer than 12 months to complete the required hours to earn a year of vesting service during the initial vesting computation period. When the vesting computation period is the anniversary year, plan sponsors should be aware of the same recordkeeping burden as described for eligibility. Namely, when using actual hours or equivalency, each employee will have a different tracking period based on his hire date.
There is another very key area in which eligibility and vesting are different when there is an hours-worked component involved. Let us again consider a plan that requires completion of 1,000 hours in a 12-month period to be credited with a year of service. For eligibility, both of these requirements must be met; an employee must complete both 1,000 hours of service and 12 months of employment before being credited with a year of service. An employee who works well over 1,000 hours but terminates employment after only 11 months does not receive credit.
For vesting, on the other hand, an employee is credited with a year of service as soon as he or she completes 1,000 hours of service during a vesting computation period regardless of the number of months worked. Therefore, it is not at all uncommon for an employee to have received credit for more years of service for vesting than for eligibility/participation. This is especially important to remember when determining vesting credit for an employee who terminates but may have already completed 1,000 hours prior to termination.
One other important difference is the years that must be counted for vesting. Although all service from date of hire must be recognized for eligibility, a plan can be written to ignore years prior to its effective date (or the effective date of any previous plans) and/or years prior to attainment of age 18 for vesting purposes.
Other Reasons to Count Service
There are several other provisions that may require counting service. Examples include
- Allocation requirements, such as completion of a year of service, to share in allocations of matching or profit sharing contributions for a year, and
- Definitions of normal retirement using both age and service such as later of attainment of age 65 or completion of five years of service.
Conclusion
While there is flexibility to count service using any of the methods described above, plan documents must specify the methods a plan elects to use. Therefore, it is advisable to review plan documents regularly to ensure proper understanding and to seek assistance from service providers to clarify any points of confusion.
This newsletter is intended to provide general information on matters of interest in the area of qualified retirement plans and is distributed with the understanding that the publisher and distributor are not rendering legal, tax or other professional advice. Readers should not act or rely on any information in this newsletter without first seeking the advice of an independent tax advisor such as an attorney or CPA.
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Spring will arrive soon, promising new growth and a fresh beginning. It could also be the perfect time to do some spring cleaning for your plan. Let’s look at some areas that you might consider reviewing to ensure your retirement plan is operating efficiently.
Document your processes and procedures to make certain that plan tasks can be handled in case of any absences during an enrollment or pay period. Having a backup in place can prevent errors and delays that could lead to penalties.
Make sure to have a process in place to notify all new enrollments of their eligibility, regardless of whether the plan has automatic enrollment. Depending on the timing for plan entry, including the plan enrollment paperwork with the new hire paperwork could make entry easier for you. Please reach out with any questions regarding when an employee enters the plan.
Deposits of employee deferrals and loan repayments must be submitted to the plan as soon as possible to avoid penalties and corrections. For plans with less than 100 participants, a safe harbor rule allows deposits to be made within seven business days. For larger plans, the expectation is that the money will be deposited more quickly. Depositing these funds on the pay date will avoid the possibility of being late.
Monitoring deferral contribution limits during the calendar year will avoid refunds after year end. Make sure that your payroll is set up to stop deferrals once the limit is reached, including any catch-up contributions for those who have reached age 50.
To keep the plan in compliance, employer contributions must be deposited timely. Due dates are impacted by the type of contributions, required status and tax deductibility. If you have questions on when to deposit your employer contribution or even whether to make an employer contribution, please contact us.
Most plans must be covered by a fidelity bond. The minimum coverage is 10% of plan assets (rounded up to the next $1,000) and the maximum coverage is $500,000. Additional requirements apply to plans with employer securities or non-publicly traded assets. If your fidelity bond is insufficient, now is the time to raise the coverage. Inflation clauses that increase the bond amount as the plan assets increase can ensure that your bond coverage is always adequate. Contact us or your insurance provider if you don’t have a fidelity bond.
Another area to review is communication with participants. Helping your employees understand and trust the plan can increase their contributions. Be sure that your procedures include distributing any plan-related communications—including required participant notices.
Distributions also involve communication, including some of the aforementioned notices. Discussing distribution options with terminated participants, possibly as part of an exit interview, can help to reduce risk of lost participants. We’ll provide instruction on distributions for force-out distributions for small balances, testing corrections and required minimum distributions.
Your plan document is the legal source on how the plan should be administered; operating within its parameters is critical. It’s always worth taking time to review the plan document to ensure that you fully understand and are following its provisions. We’ll cover more details about the plan document later in this newsletter. We’re here to support you in keeping your plan in compliance. Please feel free to reach out with any questions.
Addressing the Challenge of Uncashed Distribution Checks
Uncashed distribution checks present a persistent and often overlooked challenge for retirement plan sponsors. Despite the best efforts of plan administrators, some participants fail to cash their distribution checks, leading to administrative burdens, fiduciary concerns and potential compliance issues. A recent publication by Retirement Management Services (RMS) sheds light on this issue and offers practical guidance for employers seeking to manage and mitigate the risks associated with uncashed checks.
Uncashed checks can arise for various reasons. Participants may have moved without updating their contact information, may not recognize the check as legitimate or may simply forget to deposit it. Regardless of the cause, the responsibility for addressing these uncashed funds ultimately falls on the plan sponsor. This creates a fiduciary obligation to act in the best interest of the participant while ensuring compliance with IRS and Department of Labor (DOL) regulations.
Sponsors are encouraged to maintain up-to-date contact information for all plan participants and to follow up promptly when checks remain uncashed. This may involve sending reminder letters, making phone calls or using certified mail to confirm receipt. In some cases, plan sponsors may also consider using electronic payment methods to reduce the likelihood of checks going uncashed in the first place.
The IRS and DOL have issued guidance on how to handle these situations, including the use of forfeiture accounts and escheatment to state unclaimed property programs. However, these options come with their own set of rules and potential pitfalls. For example, using a forfeiture account may require the plan document to explicitly allow for such treatment. Escheatment laws, which allow the government to assume control of unclaimed property, vary by state. As such, plan sponsors must carefully evaluate their options and consult with legal or compliance experts as needed.
Another important consideration is the documentation of all the efforts made to contact participants and resolve uncashed checks. Maintaining a clear audit trail can help demonstrate fiduciary prudence and protect the plan sponsor in the event of an audit or legal challenge. It is extremely important to have a written policy in place that outlines the steps to be taken when a check remains uncashed beyond a certain period.
By taking a proactive, well-documented and compliant approach, employers can fulfill their fiduciary duties, reduce administrative burdens and ensure that participants receive the benefits they are entitled to.
Source: Retirement Management Services – “Uncashed Distribution Checks” https://www.consultrms.com/Resources/59/Plan-Sponsor-Tips-and-Help/212/Uncashed-Distribution-Checks
Divorce and the Retirement Plan
When a participant in a qualified retirement plan undergoes a divorce, the participant’s account balance may be an asset that is split with the former spouse. As the plan exists for the exclusive benefit of its participants, a court order is required to transfer the participant’s benefits to the ex-spouse. Once approved by the plan administrator, this court order is called a Qualified Domestic Relations Order (QDRO).
The QDRO is a judgment, decree or order that must be issued by a state authority (usually a court). It can be part of the divorce settlement or it may be a separate document. Because of the serious nature of separating the participant’s account balance, the QDRO is more than just an agreement made by both parties — it must also be signed by a judge.
A QDRO will describe how to divide the participant’s account balance between the participant and the ex-spouse, referred to as the alternate payee. In some cases, a set dollar amount will be allocated; in others, a percentage of the account may be designated. In the latter case, the amount assigned to the alternate payee represents the given percentage of the participant’s total vested account balance as of a specified valuation date. This percentage will apply to all sources — such as deferrals, matching or profit sharing — unless specified by the QDRO. Any interest and investment gains/losses that accrue between this valuation date and the date the funds are separated into an account for the alternate payee are often factored into this final calculation. If the participant has outstanding loans, the QDRO will usually indicate how the loans are handled.
Contributions such as deferrals and employer matching made after the valuation date are credited to the participant’s account. Earnings and losses are applied to the account balances. Once the division is complete, the alternate payee’s portion (either dollars or shares) is transferred to an account in the alternate payee’s name.
If the plan allows, the alternate payee may be paid out in a cash or rollover distribution. Not all plan documents allow the alternate payee to receive a distribution before reaching normal retirement age, so it’s important to follow the terms of the plan. In addition, the QDRO cannot violate the provisions of the plan document by requiring a plan to provide an alternate payee or participant with any type or form of benefit not otherwise provided under the plan.
Although the most common situation for a QDRO is a divorce, it can be issued in other situations, such as to a dependent in the case of child support. If the alternate payee is a minor child or legally incompetent, the order can also require payment to the individual with legal responsibility for the alternate payee. If a participant or their attorney provides you with a copy of a divorce decree that references the plan or a QDRO, please contact us immediately, and we will work with you to ensure it meets the requirements of the plan.
Important note for defined benefit plans: For 2025 plan years, PBGC premiums are due one month earlier than usual, specifically on the 15th day of the ninth month after the beginning of the plan year. For calendar year plans, this means the premium is due on September 15, 2025, instead of the usual October 15. This accelerated deadline is due to a provision in the Bipartisan Budget Act of 2015.
Upcoming Compliance Deadlines for Calendar-Year Plans
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